The use of digital currencies to, among other things, buy and sell goods and services and complete transactions, is part of a new and rapidly evolving industry that employs digital currency assets based upon a computer-generated mathematical and/or cryptographic protocol. Large-scale acceptance of digital currencies as a means of payment has not, and may never, occur. The growth of this industry in general, and the use of digital currencies in particular, is subject to a high degree of uncertainty, and the slowing or stopping of the development or acceptance of developing protocols may occur unpredictably. The factors include, but are not limited to:
The outcome of these factors could have negative effects on our ability to continue as a going concern or to pursue our business strategy at all, which could have a material adverse effect on our business, prospects or operations as well as potentially negative effect on the value of any bitcoin or other digital currencies we mine or otherwise acquire or hold for our own account, which would harm investors in our securities.
Banks and financial institutions may not provide banking services, or may cut off services, to businesses that provide digital currency-related services or that accept digital currencies as payment, including financial institutions of investors in our securities.
A number of companies that provide bitcoin and/or other digital currency-related services have been unable to find banks or financial institutions that are willing to provide them with bank accounts and other services. Similarly, a number of companies and individuals or businesses associated with digital currencies may have had and may continue to have their existing bank accounts closed or services discontinued with financial institutions in response to government action, particularly in China, where regulatory response to digital currencies has been particularly harsh. We also may be unable to obtain or maintain these services for our business. The difficulty that many businesses that provide bitcoin and/or derivatives on other digital currency-related services have and may continue to have in finding banks and financial institutions willing to provide them services may be decreasing the usefulness of digital currencies as a payment system and harming public perception of digital currencies, and could decrease their usefulness and harm their public perception in the future.
The usefulness of digital currencies as a payment system and the public perception of digital currencies could be damaged if banks or financial institutions were to close the accounts of businesses providing bitcoin and/or other digital currency-related services. This could occur as a result of compliance risk, cost, government regulation or public pressure. The risk applies to securities firms, clearance and settlement firms, national stock and derivatives on commodities exchanges, the over-the-counter market, and the Depository Trust Company, which, if any of such entities adopts or implements similar policies, rules or regulations, could negatively affect our relationships with financial institutions and impede our ability to convert digital currencies to fiat currencies. Such factors could have a material adverse effect on our ability to continue as a going concern or to pursue our new strategy at all, which could have a material adverse effect on our business, prospects or operations and harm investors.
We may face risks of Internet disruptions, which could have an adverse effect on the price of digital currencies.
A disruption of the Internet may affect the use of digital currencies and subsequently the value of our securities. Generally, digital currencies are dependent upon the Internet. A significant disruption in Internet connectivity could disrupt a currency's network operations until the disruption is resolved and have an adverse effect on the price of digital currencies.
The impact of geopolitical events on the supply and demand for digital currencies is uncertain.
Geopolitical crises may motivate large-scale purchases of bitcoin and other digital currencies, which could increase the price of bitcoin and other digital currencies rapidly. This may increase the likelihood of a subsequent price decrease as crisis-driven purchasing behavior dissipates, adversely affecting the value of our inventory following such downward adjustment. Such risks are similar to the risks of purchasing commodities in general uncertain times, such as the risk of purchasing, holding or selling gold.
As an alternative to fiat currencies that are backed by central governments, digital currencies, which are relatively new, are subject to supply and demand forces. How such supply and demand will be impacted by geopolitical events is largely uncertain but could be harmful to us and investors in our common stock. Political or economic crises may motivate large-scale acquisitions or sales of digital currencies either globally or locally. Such events could have a material adverse effect on our ability to continue as a going concern or to pursue our new strategy at all, which could have a material adverse effect on our business, prospects or operations and potentially the value of any bitcoin or any other digital currencies we mine or otherwise acquire or hold for our own account.
Acceptance and/or widespread use of digital currency is uncertain.
Currently, there is a relatively limited use of any digital currency in the retail and commercial marketplace, thus contributing to price volatility that could adversely affect an investment in our securities. Banks and other established financial institutions may refuse to process funds for digital currency transactions, process wire transfers to or from digital currency exchanges, digital currency-related companies or service providers, or maintain accounts for persons or entities transacting in digital currency. Conversely, a significant portion of digital currency demand is generated by investors seeking a long-term store of value or speculators seeking to profit from the short- or long-term holding of the asset. Price volatility undermines any digital currency's role as a medium of exchange, as retailers are much less likely to accept it as a form of payment. Market capitalization for a digital currency as a medium of exchange and payment method may always be low.
The relative lack of acceptance of digital currencies in the retail and commercial marketplace, or a reduction of such use, limits the ability of end users to use them to pay for goods and services. Such lack of acceptance or decline in acceptances could have a material adverse effect on our ability to continue as a going concern or to pursue our new strategy at all, which could have a material adverse effect on our business, prospects or operations and potentially the value of bitcoin or any other digital currencies we mine or otherwise acquire or hold for our own account.
Transactional fees may decrease demand for bitcoin and prevent expansion.
As the number of bitcoins currency rewards awarded for solving a block in a blockchain decreases, the incentive for miners to continue to contribute to the bitcoin network may transition from a set reward to transaction fees.
In order to incentivize miners to continue to contribute to the bitcoin network, the bitcoin network may either formally or informally transition from a set reward to transaction fees earned upon solving a block. This transition could be accomplished by miners independently electing to record in the blocks they solve only those transactions that include payment of a transaction fee. If transaction fees paid for bitcoin transactions become too high, the marketplace may be reluctant to accept bitcoin as a means of payment and existing users may be motivated to switch from bitcoin to another digital currency or to fiat currency. Either the requirement from miners of higher transaction fees in exchange for recording transactions in a blockchain or a software upgrade that automatically charges fees for all transactions may decrease demand for bitcoin and prevent the expansion of the bitcoin network to retail merchants and commercial businesses, resulting in a reduction in the price of bitcoin that could adversely impact an investment in our securities. Decreased use and demand for bitcoin may adversely affect its value and result in a reduction in the price of bitcoin and the value of our common stock.
Lack of clarity in the corporate governance of many digital currency systems may lead to ineffective decision making that slows development or prevents a network from overcoming emergent obstacles. Governance of many digital currency systems is by voluntary consensus and open competition with no clear leadership structure or authority. To the extent lack of clarity in corporate governance of digital currency systems leads to ineffective decision making that slows development and growth of such digital currencies,, the value of our common stock may be adversely affected.
It may be illegal now, or in the future, to acquire, own, hold, sell or use bitcoin, ether, or other digital currencies, participate in blockchains or utilize similar digital currency assets in one or more countries, the ruling of which would adversely affect us.
Although currently digital currencies generally are not regulated or are lightly regulated in most countries, one or more countries such as China and Russia, which have taken harsh regulatory action in recent months, may take regulatory actions in the future that could severely restrict the right to acquire, own, hold, sell or use these digital currency assets or to exchange for fiat currency. Such restrictions may adversely affect us as the large-scale use of digital currencies as a means of exchange is presently confined to certain regions globally. Such circumstances could have a material adverse effect on our ability to continue as a going concern or to pursue our new strategy at all, which could have a material adverse effect on our business, prospects or operations and potentially the value of any bitcoin or other digital currencies we mine or otherwise acquire or hold for our own account, and harm investors.
There is a lack of liquid markets, and possible manipulation of blockchain/digital currency‑based assets.
Digital assets that are represented and trade on a ledger-based platform may not necessarily benefit from viable trading markets. Stock exchanges have listing requirements and vet issuers; requiring them to be subjected to rigorous listing standards and rules, and monitor investors transacting on such platform for fraud and other improprieties. These conditions may not necessarily be replicated on a distributed ledger platform, depending on the platform's controls and other policies. The more lax a distributed ledger platform is about vetting issuers of digital currency assets or users that transact on the platform, the higher the potential risk for fraud or the manipulation of digital currency assets. These factors may decrease liquidity or volume, or increase volatility of digital securities or other assets trading on a ledger-based system, which may adversely affect us. Such circumstances could have a material adverse effect on our ability to continue as a going concern or to pursue our new strategy at all, which could have a material adverse effect on our business, prospects or operations and potentially the value of any bitcoin or other digital currencies we mine or otherwise acquire or hold for our own account, and harm investors.
Our operations, investment strategies and profitability may be adversely affected by competition from other methods of investing in digital currencies.
We compete with other users and/or companies that are mining digital currencies and other potential financial vehicles, including securities backed by or linked to digital currencies through entities similar to us. Market and financial conditions, and other conditions beyond our control, may make it more attractive to invest in other financial vehicles, or to invest in digital currencies directly, which could limit the market for our shares and reduce their liquidity. The emergence of other financial vehicles and exchange-traded funds have been scrutinized by regulators and such scrutiny and the negative impressions or conclusions resulting from such scrutiny could be applicable to us and impact our ability to successfully pursue our new strategy or operate at all, or to establish or maintain a public market for our securities. Such circumstances could have a material adverse effect on our ability to continue as a going concern or to pursue our new strategy at all, which could have a material adverse effect on our business, prospects or operations and potentially the value of any bitcoin or other digital currencies we mine or otherwise acquire or hold for our own account, and harm investors.
The development and acceptance of competing blockchain platforms or technologies may cause consumers to use alternative distributed ledgers or other alternatives.
The development and acceptance of competing blockchain platforms or technologies may cause consumers to use alternative distributed ledgers or an alternative to distributed ledgers altogether. Our business utilizes presently existent digital ledgers and blockchains and we could face difficulty adapting to emergent digital ledgers, blockchains, or alternatives thereto. This may adversely affect us and our exposure to various blockchain technologies and prevent us from realizing the anticipated profits from our investments. Such circumstances could have a material adverse effect on our ability to continue as a going concern or to pursue our new strategy at all, which could have a material adverse effect on our business, prospects or operations and potentially the value of any bitcoin or other digital currencies we mine or otherwise acquire or hold for our own account, and harm investors.
Our digital currencies may be subject to loss, theft or restriction on access.
There is a risk that some or all of our digital currencies could be lost or stolen. Digital currencies are stored in digital currency sites commonly referred to as “wallets” by holders of digital currencies which may be accessed to exchange a holder’s digital currency assets. Access to our digital currency assets. Access to our digital currency assets could also be restricted by cybercrime (such as a denial of service attack) against a service at which we maintain a hosted hot wallet. A hot wallet refers to any digital currency wallet that is connected to the Internet. Generally, hot wallets are easier to set up and access then wallets in cold storage, but they are also more susceptible to hackers and other technical vulnerabilities. Cold storage refers to any digital currency wallet that is not connected to the Internet. Cold storage is generally more secure, but is not ideal for quick or regular transactions. We hold the majority of our digital currencies in cold storage to reduce the risk of malfeasance, but this risk cannot be eliminated.
Hackers or malicious actors may launch attacks to steal, compromise or secure digital currencies, such as by attacking the digital currency network source code, exchange miners, third-party platforms, cold and hot storage locations or software, or by other means. We may be in control and possession of one of the more substantial holdings of digital currency. As we increase in size, we may become a more appealing target of hackers, malware, cyber-attacks or other security threats. Any of these events may adversely affect our operations and, consequently, our investments and profitability. The loss or destruction of a private key required to access our digital wallets may be irreversible and we may be denied access for all time to our digital currency holdings or the holdings of others held in those compromised wallets. Our loss of access to our private keys or our experience of a data loss relating to our digital wallets could adversely affect our investments and assets.
Digital currencies are controllable only by the possessor of both the unique public and private keys relating to the local or online digital wallet in which they are held, which wallet's public key or address is reflected in the network's public blockchain. We will publish the public key relating to digital wallets in use when we verify the receipt of transfers and disseminate such information into the network, but we will need to safeguard the private keys relating to such digital wallets. To the extent such private keys are lost, destroyed or otherwise compromised, we will be unable to access our digital currency rewards and such private keys may not be capable of being restored by any network. Any loss of private keys relating to digital wallets used to store our or our client's digital currencies could have a material adverse effect on our ability to continue as a going concern or to pursue our new strategy at all, which could have a material adverse effect on our business, prospects or operations and potentially the value of any bitcoin or other digital currencies we mine or otherwise acquire or hold for our own account.
Risks due to hacking or adverse software event.
In order to minimize risk, Riot has established processes to manage wallets that are associated with our digital currency holdings. There can be no assurances that any processes we have adopted or will adopt in the future are or will be secure or effective, and we would suffer significant and immediate adverse effects if we suffered a loss of our digital currency due to an adverse software or cybersecurity event. Riot utilizes several layers of threat reduction techniques, including: (i) the use of hardware wallets to store sensitive private key information; (ii) performance of transactions offline; and (iii) offline generation storage and use of private keys.
At present, the Company is evaluating several third-party custodial wallet alternatives, but there can be no assurance Riot will utilize such services, as other new options may develop in the future, and if a custodial wallet is used there can be no assurance that such services will be more secure than those the Company presently employs. Human error and the constantly-evolving state of cybercrime and hacking techniques may render present security protocols and procedures ineffective in ways which we cannot predict. If our security procedures and protocols are ineffectual and our digital currency assets are compromised by cybercriminals, we may not have adequate recourse to recover our losses stemming from such compromise and we may lose much of the accumulated value of our digital currency mining activities. This would have a negative impact on our business and operations.
Incorrect or fraudulent digital currency transactions may be irreversible.
Digital currency transactions are irrevocable and stolen or incorrectly transferred digital currencies may be irretrievable. As a result, any incorrectly executed or fraudulent digital currency transactions could adversely affect our investments and assets.
Digital currency transactions are not, from an administrative perspective, reversible without the consent and active participation of the recipient of the digital currencies from the transaction. In theory, digital currency transactions may be reversible with the control or consent of a majority of processing power on the network, however, we do not now, nor is it feasible that we could in the future, possess sufficient processing power to effect this reversal. Once a transaction has been verified and recorded in a block that is added to a blockchain, an incorrect transfer of a digital currency or a theft thereof generally will not be reversible and we may not have sufficient recourse to recover our losses from any such transfer or theft. It is possible that, through computer or human error, or through theft or criminal action, our digital currency rewards could be transferred in incorrect amounts or to unauthorized third parties, or to uncontrolled accounts. Further, at this time, there is no specifically enumerated U.S. or foreign governmental, regulatory, investigative or prosecutorial authority or mechanism through which to bring an action or complaint regarding missing or stolen digital currency. To the extent that we are unable to recover our losses from such action, error or theft, such events could have a material adverse effect on our ability to continue as a going concern or to pursue our new strategy at all, which could have a material adverse effect on our business, prospects or operations of and potentially the value of any bitcoin or other digital currencies we mine or otherwise acquire or hold for our own account.
Our interactions with a blockchain may expose us to SDN or blocked persons or cause us to violate provisions of law that did not contemplate distribute ledger technology.
The Office of Financial Assets Control of the US Department of Treasury requires us to comply with its sanction program and not conduct business with persons named on its specially designated nationals (“SDN”) list. However, because of the pseudonymous nature of blockchain transactions we may inadvertently without our knowledge engage in transactions with persons named on OFAC's SDN list. Our Company’s policy prohibits any transactions with such SDN individuals, but we may not be adequately capable of determining the ultimate identity of the individual with whom we transact with respect to selling digital currency assets. Moreover, federal law prohibits any US person from knowingly or unknowingly possessing any visual depiction commonly known as child pornography. Recent media reports have suggested that persons have imbedded such depictions on one or more blockchains. Because our business requires us to download and retain one or more blockchains to effectuate our ongoing business, it is possible that such digital ledgers contain prohibited depictions without our knowledge or consent. To the extent government enforcement authorities literally enforce these and other laws and regulations that are impacted by decentralized distributed ledger technology, we may be subject to investigation, administrative or court proceedings, and civil or criminal monetary fines and penalties, all of which could harm our reputation and affect the value of our common stock.
Digital currencies face significant scaling obstacles that can lead to high fees or slow transaction settlement times.
Digital currencies face significant scaling obstacles that can lead to high fees or slow transaction settlement times, and attempts to increase the volume of transactions may not be effective. Scaling digital currencies is essential to the widespread acceptance of digital currencies as a means of payment, which widespread acceptance is necessary to the continued growth and development of our business. Many digital currency networks face significant scaling challenges. For example, digital currencies are limited with respect to how many transactions can occur per second. Participants in the digital currency ecosystem debate potential approaches to increasing the average number of transactions per second that the network can handle and have implemented mechanisms or are researching ways to increase scale, such as increasing the allowable sizes of blocks, and therefore the number of transactions per block, and sharding (a horizontal partition of data in a database or search engine), which would not require every single transaction to be included in every single miner's or validator's block. However, there is no guarantee that any of the mechanisms in place or being explored for increasing the scale of settlement of digital currency transactions will be effective, or how long they will take to become effective, which could adversely affect an investment in our securities.
The price of digital currencies may be affected by the sale of such digital currencies by other vehicles investing in digital currencies or tracking digital currency markets.
The global market for digital currency is characterized by supply constraints that differ from those present in the markets for commodities or other assets such as gold and silver. The mathematical protocols under which certain digital currencies are mined permit the creation of a limited, predetermined amount of currency, while others have no limit established on total supply. To the extent that other vehicles investing in digital currencies or tracking digital currency markets form and come to represent a significant proportion of the demand for digital currencies, large redemptions of the securities of those vehicles and the subsequent sale of digital currencies by such vehicles could negatively affect digital currency prices and therefore affect the value of the digital currency inventory we hold. Such events could have a material adverse effect on our ability to continue as a going concern or to pursue our new strategy at all, which could have a material adverse effect on our business, prospects or operations and potentially the value of any bitcoin or other digital currencies we mine or otherwise acquire or hold for our own account.
Because there has been limited precedent set for financial accounting of bitcoin and other digital currency assets, the determination that we have made for how to account for digital currency assets transactions may be subject to change.
Because there has been limited precedent set for the financial accounting of digital currencies and related revenue recognition and no official guidance has yet been provided by the Financial Accounting Standards Board or the SEC, it is unclear how companies may in the future be required to account for digital currency transactions and assets and related revenue recognition. A change in regulatory or financial accounting standards could result in the necessity to change our accounting methods and restate our financial statements. Such a restatement could adversely affect the accounting for our newly mined digital currency rewards and more generally negatively impact our business, prospects, financial condition and results of operation. Such circumstances would have a material adverse effect on our ability to continue as a going concern or to pursue our new strategy at all, which would have a material adverse effect on our business, prospects or operations as well as and potentially the value of any digital currencies we hold or expects to acquire for our own account and harm investors.
Digital Currency Mining-Related Risks
There are risks related to technological obsolescence and difficulty in obtaining new hardware.
Our mining operations can only be successful and ultimately profitable if the costs, including hardware and electricity costs, associated with mining digital currencies are lower than the price of a bitcoin. As our mining facility operates, our miners experience ordinary wear and tear, and may also face more significant malfunctions caused by a number of extraneous factors beyond our control. The degradation of our miners will require us to, over time, replace those miners which are no longer functional. Additionally, as the technology evolves, we may be required to acquire newer models of miners to remain competitive in the market. Reports have been released which indicate that Bitmain adjusts the prices of its miners according to bitcoin prices, so the cost of new machines is unpredictable but could be extremely high. Further, given supply limitations and competition from other industry participants, those miners can be difficult to obtain from Bitmain directly on a timely basis. As a result, at times, we may obtain Bitmain miners and other hardware from third parties at premium prices, to the extent they are available. For example, in November 2017, in order to facilitate the launch of our mining operations without the potential delay associated with acquiring miners directly from Bitmain, we purchased Bitmain miners at substantially above Bitmain's list prices. Additionally, to keep pace with technological advances and competition from other mining companies, we will need to replace or update our miners and other equipment from time to time to stay competitive. This process will require substantial capital investment, and we may face challenges in doing so on a timely and cost-effective basis. Also, because our miners are expected to require replacement in a relatively short amount of time, we expect to depreciate them over only a two-year period for financial reporting purposes, adversely affecting our reported operating results. Such events could have a material adverse effect on our ability to continue as a going concern or to pursue our new strategy, which could have a material adverse effect on our business and the value of our common stock.
Our reliance primarily on a single model of miner may subject our operations to increased risk of mine failure.
The performance and reliability of our miners and our technology is critical to our reputation and our operations. Because we currently only use Bitmain miners, if there are issues with those machines, our entire system could be affected. Any system error or failure may significantly delay response times or even cause our system to fail. Any disruption in our ability to continue mining could result in lower yields and harm our reputation and business. Any exploitable weakness, flaw, or error common to Bitmain miners affects all our miners, if a defect other flaw is exploited, our entire mine could go offline simultaneously. Any interruption, delay or system failure could result in financial losses, a decrease in the trading price of our common stock and damage to our reputation.
The Company’s reliance on a third-party mining pool service provider for our mining revenue payouts may have a negative impact on the Company operations.
We use third–party mining pools to receive our mining rewards from the network. Bitcoin mining pools allow miners to combine their processing power, increasing their chances of solving a block and getting paid by the network. The rewards are distributed by the pool operator, proportionally to our contribution to the pool’s overall mining power, used to generate each block. Should the pool operator’s system suffer downtime due to a cyber-attack, software malfunction or other similar issues, it will negatively impact our ability to mine and receive revenue. Furthermore, we are reliant on the accuracy of the mining pool operator’s record keeping to accurately record the total processing power provided to the pool for a given bitcoin mining application in order to assess the proportion of that total processing power we provided. While we have internal methods of tracking both our power provided and the total used by the pool, the mining pool operator uses its own record-keeping to determine our proportion of a given reward. We have little means of recourse against the mining pool operator if we determine the proportion of the reward paid out to us by the mining pool operator is incorrect, other than leaving the pool. If we are unable to consistently obtain accurate proportionate rewards from our mining pool operators, we may experience reduced reward for our efforts, which would have an adverse effect on our business and operations.
The primary digital currencies for which we mine, bitcoin and litecoin, are subject to halving; the digital currency reward for successfully uncovering a block will halve several times in the future and their value may not adjust to compensate us for the reduction in the rewards we receive from our mining efforts.
Halving is a process designed to control the overall supply and reduce the risk of inflation in cryptocurrencies using a Proof-of-Work consensus algorithm. At a predetermined block, the mining reward is cut in half, hence the term “halving.” For bitcoin, the reward was initially set at 50 bitcoin currency rewards per block and this was cut in half to 25 in November 28, 2012 at block 210,000 and again to 12.5 on July 9, 2016 at block 420,000. The next halving for bitcoin is expected in May 2020 at block 630,000 when the reward will reduce to 6.25. This process will reoccur until the total amount of bitcoin currency rewards issued reaches 21 million, which is expected around 2140. Similarly, litecoin first halved on August 25, 2015 at block 840,000 from 50 to 25. It is expected to halve a second time in August 2019 at block 1,680,000 to 12.5. While bitcoin and litecoin prices have had a history of price fluctuations around the halving of their respective digital currency rewards, there is no guarantee that the price change will be favorable or would compensate for the reduction in mining reward. If a corresponding and proportionate increase in the trading price of these digital currencies does not follow these anticipated halving events, the revenue we earn from our mining operations would see a corresponding decrease, which would have a material adverse effect on our business and operations.
Our future success will depend in large part upon the value of bitcoin; the value of bitcoin and other digital currencies may be subject to pricing risk and has historically been subject to wide swings.
Our operating results will depend in large part upon the value of bitcoin because it’s the primary digital currency we currently mine. Specifically, our revenues from our bitcoin mining operations are based upon two factors: (1) the number of bitcoin rewards we successfully mine and (2) the value of bitcoin. In addition, our operating results are directly impacted by changes in the value of bitcoin, because under the value measurement model, both realized and unrealized changes will be reflected in our statement of operations (i.e., we will be marking bitcoin to fair value each quarter). This means that our operating results will be subject to swings based upon increases or decreases in the value of bitcoin. Furthermore, our new strategy initially focuses almost entirely on bitcoin (as opposed to other digital currencies). Further, our current application-specific integrated circuit (“ASIC”) machines (which we refer to as “miners”) are principally utilized for mining bitcoin and bitcoin cash and cannot mine other digital currencies, such as ether, that are not mined utilizing the “SHA-256 algorithm.” If other digital currencies were to achieve acceptance at the expense of bitcoin or bitcoin cash causing the value of bitcoin or bitcoin cash to decline, or if bitcoin were to switch its proof of work algorithm from SHA-256 to another algorithm for which our miners are not specialized, or the value of bitcoin or bitcoin cash were to decline for other reasons, particularly if such decline were significant or over an extended period of time, our operating results would be adversely affected, and there could be a material adverse effect on our ability to continue as a going concern or to pursue our new strategy at all, which could have a material adverse effect on our business, prospects or operations, and harm investors.
Bitcoin and other digital currency market prices, which have historically been volatile and are impacted by a variety of factors (including those discussed below), are determined primarily using data from various exchanges, over-the-counter markets and derivative platforms. Furthermore, such prices may be subject to factors such as those that impact commodities, more so than business activities, which could be subjected to additional influence from fraudulent or illegitimate actors, real or perceived scarcity, and political, economic, regulatory or other conditions. Pricing may be the result of, and may continue to result in, speculation regarding future appreciation in the value of digital currencies, or our share price, inflating and making their market prices more volatile or creating “bubble” type risks for both bitcoin and shares of our common stock.
We may not be able to realize the benefits of forks.
To the extent that a significant majority of users and miners on a digital currency network install software that changes the digital currency network or properties of a digital currency, including the irreversibility of transactions and limitations on the mining of new digital currency, the digital currency network would be subject to new protocols and software. However, if less than a significant majority of users and miners on the digital currency network consent to the proposed modification, and the modification is not compatible with the software prior to its modification, the consequence would be what is known as a “fork” of the network, with one prong running the pre-modified software and the other running the modified software. The effect of such a fork would be the existence of two versions of the digital currency running in parallel, yet lacking interchangeability and necessitating exchange-type transaction to convert currencies between the two forks. Additionally, it may be unclear following a fork which fork represents the original asset and which is the new asset. Different metrics adopted by industry participants to determine which is the original asset include: referring to the wishes of the core developers of a digital currency, blockchains with the greatest amount of hashing power contributed by miners or validators; or blockchains with the longest chain. A fork in the network of a particular digital currency could adversely affect an investment in our securities or our ability to operate.
We may not be able to realize the economic benefit of a fork, either immediately or ever, which could adversely affect an investment in our securities. If we hold a digital currency at the time of a hard fork into two digital currencies, industry standards would dictate that we would be expected to hold an equivalent amount of the old and new assets following the fork. However, we may not be able, or it may not be practical, to secure or realize the economic benefit of the new asset for various reasons. For instance, we may determine that there is no safe or practical way to custody the new asset, that trying to do so may pose an unacceptable risk to our holdings in the old asset, or that the costs of taking possession and/or maintaining ownership of the new digital currency exceed the benefits of owning the new digital currency. Additionally, laws, regulation or other factors may prevent us from benefitting from the new asset even if there is a safe and practical way to custody and secure the new asset.
There is a possibility of digital currency mining algorithms transitioning to proof of stake validation and other mining‑related risks, which could make us less competitive and ultimately adversely affect our business and the value of our stock.
Proof of stake is an alternative method in validating digital currency transactions. Should the algorithm shift from a proof of work validation method to a proof of stake method, mining would require less energy and may render any company that maintains advantages in the current climate (for example, from lower priced electricity, processing, real estate, or hosting) less competitive. We, as a result of our efforts to optimize and improve the efficiency of our digital currency mining operations, may be exposed to the risk in the future of losing the benefit of our capital investments and the competitive advantage we hope to gain form this as a result, and may be negatively impacted if a switch to proof of stake validation were to occur. This may additionally have an impact on other various investments of ours, including how it may potentially affect transactional volume on Coinsquare or affect our strategy for investigating the launch of a digital currency exchange in the United States. Such events could have a material adverse effect on our ability to continue as a going concern or to pursue our new strategy at all, which could have a material adverse effect on our business, prospects or operations and potentially the value of any bitcoin or other digital currencies we mine or otherwise acquire or hold for our own account.
To the extent that the profit margins of bitcoin mining operations are not high, operators of bitcoin mining operations are more likely to immediately sell bitcoin rewards earned by mining in the market, thereby constraining growth of the price of bitcoin that could adversely impact us, and similar actions could affect other digital currencies.
Over the past two years, bitcoin mining operations have evolved from individual users mining with computer processors, graphics processing units and first-generation ASIC servers. Currently, new processing power is predominantly added by incorporated and unincorporated “professionalized” mining operations. Professionalized mining operations may use proprietary hardware or sophisticated ASIC machines acquired from ASIC manufacturers. They require the investment of significant capital for the acquisition of this hardware, the leasing of operating space (often in data centers or warehousing facilities), incurring of electricity costs and the employment of technicians to operate the mining farms. As a result, professionalized mining operations are of a greater scale than prior miners and have more defined and regular expenses and liabilities. These regular expenses and liabilities require professionalized mining operations to maintain high profit margins on the sale of bitcoin. To the extent the price of bitcoin declines and such profit margin is constrained, professionalized miners are incentivized to more immediately sell bitcoin earned from mining operations, whereas it is believed that individual miners in past years were more likely to hold newly mined bitcoin for more extended periods. The immediate selling of newly mined bitcoin greatly increases the trading volume of bitcoin, creating downward pressure on the market price of bitcoin rewards.
The extent to which the value of bitcoin mined by a professionalized mining operation exceeds the allocable capital and operating costs determines the profit margin of such operation. A professionalized mining operation may be more likely to sell a higher percentage of its newly mined bitcoin rapidly if it is operating at a low profit margin and it may partially or completely cease operations if its profit margin is negative. In a low profit margin environment, a higher percentage could be sold more rapidly, thereby potentially depressing bitcoin prices. Lower bitcoin prices could result in further tightening of profit margins for professionalized mining operations creating a network effect that may further reduce the price of bitcoin until mining operations with higher operating costs become unprofitable forcing them to reduce mining power or cease mining operations temporarily.
The foregoing risks associated with bitcoin could be equally applicable to other digital currencies, whether existing now or introduced in the future. Such circumstances could have a material adverse effect on our ability to continue as a going concern or to pursue our new strategy at all, which could have a material adverse effect on our business, prospects or operations and potentially the value of bitcoin and any other digital currencies we mine or otherwise acquire or hold for our own account, and harm investors.
If a malicious actor or botnet obtains control of more than 50% of the processing power on a digital currency network, such actor or botnet could manipulate blockchains to adversely affect us, which would adversely affect an investment in us or our ability to operate.
If a malicious actor or botnet (a volunteer or hacked collection of computers controlled by networked software coordinating the actions of the computers) obtains a majority of the processing power dedicated to mining a digital currency, it may be able to alter blockchains on which transactions of digital currency reside and rely by constructing fraudulent blocks or preventing certain transactions from completing in a timely manner, or at all. The malicious actor or botnet could control, exclude or modify the ordering of transactions, though it could not generate new units or transactions using such control. The malicious actor could “double-spend” its own digital currency (i.e., spend the same bitcoin in more than one transaction) and prevent the confirmation of other users' transactions for as long as it maintained control. To the extent that such malicious actor or botnet does not yield its control of the processing power on the network or the digital currency community does not reject the fraudulent blocks as malicious, reversing any changes made to blockchains may not be possible. The foregoing description is not the only means by which the entirety of blockchains or digital currencies may be compromised, but is only an example.
Although there are no known reports of malicious activity or control of blockchains achieved through controlling over 50% of the processing power on the network, it is believed that certain mining pools may have exceeded the 50% threshold in bitcoin. The possible crossing of the 50% threshold indicates a greater risk that a single mining pool could exert authority over the validation of bitcoin transactions. To the extent that the bitcoin ecosystem, and the administrators of mining pools, do not act to ensure greater decentralization of bitcoin mining processing power, the feasibility of a malicious actor obtaining control of the processing power will increase because the botnet or malicions actor could compromise more than 50% mining pool and thereby gain control of blockchain, whereas if the blockchain remains decentralized it is inherently more difficult for the botnet of malicious actor to aggregate enough processing power to gain control of the blockchain, may adversely affect an investment in our common stock. Such lack of controls and responses to such circumstances could have a material adverse effect on our ability to continue as a going concern or to pursue our new strategy at all, which could have a material adverse effect on our business, prospects or operations and potentially the value of any bitcoin or other digital currencies we mine or otherwise acquire or hold for our own account, and harm investors.
Digital currencies, including those maintained by or for us, may be exposed to cybersecurity threats and hacks.
As with any computer code generally, flaws in digital currency codes may be exposed by malicious actors. Several errors and defects have been found previously, including those that disabled some functionality for users and exposed users' information. Exploitations of flaws in the source code that allow malicious actors to take or create money have previously occurred. Despite our efforts and processes to prevent breaches, our devices, as well as our miners, computer systems and those of third parties that we use in our operations, are vulnerable to cyber security risks, including cyber-attacks such as viruses and worms, phishing attacks, denial-of-service attacks, physical or electronic break-ins, employee theft or misuse, and similar disruptions from unauthorized tampering with our miners and computer systems or those of third parties that we use in our operations. Such events could have a material adverse effect on our ability to continue as a going concern or to pursue our new strategy at all, which could have a material adverse effect on our business, prospects or operations and potentially the value of any bitcoin or other digital currencies we mine or otherwise acquire or hold for our own account.
We are subject to risks associated with our need for significant electrical power. Government regulators may potentially restrict the ability of electricity suppliers to provide electricity to mining operations, such as ours.
The operation of a bitcoin or other digital currency mine can require massive amounts of electrical power. Further, our mining operations can only be successful and ultimately profitable if the costs, including electrical power costs, associated with mining a bitcoin are lower than the price of a bitcoin. As a result, any mine we establish can only be successful if we can obtain sufficient electrical power for that mine on a cost-effective basis, and our establishment of new mines requires us to find locations where that is the case. There may be significant competition for suitable mine locations, and government regulators may potentially restrict the ability of electricity suppliers to provide electricity to mining operations in times of electricity shortage, or may otherwise potentially restrict or prohibit the provision or electricity to mining operations. For example, the board of commissioners of Chelan County Public Utility District in Washington voted to stop reviewing applications for mining facilities following a review of the impact of existing operations. Additionally, our mines could be materially adversely affected by a power outage. Given the power requirement, it would not be feasible to run miners on back-up power generators in the event of a government restriction on electricity or a power outage. If we are unable to receive adequate power supply and are forced to reduce our operations due to the availability or cost of electrical power, our business would experience materially negative impacts.
If the award of digital currency rewards, for us primarily bitcoin for solving blocks and transaction fees are not sufficiently high, we may not have an adequate incentive to continue mining and may cease mining operations, which will likely lead to our failure to achieve profitability.
As the number of digital currency rewards awarded for solving a block in a blockchain decreases, our ability to achieve profitability worsens. Decreased use and demand for bitcoin rewards may adversely affect our incentive to expend processing power to solve blocks. If the award of bitcoin rewards for solving blocks and transaction fees are not sufficiently high, we may not have an adequate incentive to continue mining and may cease our mining operations. For instance, the current fixed reward for solving a new block on the bitcoin blockchain is twelve and a half bitcoin currency rewards per block, which decreased from 25 bitcoin in July 2016. It is estimated that it will halve again in about one year. This reduction may result in a reduction in the aggregate hash rate of the bitcoin network as the incentive for miners decreases. Miners ceasing operations would reduce the collective processing power on the network, which would adversely affect the confirmation process for transactions (i.e., temporarily decreasing the speed at which blocks are added to a blockchain until the next scheduled adjustment in difficulty for block solutions) and make digital currency networks more vulnerable to a malicious actor or botnet obtaining control in excess of 50 percent of the processing power active on a blockchain, potentially permitting such actor or botnet to manipulate a blockchain in a manner that adversely affects our activities. A reduction in confidence in the confirmation process or processing power of the network could result and be irreversible. Such events could have a material adverse effect on our ability to continue to pursue our new strategy at all, which could have a material adverse effect on our business, prospects or operations and potentially the value of any bitcoin or other digital currencies we mine or otherwise acquire or hold for our own account.
Our dependence on third-party software and personnel may leave us vulnerable to price fluctuations and rapidly changing technology.
Competitive conditions within the digital currency industry require that we use sophisticated technology in the operation of our business. We currently utilize third party software applications in our mining operations. Further, we are licensing Synapse and Shift Market software to run our planned exchange and we may not be able to amend or change our agreements with these third party service providers to respond to changes in the market. The industry for blockchain technology is characterized by rapid technological changes, new product introductions, enhancements and evolving industry standards. New technologies, techniques or products could emerge that might offer better performance than the software and other technologies we currently utilize, and we may have to manage transitions to these new technologies to remain competitive. We may not be successful, generally or relative to our competitors in the digital currency industry, in timely implementing new technology into our systems, or doing so in a cost-effective manner. During the course of implementing any such new technology into our operations, we may experience system interruptions and failures during such implementation. Furthermore, there can be no assurances that we will recognize, in a timely manner or at all, the benefits that we may expect as a result of our implementing new technology into our operations. As a result, our business and operations may suffer, and there may be adverse effects on the price of our common stock.
Risks Associated with our Exploratory Efforts to Launch a U.S. Digital Currency Exchange and Related Businesses
We may not successfully develop, market and launch any digital currency exchange.
We are investigating and planning the development of a digital currency exchange. For a variety of reasons (including but not limited to the regulatory challenges and other risks discussed below), we could suffer significant delays in our efforts to establish such an exchange, and may ultimately not be successful in doing so. We will need to obtain additional management, regulatory compliance and technical expertise and devote substantial time and effort to this project. We also expect to need to raise additional funds (which may be seek by offering direct investments in this business) to pursue development of the exchange, and we may not be successful in raising that capital. It is possible that the launch of our digital currency exchange may never occur, and even if it is successfully developed, it is possible that it will not be accessed or utilized by a large number of users or will otherwise not achieve market acceptance. If our planned exchange is never launched or is never accessed and used by a large number of users, than we may be forced to reduce or cease our operations of our exchange, and we could lose all of our investment therein.
If regulatory changes or interpretations require the regulation of bitcoin or other digital currency assets under the securities laws of the United States or elsewhere, including the Securities Act of 1933, the Securities Exchange Act of 1934, the Investment Company Act of 1940, the Commodity Exchange Act or similar laws of other jurisdictions and interpretations by the SEC, CFTC, IRS, Department of Treasury or other agencies or authorities, we may be required to register and comply with such regulations, including at a state or local level. To the extent that we decide to continue operations, the required registrations and regulatory compliance steps may result in extraordinary expenses or burdens to us.
Regulatory developments, including current and future legislation, SEC rulemaking, interpretations released by a regulatory authority, and/or judicial decisions, may impact the manner in which bitcoin or other digital currencies are viewed or treated for classification and clearing purposes. In particular, bitcoin and other digital currencies may not be excluded from the definition of “security” by SEC rulemaking or interpretations which require registration of all transactions therefor would occur on our planned exchange, unless another exemption is available, and require registration of trading platforms as “exchanges” with the SEC.
We cannot be certain as to how future regulatory developments will impact the treatment of bitcoin and other digital currencies under applicable law. If we determine that we are not able to comply, or otherwise fail to comply with such additional regulatory and registration requirements, we may seek to cease certain of our operations or be subjected to fines, penalties and other governmental enforcement actions. Such circumstances could have a material adverse effect on our ability to continue as a going concern or to pursue our new strategy at all, which could have a material adverse effect on our business, prospects or operations and potentially the value of any bitcoin or other digital currencies we mine or otherwise acquire or hold for our own account, which would harm investors in our common stock.
We may be required to register as a money services business with the FinCEN and as a money transmitter in states with applicable money transmitter regulations.
To the extent that our activities cause us to be deemed a money services business under the regulations promulgated by the FinCEN under the authority of the Bank Secrecy Act, we may be required to comply with FinCEN regulations, including those that would mandate us to implement anti-money laundering programs, make certain reports to FinCEN and maintain certain records which could increase our compliance costs significantly. In addition, it is possible that other regulations may apply to our spot exchange operations. For example, the SEC may take the position that digital currencies may only be traded on or subject to the rules of a national securities exchange unless exempt from such requirements.
Furthermore, to the extent that our activities cause us to be deemed a “money transmitter” under one or more state laws (e.g., engaging in the business of exchanging virtual for fiat currency or virtual for digital currency) or that we are engaged in other business involving digital currency activities that are regulated in any state in which we operate, such as business conducting digital currency business activity in New York state, which requires a so-called “Bitlicense,” we may be required to seek a license or otherwise register with a state regulator and comply with state regulations. If we are required to register in these states and comply with their individual requirements, we can expect to incur significant compliance costs, including increased legal expenses, accounting expenses and internal costs. Without a required money transmitter license, we could not engage in money transmitter activities with persons residing in the relevant state (or from such state), or engage in other activities (e.g., custody) requiring another license such as a Bitlicense.
We intend to initially obtain state money transmitter licenses, as necessary, on a state by state basis and we currently have such licenses from Florida and Georgia. The process of obtaining the necessary licenses to effect such trades can take an extensive period of time, and as a result we may initially operate our digital currency spot exchange in a limited number of states. There is also a risk that necessary licenses will not be granted and that therefore we will be unable to establish an exchange in particular states, or at all. If we are unable to establish a digital currency exchange (at all or in certain states), or if we are delayed in doing so, such factors could have a material adverse effect on our ability to continue as a going concern or to pursue our new strategy, which could have a material adverse effect on our business, prospects or operations.
To the extent that we need to register as a money services business or become licensed as a money transmitter or businesses engaged in digital currency business activity, and be subject to associated regulatory obligations, such obligations will cause us to incur additional expenses, possibly affecting an investment in us in a material and adverse manner. In addition, to the extent we are found to have operated without appropriate state or federal licenses, we may be subject to investigation, administrative or court proceedings, and civil or criminal monetary fines and penalties, all of which could harm our reputation and affect the value of our securities.
If we are successful in developing a spot exchange for trading digital currencies like bitcoin, we will begin to store, process, and use data, some of which contains personal information. This will subject us to complex and evolving federal, state and foreign laws and regulations regarding privacy, data protection, content and other matters. Many of these laws and regulations are subject to change and uncertain interpretation, and could result in investigations, claims, changes to our business practices, increased cost of operations and declines in user growth, retention, or engagement, any of which could seriously harm our business.
If we successfully launch a spot exchange for trading digital currency, we will be subject to a variety of laws and regulations in the United States and potentially other jurisdictions (such as The European Union) that affect matters central to our business, including but not limited to; anti-money laundering, user privacy, security, rights of publicity, data protection, content, intellectual property, distribution, electronic contracts and other communications, competition, protection of minors, consumer protection, taxation, and online payment services. These laws can be particularly restrictive in countries outside the United States. Both in the United States and abroad, these laws and regulations constantly evolve and remain subject to significant change. In addition, the application and interpretation of these laws and regulations are often uncertain, particularly in the new and rapidly evolving industry in which we operate. Because we may store, process and use data, some of which contains personal information, we will likely be subject to complex and evolving federal, state and foreign laws and regulations regarding privacy, data protection, content and other matters. Many of these laws and regulations are subject to change and uncertain interpretation, and could result in investigations, claims, changes to our business practices, increased cost of operations and declines in user growth, retention, or engagement, any of which could seriously harm our business. If we do not comply with all of our requirements, we may be subject to investigation, administrative or court proceedings, and civil or criminal monetary fines and penalties, all of which could harm our reputation and affect the value of our securities.
Digital currency exchanges and other trading venues (including the Coinsquare exchange, in which we have an ownership interest) are relatively new and, in most cases, largely unregulated, and may therefore be subject to fraud and failures, including security breaches that may result in a loss of all or some digital currencies.
Digital currency market prices depend, directly or indirectly, on the prices set on exchanges and other trading venues, which are new and, in most cases, largely unregulated as compared to established, regulated exchanges for securities, derivatives on commodities or currencies. For example, during the past three years, a number of exchanges offering bitcoin and other digital currencies have closed due to fraud, business failure or security breaches. In many of these instances, the customers of the closed exchanges were not compensated or made whole for the partial or complete losses of their account balances. While smaller exchanges are less likely to have the infrastructure and capitalization that may provide larger exchanges with some stability, larger exchanges may be more likely to be appealing targets for hackers and “malware” (i.e., software used or programmed by attackers to disrupt computer operations, gather sensitive information or gain access to private computer systems) and may be more likely to be targets of regulatory enforcement action. Insurance for such exchanges is not currently readily available and we do not expect any insurance for customer accounts to be available (such as federal deposit insurance) at any time in the future, putting customer accounts at risk of such events. In the event that we face fraud, security failures, operational issues or similar events, such factors could have a material adverse effect on our ability to continue as a going concern or to pursue our new strategy at all, which could have a material adverse effect on our business, prospects or operations.
Our introducing broker subsidiary is subject to oversight by the CFTC and NFA.
In connection with our plan to establish a digital currency spot exchange, our recently acquired subsidiary Logical Brokerage Corp., is a CFTC-registered introducing broker and is subject to oversight by the CFTC and the NFA. The CFTC and NFA do not have functional oversight over digital currency spot exchanges, but the CFTC has authority to bring cases based on fraud and manipulation. As a result of this, we must comply with CFTC and NFA requirements applicable to introducing brokers, including complying with anti-money laundering requirements. If we do not fully comply with all such requirements, we may be subject to investigation, administrative or court proceedings, and civil or criminal monetary fines and penalties, all of which could harm our reputation and affect the value of our securities.
Risks Related to Intellectual Property
If we are unable to protect the confidentiality of our trade secrets, our business and competitive position could be harmed.
We plan to rely upon trademarks, copyright and trade secret protection (and possibly also patents in the future), as well as non-disclosure agreements and invention assignment agreements with employees, consultants and third parties, to protect all confidential and proprietary information. Significant elements of our intended products and services are based on unpatented trade secrets and know-how that are not publicly disclosed. In addition to contractual measures, we try to protect the confidential nature of our proprietary information using physical and technological security measures. Such measures may not, for example, in the case of misappropriation of a trade secret by an employee or third party with authorized access, provide adequate protection for our proprietary information. The security measures may not prevent an employee or consultant from misappropriating our trade secrets and providing them to a competitor, and the recourse we take against such misconduct may not provide an adequate remedy to protect our interests fully. Enforcing a claim that a party illegally disclosed or misappropriated a trade secret can be difficult, expensive and time consuming, and the outcome is unpredictable. In addition, trade secrets may be independently developed by others in a manner that could prevent legal recourse by us. If any of our confidential or proprietary information, such as our trade secrets, were to be disclosed or misappropriated, or if any such information was independently developed by a competitor, our competitive position could be harmed.
We may infringe the intellectual property rights of others, which may prevent or delay our product development efforts and stop us from commercializing or increase the costs of commercializing the intended products and services.
Our commercial success depends significantly on our ability to operate without infringing the patents and other intellectual property rights of third parties however, due to the open-source and constantly evolving nature of our business, we may not always be able to determine that we are using or accessing protected information or software. For example, there could be issued patents of which we are not aware that our products infringe. There also could be patents that we believe we do not infringe, but that we may ultimately be found to infringe. Moreover, patent applications are in some cases maintained in secrecy until patents are issued. The publication of discoveries in scientific or patent literature frequently occurs substantially later than the date on which the underlying discoveries were made and patent applications were filed. Because patents can take many years to issue, there may be currently pending applications of which we are unaware that may later result in issued patents that our products infringe.
Accordingly, we could expend significant resources defending against patent infringement and other intellectual property right claims; which could require us to divert resources away from operations. Any damages we are required to pay or injunctions against our continued use of such intellectual property in resolution of such claims may cause a material adverse effect to our business and operations, which could adversely affect the trading price of our securities and harm our investors.
Risks Related to Ownership of Our Common Stock
The trading price of our common stock has been, and is likely to continue to be, volatile; you might not be able to sell your shares at or above the price that you paid for them and we may not be able to stop the decline of our stock price.
The trading price of our common stock has been, and is likely to continue to be, volatile, and may be influenced by numerous factors, some of which are beyond our control; you might not be able to sell your shares at or above the price that you paid for them.
In addition, the trading prices of bitcoin have been highly unpredictable, and the trading prices of our common stock has generally been highly and directly correlated with the trading prices of bitcoin. Specifically, we have experienced adverse effects on our stock price when the value of bitcoin has fallen, and we anticipate similar outcomes as our stock price tracks the general status of that digital currency. Furthermore, if the market for bitcoin company stocks or the stock market in general experiences a loss of investor confidence, the trading price of our stock could decline for reasons unrelated to our business, operating results or financial condition. That is, the trading price of our common stock is subject to arbitrary pricing factors that are not necessarily associated with traditional factors that influence stock prices or the value of non-digital currency assets such as revenue, cash flows, profitability, growth prospects or business activity levels since the value and price, as determined by the investing public, may be influenced by future anticipated adoption or appreciation in value of digital currencies or blockchains generally, factors over which we have little or no influence or control.
Other factors which could cause volatility in the market price of our common stock include, but are not limited to:
| · | actual or anticipated fluctuations in our financial condition and operating results or those of companies perceived to be similar to us; |
| · | actual or anticipated changes in our growth rate relative to our competitors; |
| · | commercial success and market acceptance of blockchain and bitcoin and other digital currencies; |
| · | actions by our competitors, such as new business initiatives, acquisitions and divestitures; |
| · | strategic transactions undertaken by us; |
| · | additions or departures of key personnel; |
| · | prevailing economic conditions; |
| · | disputes concerning our intellectual property or other proprietary rights; |
| · | sales of our common stock by our officers, directors or significant shareholders;stockholders; |
| · | other actions taken by our stockholders; |
| · | future sales or issuances of equity or debt securities by us; |
| · | business disruptions caused by earthquakes, tornadoes or other natural disasters; |
| · | issuance of new or changed securities analysts' reports or recommendations regarding us; |
| · | legal proceedings involving our company, our industry or both; |
| · | changes in market valuations of companies similar to ours; |
| · | the prospects of the industry in which we operate; |
| · | speculation or reports by the press or investment community with respect to us or our industry in general; |
| · | the level of short interest in our stock; and |
| · | other risks, uncertainties and factors described in this annual report. |
In addition, the stock markets in general have experienced extreme volatility that has often been unrelated to the operating performance of the issuer. These broad market fluctuations may negatively impact the price or liquidity of our common stock. When the price of a stock has been volatile, holders of that stock have sometimes instituted securities class action litigation against the issuer, and we have been impacted in that way. See Item 3 – Legal Proceedings, “We, and some of our current and former officers and directors, have been named as parties to various lawsuits arising out of, or related to, allegedly false and misleading statements made in prior securities filings, and those lawsuits could adversely affect us, require significant management time and attention, result in significant legal expenses or damages, and cause our business, financial condition, results of operations and cash flows to suffer.”
Our Bylaws contain a forum selection clause requiring stockholder suits against us to be brought in Nevada; our stockholders may be prejudiced by this clause.
In general, Nevada has traditionally been a favorable jurisdiction for companies in stockholder disputes. Our Bylaws require our stockholders to bring their derivative suits against us in Nevada. Accordingly, our stockholders may incur increased expense in bringing their own claims and may be prejudiced in such claims by judicial difference shown to corporate defendants in our chosen forum, Nevada.19
Nevada law contains provisions that could discourage, delay or prevent a change in control of our company, prevent attempts to replace or remove current management and reduce the market price of our stock.
Provisions in Nevada corporate law may discourage, delay or prevent a merger or acquisition involving us that our stockholders may consider favorable. For example, Nevada corporate law contains strong “anti-takeover” provisions, which prohibit us from entering into a business combination with an “interested stockholder” or their affiliates for a period of two years after they become an “interested stockholder” unless certain provisions are met. As a result, a proposed merger favored by our stockholders could be blocked by operation of Nevada law.
If securities or industry analysts do not publish research or publish unfavorable research about our business, our stock price and trading volume could decline.
The trading market for our common stock will be influenced by whether industry or securities analysts publish research and reports about us, our business, our market or our competitors and, if any analysts do publish such reports, what they publish in those reports. We may not obtain or maintain analyst coverage in the future. Any analysts that do cover us may make adverse recommendations regarding our stock, adversely change their recommendations from time to time and/or provide more favorable relative recommendations about our competitors. If analysts who may cover us in the future were to cease coverage of our company or fail to regularly publish reports on us, or if analysts fail to cover us or publish reports about us at all, we could lose (or never gain) visibility in the financial markets, which in turn could cause the stock price of our common stock or trading volume to decline. Moreover, if our operating results do not meet the expectations of the investor community, one or more of the analysts who cover our company may change their recommendations regarding our company and our stock price could decline.
The senior secured convertible promissory notes and warrants issued in connection with our recent private financing transactions are convertible or exercisable for shares of our common stock, which, upon conversion or exercise, will dilute the Company’s current stockholders’ equity value.
We issued senior secured convertible promissory notes and warrants in connection with a private financing completed on January 28, 2019, as previously reported on our current report on Form 8-K filed on February 2, 2019. As previously disclosed, these notes and warrants are convertible into or exercisable for shares of our common stock. To the extent such notes are converted and such warrants are exercised, additional shares of common stock will be issued, which will result in dilution to the holders of common stock. Upon registration of such shares for resale on the public market, such conversion and exercise will increase the number of shares eligible for resale in the public market. Sales of substantial numbers of such shares in the public trading market could adversely affect the market trading price of the Company’s common stock
We have not registered the shares of common stock issuable upon the conversion of the senior secured convertible promissory notes and upon exercise of the warrants we issued to our investors in connection with our recent private financing transaction under the Securities Act or any state securities laws at this time, and such registration may not be in place when an investor desires to convert such notes or exercise such warrants, thus precluding such investor from selling the conversion and warrant shares on the public market, in violation of our agreements.
We have not registered the shares of common stock issuable upon the conversion of the notes or the exercise of the warrants under the Securities Act or any state securities laws at this time. Under the terms of the registration rights agreements entered into in connection with the financing, we have agreed to file a registration statement under the Securities Act covering such shares and maintain a current prospectus relating to the common stock issuable upon the conversion of the notes and/or exercise of the warrants, until the expiration of the warrants in accordance with the provisions of the agreements with our investors. However, we can offer no assurance that we will be successful in obtaining an effective registration status to cover such issued securities that we will be able to do so if, for example, any facts or events arise which represent a fundamental change in the information set forth in such registration statement or prospectus, the financial statements contained or incorporated by reference therein are not current or correct or regulatory action prevents or delays our registration. These warrants are subject to cashless exercise in an amount representing 100% coverage of the principal balance of the notes upon issuance and are exercisable by the investors six months after the closing date of the financing, but before the fifth year anniversary of the financing. However, no warrant will be exercisable, and we will not be obligated to issue any shares to holders seeking to exercise their warrants, unless the issuance of the shares upon such exercise is registered or qualified under the securities laws of the state of the exercising holder or an exemption is available. If the issuance of the shares upon the conversion of the notes or the exercise of the warrants is not so registered or qualified or exempt from registration or qualification, our investors may declare that we have defaulted on our obligations under the financing agreements. This would entitle our investors to significant remedial rights under the financing agreements. Accordingly, our failure to register the securities issuable upon conversion of the notes and exercise of the warrants may result in a material adverse effect to the Company.
Because we do not intend to pay any cash dividends on our common stock, our stockholders will not be able to receive a return on their shares unless they sell them.
We intend to retain any future earnings to finance the development and expansion of our business. We do not anticipate paying any cash dividends on our common stock in the foreseeable future. Unless we pay dividends, our stockholders will not be able to receive a return on their shares unless they sell them. There is no assurance that stockholders will be able to sell shares when desired.
Our Bylaws contain a forum selection clause which requires our stockholders to bring claims against us in the State of New York as the sole and exclusive forum for the resolution of their claims; our stockholders may be prejudiced by this forum selection clause.
The Company’s choice of the state and federal courts located within the State of New York as the sole and exclusive forum for the resolution of claims brought by our stockholders under the forum selection clause contained in our Bylaws may limit a stockholder’s ability to bring a claim in a judicial forum that it finds favorable for such disputes and may discourage lawsuits with respect to such claims. The Company believes, however, that the choice of New York is beneficial to our stockholders and the Company, as the state and federal courts of New York have considerable experience and familiarity with stockholder derivative type claims and other similar claims which are frequently brought against corporations, which leads to greater consistency in the application of applicable law. The Company’s forum selection clause applies to civil claims and it is our intention that this forum selection clause apply to claims brought under the Securities Act and the Exchange Act to the fullest extent permitted by law.
ITEM 1B. UNRESOLVED STAFF COMMENTS.
As a smaller reporting company subject to scaled disclosure requirements, this item is not applicable to us.PART III
ITEM 2. PROPERTIES.10. DIRECTORS, NAMED EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE.
Office LeasesMANAGEMENT AND THE BOARD OF DIRECTORS
Executive officers of the Company are elected by the Company’s Board of Directors (the “Board” or the “Board of Directors”), and serve for a term of one year and until their successors have been elected and qualified or until their earlier resignation or removal by the Board of Directors. There are no family relationships among any of the directors and named executive officers of the Company. Further, other than executive employment agreements, there is no arrangement or understanding between any director or executive officer and the Company pursuant to which he or she was selected as a director or executive officer. As of December 31, 2018, Christopher Ensey, our former Interim Chief Executive Officer, and Robby Chang, our Chief Financial Officer, had employment agreements in place with the Company rents certain limited office and storage space under short-term arrangements, including office space were its accounting and financial reporting activities are located at 202 6th Street, Suite 401, Castle Rock, CO 80104.
On April 9, 2018, the Company entered into a commercial lease agreement (the “Lease”) with W-Crocker Fin Place Owner VII, LLC, a Delaware limited liability company (the “Landlord”), pursuantrespect to which the Company shall lease approximately 1,694 rentable square feet of office and common area space in Fort Lauderdale, Florida from the Landlord. Pursuant to the terms of the Lease, the initial term shall be for thirty-nine (39) months (the “Lease Term”) expiring on August 09, 2021, with one, five-year option to renew. The initial base rent shall be $4,658.50 per month ($2.75 per sq. ft.) for the first year of the Lease Term and shall escalate at the rate of 3.0% per annum thereafter.
Mining Facility Lease
On February 27, 2018, the Company's wholly-owned subsidiary Kairos Global Technology, Inc., a Nevada corporation (“Tenant”), entered into a lease agreement (the “Lease”) with 7725 Reno #1, LLC, an Oklahoma limited liability company (the “Landlord”), pursuant to which the Tenant is leasing an approximately 107,600 square foot warehouse located in Oklahoma City, Oklahoma, including improvements thereon. Pursuant to the terms of the Lease, the Initial Term of one year shall terminate on February 15, 2019, unless terminated earlier pursuant to the terms of the Lease. Tenant shall have the right to operate from the premises on a 24 hour/seven day a week basis. Provided Tenant is not in default under the Lease, Tenant shall have four one-year renewal options, subject to increases in base rent as provided in the Lease. At least three months, but no more than six months, prior to the expiration of the initial Lease term or renewal term, as applicable, Tenant shall give Landlord written notice of its intent to exercise the applicable renewal option, which also includes incremental payment for additional electric capacity delivery. If Tenant does not elect to exercise a renewal option, all remaining renewal options, if any, shall terminate.
Base rent for the premises during the first 12 months shall be equal to $55.95/kW per month for a total of 4 Megawatts (MW) of available electrical power, or $223,800 per month. Base rent is calculated based upon the monthly electrical power made available to Tenant within the premises, and not based on Tenant's actual usage. Payment of rent commences immediately. In connectiontheir executive officer positions with the Lease, Riot has agreed to guaranty Tenant's failure to make payment of base rent or additional rent pursuant to the Lease. The lease contains an option whereby at the election of the Tenant after the effective date of the Lease, Landlord, at Landlord's expense, agrees to provide additional 12.5 kV transformer equipment to increase the electrical power available for Tenant's use by an additional 2MW. Tenant agrees to pay $55.12/kW for the additional 2MW of power when it is made available and continuing for the remainder of the Initial Term and any Renewal Term(s). Provided that Tenant is not in default under this Lease beyond any applicable notice and cure periods, Tenant may request Landlord to further increase the electrical power available, in increments from 6.01 MW up to 12.0 MW, by giving written notice to Landlord of the requested increase. Landlord, at Landlord's expense, agrees to provide additional 12.5kV electrical transforming equipment to increase the electrical power available for Tenant's use by the additional MW requested by Tenant. Effective as of the date the additional power is made available to Tenant, Base Rent will increase by an amount equivalent to the additional MW requested by Tenant multiplied by $55.12/kW.
On March 26, 2018, Kairos entered into a first amendment to the above lease (the “Lease Amendment”), whereby 7725 Reno agreed to increase the electrical power available for Kairos's use from 6MW to 12MW, and the base rent under the lease was increased to approximately $664,760 per month, effective as of the date when such additional power is available.
Effective as of November 29, 2018, Kairos entered into a second amendment to the lease (the “Second Lease Amendment”), whereby certain provisions of the Lease are amended. The Second Lease Amendment amends the lease by: (i) extending the initial term of the Lease through August 15, 2019; (ii) effective as of December 1, 2018, changing the monthly rent for the Lease as follows: (a) Kairos shall pay $235,000 for December of 2018, (b) $230,000 for January of 2019, and (c) $190,000 per month thereafter for the duration of the Lease, including any renewals; (iii) changing the monthly electricity usage charges due under the Lease as shown in the Second Lease Amendment; (iv) providing that Kairos shall reimburse 7725 Reno for up to $14,000 of the costs of installing electricity metering devices in the leased facility; and (v) providing that, if it is not in default at that time, Kairos shall be have the option to renew the Lease for up to two (2) three (3) month periods after the expiration of the initial term of the Lease.
The Company believes that its leased facilities are adequate for its near-term needs.Company.
The following table sets forth names, ages and positions with the Company for all directors and executive officers of the Company:
ITEM 3. LEGAL PROCEEDINGS.
Name | | Age | | Position |
| | | | |
Remo Mancini | | 67 | | Director, Chairman and Lead Director |
Jason Les | | 33 | | Director |
Benjamin Yi | | 37 | | Director |
Jeffrey McGonegal | | 68 | | Chief Executive Officer |
Robby Chang | | 41 | | Chief Financial Officer and Secretary |
The Company, and its subsidiaries, are subject at times to various claims, lawsuits and governmental proceedings relating to the Company’s business and transactions arising in the ordinary course of business. The Company cannot predict the final outcome of such proceedings. Where appropriate, the Company vigorously defends such claims, lawsuits and proceedings. Some of these claims, lawsuits and proceedings seek damages, including, consequential, exemplary or punitive damages, in amounts that could, if awarded, be significant. Certain of the claims, lawsuits and proceedings arising in ordinary course of business are covered by the Company’s insurance program. The Company maintains property, and various types of liability insurance in an effort to protect the Company from such claims. In terms of any matters where there is no insurance coverage available to the Company, or where coverage is available and the Company maintains a retention or deductible associated with such insurance, the Company may establish an accrual for such loss, retention or deductible based on current available information. In accordance with accounting guidance, if it is probable that an asset Remo Mancini has been impaired or a liability has been incurred as of the date of the financial statements, and the amount of loss is reasonably estimable, then an accrual for the cost to resolve or settle these claims is recorded by the Company in the accompanying consolidated balance sheets. If it is reasonably possible that an asset may be impaired as of the date of the financial statement, then the Company discloses the range of possible loss. Paid expenses related to the defense of such claims are recorded by the Company as incurred and paid and included in the accompanying consolidated statements of operations. Management, with the assistance of outside counsel, may from time to time adjust such accruals according to new developments in the matter, court rulings, or changes in the strategy affecting the Company’s defense of such matters. On the basis of current information, the Company does not believe there is a reasonable possibility that, other than with regard to the Class Action described below, any material loss, if any, will result from any claims, lawsuits and proceedings to which the Company is subject to either individually, or in the aggregate.
On February 17, 2018, Creighton Takata filed an action asserting putative class action claims on behalf of the Company's shareholders in the United District Court for the District of New Jersey, Takata v. Riot Blockchain Inc., et al., Case No. 3: 18-cv-02293. The complaint asserts violations of federal securities laws under Section 10(b) and Section 20(a) of the Securities Exchange Act of 1934 on behalf of a putative class of shareholders that purchased stock from November 13, 2017 through February 15, 2018. The complaint alleges that the Company and certain of its officers and directors made, caused to be made, or failed to correct false and/or misleading statements in press releases and public filings regarding its business plan in connection with its cryptocurrency business. The complaint requests damages in unspecified amounts, costs and fees of bringing the action, and other unspecified relief.
Two additional, nearly identical complaints were subsequently filed by Richard Roys and Bruce Greenawalt in the United District States Court for the Southern District of Florida (Roys v. Riot Blockchain Inc., et al., Case No. 9:18-cv-80225) and the United States District Court for the District of Colorado (Greenawalt v. Riot Blockchain Inc., et al., Case No. 1:18-cv-00440), respectively. On March 27, 2018, the court closed the Roys case for administrative purposes. On April 2, 2018, Mr. Greenawalt filed a notice of voluntary dismissal of his action, which the court entered on the same date.
On April 18, 2018, Joseph J. Klapper, Jr., filed a complaint against Riot Blockchain, Inc., and certain of its officers and directors in the United District Court for the District of New Jersey (Klapper v. Riot Blockchain Inc., et al., Case No. 3: 18-cv-8031). The complaint contained substantially similar allegations and the same claims as those filed by Mr. Takata, and requests damages in unspecified amounts, costs and fees of bringing the action, and other unspecified relief. On November 6, 2018, the court in the Takata action issued an order consolidating Takata with Klapper into a single putative class action. The court also appointed Dr. Golovac as Lead Plaintiff and Motely Rice as Lead Counsel of the consolidated class action.
Lead Plaintiff filed a consolidated complaint on January 15, 2019. Defendants filed motions to dismiss on March 18, 2019. The briefing on the motions to dismiss will be completed in June 2019. Subject to the outcome of the pending motions, defendants intend to continue to vigorously contest Lead Plaintiff’s allegations. Because this litigation is still at this early stage, we cannot reasonably estimate the likelihood of an unfavorable outcome or the magnitude of such an outcome, if any.
Shareholder Derivative Cases
On April 5, 2018, Michael Jackson filed a shareholder derivative complaint on behalfdirector of the Company since February 2018. Mr. Mancini is a professional corporate director with significant experience at senior levels in both government and the private sector. He served in the Supreme CourtLegislative Assembly of Ontario, Canada (Liberal Party member) from 1975-1993. During this time Mr. Mancini held a number of notable positions including Minister of Revenue, Parliamentary Assistant to the Premier, Official Opposition Party House Leader, and Chairman of the StatePublic Accounts Committee. He has earned the internationally recognized designation of New York, County of Nassau, against certainICD.D and is a graduate of the Company's officersDirectors Education Program offered by the Institute of Corporate Directors and directors,the University of Toronto's Rotman School of Management. He has served on a number of boards of both publicly listed and private companies. The public companies for which he has served include the following:
Melior Resources Inc. (TSX-V) | February 2013 to March 2014 |
Estrella Int. Energy Services Inc. (TSX-V) | June 2010 to March 2016 |
Niocan Inc. (TSX and TSX-V) | June 2007 to June 2018 |
This extensive experience in both the public and private sectors positions him to lead organizations, offer insightful and decisive management guidance, and board leadership. He combines his experience as well as against an investor (Jackson v. Riot Blockchain, Inc., et al., Case No. 604520/18). The complaint contains similar allegationsa former Canadian and U.S. senior corporate executive, corporate director and former Ontario Cabinet Minister to those contained in the shareholder class action complaints and seeks recovery for alleged breaches of fiduciary duty, unjust enrichment, waste of corporate assets, abuse of control and gross mismanagement. The complaint seeks unspecified monetary damagesbring a valuable perspective to business affairs, senior executive management, and corporate governance changes. At the preliminary conference, the court adjourned the conference until September 9, 2019 in lieu of staying the action. Defendants do not anticipate any other activity on this case until the next preliminary conference.governance.
On May 22, 2018, two additional shareholder derivative complaints were filed on behalfJason Les has served as a Director of the Company since November 2017. He is a certified Bitcoin developer and participates extensively in the Eighth Judicial District CourtBitcoin development community. Mr. Les is a contributor to open source development for Bitcoin related software and has been selected by various media outlets as a commentator on Bitcoin. Mr. Les is lead technical consultant to CoinCentral.com, a popular Bitcoin and cryptocurrency news source and is a producer of technical Bitcoin education materials. Additionally, he is an active participant in cryptocurrency mining social networks and has operated a personal mining operation for the past 18 months. Mr. Les played professional poker for over ten years where he has been regarded as one of the Statebest in the game and twice selected as the human benchmark to test artificial intelligence in “Man vs Machine” at Carnegie Mellon University. After extensively studying game theory, Mr. Les developed mathematical models that were used to construct an approximation of Nevada in anda Nash equilibrium strategy for poker that was the Countyfoundation of Clark (Kish v. O'Rourke, et al., Case No. A-18-774890-B & Gaft v. O'Rourke, et al., Case No. A-18-774896-8). The two complaints make identical allegations, which are similarhis playing prior to transitioning to the allegations containedBitcoin industry after gaining interest in Bitcoin in 2013. Mr. Les graduated from U.C. Irvine in 2010 with a B.S. in Information and Computer Science. Mr. Les is qualified as a director based on the fact that he has been active in the shareholder class action complaints. The shareholder derivative plaintiffs also seek recovery for alleged breaches of fiduciary duty, unjust enrichment, waste of corporate assets,cryptocurrency industry and aiding abetting a breach of fiduciary duty. The complaints seek unspecific monetary damagesbrings technical expertise regarding cryptocurrency mining, protocol development, and corporate governance changes.
On September 24, 2018, the court entered an order consolidating the Gaft and Kish actions, which is now styled as In re Riot BlockChain, Inc. Shareholder Derivative Litigation, Case No. A-18-774890-B. The plaintiffs filed a consolidated complaint on March 15, 2019. The consolidated action has been temporarily stayed until the resolutiongeneral evaluation of the motion(s) to dismiss in the securities class action pending in the United District Court for the District of New Jersey.industry.
On October 9, 2018, another shareholder derivative complaint was filed on behalfBenjamin Yi has been serving as a Director of the Company since October 2018. Mr. Yi is a CFA charter holder and holds a Master of Finance degree from the Rotman School of Management at the University of Toronto. Mr Yi is a valuable addition to the Board of Directors, as he brings over a decade of dedicated financial markets experience to the Company, and will leverage his expertise in capital markets and corporate development to continue to drive the United District Court for the Eastern District of New York (Rotkowitz v. O'Rourke, et al., Case No. 2:18-cv-05632). As with the other shareholder derivative actions, the shareholder plaintiff alleges breach of fiduciary duty, waste of corporate assets, and unjust enrichment against certaingrowth of the Company's officers, directors, andCompany. Mr. Yi previously served as an investor. The complaint's allegations are substantially similar to those made in the other securities class action and shareholder derivative complaints filed in 2018. The complaint seeks unspecific monetary damages and corporate governance changes. The parties filedindependent director of PetroMaroc Corporation plc, as a motion with the court to temporarily stay this action until the resolutionmember of the motion(s) to dismiss in the securities class action pending in the United District Court for the District of New Jersey. In response, the court dismissed the action without prejudice with leave to refileboard and as a complaint following the resolutionmember of the motion(s) to dismiss inAudit Committee of Android Industries, LLC, and as an independent director and member of the securities class action pending inAudit Committee of Woulfe Mining Corporation where he also served as the United District Courtchairman of the Audit Committee for the Districta period of New Jersey.time.
On October 22, 2018, a fifth shareholder derivative complaint Jeffrey G. McGonegal was filed on behalfappointed Chief Executive Officer as of February 6, 2019. He previously served as Chief Financial Officer of the Company in the United District Court for the Southern District of New York (Finitz v. O'Rourke, et al., Case No. 1: 18-cv-09640). The shareholder plaintiffs allege breach of fiduciary duty, waste of corporate assets, and unjust enrichment against certain offrom June 2003 to February 27, 2018, subsequently serving as the Company's officers, directors, and an investor. The complaint's allegations are substantially similarPrincipal Accounting Officer to those made inApril 30, 2018 to sign the other securities class action and shareholder derivative complaints filed in 2018. The complaint seeks unspecific monetary damages and corporate governance changes. Upon the parties' stipulation, the court issued an order temporarily staying this action until the resolution of the motion(s) to dismiss in the securities class action pending in the United District Court for the District of New Jersey.
Defendants intend to vigorously contest plaintiffs’ allegations in the shareholder derivative actions and plaintiffs’ right to bring the action in the name of Riot Blockchain. But because the above litigation is still in the early stages, we cannot reasonably estimate the likelihood of unfavorable outcomes or the magnitude of such an outcomes, if any.
SEC Subpoena and Communications
On April 9, 2018, the Company received a subpoena from the SEC requesting documents. We have and intend to fully cooperate with the SEC inquiry.
During 2018 the Company received several comment letters (the “Comment Letters”) from the Division of Corporation Finance and the Division of Investment Management of the Securities and Exchange Commission (“SEC”). The Comment Letters have been issued on the Company’s periodic reports on Form 10-Q for the quarter ended March 31, 2018,Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2017, and to provide all certifications required including under Section 302 of the Sarbanes Oxley Act of 2002. He was appointed Corporate Secretary in January 2010 through April 30, 2018, and served as interim President in December 2004 and January 2005. Subsequent to April 30, 2018, Mr. McGonegal served as a consultant to the Company. From 1974 to 1997, Mr. McGonegal was an accountant with BDO Seidman LLP. While at BDO Seidman LLP, Mr. McGonegal served as Managing Partner of the Denver, Colorado office. He received a B.S. degree in accounting from Florida State University.
Robby Chang has served as our Chief Financial Officer since February 2018. Mr. Chang was employed by Cantor Fitzgerald from 2011-2018 as Managing Director, Senior Analyst, and Head of Metals & Mining. Previously, Mr. Chang held various positions as Institutional Equity Research Analyst and Director, Research and Trading, and Portfolio Manager for several financial companies. While at Cantor Fitzgerald, he provided research coverage in precious metals, base metals, lithium, and uranium. He was recognized by Bloomberg as the “Best Precious Metals Analyst” in Q1 2016. Mr. Chang has been frequently quoted by and has been a regular guest of several media outlets including: Bloomberg, Reuters, CNBC, and the Wall Street Journal. Mr. Chang has 23 years of experience in the financial services industry including as Director of Research/Portfolio Manager at a Canadian investment firm that managed $3 billion in assets and serving on a five-person multi-strategy hedge fund team for Blair Franklin Capital Partners where he specialized in equity and derivative investments. Mr. Chang holds a Master of Business Administration from the University of Toronto. Mr. Chang does not maintain a certified public accounting license or have experience in public accounting, which present risks to the Company and requires that we utilize outside services for review and preparation of our financial statements and reports. Mr. Chang brings technical expertise regarding institutional portfolio investing and relations and valuation skills applicable to comparable non cryptocurrency mining operations which we believe are valuable but necessarily require we incur additional costs associated with regulatory compliance and SEC reporting.
Corporate Governance Policies and Code of Ethics
We have adopted a Standard of Ethics and Business Conduct, Corporate Governance Guidelines. Those policies are available on our website at www.riotblockchain.com and in print to any stockholder upon request at no charge. Requests should be addressed to: Riot Blockchain, Inc., 202 6th Street, Suite 401, Castle Rock, Colorado 80104.
The Standards of Ethics and Business Conduct is applicable to all directors, officers and employees of Riot. To date, there have been no waivers under our Standards of Ethics and Business Conduct. We intend to disclose future amendments to or waivers from our Standards of Ethics and Business Conduct on our website within four business days following the date of such amendment or waiver.
Independence of Directors
The Company’s Board is currently comprised of three independent directors: (i) Mr. Remo Mancini; (ii) Mr. Jason Les; and (iii) Mr. Benjamin Yi. Mr. Mancini serves as Chairman of the Board.
The Board, upon recommendation of the Nominating and Corporate Governance Committee, unanimously determined that each of our three non-employee directors is “independent,” as such term is defined in the Nasdaq Stock Market Rules (“Stock Market Rules”).
The definition of “independent director” included in the Stock Market Rules includes a series of objective tests, such as whether the director is an employee of the Company, whether the director has engaged in various types of specified business dealings with the Company, and whether the director has an affiliation with an organization that has had specified business dealings with the Company. Consistent with the Company's Corporate Governance Principles, the Board's determination of independence is made in accordance with the Stock Market Rules, as the Board has not adopted supplemental independence standards. As required by the Stock Market Rules, the Board also has made a subjective determination with respect to each director that such director has no material relationship with the Company (either directly or as a partner, stockholder or officer of an organization that has a relationship with the Company), even if the director otherwise satisfies the objective independence tests included in the definition of an “independent director” included in the Stock Market Rules.
In determining that each individual who served as a member of the Board is independent, the Board considered that, in the ordinary course of business, transactions may occur between the Company and entities with which some of our directors are affiliated. The Board unanimously determined that such transaction occurring in the ordinary course of business with members of the Board were not material. No unusual discounts or terms were extended to members of the Board by the Company in any such transactions.
Board Leadership Structure
The Board believes that the Company's stockholders are best served if the Board retains the flexibility to adapt its leadership structure to applicable facts and circumstances, which necessarily change over time. Accordingly, the Company's Corporate Governance Principles provide that the Board may combine or separate the roles of the CEO and Chairman of the Board, and it may suspend, dissolve and form separate committees of the Board as it deems advisable and in the best interests of the Company and its stockholders.
Board Role in Risk Oversight
The Company's Board plays an active role in risk oversight of the Company. The Board does not have a formal risk management committee, but administers this oversight function through various standing committees of the Board, which are described below. The Audit Committee periodically reviews overall enterprise risk management, in addition to maintaining responsibility for oversight of financial reporting-related risks, including those related to the Company's accounting, auditing and financial reporting practices. The Audit Committee also reviews reports and considers any material allegations regarding potential violations of the Company's Code of Ethics. The Compensation Committee oversees risks arising from the Company's compensation policies and programs. This Committee has responsibility for evaluating and approving the executive compensation and benefit plans, policies and programs of the Company. The Nominating Committee oversees corporate governance risks and oversees and advises the Board with respect to the Company's policies and practices regarding significant issues of corporate responsibility.
The Board of Directors has a process for stockholders to communicate with directors. Stockholders should write to the Chief Executive Officer of the Company at the Company's mailing address and specifically request that a copy of the letter be distributed to a particular Board member or to all Board members. Where no such specific request is made, the letter will be distributed to Board members if material, in the judgment of the President, to matters on the Board's agenda.
Committees of the Board
Our Board has three standing committees: Audit, Compensation, and Nominating and Corporate Governance. Each of the committees is solely comprised of and chaired by independent directors, each of whom the Board has affirmatively determined is independent pursuant to the Stock Market Rules. Each of the committees operates pursuant to its charter. The committee Charters are reviewed annually by the Nominating and Corporate Governance Committee. If appropriate, and in consultation with the chairs of the other committees, the Nominating and Corporate Governance Committee proposes revisions to the charters. The responsibilities of each of the standing committees of the Board are described in more detail below. The charters for the three committees are available on the Company's website at www.riotblockchain.com by following the link to “Investor Relations” and then to “Governance.”
Director | | Audit Committee | | Compensation Committee | | Nominating and Corporate Governance Committee | | Independent |
Remo Mancini | | Member | | Member | | Chairman | | Yes |
Benjamin Yi | | Chairman | | Member | | Member | | Yes |
Jason Les | | Member | | Chairman | | Member | | Yes |
Audit Committee
The Audit Committee is responsible for, among other things:
| ● | appointing; approving the compensation of; overseeing the work of; and assessing the independence, qualifications, and performance of the independent auditor; |
| ● | reviewing the internal audit function, including its independence, plans, and budget; |
| ● | approving, in advance, audit and any permissible non-audit services performed by our independent auditor; |
| ● | reviewing our internal controls of accounting and financial reporting with the independent auditor and management; |
| ● | reviewing the adequacy of our accounting and financial controls as reported by the independent auditor and management; |
| ● | overseeing our financial compliance system; and |
| ● | overseeing our major risk exposures regarding our accounting and financial reporting policies, the activities of our internal audit function, and information technology. |
The Audit Committee has reviewed and discussed the Company's audited financial statements for the year ended December 31, 2018 with management of the Company and has discussed with our independent auditors, Marcum LLP, the matters required to be discussed by the statement on Public Company Accounting Oversight Board Auditing Standard No. 1301, Communications with Audit Committees, and No. 2410, Related Parties.. The Audit Committee agreed with Marcum, LLP’s assessment of our 2018 financials and our internal controls over financial reporting and The Board has affirmatively determined that each member of the Audit Committee meets the additional independence criteria applicable to audit committee members under SEC rules and the Stock Market Rules. The Board has adopted a written charter setting forth the authority and responsibilities of the Audit Committee. The Board has affirmatively determined that Remo Mancini meets the qualifications of an Audit Committee financial expert. The entire Board serves on the Audit Committee and, accordingly, the membership of the Audit Committee is comprised of: (i) Benjamin Yi, (ii) Remo Mancini, and (iii) Jason Les. Mr. Yi serves as Chairman of the Audit Committee.
Compensation Committee
The Compensation Committee is responsible for, among other things:
| ● | reviewing and making recommendations to the Board with respect to the compensation of the Company’s officers and directors, including the CEO; |
| ● | overseeing and administering the Company's executive compensation plans, including equity-based awards; |
| ● | negotiating and overseeing employment agreements with officers and directors; and |
| ● | overseeing how the Company's compensation policies and practices may affect the Company's risk management practices and/or risk-taking incentives. |
The Board has adopted a written charter setting forth the authority and responsibilities of the Compensation Committee.
When evaluating the compensation of our executive officers, the Compensation Committee evaluates factors including the executive's responsibilities, experience and the competitive marketplace. The Compensation Committee may also invite the senior executives and other members of management to participate in their deliberations, or to provide information to the Compensation Committee for its consideration with respect to such deliberations, except that the Chief Executive Officer may not be present for the deliberation of or the voting on compensation for the Chief Executive Officer. The Chief Executive Officer may, however, be present for the deliberation of or the voting on compensation for any other officer.
The Compensation Committee has authority to retain such compensation consultants, outside counsel and other advisors as the Compensation Committee in its sole discretion deems appropriate. The Company's Compensation Committee currently consists of the following members: (i) Benjamin Yi, (ii) Remo Mancini and (iii) Jason Les. Mr. Les serves as Chairman of the Compensation Committee. The Board has affirmatively determined that each member of the Compensation Committee meets the additional independence criteria applicable to compensation committee members under the Stock Market Rules.
Nominating and Corporate Governance Committee
The Nominating and Corporate Governance Committee is responsible for, among other things:
| ● | reviewing and assessing the development of the executive officers, and considering and making recommendations to the Board regarding promotion and succession issues; |
| ● | evaluating and reporting to the Board on the performance and effectiveness of the directors, committees, and the Board as a whole; |
| ● | working with the Board to determine the appropriate and desirable mix of characteristics, skills, expertise, and experience, including diversity considerations, for the full Board and each committee; |
| ● | annually presenting to the Board a list of individuals recommended to be nominated for election to the Board; |
| ● | reviewing, evaluating, and recommending changes to the Company's Corporate Governance Principles and committee Charters; |
| ● | recommending to the Board individuals to be elected to fill vacancies and newly created directorships; |
| ● | overseeing the Company's compliance program, including the Code of Conduct; and |
| ● | overseeing and evaluating how the Company's corporate governance and legal and regulatory compliance policies and practices, including leadership, structure, and succession planning, may affect the Company's major risk exposures. |
The Board of Directors has adopted a written charter setting forth the authority and responsibilities of the Corporate Governance/Nominating Committee. The Company's Nominating and Corporate Governance Committee currently consists of the following members: (i) Benjamin Yi, (ii) Remo Mancini, and (iii) Jason Les. Mr. Mancini serves as Chairman of the Nominating and Corporate Governance Committee.
Section 16(a) Beneficial Ownership Reporting Compliance
Section 16(a) of the Securities Exchange Act of 1934 requires the Company's directors, executive officers, and stockholders who own more than 10% of the Company's stock to file forms with the SEC to report their ownership of the Company's stock and any changes in their ownership of our securities. The Company assists its directors and executives by identifying reportable transactions of which it is aware and preparing and filing the forms on their behalf. All persons required to file forms with the SEC must also send copies of the forms to the Company. We have reviewed all forms provided to us. Based on that review and on written information given to us by our executive officers and directors, we believe that all Section 16(a) filings during the past fiscal year were filed on a timely basis and that all directors, executive officers and 10% beneficial owners have fully complied with such requirements during the past fiscal year.
Meetings of the Board
Board of Directors: The Company's Board of Directors held twenty-one meetings and acted by written consent twenty-five times during the year ended December 31, 2018. Such formal meetings of the Board of Directors consisted of meetings at which a quorum of the directors were present in person or by telephone. The Board of Directors also met informally throughout the year and took action by unanimous written consent of the entire Board of Directors. The Company does not have a formal policy with regard to board members' attendance at annual meetings, but encourages them to attend shareholder meetings. Each Board member then serving attended our most recent Annual Meeting of Shareholders held on June 15, 2018.
ITEM 11. EXECUTIVE COMPENSATION.
Summary Compensation Table
This table provides disclosure, for fiscal years 2018 and 2017 for the Named Executive Officers, who are or who were the Chief Executive Officer and the Chief Financial Officer of the Company.
Name and Principal Position | | Year | | Salary | | | Bonus ($) | | | Stock Awards (6) ($) | | | Option Awards (7) ($) | | | All Other Compensation ($) | | | Total ($) | |
| | | | | | | | | | | | | | | | | | | | |
Christopher Ensey | | 2018 | | $ | 248,208 | | | $ | — | | | $ | 859,660 | | | $ | 701,970 | | | $ | 5,845 | | | $ | 1,815,683 | |
Interim Chief Executive Officer (1) | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | |
Robby Chang | | 2018 | | $ | 210,256 | | | $ | — | | | $ | 646,680 | | | $ | — | | | $ | 4,370 | | | $ | 861,306 | |
Chief Financial Officer (2) | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | |
Jeffrey Vormittag | | 2018 | | $ | 213,173 | | | $ | 25,000 | | | $ | 584,400 | | | $ | — | | | $ | 4,247 | | | $ | 826,820 | |
Chief Operating Officer (3) | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | |
Jeffrey G. McGonegal, | | 2018 | | $ | 272,005 | | | $ | 70,000 | | | $ | — | | | $ | 45,017 | | | $ | 13,632 | | | $ | 400,654 | |
Chief Financial Officer (former) (4) | | 2017 | | $ | 272,005 | | | $ | 140,000 | | | $ | 127,800 | | | $ | — | | | $ | 169,843 | | | $ | 709,648 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | |
John O'Rourke III | | 2018 | | $ | 206,500 | | | $ | — | | | $ | — | | | $ | — | | | $ | 920 | | | $ | 207,420 | |
Chief Executive Officer (former) (5) | | 2017 | | $ | 50,000 | | | $ | — | | | $ | — | | | $ | 609,742 | | | $ | — | | | $ | 659,742 | |
___________________________(1) Effective January 28, 2018, Mr. Ensey was named Chief Operating Officer at an annual base salary of $250,000 and, effective September 8, 2018, he was named the Interim Chief Executive Officer with his annual compensation increased to $306,000. The amounts included in “All Other Compensation” for Mr. Ensey represent a $3,000 relocation expense allowance paid under the terms of his original employment agreement and $2,845 for amounts paid to or on his behalf for medical insurance in 2018. Mr. Ensey’s Executive Employment Agreement was terminated without cause as of February 5, 2019, thereby terminating his roles as Interim Chief Executive Officer and Chief Operating Officer of the Company.
(2) Effective February 27, 2018, Mr. Chang was named Chief Financial Officer at an annual base salary of $250,000. The amounts included in “All Other Compensation” for Mr. Chang represent a $3,000 office allowance expense paid under the terms of his employment agreement and $1,370 for amounts paid to or on his behalf for medical insurance in 2018.
(3) Effective January 20, 2018, Mr. Vormittag was named Chief Operating Officer of a wholly owned subsidiary of the Company at an annual base salary of $225,000. Upon execution of the original employment agreement, Mr. Vormittag was entitled to and paid a $25,000 signing bonus. The amounts included in “All Other Compensation” for Mr. Vormittag represent $4,247 for amounts paid to or on his behalf for medical insurance in 2018. Mr. Vormittag’s Executive Employment Agreement was terminated without cause as of February 6, 2019, terminating his role as Chief Operating Officer of our wholly-owned subsidiary, Riot Blockchain Canada, Inc.
(4) Mr. McGonegal served as Chief Financial Officer until February 27, 2018, and thereafter as Principal Accounting Officer until April 30, 2018. Subsequent to April 30, 2018, Mr. McGonegal served in a consulting role. During 2018 his aggregate annual compensation was $272,005. During the first quarter of 2018 Mr. McGonegal was awarded a performance bonus of $70,000 and during 2017 he was awarded a performance bonus and a retention bonus which in total amounted to $140,000. The amounts included in “All Other Compensation” for Mr. McGonegal represent a one-time payment of $150,013 paid in 2017 to Mr. McGonegal for his agreement to waive his rights to stock options and unvested restricted common share rights and the amounts paid to or on his behalf for medical insurance at a total cost of $13,632 and $19,830 in 2018 and 2017, respectively. Effective February 6, 2019, Mr. McGonegal was named Chief Executive Officer of the Company.
(5) Effective October 9, 2017, Mr. O’Rourke was named President of the Company at an annual base salary of $120,000 and as of November 3, 2017 to the additional office of Chief Executive Officer, with a revised annual base salary of $300,000. The amounts included in “All Other Compensation” for Mr. O’Rourke represent $920 for amounts paid to or on his behalf for medical insurance in 2018.Mr. O’Rourke has also served as a director of the Company since January 6, 2017 and received additional compensation for Board service as further disclosed under Item 11, Director Compensation. Mr. O’Rourke resigned as of September 8, 2018.
(6) The “Stock Awards” columns reflect the aggregate grant date fair value for restricted stock awards granted during fiscal years 2018 and 2017, computed in accordance with FASB ASC Topic 718. See Note 11 to our consolidated financial statements reported in our Annual Report on Form 10-K/A10-K for our fiscal year ended December 31, 2018 for details as to the assumptions used to determine the grant date fair value of the restricted stock awards.
(7) The “Option Awards” columns reflect the grant date fair value for all stock option awards granted under the 2002 Stock Plan or the Riot Blockchain, Inc. 2017 Equity Incentive Plan (the “2017 Plan”) during 2018 and 2017. These amounts are determined in accordance with FASB Accounting Standards Codification 718 (ASC 718), without regard to any estimate of forfeiture for service vesting. Assumptions used in the calculation of the amounts in these columns for 2018 and 2017 are included in footnote 11 to the Company's audited financial statements for the fiscal year ended December 31, 2017 and current report2018 included in the Company's Annual Report on Form 8-K filed October 4, 2017. The comments raise matters related to, among other things, the unsettled nature of accounting treatment10-K for the Company’s digital currency miningyear ended December 31, 2018, as amended.
Outstanding Equity Awards at Fiscal Year End
The following table shows the outstanding equity awards held by the Named Executive Officers as of December 31, 2018:
| | Option Awards | | Restricted Stock Awards | |
Named Executive | | Number of Securities Underlying Unexercised Options Exercisable | | | Number of Securities Underlying Unexercised Options Unexercisable | | | Equity Incentive Plan Awards: Number of Securities Underlying Unexercised Unearned Options | | | Option Exercise Price | | | Number of Stock Options Held at Fiscal Year-End | | Option Expire Date | | Number of Shares or Units of Stock That Have Not Vested | | | Market Value of Shares or Units of Stock That Have Not Vested | | | Number of Shares of Restricted Stock Held at Fiscal Year-End | |
Officer | | | (#) | | | | (#) | | | | (#) | | | ($) | | | | (#) | | ($) | | | (#) | | | ($) | | | | (#) | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Christopher Ensey (1) | | | 45,833 | | | | 4,167 | | | | -- | | | $ | 18.50 | | | | 50,000 | | 27-Jan-28 | | | 27,084 | | | $ | 40,897 | | | | 46,916 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Robby Chang (2) | | | -- | | | | -- | | | | -- | | | | -- | | | | -- | | | | | 35,000 | | | $ | 52,850 | | | | 37,000 | |
__________
(1) Includes options to purchase: 50,000 at $18.50 per share granted on January 28, 2018, vesting monthly at a rate of 1/12 of such shares per month, starting one month after the grant date issued in connection with signing an employment agreement. Also includes 50,000 restricted common shares awarded in connection with signing an employment agreement at a value of $15.23 on the date of award, January 28, 2018, which shares vest monthly at a rate of 1/24 of such shares per month, starting one month after the grant date, with 22,916 vested but unissued shares accrued as of December 31, 2018. Also includes 24,000 restricted common shares awarded at a value of $4.09 on the date of award, September 20, 2018, 100% of which vested as of the date of the grant, with 24,000 of such shares vested but unissued as of December 31, 2018.
(2) Includes 60,000 restricted common shares awarded at a value of $9.96, on February 27, 2018, 2017, in connection with signing an employment agreement, vesting monthly at a rate of 1/24 of such shares per month, starting one month after the grant date, with 25,000 vested but none issued as of December 31, 2018. Also includes 12,000 restricted common shares awarded at a value of $4.09, on September 20, 2018, 100% vested at grant date, with 12,000 vested but not issued as of December 31, 2018.
Employment Agreements
The Company has entered into employment agreements with, and provides post-employment benefits to, its Named Executive Officers as follows:
Christopher Ensey, Interim Chief Executive Officer – On September 8, 2018 we entered into an amended employment agreement with Mr. Ensey to serve as Interim Chief Executive Officer at an annual base salary of $306,000. This agreement amended the fair value method selectedoriginal employment agreement dated January 28, 2018, entered into by the Company (as opposedwith Mr. Ensey to intangible accounting methods proposed by some experts)serve as Chief Operating Officer at an annual base salary of $250,000. The employment agreement, as amended, with Mr. Ensey provided for an initial term of two years and applicabilityprovides for (i) a restricted stock award of 50,000 shares of common stock which shall vest in 24 equal monthly installments beginning one month from the date of issuance and (ii) an option to the Companypurchase up to 50,000 shares of the Investment Company ActCompany's common stock which shall vest in 12 equal monthly installments beginning one month from the date of 1940, particularlyissuance, at an exercise price of $18.50 per share of common stock, which options are fully vested and which expire 90 days after his termination. Mr. Ensey’s Executive Employment Agreement was terminated without cause as relatesof February 5, 2019, terminating his roles as Interim Chief Executive Officer and Chief Operating Officer; accordingly, his options will terminate on May 6, 2019.
Robby Chang, Chief Financial Officer – On February 27, 2018, we entered into an employment agreement with Mr. Chang to serve as Chief Financial Officer at an annual base salary of $250,000. The employment agreement with Mr. Chang provided for an initial term of two years and provides for (i) a restricted stock award of 60,000 shares of common stock which shall vest in 24 equal monthly installments beginning one month from the Company’s minority interest in goNumerical, Inc. a/k/a Coinsquare. The Company continues to engage in conversations with the staffdate of the Division of Enforcement, Division of Investment Management, Division of Corporation Finance, and Office of the Chief Accountant regarding the issues raised in the comment letters.issuance.
Post-Employment Benefits
On July 30, 2018,The following table discloses the Company received a letter from the SEC (the “Letter”)post-employment termination benefits that the Commission has issued an Order Directing Examination and Designating Officers Pursuant to Section 8(e) of the Securities Act of 1933 with respect to the following registration statements: (1) a Form S-8 filed on July 19, 2017 (File No. 333-219357); (2) a Form S-3 initially filed January 5, 2018 and subsequently amended on February 7, 2018 (File No. 333-222450); and (3) a Form S-3 filed on July 10, 2018 (File No. 333-226111). The Letter stated, “while the Section 8(e) examination is pending, the Division of Corporation Finance will not take any further action on the Registration Statements, and all communications with regard to the Registration Statements and the Section 8(e) examination should be made to the Commission’s Division of Enforcement.”
On October 12, 2018, the Company filed for withdrawal of the Form S-3 registration statement initially filed on January 5, 2018 and amended on February 7, 2018 (File No. 333-222450); and terminated the Form S-8 registration statement filed on July 19, 2017 (File No. 333-219357).
On October 22, 2018, the Company was notified by SEC staff that the SEC had terminated the Section 8(e) examination with respect to the above-referenced registration statements. The previously disclosed SEC investigation associated with the subpoenawould have been received by the CompanyNamed Executive Officers if a termination event had occurred on April 9,December 31, 2018:
Named Executive Officer / Benefit | | Termination without Cause ($) | | | Death or Disability ($) | | | Change in Control (Single Trigger) ($) | | | Change in Control (Double Trigger) (1) ($) | |
| | | | | | | | | | | | |
Christopher Ensey: | | | | | | | | | | | | |
Severance | | | 153,000 | | | | 153,000 | | | | - | | | | 153,000 | |
Restricted Common Shares | | | - | | | | - | | | | - | | | | 40,897 | |
Options | | | - | | | | - | | | | - | | | | - | |
Total | | | 153,000 | | | | 153,000 | | | | - | | | | 193,897 | |
| | | | | | | | | | | | | | | | |
Robby Chang: | | | | | | | | | | | | | | | | |
Severance | | | 125,000 | | | | - | | | | - | | | | 125,000 | |
Restricted Common Shares | | | - | | | | - | | | | - | | | | 52,850 | |
Options | | | - | | | | - | | | | - | | | | - | |
Total | | | 125,000 | | | | - | | | | - | | | | 177,850 | |
__________
(1) Under the Change in Control Policy upon consummation of a Change in Control (as defined in the 2017 Plan) any unvested restricted shares of common stock and stock options held by a Named Executive Officer accelerate and vest upon the consummation of a Change in Control. This column shows the value of unvested restricted shares of common stock and stock options that would have been received upon acceleration of unvested equity rights as of December 31, 2018. The closing price of the Company's common stock on December 31, 2018 is still ongoing. The SEC has continued to request information from the Company and the Company has been fully cooperating with the SEC in that investigation.was $1.51 per share.
Beneficial OwnershipDirector Compensation
PursuantThe following table shows the total compensation paid or accrued during the year ended December 31, 2018 to the rules of the Securities and Exchange Commission (the “SEC”), the Company has consistently reported its beneficial ownership positions in its proxy and other filings where beneficial ownership disclosures are presented, for certain beneficial owners with respect to any person (including any “group” as that term is used in section 13(d)(3) of the Securities and Exchange Act of 1934 (the “Exchange Act”) who is known to the Company to be the beneficial owner of more than 5% of the Company’s common stock. The Company has relied on each person who has reported to the SEC beneficial ownership of more than 5% of our common stock to provide completedirectors, current and accurate information regarding their ownership, based on the reports filed by these persons.former, for services as our director:
Name | | Cash Fees ($) | | | Stock Awards (6) ($) | | | Option Awards ($) | | | Total ($) | |
| | | | | | | | | | | | |
Remo Mancini (1) | | | 85,009 | | | | 619,860 | | | | - | | | | 704,869 | |
Jaeon Les (2) | | | 46,160 | | | | 108,630 | | | | - | | | | 154,790 | |
Benjamin Yi | | | 10,688 | | | | - | | | | - | | | | 10,688 | |
Andrew J. Kaplan (3) | | | 32,489 | | | | 108,630 | | | | - | | | | 141,119 | |
John O'Rourke (4) | | | 2,000 | | | | - | | | | - | | | | 2,000 | |
Eric So (5) | | | 2,000 | | | | - | | | | - | | | | 2,000 | |
On September 7, 2018, a complaint was filed by the SEC (Case 1:18-cv-08175) (the “Complaint”) against, among others, a number of individuals and entities some of whom the Company has previously disclosed as its beneficial owners, as well as, Mr. John O’Rourke III, the Company’s former chairman of the board of directors and chief executive officer who resigned from the Company on September 8, 2018, as disclosed in the Current Periodic Report on Form 8-K filed September 10, 2018. Other persons named in the Complaint have previously reported that they were beneficial owners of the Company’s common stock, however, the Company has no basis to determine whether any such persons may have operated as a control group, collectively beneficially owning more than 5% of the Company’s common stock.
Other Actions(1) Stock awards include 45,000 restricted common shares awarded at a value of $10.27, on February 23, 2018, vesting 50% at date of award and the balance on the six-month anniversary of grant. Also includes 7,500 restricted common shares awarded at a value of $7.94, on March 21, 2018, vesting monthly at a rate of 1/6 of such shares per month, starting one month after the grant date. Also includes 24,000 restricted common shares awarded at a value of $4.09, on September 20, 2018, vested 100% at date of grant.
On May 31,(2) Stock awards include 7,500 restricted common shares awarded at a value of $7.94, on March 21, 2018, M. Reese Everson filedvesting monthly at a direct action againstrate of 1/6 of such shares per month, starting one month after the grant date. Also includes 12,000 restricted common shares awarded at a value of $4.09, on September 20, 2018, vested 100% at date of grant.
(3) Stock awards include 7,500 restricted common shares awarded at a value of $7.94, on March 21, 2018, vesting monthly at a rate of 1/6 of such shares per month, starting one month after the grant date. Also includes 12,000 restricted common shares awarded at a value of $4.09, on September 20, 2018, vested 100% at date of grant. Mr. Kaplan resigned from his position as a director of the Company effective as of October 22, 2018.
(4) Compensation paid to Mr. O’Rourke’s is for fees for Board service in January 2018 and February 2018. Also see Item 11, Executive Compensation. Mr. O’Rourke resigned from his position as a director of the United District CourtCompany effective as of September 8, 2018.
(5) Mr. So resigned from his position as a director of the Company effective as of February 16, 2018.
(6) The “Stock Awards” columns reflect the aggregate grant date fair value for restricted stock awards granted during fiscal years 2018, computed in accordance with FASB ASC Topic 718. See Note 11 to our consolidated financial statements reported in our Annual Report for details as to the Districtassumptions used to determine the grant date fair value of Columbia (Everson v. Riot Blockchain Inc., Case No. 1: 18-cv-01292-CRC). the restricted stock awards.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCK HOLDER MATTERS.
The complaint alleges thatfollowing table sets forth certain information, as of April 22, 2019, based upon 14,762,809 shares of common stock issued and outstanding, with respect to the beneficial ownership of the outstanding common stock by (i) any person know to us to beneficially own more than five (5%) percent; (ii) each of the Company's Proposal 4 includednamed executive officers and directors; and (iii) the Company's directors and executive officers as a group. Beneficial ownership is determined in accordance with the 2018 Proxy Statement violated Section 14(a)Rule 13d-3 of the Securities Exchange ActAct. Accordingly, in computing the number of 1934,shares beneficially owned by a person or a group and sought to enjoin the stockholder's vote on Proposal 4 in advancepercentage ownership of the annual meeting scheduled for June 15, 2018. On June 8, 2018, the Company issued a press release stating that it resolved to withdraw the portion of the 2018 Proxy Statement related to Proposal 4 and will no longer solicit votes for Proposal 4. Plaintiff filed a notice of voluntarily dismissal of the action on June 8, 2018 after being notified of the Company's press release.
ITEM 4. MINE SAFETY DISCLOSURES.
Not applicable.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES.
Market Information
Our common stock trades on the Nasdaq Capital Market under the symbol “RIOT” (previously traded under the symbol “BIOP” from December 13, 2016 to October 18, 2017 and under the symbol “APPY” from August 28, 2007 to December 12, 2016).
As of April 1, 2019, we had approximately 1,030 holders of record of our common stock.
The closing priceperson or group, shares of our common stock onthat the owner has the right to acquire within 60 days after April 1,22, 2019 was $3.54 per share.are deemed outstanding, but are not deemed outstanding for the purpose of computing the percentage ownership of any other person. Except as otherwise indicated, each of the stockholders listed below has sole voting and investment power over the shares beneficially owned and addresses are c/o Riot Blockchain, Inc., 202 6th Street, Suite 401, Castle Rock, CO 80104.
Name and Address | | Number of Shares | | | Percent | |
Directors: | | | | | | |
Remo Mancini (1) | | | 76,500 | | | | * | % |
Jason Les (2) | | | 40,437 | | | | * | |
Benjamin Yi | | | - | | | | - | |
| | | | | | | | |
Other Executive Officers: | | | | | | | | |
Jeffrey G. McGonegal (3) | | | 38,701 | | | | * | |
Robby Chang (4) | | | 49,503 | | | | * | |
| | | | | | | | |
All Directors and Executive Officers as a Group (5 persons) (5) | | | 206,704 | | | | 1.4 | % |
On October 2, 2017, the Company's Board of Directors approved a special cash dividend pursuant to which the holders of the Company's common stock and Series A Preferred Stock, received $1.00 for each share of Common Stock held, including each share of Common Stock that would be issuable upon conversion of the Series A Preferred Stock, on an as converted basis. The cash dividend totaled approximately $9,562,000 with a record date of the close of business on October 13, 2017 and payment date of October 18, 2017. Other____________________
* Holds less than the above special cash dividend, during the last two fiscal years we have not paid any dividend on any class of equity securities. We anticipate that for the foreseeable future all earnings will be retained for use in our business and no cash dividends will be paid to stockholders. Any payment of cash dividends in the future on the Company's common stock will be dependent upon our financial condition, results of operations, current and anticipated cash requirements, plans for expansion, as well as other factors that the Board of Directors deems relevant at the time a decision to make such a dividend may be determined by the Board.1%
(1) | Represents vested restricted stock grants of 45,000 shares granted February 23, 2018, 7,500 shares granted March 21, 2018 and 24,000 shares granted September 20, 2018, all under the 2017 Plan. |
(2) | Includes (i) 15,000 shares of common stock, (ii) 5,937 shares of common stock vested or to be vested pursuant to a restricted stock award of an aggregate of 7,500 shares that has vested or will vest within 60 days of April 19, 2019, pursuant to the 2017 Plan which vest in 24 equal monthly installments over a two year period, beginning on the one month anniversary of November 3, 2017 and (iii) vested restricted stock grants of 7,500 granted March 21, 2018 and vested restricted stock grants of 12,000 shares granted September 20, 2018, all under the 2017 Plan. |
(3) | Includes (i) 21,638 shares of common stock, (ii) 63 shares of common stock held in Mr. McGonegal's IRA (iii) vested restricted stock grants of 5,000 shares of common stock pursuant to a restricted stock award of under the 2017 Plan. |
(4) | Represents vested portion of restricted stock grant totaling 37,503 shares out of a total grant of 60,000 shares that has vested or will vest within 60 days of April 19, 2019, which vest in 24 equal monthly installments over a two year period, beginning on the one month anniversary of February 27, 2018 and vested restricted stock grants totaling 12,000 shares granted September 20, 2018, all under the 2017 Plan. |
(5) | Includes footnotes (1) through (4). |
Securities Authorized underUnder Equity Compensation Plans Information
The Company currently has one current equity compensation plan, The Riot Blockchain, Inc. 2017 Equity Incentive Plan (the “2017 Plan”). TheAs approved by the Company’s stockholders on August 21, 2017, the Company currently providesmay provide stock-based compensation to employees, directors and consultants, under the 2017 Plan, as approved by the Company's shareholders on August 21, 2017.Plan. The Company's previous 2002 Stock Incentive Plan, as amended, was replaced by the 2017 Plan, with the 2002 Stock Incentive Plan continuing to govern the then outstanding grants and awards for 91,333 options and 157,000 shares of restricted common stock, but no additional grants to be made under that plan. The 2017 Plan was approved reserving 895,000 common shares under the Plan and the Company has granted 767,811 share rights under the 2017 Plan and has 127,189 shares which remain issuable under the 2017 Plan.
The following table provides information as of December 31, 2018, about the shares of common stock that may be issued upon the exercise of options or the vesting of restricted common stock under the 2017 Plan:
Plan Category | | Number of securities to be issued upon exercise of outstanding options and restricted common stock | | | Weighted average exercise price of outstanding options | | | Number of securities remaining available for future issuance | |
| | | | | | | | | |
Equity compensation plans approved by security holders (1) | | | 493,354 | | | $ | 15.71 | | | | 127,189 | |
| | | | | | | | | | | | |
Equity compensation plans not approved by security holders | | | — | | | | — | | | | — | |
| | | | | | | | | | | | |
Total | | | 493,354 | | | $ | 15.71 | | | | 127,189 | |
| (1) | Consists of 62,000 stock options with a weighted average exercise price of $15.71 and 431,354 shares of restricted stock. |
Recent Sales of Unregistered Securities
On December 18, 2018, the Company issued 22,523 shares of common stock at a fair value of $5.55 per share, related to a settlement fee for consulting services, which was exempt from registration in reliance on Section 4(a)(2) under the Securities Act.
ITEM 6. SELECTED FINANCIAL DATA.
Not applicable.
ITEM 7. MANAGEMENT'S DISCUSSION13. CERTAIN RELATIONSHIPS AND ANALYSIS OF FINANCIAL CONDITIONRELATED TRANSACTIONS, AND RESULTS OF OPERATIONS.DIRECTOR INDEPENDENCE.
Certain Relationships and Related Transactions
The discussionAudit Committee has responsibility for reviewing and, analysis below includes certain forward-looking statementsif appropriate, for approving any related party transactions that are subject to risks, uncertainties and other factors, as described in “Risk Factors” and elsewhere in this Annual Report on Form 10-K, that could cause our actual growth, results of operations, performance, financial position and business prospects and opportunities for this fiscal year and the periods that follow to differ materially from those expressed in, or implied by, those forward-looking statements. See also “Forward-Looking Statements.”
RESULTS OF OPERATIONS
Management's plans and basis of presentation:
The Company has experienced recurring losses and negative cash flows from operations. At December 31, 2018, the Company had approximate balances of cash and cash equivalents of $225,000, negative working capital of $4,348,000, total stockholders' equity of $4,491,000 and an accumulated deficit of $197,199,000. To date, the Company has in large part relied on debt and equity financing to fund its operations.
The Company’s primary focus is on its digital currency mining operation located in Oklahoma City, Oklahoma, along with its investigation of the launch of RiotX as a digital currency exchange in the United States. That operational focus and the Company’s completed acquisitions of Kairos and 1172767 B.C. Ltd. (“1172767” or “Tess”), formerly known as Tess Inc., and its investment in goNumerical Ltd., (d/b/a “Coinsquare”), reflects a strategic decision by the Company to operate in the blockchain and digital currency related business sector. The Company's current strategy will continue to expose the Company to the numerous risks and volatility associated within this sector.
Effective January 14, 2017, the Company adopted a plan to exit the business of BiOptix Diagnostics Inc. (“BDI”) and commenced a significant reduction in the workforce. The decision to adopt this plan was made following an evaluation by the Company's Board of Directors in January 2017, of the estimated results of operations projected during the near to mid-term period for BDI, including consideration of product development required and updated sales forecasts, and estimated additional cash resources required. Accordingly, the historical results of BDI have been classified as discontinued operations for all periods presented. During early 2018 all remaining operations of BDI were completed.
The Company expects to continue to incur losses from operations for the near-term and these losses could be significant as the Company incurs costs and expenses associated with recent and potential future acquisitions and development of the RiotX exchange platform, as well as public company, legal and administrative related expenses being incurred. The Company is closely monitoring its cash balances, cash needs and expense levels.
The Company believes that in order for the Company to meet its obligations arising from normal business operations for the next twelve months, the Company requires additional capital either in the form of equity or debt. Without additional capital, the Company’s ability to continue to operate will be limited. If the Company is unable to obtain adequate capital, it could be forced to cease or reduce its operations. The Company is currently pursuing capital transactions in the form of debt and equity, however, the Company cannot provide any assurance that it will be successful in its plans. These consolidated financial statements do not include any adjustments to the recoverability and classification of recorded assets amounts and classification of liabilities that might be necessary should the Company not be able to continue as a going concern. In the opinion of management, these factors, among others, raise substantial doubt about the ability of the Company to continue as a going concern.
Management's strategic plans include the following:
| • | continuing expansion of digital currency mining operations relative to the price of digital currencies; |
| • | continuing to evaluate opportunities for acquisitions in the blockchain and digital currency sector; |
| • | establishing a virtual currency exchange; |
| • | exploring other possible strategic options and financing opportunities available to the Company; |
| • | evaluating options to monetize, partner or license the Company's assets; and |
| • | continuing to implement cost control initiatives to conserve cash. |
2018 compared to 2017
Revenues
Revenue for the years ended December 31, 2018 and 2017, consisted of our digital currency mining revenue of approximately $7,749,000, and $173,000, respectively, and other revenue consisting of license payments of approximately $97,000 in each period.
Cost of Revenues
Cost of revenue for the year ended December 31, 2018 of approximately $5,820,000 consisted primarily of direct production costs of the mining operations, including rent and utilities, but excluding depreciation and amortization which are separately stated. The cost of revenue for the year ended December 31, 2017 was approximately $25,000.
Selling, General and Administrative Expenses
Selling, general and administrative expenses for the year ended December 31, 2018 totaled approximately $20,857,000, which is approximately $13,543,000, or a 185% increase, as compared to $7,314,000 in the 2017 period. Stock compensation increased by approximately $1,697,000 for the year ended December 31, 2018 as compared to the 2017 period relating to additional stock awards in 2018 primarily related to new hires. Consulting fees increased by approximately $4,096,000 for services related to our digital currency miners. Investor, public relations and public company expenses increased by approximately $760,000 related to expanded public company activities in the 2018 period. Legal fees increased by approximately $2,962,000 due to legal matters associated with the SEC regulatory matters, litigation and increased general level of corporate activities in the 2018 period. Audit and related professional fees increased by approximately $56,000 due primarily increased level of operations and acquisitions and other reporting matters. Compensation related expenses increased by approximately $1,271,000 due primarily to increased payroll related to the Company’s additional hiring activities in late 2017 and early 2018 in addition to compensation expenses for Tess being for a full year in 2018 as compared to a partial year in 2017. Sales and marketing expenses incurred by Tess increased by approximately $578,000 for the year ended December 31, 2018 as compared to a partial year in 2017. General and administrative operating expenses increased by approximately $1,297,000 for the year ended December 31, 2018, due to increases of approximately $826,000 in insurance expenses plus general overhead expenses relating to the Company’s acquisitions and related activities in late 2017 and early 2018.
Depreciation and Amortization
Depreciation and amortization expenses in the year ended December 31, 2018 totaled approximately $5,267,000, which is an approximately $4,376,000, or 83%, increase as compared to $891,000 during the year ended December 31, 2017. The increase was due to the depreciation associated with the assets acquired after September 30, 2017, for the digital currency mining operations.
Asset Impairment Charges
Asset impairment charges of $35,266,000 were recognized during the year ended December 31, 2018. The impairment charges consisted of approximately $29,238,000 related to impairments of our digital currency mining equipment, $3,501,000 related to the impairment of our digital currencies accounted for as intangible assets, $2,140,000 consisting of the impairment charges of $799,000 of goodwill and $1,341,000 for the impairment of intangible rights acquired of associated with the Tess Investment, and impairment charges of $387,000 of goodwill related to our original acquisition of the animal health legacy business. Asset impairment charges of $5,218,000 were recognized for the year ended December 31, 2017, related to impairments of our digital currency miners.
Other Income and Expense
Interest expense for the year ended December 31, 2018 totaled approximately $123,000, compared to $4,807,000 for the year ended December 31, 2017. In 2017 interest expense included the expenses recognized based on accretion of values allocated to the value of the warrants and the beneficial conversion feature computed upon the release of the securities from escrow in 2017. For the year ended December 31, 2018, the Company recorded a loss of $266,000 related to the amendment of the BMSS deferred purchase price which was recorded as a loss on extinguishment of debt.
For the year ended December 31, 2018, the Company recorded a gain on sale of digital currencies of approximately $26,000.
For the year ended December 31, 2018, the Company recorded other expenses of approximately $1,350,000, which is primarily related to the penalty accrual of $1,358,000 for our registration rights agreement associated with our private placement on December 19, 2017. The agreement provided that the Company register our securities by the effectiveness date of March 5, 2018. The registration rights were not registered by the effectiveness date and the Company recognized a contingency.
For the year ended December 31, 2017, the Company recognized an inducement expense of $174,000, recorded as the estimated inducement value of warrants exercised at a reduced exercise price for a temporary period.
For the year ended December 31, 2018, the Company recorded investment income of approximately $70,000 compared to investment income of $99,000 in the 2017 period, generally due to a lower level of average outstanding interest-bearing investments.
Income Taxes
For the years ended December 31, 2018 and 2017, the Company’s income tax benefit totaled $699,000 and $1,609,000, respectively, and resulted from the difference in book and tax basis of the Kairos mining equipment and its deprecation and impairment expense for the years ended December 31, 2018 and 2017.
LIQUIDITY AND CAPITAL RESOURCES
At December 31, 2018, we had negative working capital of approximately $4,348,000, which included cash and cash equivalents of $225,000. We reported a net loss of $60,213,000, consisting of a net loss from continuing operations of $60,309,000 and net income from discontinued operations of approximately $96,000, during the year ended December 31, 2018. The net loss from continuing operations included $45,041,000 in non-cash items consisting of an impairment charges of $35,266,000, stock-based compensation totaling $4,660,000, common stock issued for services totaling $403,000, stock issued for the extinguishment of the BMSS payable of $265,000, and depreciation and amortization totaling $5,267,000, net of $699,000 of deferred income tax benefit and other noncash items totaling $124,000.
Effective November 29, 2018, Kairos entered into the second amendment to the lease agreement for the approximate 107,600 square foot warehouse located in Oklahoma City, Oklahoma, including improvements thereon. The amendment extends the lease term to August 2019, provides renewal options for two three-month periods, revises the monthly rent to a base rent, currently $190,000 per month and includes an electrical cost based upon actual usage.
Commencing February 2018 certain class action and derivative suits have been filed against the Company and certain officers and directors. The costs to respond to and defend these actions has, and may continue to have significant impact the Company's resources and management's time.
On March 26, 2018, we acquired 92.5% of Logical Brokerage Corp., a futures introducing broker headquartered in Miami, Florida, registered with the Commodity Futures Trading Commission (“CFTC”), and a member of the National Futures Association (“NFA”). We are investigating launching a digital currency exchange within the United States. To this end, we formed a wholly-owned subsidiary, RiotX Holdings Inc (“RiotX”) has obtained a CFTC license, a Money Service Business license with FinCEN, and a Money Transmitter License from the state of Florida. RiotX is pursuing additional Money Transmitter licenses from other states within the United States. We are also vetting and negotiating with several third parties as service providers to the proposed exchange.
The time and costs to advance development of the RiotX exchange are expected to grow as expansion into additional states is pursued. Such costs include expenses for additional development, current and additional service providers, insurance and bonding requirements, sales and marketing activities to support the launch and general overhead and IT costs. Such costs could be significant and there is no assurance that the exchange will be able to generate significant revenues needed to obtain profitability.
We expect to continue to incur losses from operations for the near-term and these losses could be significant as we incur costs and expenses associated with recent and potential future acquisitions and development of the RiotX exchange platform, as well as public company, legal and administrative related expenses being incurred. We are closely monitoring our cash balances, cash needs and expense levels.
On January 28, 2019, we completed a private placement issuing a series of Senior Secured Convertible Promissory Notes (the “Notes”), to investors for a net cash investment amount of $3,000,000. The Notes are convertible into shares of the Company’s common stock at any time after the issuance date, subject to terms and conditions as defined in the agreements. The Notes mature twelve months from date of issuance and accrue interest at a rate of 8% per annum (guaranteed interest).
We believe that in order for us to meet our obligations arising from normal business operations for the next twelve months, we require additional capital either in the form of equity or debt. Without additional capital, our ability to continue to operate will be limited. If we our unable to obtain adequate capital, we could be forced to cease or reduce our operations. We are currently pursuing capital transactions in the form of debt and equity, however, we cannot provide any assurance that we will be successful in our plans. These financial statements do not include any adjustments to the recoverability and classification of recorded assets amounts and classification of liabilities that might be necessary should we not be able to continue as a going concern.
Funding our operations on a go-forward basis will rely significantly on our ability to continue to mine digital currency and the spot or market price of the digital currency we mine. We expect to generate ongoing revenues from the production of digital currencies, primarily bitcoin currency rewards, for example, in our mining facilities and our ability to liquidate bitcoin currency rewards at future values will be evaluated from time to time to generate cash for operations. Generating bitcoin currency rewards, for example, which exceed our production and overhead costs will determine our ability to report profit margins related to such mining operations, although accounting for our reported profitability is significantly complex. Furthermore, regardless of our ability to generate revenue from the sale of our digital currency assets, we will need to raise additional capital in the form of equity or debt to fund our operations and pursue our business strategy.
The ability to raise funds as equity, debt or conversion of digital currency to maintain our operations is subject to many risks and uncertainties and, even if we were successful, future equity issuances would result in dilution to our existing stockholders and any future debt or debt securities may contain covenants that limit our operations or ability to enter into certain transactions. Our ability to realize revenue through bitcoin production and successfully convert bitcoin into cash or fund overhead with bitcoin is subject to a number of risks, including regulatory, financial and business risks, many of which are beyond our control. Additionally, the value of bitcoin currency rewards has been extremely volatile recently and such volatility has recently been lower and future prices cannot be predicted.
If we are unable to generate sufficient revenue from our bitcoin production when needed or secure additional sources of funding, it may be necessary to significantly reduce our current rate of spending or explore other strategic alternatives.
During 2018, the Company was named a defendant in several lawsuits seeking class action status, and other lawsuits as more fully described in Part II – Item 1. Legal Proceedings, of this report. In addition, the Company has received comments, inquiries and subpoenas from regulatory bodies, including NASDAQ and the SEC, which are costly and time consuming to respond to. While the Company maintains policies of insurance, such policies may not cover all of the costs or expenses associated with responding to such matters or any liability or settlement associated with any lawsuits and are subject to significant deductible or retention amounts.
Operating Activities
Net cash consumed by operating activities was $19,051,000, consisting of $18,983,000 from continuing operations and $69,000 from discontinued operations during the year ended December 31, 2018. Cash was consumed from continuing operations by the loss of $60,309,000, less non-cash items of $35,266,000 consisting of an asset impairment for the Company’s miners of $29,238,000, impairment of our digital currencies of $3,501,000, impairment of acquired intangible rights of $1,341,000, the write-off of goodwill of $1,186,000, depreciation and amortization totaling $5,267,000, stock-based compensation totaling $4,660,000, stock issued for the extinguishment of the BMSS payable of $265,000 and common stock issued for services totaling $403,000, net of deferred income tax benefit of $699,000, amortization of license fee revenue totaling $97,000 and the realized gain on sale of digital currencies of $26,000. Prepaid expenses and other current assets increased $840,000 due primarily to increases in prepaid insurance premiums, digital currencies increased $7,749,000 and accounts payable and accrued expenses increased $4,719,000 related to the significant expansion of the Company’s operating activities in 2018.
Net cash consumed by operating activities was $4,440,000, consisting of $3,521,000 from continuing operations and $919,000 from discontinued operations, during the year ended December 31, 2017. Cash was consumed from continuing operations by the loss of $16,428,000, less non-cash items of $13,099,000 in non-cash items consisting of an impairment charge of $5,218,000, amortization of debt discount and warrant values to interest of $4,750,000, stock-based compensation totaling $2,590,000, common stock issued for services totaling $1,178,000 and depreciation and amortization totaling $891,000, net of $1,609,000 of deferred income tax benefit and other noncash items totaling $81,000. Digital currencies increased by $200,000 due to revenue production and fluctuation in digital currency values. Increases in prepaid and other current assets of $41,000 consumed cash, primarily related to normal changes in operating activities. There was a net $49,000 decrease in accounts payable and accrued expenses in the year ended December 31, 2017, primarily due to normal changes in operating activities and the payment of a 2016 litigation settlement accrual in early 2017.
Investing Activities
Net cash consumed by investing activities during the year ended December 31, 2018 was $24,862,000 primarily consisting of purchases of digital currencies of $5,625,000, purchases of property and equipment of $20,195,000 related to the Company’s digital currency miners, an additional investment in Coinsquare of $6,413,000, security deposits of $703,000, purchases of patent and trademark application costs of $60,000, an investment in Logical Brokerage of $517,000 and a purchase of developed technology of $587,000, offset by proceeds from the sale of digital currencies of $9,237,000.
Net cash inflows from investing activities provided cash of $5,579,000, consisting of $5,575,000 from continuing operations and a cash inflow of $4,000 from discontinued operations, during the year ended December 31, 2017. Sales of marketable securities investments totaling approximately $7,507,000 provided cash. Cash of $3,200,000 was used in the Coinsquare and Verady investments. A $61,000 use of cash was attributable to additional costs incurred from patent filings associated with the legacy animal health business. As part of the Kairos and Tess acquisitions $1,329,000 in cash was acquired.
Financing Activities
Net cash inflows from financing activities was $2,487,000 during the year ended December 31, 2018, primarily consisting of $1,696,000 of proceeds from a convertible demand note issued by Tess, $350,000 from the exercise of warrants, $506,000 from the sale of the Company’s shares of common stock held by Tess, $220,000 from the sale of common shares by Tess, $79,000 from the exercise of stock options and $72,000 from a refund of previously escrowed dividend, offset by $300,000 for payments made related to our BMSS Agreement and $136,000 used in scheduled payments under debt agreements.
Net cash inflows from financing activities provided $34,983,000 from continuing operations, during the year ended December 31, 2017, consisting of net proceeds of $4,750,000 from convertible notes payable, $38,451,000 from the sale of common stock and $2,009,000 from the exercise of warrants and options, net of $273,000 in scheduled payments under debt agreements, and $392,000 consumed from the redemption of equity rights payments. Net cash outflow also included a special cash dividend payment of $9,562,331, consisting of $8,410,648 paid to common shareholders and $1,151,683 paid to holders of Series A Preferred Shares.
Critical Accounting Policies
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America (GAAP) requires management to make estimates and assumptions about future events that affect the amounts reported in the financial statements and accompanying notes. Future events and their effects cannot be determined with absolute certainty. Therefore, the determination of estimates requires the exercise of judgment. Actual results inevitably will differ from those estimates, and such differences may be material to the financial statements. The most significant accounting estimates inherent in the preparation of our financial statements include estimates associated with revenue recognition, investments, intangible assets, stock-based compensation and business combinations.
The Company's financial position, results of operations and cash flows are impacted by the accounting policies the Company has adopted. In order to get a full understanding of the Company's financial statements, one must have a clear understanding of the accounting policies employed. A summary of the Company's critical accounting policies follows:
Long Term Investments: As described in our consolidated financial statements, effective January 1, 2018, the Company adopted Accounting Standards Update (“ASU”) 2016-01 and related ASU 2018-03 concerning recognition and measurement of financial assets and financial liabilities. In adopting this new guidance, the Company has made an accounting policy election to adopt a new measurement alternative for investments in equity securities without readily determinable fair values.
For equity investments that qualify to use the measurement alternative, the Company initially records such equity investments at cost but will be required to adjust the carrying value through earnings when there is an observable transaction involving the samebe disclosed pursuant to applicable SEC rules. This includes current or a similar investment with the same issuer or upon an impairment.
Digital Currencies: Digital currencies, (including bitcoin and litecoin) are included in current assets in the consolidated balance sheets as intangible assets with indefinite useful lives. Digital currencies are recorded at cost less impairment.
An intangible asset with an indefinite useful life is not amortized but assessed for impairment annually, or more frequently, when events or changes in circumstances occur indicating that it is more likely than not that the indefinite-lived asset is impaired. Impairment exists when the carrying amount exceeds its fair value, which is measured using the quoted price of the digital currency at the time its fair value is being measured. In testing for impairment, the Company has the option to first perform a qualitative assessment to determine whether it is more likely than not that an impairment exists. If it is determined that it is not more likely than not that an impairment exists, a quantitative impairment test is not necessary. If the Company concludes otherwise, it is required to perform a quantitative impairment test. To the extent an impairment loss is recognized, the loss establishes the new cost basis of the asset. Subsequent reversal of impairment losses is not permitted.
Goodwill: The Company performs a goodwill impairment analysis on December 31 of each year. When conducting its annual goodwill impairment assessment, the Company initially performs a qualitative evaluation to determine if it is more likely than not that the fair value of its reporting unit is less than its carrying amount as a basis for determining whether it is necessary to perform a two-step goodwill impairment test. The Company has determined, based on its evaluations, that $799,000 of goodwill related to the Tess Investment and $387,000 of goodwill related to the Company’s original acquisition of the animal health legacy business was impaired during the year ended December 31, 2018. The goodwill associated with the BDI acquisition was impaired during the year ended December 31, 2017, included as part of the discontinued operations impairment loss.
Impairment of long-lived assets: Management reviews long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to undiscounted expected future cash flows expected to be generated by the asset. If such assets are considered to be impaired, the impairment to be recognized is measured by comparing the amount by which the carrying amount of the assets to their fair value. Based on its reviews, management determined that its digital currency miners were impaired by a total of $29,238,000 based upon an assessment as of December 31, 2018, including consideration of the decline in bitcoin values which occurred commencing in late December 2017 and into 2018.
Intangible assets acquired in the Tess business combination consist primarily of in-process research and development (“IPR&D”) assets. The value attributable to IPR&D projects at the time of acquisition was capitalized as an indefinite-lived intangible asset and tested for impairment until the project is completed or abandoned. Upon completion of the project, the indefinite-lived intangible asset will be accounted for as a finite-lived intangible asset and amortized on a straight-line basis over its estimated useful life. If the project is abandoned, the indefinite-lived intangible asset will be charged to expense. During the year ended December 31, 2018, management determined based upon an assessment of the operations and cash needs of Tess, that the intangible assets related to the Tess Investment were impaired and recorded an impairment charge of $1,341,000 as of December 31, 2018.
Revenue Recognition: The Company recognizes revenue under ASC 606, Revenue from Contracts with Customers. The core principle of the new revenue standard is that a company should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the company expects to be entitled in exchange for those goods or services. The following five steps are applied to achieve that core principle:
· Step 1: Identify the contract with the customer
· Step 2: Identify the performance obligations in the contract
· Step 3: Determine the transaction price
· Step 4: Allocate the transaction price to the performance obligations in the contract
· Step 5: Recognize revenue when the Company satisfies a performance obligation
In order to identify the performance obligations in a contract with a customer, a company must assess the promised goods or services in the contract and identify each promised good or service that is distinct. A performance obligation meets ASC 606’s definition of a “distinct” good or service (or bundle of goods or services) if both of the following criteria are met: The customer can benefit from the good or service either on its own or together with other resources that are readily available to the customer (i.e., the good or service is capable of being distinct), and the entity’s promise to transfer the good or service to the customer is separately identifiable from other promises in the contract (i.e., the promise to transfer the good or service is distinct within the context of the contract).
If a good or service is not distinct, the good or service is combined with other promised goods or services until a bundle of goods or services is identified that is distinct.
The transaction price is the amount of consideration to which an entity expects to be entitled in exchange for transferring promised goods or services to a customer. The consideration promised in a contract with a customer may include fixed amounts, variable amounts, or both. When determining the transaction price, an entity must consider the effects of all of the following:
| · | Constraining estimates of variable consideration |
| · | The existence of a significant financing component in the contract |
| · | Consideration payable to a customer |
Variable consideration is included in the transaction price only to the extent that it is probable that a significant reversal in the amount of cumulative revenue recognized will not occur when the uncertainty associated with the variable consideration is subsequently resolved. The transaction price is allocated to each performance obligation on a relative standalone selling price basis. The transaction price allocated to each performance obligation is recognized when that performance obligation is satisfied, at a point in time or over time as appropriate.
The Company has entered into digital asset mining pools by executing contracts with the mining pool operators to provide computing power to the mining pool. The contracts are terminable at any time by either party and the Company’s enforceable right to compensation only begins when the Company provides computing power to the mining pool operator. In exchange for providing computing power, the Company is entitled to a fractional share of the fixed digital currency award the mining pool operator receives (less digital asset transaction fees to the mining pool operator which are recorded as a component of cost of revenues), for successfully adding a block to the blockchain. The Company’s factional share is based on the proportion of computing power the Company contributed to the mining pool operator to the total computing power contributed by all mining pool participants in solving the current algorithm.
Providing computing power in digital asset transaction verification services is an output of the Company’s ordinary activities. The provision of providing such computing power is the only performance obligation in the Company’s contracts with mining pool operators. The transaction consideration the Company receives, if any, is noncash consideration, which the Company measures at fair value on the date received, which is not materially different than the fair value at contract inception or the time the Company has earned the award from the pools. The consideration is all variable. Because it is not probable that a significant reversal of cumulative revenue will not occur, the consideration is constrained until the mining pool operator successfully places a block (by being the first to solve an algorithm) and the Company receives confirmation of the consideration it will receive, at which time revenue is recognized. There is no significant financing component in these transactions.
Fair value of the digital currency award received is determined using the market rate of the related digital currency at the time of receipt.
There is currently no specific definitive guidance under GAAP or alternative accounting framework for the accounting for digital currencies recognized as revenue or held, and management has exercised significant judgment in determining the appropriate accounting treatment. In the event authoritative guidance is enacted by the FASB, the Company may be required to change its policies, which could have an effect on the Company’s consolidated financial position and results from operations.
Stock-based Compensation: ASC 718, Share-Based Payment, defines the fair-value-based method of accounting for stock-based employee compensation plans andproposed transactions used by the Company to account for its issuances of equity instruments to record compensation cost for stock-based employee compensation plans at fair value as well as to acquire goods or services from non-employees. Transactions in which the Company issues stock-based compensationwas or is to employees, directors and consultants and for goodsbe a participant in which the amount involved exceeds the lower of either $120,000 or services received from non-employees are accounted for based on the fair value1% of the equity instruments issued. The Company utilizes the Black-Scholes pricing model in determining the fair values of options and warrants issued as stock-based compensation. These pricing models utilize the market priceaverage of the Company's common stock and the exercise price of the option or warrant, as well as time value and volatility factors underlying the positions.
Business Combinations: The Company applies the provisions of ASC 805 in the accounting for acquisitions. ASC 805 requires us to recognize separately from goodwill thetotal assets acquired and the liabilities assumed at their acquisition date fair values. Goodwill as of the acquisition date is measured as the excess of consideration transferred over the net of the acquisition date fair values of the assets acquired and the liabilities assumed. While we use our best estimates and assumptions to accurately apply preliminary value to assets acquired and liabilities assumed at the acquisition date as well as contingent consideration, where applicable, these estimates are inherently uncertain and subject to refinement. As a result, during the measurement period, which may be up to one year from the acquisition date, we record adjustments to the assets and acquired liabilities assumed with the corresponding offset to goodwill in the current period, rather than a revision to a prior period. Upon the conclusion of the measurement period or final determination of the values of the assets acquired or liabilities assumed, whichever comes first, any subsequent adjustments are recorded in our Consolidated Statements of Operations. Accounting for business combinations requires management to make significant estimates and assumptions, especially at the acquisition date, including estimates for intangible assets, contractual obligations assumed, restructuring liabilities, pre-acquisition contingencies, and contingent consideration, where applicable. Although we believe the assumptions and estimates we have made have been reasonable and appropriate, they are based in part on historical experience and information obtained from management of the acquired companies and are inherently uncertain. Critical estimates in valuing certain of the intangible assets we have acquired include; future expected cash flows from product sales; customer contracts and acquired technologies; expected costs to develop in-process research and development into commercially viable products and estimated cash flows from the projects when completed; and discount rates. Unanticipated events and circumstances may occur that may affect the accuracy or validity of such assumptions, estimates, or actual results.
Recently issued and adopted accounting pronouncements: The Company continually assesses any new accounting pronouncements to determine their applicability. When it is determined that a new accounting pronouncement affects the Company's financial reporting, the Company undertakes a review to determine the consequences of the change to its financial statements and believes that there are proper controls in place to ascertain that the Company's financial statements properly reflect the change.
We have considered recently issued accounting pronouncements and do not believe the adoption of such pronouncements will have a material impact on our consolidated financial statements.
See Note 3 to our financial statements beginning on page F-1 of this prospectus for a description of recent accounting pronouncements applicable to our financial statements.
Off-Balance Sheet Arrangements
We do not have any off-balance sheet arrangements.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
Not required for Smaller Reporting Company.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
Reports of Independent Registered Public Accounting Firms | F-1 – F-2 |
Consolidated Balance Sheets at December 31, 2018 and 2017 | F-3 |
Consolidated Statements of Operations for the years ended December 31, 2018 and 2017 | F-4 |
Consolidated Statements of Changes in Stockholders' Equity for the years ended December 31, 2018 and 2017 | F-5 |
Consolidated Statements of Cash Flows for the years ended December 31, 2018 and 2017 | F-6 |
Notes to Consolidated Financial Statements | F-7 |
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Shareholders and Board of Directors of
Riot Blockchain, Inc.
Opinion on the Financial Statements
We have audited the accompanying consolidated balance sheet of Riot Blockchain, Inc. and Subsidiaries (the “Company”) as of December 31, 2018, and the related consolidated statements of operations, changes in stockholders’ equity and cash flowsyear-end for the year then ended,last two completed fiscal years, and the related notes (collectively referred to as the “financial statements”). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2018, and the results of its operations and its cash flows for the year then ended, in conformity with accounting principles generally accepted in the United States of America.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (“PCAOB”), the Company's internal control over financial reporting as of December 31, 2018, based on the criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in 2013 and our report dated April 2, 2019, expressed an adverse opinion on the effectiveness of the Company’s internal control over financial reporting because of material weaknesses.
Explanatory Paragraph – Going Concern
The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. As more fully described in Note 2, the Company has a significant working capital deficiency, has incurred significant losses, and needs to raise additional funds to meet its obligations and sustain its operations. These conditions raise substantial doubt about the Company's ability to continue as a going concern. Management's plans about these matters are also described in Note 2. The consolidated financial statements do not includewhich any adjustments that might result from the outcome of this uncertainty.
Basis for Opinion
These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the Company's financial statements based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audit included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audit also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audit provides a reasonable basis for our opinion.
/s/ Marcum llp
Marcum llp
We have served as the Company’s auditor since 2018.
New York, NY
April 2, 2019
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Shareholders of Riot Blockchain, Inc.
Opinion on the Financial Statements
We have audited the accompanying consolidated balance sheet of Riot Blockchain, Inc. (formerly: Bioptix, Inc.) and Subsidiaries (the “Company”) as of December 31, 2017, and the related consolidated statements of operations, stockholders' equity, and cash flows for the year then ended. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Riot Blockchain, Inc. and Subsidiaries as of December 31, 2017, and the consolidated results of their operations and their cash flows for the year then ended, in conformity with accounting principles generally accepted in the United States of America.
Basis for Opinion
These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the Company's financial statements based on our audit. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audit, we are required to obtain an understanding of internal control over financial reporting, but not for the purpose of expressing an opinion on the effectiveness of the Company's internal control over financial reporting. Accordingly, we express no such opinion.
Our audit included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audit also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that our audit provides a reasonable basis for our opinion.
| Chartered Professional Accountants
Licensed Public Accountants
|
We have served as the Company's auditor from January 5, 2018 through January 30, 2019
Toronto, Ontario
April 17, 2018
Riot Blockchain, Inc. and Subsidiaries
Consolidated Balance Sheets
| | December 31, 2018 | | | December 31, 2017 | |
ASSETS | | | | | | |
Current assets | | | | | | |
Cash and cash equivalents | | $ | 225,390 | | | $ | 41,651,965 | |
Prepaid expenses and other current assets | | | 1,378,534 | | | | 538,812 | |
Digital currencies | | | 706,625 | | | | 200,164 | |
Current assets of discontinued operations | | | - | | | | 44 | |
Total current assets | | | 2,310,549 | | | | 42,390,985 | |
Property and equipment, net | | | 26,269 | | | | 4,294,166 | |
Intangible rights acquired | | | 700,167 | | | | 754,244 | |
Long-term investments | | | 9,412,726 | | | | 3,000,000 | |
Security deposits | | | 703,275 | | | | - | |
Other long-term assets, net: | | | | | | | | |
Patents, net | | | 507,342 | | | | 509,649 | |
Goodwill | | | - | | | | 1,186,496 | |
Convertible note | | | 200,000 | | | | 200,000 | |
Total assets | | $ | 13,860,328 | | | $ | 52,335,540 | |
| | | | | | | | |
LIABILITIES AND STOCKHOLDERS' EQUITY | | | | | | | | |
Current liabilities | | | | | | | | |
Accounts payable | | $ | 3,829,315 | | | $ | 410,029 | |
Accrued expenses | | | 1,516,252 | | | | 216,883 | |
Deferred purchase price - BMSS | | | 1,200,000 | | | | - | |
Notes and other obligations, current | | | - | | | | 135,574 | |
Deferred revenue, current portion | | | 96,698 | | | | 96,698 | |
Current liabilities of discontinued operations | | | 16,340 | | | | 181,340 | |
Total current liabilities | | | 6,658,605 | | | | 1,040,524 | |
| | | | | | | | |
Demand note, Tess subsidiary | | | 1,696,083 | | | | - | |
Deferred revenue, less current portion | | | 871,919 | | | | 968,617 | |
Deferred income tax liability | | | 142,709 | | | | 699,000 | |
Total liabilities | | | 9,369,316 | | | | 2,708,141 | |
| | | | | | | | |
Commitments and contingencies - Note 15 | | | | | | | | |
| | | | | | | | |
Stockholders' equity | | | | | | | | |
Preferred stock, no par value, 15,000,000 share authorized: | | | | | | | | |
2% Series A Convertible stock, 2,000,000 shares authorized; no shares issued and outstanding as of December 31, 2018 and 2017, respectively | | | - | | | | - | |
0% Series B Convertible stock, 1,750,001 shares authorized; 13,000 and 1,458,001 shares issued and outstanding as of December 31, 2018 and 2017, respectively; liquidation preference over common stock, equal to carrying value | | | 69,059 | | | | 7,745,266 | |
Common stock, no par value; 170,000,000 shares authorized; 14,519,058 and 11,622,112 shares issued and outstanding as of December 31, 2018 and 2017, respectively | | | 202,917,443 | | | | 180,387,518 | |
Accumulated deficit | | | (197,199,197 | ) | | | (139,263,480 | ) |
Total Riot Blockchain stockholders' equity | | | 5,787,305 | | | | 48,869,304 | |
Non-controlling interest | | | (1,296,293 | ) | | | 758,095 | |
Total stockholders' equity | | | 4,491,012 | | | | 49,627,399 | |
Total liabilities and stockholders' equity | | $ | 13,860,328 | | | $ | 52,335,540 | |
See Accompanying Notes to Consolidated Financial Statements.
Riot Blockchain, Inc. and Subsidiaries
Consolidated Statements of Operations
| | Years Ended December 31, | |
| | 2018 | | | 2017 | |
Revenue: | | | | | | |
Revenue - digital currency mining | | $ | 7,748,634 | | | $ | 172,959 | |
License fees | | | 96,698 | | | | 96,698 | |
Total Revenue | | | 7,845,332 | | | | 269,657 | |
| | | | | | | | |
Costs and expenses: | | | | | | | | |
Cost of revenues (exclusive of depreciation and amortization shown below) | | | 5,819,925 | | | | 25,186 | |
Selling, general and administrative | | | 20,857,078 | | | | 7,313,626 | |
Depreciation and amortization | | | 5,267,372 | | | | 890,889 | |
Impairment of property and equipment | | | 29,237,719 | | | | 5,218,004 | |
Impairment of goodwill | | | 1,186,496 | | | | - | |
Impairment of intangible rights acquired | | | 1,341,013 | | | | - | |
Impairment of digital currencies | | | 3,501,250 | | | | (27,205 | ) |
Loss on sale of property and equipment | | | - | | | | 3,639 | |
Total costs and expenses | | | 67,210,853 | | | | 13,424,139 | |
Operating loss from continuing operations | | | (59,365,521 | ) | | | (13,154,482 | ) |
| | | | | | | | |
Other income (expense) | | | | | | | | |
Interest expense | | | (122,973 | ) | | | (4,806,637 | ) |
Realized gain on sale of digital currencies | | | 26,443 | | | | - | |
Non-compliance penalty for SEC registration requirement | | | (1,350,390 | ) | | | (1,237 | ) |
Warrant inducement expense | | | - | | | | (173,867 | ) |
Loss on extinguishment of BMSS payable | | | (265,500 | ) | | | - | |
Investment income | | | 70,281 | | | | 99,255 | |
Total other expense | | | (1,642,139 | ) | | | (4,882,486 | ) |
| | | | | | | | |
Loss from continuing operations before income taxes | | | (61,007,660 | ) | | | (18,036,968 | ) |
| | | | | | | | |
Deferred income tax benefit | | | 699,000 | | | | 1,609,000 | |
| | | | | | | | |
Loss from continuing operations | | | (60,308,660 | ) | | | (16,427,968 | ) |
| | | | | | | | |
Discontinued operations | | | | | | | | |
Income (loss) from operations | | | 96,132 | | | | (923,645 | ) |
Escrow forfeiture gain | | | - | | | | 134,812 | |
Impairment loss | | | - | | | | (2,754,131 | ) |
Income (loss) from discontinued operations | | | 96,132 | | | | (3,542,964 | ) |
| | | | | | | | |
Net loss | | | (60,212,528 | ) | | | (19,970,932 | ) |
| | | | | | | | |
Net loss attributable to non-controlling interest | | | 2,204,755 | | | | 125,059 | |
| | | | | | | | |
Net loss attributable to Riot Blockchain | | $ | (58,007,773 | ) | | $ | (19,845,873 | ) |
| | | | | | | | |
Basic and diluted net loss per share: | | | | | | | | |
Continuing operations attributable to Riot Blockchain | | $ | (4.34 | ) | | $ | (2.71 | ) |
Discontinued operations attributable to Riot Blockchain | | | 0.01 | | | | (0.59 | ) |
Net loss per share | | $ | (4.33 | ) | | $ | (3.30 | ) |
| | | | | | | | |
Basic and diluted weighted average number of shares outstanding | | | 13,403,846 | | | | 6,019,817 | |
| | | | | | | | |
See Accompanying Notes to Consolidated Financial Statements.
Riot Blockchain, Inc. and Subsidiaries
Consolidated Statement of Stockholders' Equity
Years Ended December 31, 2018 and 2017
| | | | | | | | | | | | | | | | | Total | | | | | | | |
| | Preferred Stock | | | Common Stock | | | Accumulated | | | Riot Blockchain stockholders' | | | Non-controlling | | | | |
| | Shares | | | Amount | | | Shares | | | Amount | | | deficit | | | equity | | | interest | | | equity | |
Balance as of January 1, 2017 | | | - | | | $ | - | | | | 4,503,971 | | | $ | 124,775,635 | | | $ | (109,855,276 | ) | | $ | 14,920,359 | | | $ | - | | | $ | 14,920,359 | |
Private placement of common stock | | | - | | | | - | | | | 900,000 | | | | 1,913,509 | | | | - | | | | 1,913,509 | | | | - | | | | 1,913,509 | |
Common shares in escrow forfeited and retired | | | - | | | | - | | | | (32,801 | ) | | | (134,812 | ) | | | - | | | | (134,812 | ) | | | - | | | | (134,812 | ) |
Equity rights redemptions | | | - | | | | - | | | | - | | | | (392,007 | ) | | | - | | | | (392,007 | ) | | | - | | | | (392,007 | ) |
Discount on convertible debt arising from values of: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Warrants | | | - | | | | - | | | | - | | | | 2,325,151 | | | | - | | | | 2,325,151 | | | | - | | | | 2,325,151 | |
Beneficial conversion feature | | | - | | | | - | | | | - | | | | 2,424,849 | | | | - | | | | 2,424,849 | | | | - | | | | 2,424,849 | |
Preferred stock issued upon conversion of notes payable | | | 19,194.72 | | | | 4,798,671 | | | | - | | | | - | | | | - | | | | 4,798,671 | | | | - | | | | 4,798,671 | |
Common stock issued for acquisition | | | - | | | | - | | | | 75,000 | | | | 636,750 | | | | - | | | | 636,750 | | | | - | | | | 636,750 | |
Cash dividend paid | | | - | | | | - | | | | - | | | | - | | | | (9,562,331 | ) | | | (9,562,331 | ) | | | - | | | | (9,562,331 | ) |
Preferred stock issued for acquisition | | | 1,750,001 | | | | 9,296,443 | | | | - | | | | - | | | | - | | | | 9,296,443 | | | | - | | | | 9,296,443 | |
Exercise of common stock purchase warrants | | | - | | | | - | | | | 620,000 | | | | 1,860,000 | | | | - | | | | 1,860,000 | | | | - | | | | 1,860,000 | |
Value of inducement upon temporary price reduction of common stock purchase warrants | | | - | | | | - | | | | - | | | | 173,867 | | | | - | | | | 173,867 | | | | - | | | | 173,867 | |
Cashless exercise of common stock purchase warrants | | | - | | | | - | | | | 1,335,408 | | | | - | | | | - | | | | - | | | | - | | | | - | |
Preferred stock converted to common stock | | | (311,194.72 | ) | | | (6,349,848 | ) | | | 2,211,472 | | | | 6,349,848 | | | | - | | | | - | | | | - | | | | - | |
Exercise of stock options | | | - | | | | - | | | | 50,800 | | | | 149,136 | | | | - | | | | 149,136 | | | | - | | | | 149,136 | |
Private placement of common stock | | | - | | | | - | | | | 1,646,113 | | | | 36,537,543 | | | | - | | | | 36,537,543 | | | | - | | | | 36,537,543 | |
Common stock issued for services | | | - | | | | - | | | | 138,067 | | | | 1,178,237 | | | | - | | | | 1,178,237 | | | | - | | | | 1,178,237 | |
Stock-based compensation | | | - | | | | - | | | | 174,082 | | | | 2,589,812 | | | | - | | | | 2,589,812 | | | | - | | | | 2,589,812 | |
Non-controlling interest - Tess | | | - | | | | - | | | | - | | | | - | | | | - | | | | - | | | | 883,154 | | | | 883,154 | |
Net loss attributable to non-controlling interest | | | - | | | | - | | | | - | | | | - | | | | - | | | | - | | | | (125,059 | ) | | | (125,059 | ) |
Net loss | | | - | | | | - | | | | - | | | | - | | | | (19,845,873 | ) | | | (19,845,873 | ) | | | - | | | | (19,845,873 | ) |
Balance as of December 31, 2017 | | | 1,458,001.00 | | | $ | 7,745,266 | | | | 11,622,112 | | | $ | 180,387,518 | | | $ | (139,263,480 | ) | | $ | 48,869,304 | | | $ | 758,095 | | | $ | 49,627,399 | |
Common stock issued for asset purchase - Prive | | | - | | | | - | | | | 800,000 | | | | 8,480,000 | | | | - | | | | 8,480,000 | | | | - | | | | 8,480,000 | |
Common stock escrow shares issued for asset purchase - Prive | | | - | | | | - | | | | 200,000 | | | | - | | | | - | | | | - | | | | - | | | | - | |
Preferred stock converted to common stock | | | (1,353,505 | ) | | | (7,190,157 | ) | | | 1,353,505 | | | | 7,190,157 | | | | - | | | | - | | | | - | | | | - | |
Preferred stock canceled | | | (91,496 | ) | | | (486,050 | ) | | | - | | | | 486,050 | | | | - | | | | - | | | | - | | | | - | |
Exercise of warrants | | | - | | | | - | | | | 100,000 | | | | 350,000 | | | | - | | | | 350,000 | | | | - | | | | 350,000 | |
Stock-based compensation | | | - | | | | - | | | | - | | | | 4,660,406 | | | | - | | | | 4,660,406 | | | | - | | | | 4,660,406 | |
Exercise of stock options | | | - | | | | - | | | | 19,533 | | | | 78,522 | | | | - | | | | 78,522 | | | | - | | | | 78,522 | |
Common stock issued for services | | | - | | | | - | | | | 43,277 | | | | 402,941 | | | | - | | | | 402,941 | | | | - | | | | 402,941 | |
Refund of escrow dividend | | | - | | | | - | | | | - | | | | - | | | | 72,056 | | | | 72,056 | | | | - | | | | 72,056 | |
Sale of Riot shares held by 1172767 B.C. Ltd. | | | - | | | | - | | | | - | | | | 505,729 | | | | - | | | | 505,729 | | | | - | | | | 505,729 | |
Stock issued for the extinguishment of the BMSS payable | | | - | | | | - | | | | 50,000 | | | | 265,500 | | | | - | | | | 265,500 | | | | - | | | | 265,500 | |
Cashless exercise of stock purchase warrants | | | - | | | | - | | | | 3,215 | | | | - | | | | - | | | | - | | | | - | | | | - | |
Delivery of common stock underlying restricted stock units | | | - | | | | - | | | | 327,416 | | | | - | | | | - | | | | - | | | | - | | | | - | |
Non-controlling interest - Logical Brokerage | | | - | | | | - | | | | - | | | | - | | | | - | | | | - | | | | 40,541 | | | | 40,541 | |
Net loss attributable to non-controlling interest | | | - | | | | - | | | | - | | | | - | | | | - | | | | - | | | | (2,204,755 | ) | | | (2,204,755 | ) |
Sale of common shares by 1172767 B.C. Ltd. | | | - | | | | - | | | | - | | | | 110,620 | | | | - | | | | 110,620 | | | | 109,826 | | | | 220,446 | |
Net loss | | | - | | | | - | | | | - | | | | - | | | | (58,007,773 | ) | | | (58,007,773 | ) | | | - | | | | (58,007,773 | ) |
Balance as of December 31, 2018 | | | 13,000 | | | $ | 69,059 | | | | 14,519,058 | | | $ | 202,917,443 | | | $ | (197,199,197 | ) | | $ | 5,787,305 | | | $ | (1,296,293 | ) | | $ | 4,491,012 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
See Accompanying Notes to Consolidated Financial Statements
Riot Blockchain, Inc. and Subsidiaries
Consolidated Statements of Cash Flows
| | Years Ended December 31, | |
| | 2018 | | | 2017 | |
Cash flows from operating activities | | | | | | |
Net loss | | $ | (60,212,528 | ) | | $ | (19,970,932 | ) |
Income (loss) from discontinued operations | | | 96,132 | | | | (3,542,964 | ) |
Loss from continuing operations | | | (60,308,660 | ) | | | (16,427,968 | ) |
Adjustments to reconcile net loss from continuing operations to net cash used in operating activities of continuing operations: | |
Stock-based compensation | | | 4,660,406 | | | | 2,589,812 | |
Depreciation and amortization | | | 5,267,372 | | | | 890,889 | |
Deferred income tax benefit | | | (699,000 | ) | | | (1,609,000 | ) |
Amortization of license fee revenue | | | (96,698 | ) | | | (96,698 | ) |
Amortization of debt discount | | | - | | | | 4,750,000 | |
Common stock issued for services | | | 402,941 | | | | 1,178,237 | |
Loss on extinguishment of BMSS payable | | | 265,500 | | | | - | |
Inducement expense on warrant exercises | | | - | | | | 173,867 | |
Impairment of property and equipment | | | 29,237,719 | | | | 5,218,004 | |
Impairment of digital currencies | | | 3,501,250 | | | | - | |
Goodwill impairment charge | | | 1,186,496 | | | | - | |
Acquired rights impairment charge | | | 1,341,013 | | | | - | |
Realized gain on sale of digital currencies | | | (26,443 | ) | | | - | |
Loss on sale of property and equipment | | | - | | | | 3,639 | |
Changes in assets and liabilities: | | | | | | | | |
Prepaid expenses and other current assets | | | (839,722 | ) | | | (41,386 | ) |
Digital currencies - mining, net of mining pool operating fees | | | (7,593,661 | ) | | | (200,164 | ) |
Accounts payable | | | 3,419,286 | | | | 90,022 | |
Accrued expenses | | | 1,299,369 | | | | (40,641 | ) |
Net cash used in operating activities of continuing operations | | | (18,982,832 | ) | | | (3,521,387 | ) |
Net cash used in operating activities of discontinued operations | | | (68,824 | ) | | | (918,663 | ) |
Net cash used in operating activities | | | (19,051,656 | ) | | | (4,440,050 | ) |
| | | | | | | | |
Cash flows from investing activities - continuing operations: | | | | | | | | |
Proceeds from sale of digital currencies | | | 9,237,225 | | | | - | |
Purchase of digital currencies | | | (5,624,832 | ) | | | - | |
Purchases of property and equipment | | | (20,195,290 | ) | | | - | |
Purchases of other investments | | | (6,412,726 | ) | | | (3,200,000 | ) |
Proceeds from sale of short-term investments | | | - | | | | 7,506,761 | |
Net cash acquired from purchase of subsidiaries | | | - | | | | 1,329,324 | |
Security deposits | | | (703,275 | ) | | | - | |
Purchases of patent and trademark application costs | | | (59,597 | ) | | | (61,094 | ) |
Investment in Logical Brokerage, net of cash acquired | | | (516,917 | ) | | | - | |
Purchase of developed technology by 1172767 B.C. Ltd. | | | (586,769 | ) | | | - | |
Net cash (used in) provided by investing activities of continuing operations | | | (24,862,181 | ) | | | 5,574,991 | |
Net cash provided by investing activities of discontinued operations | | | - | | | | 4,004 | |
Net cash (used in ) provided by investing activities | | | (24,862,181 | ) | | | 5,578,995 | |
| | | | | | | | |
Cash flows from financing activities - continuing operations: | | | | | | | | |
Proceeds from issuance of convertible notes | | | - | | | | 4,750,000 | |
Proceeds from issuance of common stock, net of $500,000 in offering expenses | | | - | | | | 38,451,052 | |
Redemption of equity rights | | | - | | | | (392,007 | ) |
Special dividend payment | | | - | | | | (9,562,331 | ) |
Proceeds from notes payable | | | 1,696,083 | | | | - | |
Payments on BMSS purchase agreement | | | (300,000 | ) | | | - | |
Repayment of notes payable and other obligations | | | (135,574 | ) | | | (272,678 | ) |
Proceeds from exercise of warrants | | | 350,000 | | | | 1,860,000 | |
Proceeds from exercise of stock options | | | 78,522 | | | | 149,136 | |
Proceeds from sale of Riot shares held by 1172767 B.C. Ltd. | | | 505,729 | | | | - | |
Proceeds from common shares sold by 1172767 B.C. Ltd., net | | | 220,446 | | | | - | |
Refund of escrow dividend | | | 72,056 | | | | - | |
Net cash provided by financing activities of continuing operations | | | 2,487,262 | | | | 34,983,172 | |
| | | | | | | | |
Net (decrease) increase in cash and cash equivalents | | | (41,426,575 | ) | | | 36,122,117 | |
Cash and cash equivalents at beginning of year | | | 41,651,965 | | | | 5,529,848 | |
Cash and cash equivalents at end of year | | $ | 225,390 | | | $ | 41,651,965 | |
| | | | | | | | |
Supplemental disclosure of cash flow information: | | | | | | | | |
Cash paid for interest | | $ | 6,585 | | | $ | 5,605 | |
Cash paid for taxes | | $ | - | | | $ | - | |
| | | | | | | | |
Supplemental disclosure of noncash investing and financing activities: | | | | | |
Value of shares issued for Prive asset acquisition | | $ | 8,480,000 | | | $ | - | |
Value of preferred shares issued for Kairos asset acquisition | | $ | - | | | $ | 9,296,443 | |
Value of common shares issued for Tess asset acquisition | | $ | - | | | $ | 636,750 | |
Conversion of preferred stock to common stock | | $ | 7,190,157 | | | $ | 6,349,848 | |
Deferred purchase price for BMSS | | $ | 1,500,000 | | | $ | - | |
Preferred stock canceled | | $ | 486,050 | | | $ | - | |
Deferred tax liability for Logical Brokerage | | $ | 142,709 | | | $ | - | |
Acquisition of assets for installment obligations | | $ | - | | | $ | 268,640 | |
| | | | | | | | |
See Accompanying Notes to Consolidated Financial Statements
Riot Blockchain, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
Note 1. Organization:
Riot Blockchain, Inc. (the “Company” or “Riot Blockchain”) was originally organized on July 24, 2000, as a Colorado corporation. Effective October 19, 2017, the Company's name was changed to Riot Blockchain, Inc., from Bioptix, Inc. Effective October 19, 2017, the Company changed its state of incorporation to Nevada from Colorado.
The Company operates a digital currency mining operation, which utilizes specialized computers (also known as “miners”) that generate digital currency (primarily bitcoin) from the Blockchain. The Company acquired approximately 8,000 miners through its acquisition of Kairos Global Technology, Inc., (“Kairos”) in November 2017, and from Prive Technologies, Inc. (“Prive”) Blockchain Mining Supply & Services Ltd. (“BMSS”) in February 2018.
On January 2, 2018, the Company formed Digital Green Energy Corp. (“Digital Green”), a wholly owned subsidiary, which is seeking to identify environmentally friendly projects with large energy capacity and a cost-effective rate for energy for digital currency mining operations and data center projects. Subsequent to December 31, 2018, activities of Digital Green were suspended. Digital Green’s operations were not significant for the year ended December 31, 2018.
On February 27, 2018, Kairos entered into a lease agreement for an approximately 107,000-square foot facility in Oklahoma City, Oklahoma, which included data center improvements. Upon the execution of the facility lease, the Company consolidated all of its miners at the data center facility.
On March 26, 2018, the Company acquired 92.5% of Logical Brokerage Corp. (“Logical Brokerage”). Logical Brokerage is a futures introducing broker headquartered in Miami, Florida registered with the Commodity Futures Trading Commission (“CFTC”), and a member of the National Futures Association (“NFA”). The Company is investigating launching a digital currency exchange and a futures brokerage operation within the United States under the name “RiotX”.
Note 2. Liquidity, Financial Condition, and Going Concern:
The Company has experienced recurring losses and negative cash flows from operations. At December 31, 2018, the Company had approximate balances of cash and cash equivalents of $225,000, a working capital deficit of $4,348,000, total stockholders' equity of $4,491,000 and an accumulated deficit of $197,199,000. To date, the Company has, in large part, relied on equity financing to fund its operations.
The Company’s primary focus is on its digital currency mining operation located in Oklahoma City, Oklahoma, along with its investigation of the launch of RiotX as a digital currency exchange in the United States. That operational focus and the Company’s recently completed acquisitions of Kairos and 1172767 B.C. Ltd. (“1172767” or “Tess”), formerly known as Tess Inc., and its investment in goNumerical Ltd., (d/b/a “Coinsquare”), as well as the Company’s new name, reflects a strategic decision by the Company to operate in the blockchain and digital currency related business sector. The Company's current strategy will continue to expose the Company to the numerous risks and volatility associated within this sector.
The Company expects to continue to incur losses from operations for the near-term and these losses could be significant as the Company incurs costs and expenses associated with recent and potential future acquisitions, and development of the RiotX exchange platform, as well as public company, legal and administrative related expenses being incurred. As disclosed in Note 17, subsequent to December 31, 2018, the Company issued a series of Senior Secured Convertible Promissory Notes, to investors for an aggregate principal amount of $3,358,333 and an equal value of warrants for the purchase of shares of the Company’s common stock. The Company is closely monitoring its cash balances, cash needs and expense levels.
The Company believes that in order for the Company to meet its obligations arising from normal business operations for the next twelve months, the Company requires additional capital either in the form of equity or debt. Without additional capital, the Company’s ability to continue to operate will be limited. If the Company is unable to obtain adequate capital, it could be forced to cease or reduce its operations. The Company is currently pursuing capital transactions in the form of debt and equity, however, the Company cannot provide any assurance that it will be successful in its plans. These consolidated financial statements do not include any adjustments to the recoverability and classification of recorded assets amounts and classification of liabilities that might be necessary should the Company not be able to continue as a going concern. In the opinion of management, these factors, among others, raise substantial doubt about the ability of the Company to continue as a going concern.
Riot Blockchain, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
Providing computing power in digital asset transaction verification services is an output of the Company’s ordinary activities. The provision of providing such computing power is the only performance obligation in the Company’s contracts with mining pool operators. The transaction consideration the Company receives, if any, is noncash consideration, which the Company measures at fair value on the date received, which is not materially different than the fair value at contract inception or the time the Company has earned the award from the pools. The consideration is all variable. Because it is not probable that a significant reversal of cumulative revenue will not occur, the consideration is constrained until the mining pool operator successfully places a block (by being the first to solve an algorithm) and the Company receives confirmation of the consideration it will receive, at which time revenue is recognized. There is no significant financing component in these transactions.
Fair value of the digital currency award received is determined using the quoted price of the related digital currency at the time of receipt.
There is currently no specific definitive guidance under GAAP or alternative accounting framework for the accounting for digital currencies recognized as revenue or held, and management has exercised significant judgment in determining the appropriate accounting treatment. In the event authoritative guidance is enacted by the FASB, the Company may be required to change its policies, which could have an effect on the Company’s consolidated financial position and results from operations.
Cost of revenue
The Company's cost of revenue consists primarily of direct production costs related to mining operations, including mining pool fees, rent and utilities, but excluding depreciation and amortization, which are separately stated in the Company’s consolidated statements of operations.
Business combinations:
The Company applies the provisions of ASC 805 in the accounting for acquisitions. ASC 805 requires us to recognize separately from goodwill the assets acquired and the liabilities assumed at their acquisition date fair values. Goodwill as of the acquisition date is measured as the excess of consideration transferred over the net of the acquisition date fair values of the assets acquired and the liabilities assumed. While we use our best estimates and assumptions to accurately apply preliminary value to assets acquired and liabilities assumed at the acquisition date as well as contingent consideration, where applicable, these estimates are inherently uncertain and subject to refinement. As a result, during the measurement period, which may be up to one year from the acquisition date, the Company records adjustments in the current period, rather than a revision to a prior period. Upon the conclusion of the measurement period or final determination of the values of the assets acquired or liabilities assumed, whichever comes first, any subsequent adjustments are recorded in our Consolidated Statements of Operations. Accounting for business combinations requires management to make significant estimates and assumptions, especially at the acquisition date, including estimates for intangible assets, contractual obligations assumed, restructuring liabilities, pre-acquisition contingencies, and contingent consideration, where applicable. Although we believe the assumptions and estimates we have made have been reasonable and appropriate, they are based in part on historical experience and information obtained from management of the acquired companies and are inherently uncertain. Critical estimates in valuing certain of the intangible assets we have acquired include; future expected cash flows from product sales; customer contracts and acquired technologies; expected costs to develop in-process research and development into commercially viable products and estimated cash flows from the projects when completed; and discount rates. Unanticipated events and circumstances may occur that may affect the accuracy or validity of such assumptions, estimates, or actual results.
Income taxes:
The Company accounts for income taxes under the asset and liability method, in which deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carry forwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in operations in the period that includes the enactment date. A valuation allowance is required to the extent any deferred tax assets may not be realizable.
ASC Topic 740, Income Taxes, (“ASC 740”), also clarifies the accounting for uncertainty in income taxes recognized in an enterprise's financial statements and prescribes a recognition threshold and measurement process for financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. For those benefits to be recognized, a tax position must be more-likely-than-not to be sustained upon examination by taxing authorities. ASC 740 also provides guidance on derecognition, classification, interest and penalties, accounting in interim period, disclosure and transition. Based on the Company's evaluation, it has been concluded that there are no significant uncertain tax positions requiring recognition in the Company's consolidated financial statements. The Company believes that its income tax positions and deductions would be sustained on audit and does not anticipate any adjustments that would result in material changes to its financial position.
Riot Blockchain, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
Stock-based compensation:
ASC 718, Share-Based Payment, defines the fair-value-based method of accounting for stock-based employee compensation plans and transactions used by the Company to account for its issuances of equity instruments to record compensation cost for stock-based employee compensation plans at fair value as well as to acquire goods or services from non-employees. Transactions in which the Company issues stock-based compensation to employees, directors and consultants and for goods or services received from non-employees are accounted for based on the fair value of the equity instruments issued. The Company utilizes the Black-Scholes pricing model in determining the fair values of options and warrants issued as stock-based compensation. These pricing models utilize the market price of the Company's common stock and the exercise price of the option or warrant, as well as time value and volatility factors underlying the positions.
Loss per share:
Basic net loss per share (“EPS”) of common stock is computed by dividing net loss by the weighted average number of shares of common stock outstanding during the period. Diluted EPS reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that then shared in the earnings of the entity. The Company excludes its unvested restricted shares and escrow shares from the net loss per share calculation. The escrow shares are excluded because of related contingencies and including them would result in anti-dilution.
Since the Company has only incurred losses, basic and diluted net loss per share is the same. Securities that could potentially dilute loss per share in the future that were not included in the computation of diluted loss per share at December 31, 2018 and 2017 because their inclusion would be anti-dilutive are as follows:
| | December 31, | |
| | 2018 | | | 2017 | |
Warrants to purchase common stock | | | 1,671,113 | | | | 1,944,895 | |
Options to purchase common stock | | | 62,000 | | | | 119,533 | |
Unvested restricted stock awards | | | 95,939 | | | | 342,070 | |
Escrow shares of common stock | | | 200,000 | | | | - | |
Convertible Series B preferred shares | | | 13,000 | | | | 1,458,001 | |
| | | 2,042,052 | | | | 3,864,499 | |
Segment reporting:
Operating segments are defined as components of an enterprise about which separate financial information is available that is evaluated regularly by the chief operating decision maker, or decision–making group in deciding how to allocate resources and in assessing performance. Our chief operating decision–making group is composed of the chief executive officer. We currently operate in one segment surrounding our digital currency mining operation.
Reclassifications
Certain prior period amounts reported in the consolidated statement of operations have been reclassified to conform to the presentations currently used. The reclassifications did not have a material impact on the Company's consolidated financial statements and related disclosures. Research and development expenses during the year ended December 31, 2017, were immaterial and have been included in selling, general and administrative expenses in the Company’s consolidated statements of operations.
Subsequent events
The Company has evaluated all events that occurred after the balance sheet date through the date when the financial statements were issued. See Note 17.
Recently issued and adopted accounting pronouncements:
The Company continually assesses any new accounting pronouncements to determine their applicability. When it is determined that a new accounting pronouncement affects the Company's financial reporting, the Company undertakes a study to determine the consequences of the change to its consolidated financial statements and assures that there are proper controls in place to ascertain that the Company's consolidated financial statements properly reflect the change.
Riot Blockchain, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
In May 2014, the FASB issued Accounting Standards Update (“ASU”) 2014-09, Revenue from Contracts with Customers (Topic 606), as modified by ASU 2015-14, Revenue from Contracts with Customers (Topic 606): Deferral of the Effective Date, ASU 2016-08, Revenue from Contracts with Customers (Topic 606): Principal versus Agent Considerations (Reporting Revenue Gross versus Net), ASU 2016-10, Revenue from Contracts with Customers (Topic 606): Identifying Performance Obligations and Licensing, and ASU 2016-12, Revenue from Contracts with Customers (Topic 606): Narrow-Scope Improvements and Practical Expedients. The revenue recognition principle in ASU 2014-09 is that an entity should recognize revenue to depict the transfer of goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. In addition, new and enhanced disclosures will be required. Companies may adopt the new standard either using the full retrospective approach, a modified retrospective approach with practical expedients, or a cumulative effect upon adoption approach. The Company adopted the new standard with practical expedients on January 1, 2018, using the modified retrospective approach. While the adoption of ASU 2014-09 did not have a material impact on the Company's consolidated financial statements, the Company has included the additional required disclosures in its consolidated financial statements in accordance with the adoption of this ASU.
In January 2016, the FASB issued ASU 2016-01, Recognition and Measurement of Financial Assets and Financial Liabilities. ASU 2016-01 requires equity investments to be measured at fair value with changes in fair value recognized in net income; simplifies the impairment assessment of equity investments without readily determinable fair values by requiring a qualitative assessment to identify impairment; eliminates the requirement for public business entities to disclose the method(s) and significant assumptions used to estimate the fair value that is required to be disclosed for financial instruments measured at amortized cost on the balance sheet; requires public business entities to use the exit price notion when measuring the fair value of financial instruments for disclosure purposes; requires an entity to present separately in other comprehensive income the portion of the total change in the fair value of a liability resulting from a change in the instrument-specific credit risk when the entity has elected to measure the liability at fair value in accordance with the fair value option for financial instruments; requires separate presentation of financial assets and financial liabilities by measurement category and form of financial assets on the balance sheet or the accompanying notes to the financial statements and clarifies that an entity should evaluate the need for a valuation allowance on a deferred tax asset related to available-for-sale securities in combination with the entity's other deferred tax assets. ASU 2016-01 is effective for financial statements issued for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years. The Company adopted the new standard on January 1, 2018. In adopting this new standard, the Company has made an accounting policy election to adopt the new equity method measurement alternative for its investments in Coinsquare.
In August 2016, the FASB issued ASU 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments. This standard provides guidance for eight cash flow classification issues in current GAAP. ASU 2016-15 is effective for fiscal years beginning after December 15, 2017 and interim periods within those fiscal years. The Company adopted the new standard on January 1, 2018 and the adoption did not have a material impact on the Company’s consolidated statement of cash flows.
In January 2017, the FASB issued ASU No. 2017-01, “Business Combinations (Topic 805) Clarifying the Definition of a Business” The amendments in this ASU clarify the definition of a business with the objective of adding guidance to assist entities with evaluating whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses. The definition of a business affects many areas of accounting including acquisitions, disposals, goodwill, and consolidation. The guidance is effective for annual periods beginning after December 15, 2017, including interim periods within those periods. Early adoption is permitted, including for interim or annual periods for which the financial statements have not been issued or made available for issuance. The Company adopted this guidance as of January 1, 2018. See Note 4 - Acquisitions regarding the adoption of ASU 2017-01.
In May 2017, the FASB issued ASU 2017-09, Compensation-Stock Compensation (Topic 718): Scope of Modification Accounting. ASU 2017-09 provides clarity and reduces both (1) diversity in practice and (2) cost and complexity when applying the guidance in Topic 718, to a change to the terms or conditions of a share-based payment award. The amendments in ASU 2017-09 should be applied prospectively to an award modified on or after the adoption date. This ASU is effective for fiscal years beginning after December 15, 2017, including interim periods within those years. The Company adopted the new standard on January 1, 2018 and the adoption of ASU 2017-09 did not have a material impact on the Company’s consolidated financial statements and related disclosures.
In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842) in order to increase transparency and comparability among organizations by, among other provisions, recognizing lease assets and lease liabilities on the balance sheet for those leases classified as operating leases under previous U.S. GAAP. For public companies, ASU 2016-02 is effective for fiscal years beginning after December 15, 2018 (including interim periods within those periods) using a modified retrospective approach and early adoption is permitted. In transition, entities may also elect a package of practical expedients that must be applied in its entirety to all leases commencing before the adoption date, unless the lease is modified, and permits entities to not reassess (a) the existence of a lease, (b) lease classification or (c) determination of initial direct costs, as of the adoption date, which effectively allows entities to carryforward accounting conclusions under previous U.S. GAAP. In July 2018, the FASB issued ASU 2018-11, Leases (Topic 842): Targeted Improvements, which provides entities an optional transition method to apply the guidance under Topic 842 as of the adoption date, rather than as of the earliest period presented. The Company adopted Topic 842 on January 1, 2019, using the optional transition method to apply the new guidance as of January 1, 2019, rather than as of the earliest period presented, and elected the package of practical expedients described above. The Company is still finalizing its analysis, but expects to recognize additional operating liabilities of approximately $1.4 million, with corresponding ROU assets of approximately the same amount as of January 1, 2019 based on the present value of the remaining lease payments.
Riot Blockchain, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
In January 2017, the FASB issued ASU 2017-04, Intangibles - Goodwill and Other (Topic 350): Simplifying the Accounting for Goodwill Impairment. ASU 2017-04 removes Step 2 of the goodwill impairment test, which requires a hypothetical purchase price allocation. A goodwill impairment will now be the amount by which a reporting unit's carrying value exceeds its fair value, not to exceed the carrying amount of goodwill. This standard will be effective for the Company beginning in the first quarter of fiscal year 2020 and is required to be applied prospectively. Early adoption is permitted for interim or annual goodwill impairment tests performed on testing dates after January 1, 2017. The Company does not expect the adoption of ASU 2017-04 to have a material impact on its consolidated financial statements.
In June 2018, the FASB issued ASU 2018-07, Improvements to Nonemployee Share-Based Payment Accounting, which simplifies the accounting for share-based payments granted to nonemployees for goods and services. Under the ASU, most of the guidance on such payments to nonemployees would be aligned with the requirements for share-based payments granted to employees. The amendments are effective for fiscal years beginning after December 15, 2019, and interim periods within fiscal years beginning after December 15, 2020. Early adoption is permitted, but no earlier than an entity’s adoption date of Topic 606. The Company adopted this new standard on January 1, 2019 and the adoption did not have a material impact on its consolidated financial statements and related disclosures.
In August 2018, the FASB issued ASU 2018-13, Fair Value Measurement (Topic 820), Disclosure Framework, Changes to the Disclosure Requirements for Fair Value Measurement, which makes a number of changes meant to add, modify or remove certain disclosure requirements associated with the movement amongst or hierarchy associated with Level 1, Level 2 and Level 3 fair value measurements. This guidance is effective for us on December 1, 2020. Early adoption is permitted upon issuance of the update. We do not expect the adoption of this guidance to have a material impact on our Consolidated Financial Statements.
In August 2018, the FASB issued ASU 2018-15, “Intangibles–Goodwill and Other–Internal-Use Software (Subtopic 350-40): Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is A Service Contract” (“ASU 2018-15”). This update clarifies the accounting treatment for fees paid by a customer in a cloud computing arrangement (hosting arrangement) by providing guidance for determining when the arrangement includes a software license. This guidance is effective for public business entities for fiscal years, and interim periods within those years, beginning after December 15, 2019, with early adoption permitted. The amendments may be applied either retrospectively or prospectively to all implementation costs incurred after the date of adoption. The Company is still evaluating the prospective impact of this guidance on its future consolidated financial statements and related disclosures.
Note 4. Acquisitions:
Asset Purchase Agreement with Prive Technologies LLC (“Prive”):
On February 21, 2018, the Company and Kairos, completed an asset purchase under an agreement (the “Prive Purchase Agreement”) with Prive on behalf of certain persons and entities who owned certain digital currency mining machines and related operating equipment (the “Prive Equipment”). Pursuant to the Prive Purchase Agreement, the aggregate consideration for the Prive Equipment consisted of (i) Eleven Million Dollars ($11,000,000) and (ii) One Million (1,000,000) shares of the Company’s common stock (the “Prive Shares”). Upon closing of the transaction, and pursuant to the terms of the Prive Purchase Agreement, Kairos became the owner of the Prive Equipment used for the mining of digital currency, including, but not limited to, 3,800 Bitmain AntMiner S9s. On February 21, 2018, the Prive Equipment was recorded for a purchase price of $19,482,000, consisting mainly of cash of $11,000,000 and 800,000 of the Company’s shares of common stock valued at $10.60 per share (excludes 200,000 shares of Common Stock currently held in escrow).
The purchase price for the miners was recorded as follow:
Cash consideration | | $ | 11,000,000 | |
Fair value of common stock | | | 8,480,000 | |
Other expenses | | | 2,000 | |
| | $ | 19,482,000 | |
Riot Blockchain, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
At the time of closing of the Prive Purchase Agreement, two principal shareholders of Prive were minority stockholders of Kairos at the time of Kairos acquisition by the Company in October 2017.
Two Hundred Thousand (200,000) of the Shares (the “Escrow Shares”) were deposited into an escrow account with Corporate Stock Transfer, Inc., as escrow agent (the “Escrow Agent”), pursuant to an escrow agreement (the “Escrow Agreement”). Certificates representing the Escrow Shares were deposited and recorded with the Escrow Agent to be held in escrow and not be transferred, pledged or hypothecated except as provided in the Escrow Agreement. No value was assigned to the Escrow Shares at the time of the acquisition as they are contingent consideration. The Escrow Shares will be released to the Sellers upon the Company generating Net Cash Flow (as defined in the Prive Purchase Agreement) of at least Ten Million Dollars ($10,000,000) from the Equipment. If the Escrow Shares are not released to the Sellers on or before the two-year anniversary (February 2020) of the Prive Purchase Agreement, the Escrow Shares shall be returned to the Company for cancellation. As of December 31, 2018, no escrow shares have been released based upon not achieving required net cash flow.
Under the guidance of ASC 360, Impairment or Disposal of Long-lived Assets, a long-lived asset or asset group (including intangibles) will be tested for recoverability whenever events or changes in circumstances indicate that its carrying amount may not be recoverable. Based upon the significant decline in the price of bitcoin during the year ended December 31, 2018 and the decline in projected cash flows over the life of the miners, the Company performed an analysis to determine if the Prive Equipment was impaired. The undiscounted cash flows were less than the carrying amount of the miners and therefore, the carrying amount of the assets were compared to the fair value of the miners, and the Company determined that there were impairment charges to be recorded on the miners purchased from Prive. Impairment charges for the year ended December 31, 2018 totaled approximately $17.7 million.
Asset Purchase Agreement with Blockchain Mining Supply & Services Ltd. (“BMSS”):
On February 21, 2018, the Company completed an asset purchase under an agreement (the “BMSS Purchase Agreement”) with BMSS which owned 3,000 AntMiner S9 bitcoin mining machines (the “BMSS Equipment”). Pursuant to the BMSS Purchase Agreement, the Company purchased the BMSS Equipment for aggregate consideration of Eight Million Five Hundred Thousand Dollars ($8,500,000). On February 21, 2018, the BMSS Equipment was recorded for purchase price of $8,500,000 paid or payable in cash. Seven Million Dollars ($7,000,000) of the purchase price was paid at closing and $1,500,000 was payable within six-months, as further defined in the BMSS Purchase Agreement.
On August 21, 2018, the Company and BMSS entered into a waiver letter, amending the BMSS Purchase Agreement (the “Waiver”) whereby the Company and BMSS agreed to waive any and all past due amounts payable by the Company to BMSS pursuant to Section 2(b)(ii) of the BMSS Purchase Agreement. Pursuant to the Waiver, the Company agreed to pay to BMSS the remaining $1,500,000 in monthly installments plus accrued and unpaid interest calculated at a rate equal to 10% per year. In addition to the foregoing, the Company agreed to issue to BMSS 50,000 shares of restricted common stock in connection with the Waiver within seven days of the execution of the Waiver. In connection with the foregoing, the Company relied upon the exemption from registration provided by Section 4(a)(2) under the Securities Act of 1933, as amended, for transactions not involving a public offering. During the year ended December 31, 2018, a total of $300,000 in payments were made against the $1,500,000 deferred price and the Company recorded a loss of $266,000 related to the computed value of the modification of the BMSS deferred purchase price which was recorded as a loss on extinguishment of debt in connection with the Waiver. All required payments under the amended BMSS agreements have not been timely made and the Company and BMSS are currently discussing plans to resolve.
Under the guidance of ASC 360, Impairment or Disposal of Long-lived Assets, a long-lived asset or asset group (including intangibles) will be tested for recoverability whenever events or changes in circumstances indicate that its carrying amount may not be recoverable. Based upon the significant decline in the price of bitcoin during the year ended December 31, 2018 and the decline in projected cash flows over the life of the miners, the Company performed an undiscounted cash flow test to determine if the miners were impaired. The undiscounted cash flows were less than the carrying amount of the BMSS Equipment and therefore, the carrying amount of the assets were compared to the fair value of the miners, and the Company determined that there were impairment charges to be recorded on the miners purchased from BMSS. Impairment charges for the year ended December 31, 2018 totaled approximately $6.7 million.
Acquisition of Logical Brokerage Corp.:
On March 26, 2018, the Company entered into and closed a stock purchase agreement (the “Logical Brokerage Purchase Agreement”) between the Company and Mark Bradley Fisher (the “Logical Brokerage Seller”). Pursuant to the Logical Brokerage Purchase Agreement, the Company purchased from the Logical Brokerage Seller 9.25 shares of Logical Brokerage, representing 92.5% of the outstanding capital stock of Logical Brokerage, for a cash purchase price of $600,000. Logical Brokerage, a futures introducing broker headquartered in Miami, Florida is registered with the CFTC and is a member of the NFA.
The Company considered the provisions of FASB ASU 2017-01, Business Combinations (Topic 805), and has determined that the Logical Brokerage Purchase Agreement should be accounted for as an acquisition of assets since the majority of the fair value of the assets acquired was concentrated in a single identifiable asset (CFTC License), and the acquired assets did not have outputs or employees. The asset recorded at the purchase price of $600,000, net of cash received with the asset acquisition of $100,000, plus any transaction costs. The CFTC license is included as intangible rights acquired, within the non-current asset section of the Company’s consolidated balance sheets.
Riot Blockchain, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
As a result of an asset acquisition through the acquisition of ownership, temporary differences may arise due to differences between the tax bases of assets acquired and liabilities assumed (determined by tax law) and the values of those assets and liabilities recognized for financial statement purposes (determined based on the provisions of ASC 805). ASC 740 requires an entity to recognize deferred tax assets and liabilities for those temporary differences and acquired operating loss or other tax credit carryforwards that arise as a result of the purchase of an asset. However, deferred taxes are not recognized for differences related to nondeductible goodwill, leveraged leases, and certain other differences for which there are specific exceptions. The deferred tax liability represents the difference between the book basis and the tax basis of Riot Blockchain’s intangible assets, calculated using a 25.6% effective tax rate.
On March 26, 2018, the CFTC license was recorded as follows:
Cash, net of cash acquired | | $ | 500,000 | |
Deferred tax liability | | | 142,709 | |
Non-controlling interest | | | 40,541 | |
Legal costs | | | 16,917 | |
Intangible rights acquired | | $ | 700,167 | |
In connection with the closing of the Logical Brokerage Purchase Agreement, on March 26, 2018, the Company entered into a stockholders’ agreement (the “Stockholders Agreement”) with Logical Brokerage and Mark Bradley Fisher. The Stockholders Agreement provides, among other things, that, subject to certain exceptions, the Logical Brokerage Seller may not transfer any of his remaining shares of Logical Brokerage without the written consent of the Company. The Stockholders Agreement also provides that, subject to certain exceptions, in the event the Company proposes to transfer 35% or more of Logical Brokerage’s total issued and outstanding capital stock, the Logical Brokerage Seller will be entitled to certain “tag-along” rights.
1172767 B.C. Ltd. Investment (formerly Tess Inc.):
On October 20, 2017, the Company acquired approximately 52% of Tess which is developing blockchain solutions for telecommunications companies. Under the terms of the Purchase Agreement (the “Purchase Agreement”) the Company invested cash of $320,000 in Tess and issued 75,000 shares of restricted Common Stock to Tess in exchange for 2,708,333 shares of common stock of Tess. The 75,000 shares of Common Stock were valued at the $8.49 market price as of October 20, 2017 for a total of $636,750. Accordingly, Tess became a majority-owned subsidiary of the Company. As part of the transaction, the Company and Tess entered into a registration rights agreement pursuant to which the Company agreed to file a registration statement to register the resale of 25,000 shares (of 75,000 shares) of Common Stock issued to Tess. The acquisition of Tess was accounted for as a business combination in accordance with the provisions of ASC 805.
The following is the allocation of the assets and liabilities acquired:
Cash | | $ | 198,000 | |
Accounts receivable and prepaid expenses | | | 9,000 | |
| | | | |
In-process research and development | | | 720,000 | |
Goodwill | | | 799,000 | |
Accounts payable | | | (21,000 | ) |
Deferred income tax liability | | | (186,000 | ) |
Non-controlling interest | | | (883,000 | ) |
Purchase price | | $ | 636,000 | |
The non-controlling interest represents the 48% proportionate share held by the minority shareholders of Tess. As of the acquisition the value of the 48% non-controlling interest implied from the purchase price totaled $883,000. The net loss attributable to the non-controlling interest for the period from acquisition to December 31, 2017 totaled $125,000, leaving a balance of $758,000 at December 31, 2017.
Riot Blockchain, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
Tess is developing TessPay and other blockchain on-line solutions for telecommunications companies. TessPay is a payments ecosystem for component and sub-component supply chain settlements (payments). The allocation of purchase consideration includes $720,000 as in-process research and development (IPR&D) related to the TessPay project. As of December 31, 2018, the Company had $587,000 of intangibles related to Tess’s internal technology platform. The valuation considered assumptions consistent with similar projects, including expectation of cash flows expected to commence in late 2018, future probable cash flows from the Tesspay project, discounted at a present value factor of approximately 60%.
In January 2018, following the execution of a non-binding letter of intent as of December 11, 2017, the parties executed a definitive agreement providing that the Company's majority owned subsidiary Tess agreed to merge with Cresval Capital Corp. (“Cresval”) (TSX-V: CRV). Assuming closing conditions are met, upon closing of the anticipated merger, Tess will be publicly traded on the TSX Venture Exchange (the “TSXV”) and change its name to “TessPay Inc.”. The agreement provides that Tess will be issued 80,000,000 shares of Cresval, and the present shareholders of Cresval will retain 8,400,000 shares of the combined company TessPay post-merger. The Company will receive 41,600,000 shares in the transaction resulting from its 52% ownership of Tess.
The merger transaction was completed in the third quarter of 2018 subject to specific closing conditions. The shares of Tess are expected to commence on the TSXV once regulatory approvals are obtained. Based upon the terms of the merger and related agreements, the acquisition will result in the Company owning less than 50% of Tess, at which time it would no longer be consolidated within the Company’s financial statements. On February 15, 2019, Cresval terminated its definitive agreement with Tess due to its inability to complete one of the specified closing conditions in the agreement.
During the year ended December 31, 2018, Tess received approximately $506,000 from the sale of shares of Riot Blockchain common stock held by Tess, which has been recorded as a credit to the consolidated Common Stock of the Company. Additionally, Tess issued approximately 189,000 of its common shares in exchange for cash proceeds of approximately $220,000 thereby reducing the investment percentage held by the Company from 52.01% to 50.2% as of December 31, 2018. Due to the termination of the Cresval Agreement on February 15, 2019, the Company recorded an impairment loss of $2.1 million consisting of $0.7 million of in process research and development costs, $0.6 million related to capitalized costs of Tess’s internal technology platform and $0.8 million of goodwill during the year ended December 31, 2018.
Pro Forma Results of Operations:
The unaudited supplemental pro forma information for the year ended December 31, 2017, as if the Tess acquisition had occurred as of its date of inception in 2017 were not material to the consolidated financial results as presented.
Tess Related Party Transactions:
Tess related parties include: Powercases Inc., and 2227470 Ontario Inc., (companies that are wholly-owned by Jeffrey Mason, President and Chief Executive Officer of Tess), 1038088 Ontario Limited (a company that is wholly-owned by Fraser Mason, Chairman and Chief Financial Officer of Tess), and JLM Strategic Marketing (a proprietorship owned by Jennifer Mason, Manager Corporate Communications of Tess).
The following table provides the total amount of transactions that have been entered into with Tess related parties and outstanding balances with Tess related parties as of and for the years ended December 31, 2018 and 2017:
Services to Tess provided by: | | December 31, 2018 | | | December 31, 2017 | |
Powercases Inc. | | $ | 655,236 | | | $ | 99,671 | |
JLM Strategic Marketing | | $ | 227,589 | | | $ | 11,766 | |
1038088 Ontario Limited | | $ | 187,136 | | | $ | 36,030 | |
Cryptocash Inc. | | $ | - | | | $ | 2,252 | |
2227470 Ontario Inc. | | $ | - | | | $ | - | |
| | | | | | | | |
(Payable) Receivable from: | | | | | | | | |
Powercases Inc. | | $ | (37,250 | ) | | $ | - | |
JLM Strategic Marketing | | $ | (9,483 | ) | | $ | - | |
1038088 Ontario Limited | | $ | (52,053 | ) | | $ | (36,030 | ) |
Cryptocash Inc. | | $ | - | | | $ | (2,252 | ) |
2227470 Ontario Inc. | | $ | - | | | $ | 7,971 | |
During the years ended December 31, 2018 and 2017, included in Tess's recorded services from related parties was $726,926 and $173,905, respectively for Tess's key management personnel salaries.
Riot Blockchain, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
Kairos Global Technology, Inc. Acquisition:
On November 3, 2017, the Company closed on a business combination share exchange agreement (the “Agreement”) with Kairos Global Technology, Inc., a Nevada corporation. Under the Agreement, the shareholders of Kairos agreed to exchange all outstanding shares of Kairos' common stock to the Company and the Company agreed to issue an aggregate of One Million Seven Hundred Fifty Thousand and One (1,750,001) newly-designated shares of Series B Convertible Preferred Stock (the “Series B Preferred Stock”) which are convertible into an aggregate of One Million Seven Hundred Fifty Thousand and One (1,750,001) shares of the Company's common stock, no par value per share (the transaction, the “Kairos Transaction”) to such shareholders. See Note 10 for further information about the Series B Preferred Stock. The 1,750,001 Series B Preferred Shares were valued at approximately $5.31 per share based upon the then value of the Company's common shares, discounted based upon restrictions associated with the preferred shares, for a total value of approximately $9,296,000. The shareholders of Kairos also will receive a royalty to be paid from cash flow generated from operations, as defined in the Agreement, which shall entitle such shareholders to receive 40% of the gross profits generated on a monthly basis until they have received a total of $1,000,000, at which point the royalty is extinguished. For financial reporting purposes the royalty liability will be recorded as the contingency is resolved and obligation determined. To date no royalty amounts have been achieved. Kairos owned certain computer equipment and other assets used for the mining of digital currency, specifically miners consisting of 700 AntMiner S9s and 500 AntMiner L3s, all manufactured by Bitmain. The acquisition of Kairos was accounted for as a business combination in accordance with the provisions of ASC 805.
We have completed an allocation of the purchase consideration. The following is the allocation of the purchase consideration:
Cash | | $ | 1,131,000 | |
Equipment | | | 10,333,000 | |
Accounts payable and accrued expenses | | | (46,000 | ) |
Deferred income tax liability | | | (2,122,000 | ) |
Purchase price | | $ | 9,296,000 | |
Based upon the significant decline in the price of bitcoin during the year ended December 31, 2018 and the decline in projected cash flows over the life of the miners, the Company performed an undiscounted cash flow test to determine if the miners were impaired. The undiscounted cash flows were less than the carrying amount of the miners and therefore, the carrying amount of the assets were compared to the fair value of the miners, and the Company determined that there were impairment charges to be recorded on the miners purchased from Kairos. Impairment charges for the years ended December 31, 2018 and 2017, totaled approximately $3.0 million and $5.2 million, respectively.
Note 5. Digital Currencies:
The following table presents additional information about digital currencies:
| | December 31, 2018 | | | December 31, 2017 | |
Beginning balance | | $ | 200,164 | | | $ | - | |
Revenue recognized from digital currencies mined | | | 7,748,634 | | | | 200,164 | |
Mining pool operating fees | | | (154,973 | ) | | | - | |
Purchase of digital currencies | | | 5,624,832 | | | | - | |
Sale of digital currencies | | | (9,237,225 | ) | | | - | |
Impairment of digital currencies | | | (3,501,250 | ) | | | - | |
Realized gain on sale of digital currencies | | | 26,443 | | | | - | |
Ending balance | | $ | 706,625 | | | $ | 200,164 | |
Riot Blockchain, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
Note 6. Property and equipment:
The breakdown of the impairment charges are as follows:
| | December 31, 2018 | | | December 31, 2017 | |
Prive miners | | $ | 17,690,541 | | | $ | - | |
BMSS miners | | | 6,701,971 | | | | - | |
Kairos miners | | | 3,025,761 | | | | 5,218,004 | |
Leasehold improvements | | | 1,819,446 | | | | - | |
Total impairment charge | | $ | 29,237,719 | | | $ | 5,218,004 | |
Property and equipment consisted of the following as of December 31, 2018 and 2017:
| | December 31, 2018 | | | December 31, 2017 | |
Digital currency machines | | $ | - | | | $ | 4,700,575 | |
Office and computer equipment | | | 92,840 | | | | 61,670 | |
Total cost of property and equipment | | | 92,840 | | | | 4,762,245 | |
Less accumulated depreciation | | | (66,571 | ) | | | (468,079 | ) |
Property and equipment, net | | $ | 26,269 | | | $ | 4,294,166 | |
Depreciation and amortization expense totaled approximately $5.2 million and $0.9 million, for the years ended December 31, 2018 and 2017, respectively. Depreciation is computed on the straight-line basis for the periods the assets are in service.
Note 7. Investment in Coinsquare:
In September 2017, the Company acquired a minority interest for $3.0 million in Coinsquare, which operates a digital crypto currency exchange platform in Canada. During February 2018, the Company invested an additional $6.4 million to acquire additional common stock of Coinsquare. The investment included an additional equity investment of $2.8 million that is part of an approximate $24 million financing by Coinsquare. Additionally, warrants acquired in the original investment were exercised in exchange of a cash payment of $3.6 million. These additional investments resulted in a current ownership in Coinsquare by the Company of approximately 12.9% ownership in Coinsquare based upon Coinsquare’s issued and outstanding shares. The Company has evaluated the guidance in ASU 2016-01, Recognition and Measurement of Financial Assets and Financial Liabilities, and elected to account for the investment using the measurement alternative as the equity securities are without a readily determinable fair value and do not give the Company significant influence over Coinsquare. The measurement alternative at cost, less any impairment, plus or minus changes resulting from observable price changes. As of December 31, 2018 and 2017, the Company considered the cost of the investment to not exceed the fair value of the investment and did not observe price changes.
Riot Blockchain, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
Note 8. Other long-term assets
Intangible rights acquired totaling $700,000 and $754,000, as of December 31, 2018 and 2017, respectively, consisted of intangible rights associated with the Tess and Logical Brokerage acquisitions.
Other long-term assets consisted of the following as of December 31, 2018 and December 31, 2017:
Cost: | | December 31, 2018 | | | December 31, 2017 | |
Patents | | $ | 1,119,428 | | | $ | 1,059,832 | |
Goodwill | | | - | | | | 1,186,496 | |
Convertible note investment | | | 200,000 | | | | 200,000 | |
Total | | | 1,319,428 | | | | 2,446,328 | |
| | | | | | | | |
Accumulated amortization: | | | | | | | | |
Patents | | | (612,086 | ) | | | (550,183 | ) |
Total | | | (612,086 | ) | | | (550,183 | ) |
| | | | | | | | |
Net other long-term assets | | $ | 707,342 | | | $ | 1,896,145 | |
Patents
The Company’s intangible assets with finite lives consist of its patents pertaining to its legacy animal health business, which have been out-licensed. For all periods presented, all of the Company’s identifiable intangible assets were subject to amortization. The carrying amounts related to acquired intangible assets as of December 31, 2018 and 2017 were as follows:
Patents at January 1, 2017, net | | $ | 550,799 | |
Additions | | | 26,850 | |
Less: amortization expense | | | 68,000 | |
Patents at December 31, 2017, net | | | 509,649 | |
Additions | | | 59,597 | |
Less: amortization expense | | | 61,904 | |
Patents at December 31, 2018, net | | $ | 507,342 | |
The following table represents the total estimated amortization of intangible assets for the five succeeding years and thereafter:
For the year ended December 31, | | Estimated amortization expense | |
2019 | | $ | 58,000 | |
2020 | | | 58,000 | |
2021 | | | 58,000 | |
2022 | | | 58,000 | |
2023 and thereafter | | | 275,342 | |
Total | | $ | 507,342 | |
The Company capitalizes legal costs and filing fees associated with obtaining patents on its new discoveries. Once the patents have been issued, the Company amortizes these costs over the shorter of the legal life of the patent or its estimated economic life using the straight-line method. Amortization expense totaled $62,000 and $68,000 for the years ended December 31, 2018 and 2017, respectively. The Company tests intangible assets with finite lives upon significant changes in the Company’s business environment. The testing resulted in no patent impairment charges during the years ended December 31, 2018 and 2017.
Investment in Verady, LLC
During November 2017, the Company made a $200,000 investment in a convertible note as part of a series of notes issued and being issued by Verady, LLC (“Verady”). The notes are unsecured, subordinated to other approved liabilities, mature December 31, 2022, bear interest at 6%, unless previously repaid or converted and contain other conditions and restrictions, all as defined under the subscription documents. The Verady convertible note is recorded at fair value (which approximates cost) as of December 31, 2018 and 2017. The conversion rate of the convertible note is defined based upon the possible occurrence of certain defined events which may or may not occur. If such a defined event successfully occurs, the Company currently estimates that its convertible note would result in a maximum ownership interest of approximately 12%. The Company has no other relationship or rights associated with Verady. Founded in 2016, Verady is privately held and recently launched VeraNet, a decentralized network of financial reporting and accounting tools targeted to the needs of the digital currency community. As of December 31, 2018 and 2017, the Company considered the cost of the investment to not exceed the fair value of the investment and did not observe price changes.
Riot Blockchain, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
Note 9. Notes, warrants and other obligations:
In March 2017, the Company completed a 2% convertible note financing with certain accredited investors with gross proceeds totaling $4,750,000. The convertible note financing proceeds were held in escrow pending successful completion of defined release conditions. As of August 18, 2017, the lead investor in the convertible note financing, agreed to waive the release conditions and the cash proceeds and securities were released from escrow. Upon the successful completion of conditions specified in the offering documents, primarily approval by the Company's shareholders for authorization of preferred shares and approval of the Nasdaq Capital Market (“NASDAQ”), the notes automatically converted into shares of Series A Preferred Stock, convertible into shares of common stock at an initial equivalent conversion price of $2.50 per common share. The specified conditions were successfully completed as of September 20, 2017, resulting in the conversion of $4,750,000 in principal and accrued interest of $48,671 for a total of $4,798,671 worth of convertible notes, exchanged for 19,194.72 shares of Series A Preferred Stock, with a stated value of $250 per share, equaling rights to 1,919,472 shares of common stock. The convertible notes accrued interest at 2% per annum commencing with their execution and the Company recorded interest expense of $48,671 through the date of conversion of the notes.
Warrants to purchase 1,900,000 shares of the Company's common stock at an initial exercise price of $3.56 per share and expiring March 15, 2020, were also issued with the convertible note financing.
The warrants were determined to meet requirements for equity classification. Accordingly, the relative fair value computed for the warrants, totaling $2,325,151 has been allocated to equity. The fair value of the warrants was estimated using the Black-Scholes option-pricing model using the assumptions of a three-year term, expected price volatility of 108%, dividend yield of 0% and a risk-free interest rate of 1.47%. The convertible debt was also evaluated for beneficia conversion feature (“BCF”). Based upon the effective conversion price of the convertible notes after considering the stock price at the date of the escrow release and the allocation of value to the warrants, it was determined that the convertible notes contain a BCF. The value of the BCF was computed to be $2,424,849, which has been capped not to exceed the total proceeds from the convertible notes after deducting the value allocated to the warrants. The resulting discount on the convertible debt was being amortized to interest expense over the term of the convertible notes. Upon the September 20, 2017 conversion of the convertible notes into Series A Preferred Stock, the then remaining unamortized discount was recorded as additional interest, resulting in a total of $4,750,000 being recorded as interest expense in the year ended December 31, 2017.
In connection with the March 2017 private placement, the Company also entered into a Registration Rights Agreement, with the investors. On December 21, 2017, investors holding a majority of the outstanding securities registrable pursuant to the agreement, agreed on behalf of all investors to waive the requirement for the filing of a registration statement and terminate the registration rights agreements. The investors further waived any and all damages, penalties and defaults related to the Company's not filing the registration statement by the filing date and any damages, penalties and defaults related to the Company not having a registration statement be declared effective by the specified date (as such terms are originally defined in the Unit Registration Rights Agreement).
As of March 28, 2018, Tess, a subsidiary of the Company, entered into a note purchase agreement with a private investor under which a convertible promissory note issued by Tess in the principal amount CAD $2.2 million (the “Convertible Note”) and cash proceeds of CAD $2.2 million were placed into a third-party controlled escrow account. Upon the successful achievement of conditions defined under the escrow agreement relating to closing of a transaction between Tess and Cresval Capital Corp, (“Cresval”) whereby Tess and Cresval would merge as provided in the merger agreements and Tess would become publicly traded on the TSXV Venture Exchange, the then remaining cash and the Convertible Note would be issued to Tess and the investor, respectively. The Convertible Note is convertible at $0.10 per share of the merged entity, as defined, subject to certain adjustments. On February 15, 2019, Cresval terminated its definitive agreement with Tess due to Tess’s inability to complete one of the specified closing conditions in the agreement.
The interim release consisted of CAD $1.0 million (USD $775,555) of cash released to Tess and an unsecured promissory note issued by Tess (“Promissory Note”) released to the investor. The Promissory Note bears interest at 5%, is unsecured and due in 2021. On August 23, 2018, the final release from escrow occurred. Tess received approximately USD $921,000, bringing the total Promissory Note balance to approximately $1,696,000.
Notes and other obligations on the accompanying consolidated balance sheets also consisted of short-term installment obligations, arising from insurance premium financing programs bearing interest at approximately 4.5%, with outstanding balances of $0 and $135,574, as of December 31, 2018 and 2017, respectively.
Riot Blockchain, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
Note 10. Stockholders' equity:
Articles of Incorporation amendments:
Effective September 19, 2017, the Company changed its state of incorporation from Colorado to Nevada (the “Reincorporation”). In connection with the Reincorporation and as approved by the Company's shareholders at a special meeting held August 21, 2017 Special Shareholders' Meeting, the Company's Articles of Incorporation were amended to increase the number of shares of common stock authorized for issuance to 170,000,000 from 60,000,000. Additionally, the Articles of Incorporation were amended to authorize 15,000,000 shares of “blank check” preferred stock.
Preferred Stock:
Series A – Preferred Stock
On September 20, 2017, 2,000,000 shares of preferred stock were designated as “2% Series A Convertible Preferred Stock” in connection with the filing of a Certificate of Designation of Rights, Powers, Preferences, Privileges and Restrictions of 2% Series A Convertible Preferred Stock with the Secretary of State of the State of Nevada.
The Series A Preferred Stock are convertible into shares of common stock based on a conversion calculation equal to the stated value ($250.00 per share) of such shares of Series A Preferred Stock, plus all accrued and unpaid dividends, if any, on such shares of Series A Preferred Stock, divided by the conversion price of $2.50, subject to adjustments. The shares of Series A Preferred Stock are subject to adjustment for stock splits, stock dividends, recapitalizations, combinations, subdivisions or other similar events. Shares of capital stock of the Company shall be junior in rank to all shares of Series A Preferred Stock with respect to the preferences as to dividends, distributions and payments upon the liquidation, dissolution and winding-up of the Company. Each holder of shares of Series A Preferred Stock shall be entitled to receive dividends, which dividends shall be paid by the Company out of funds legally available therefor, payable, subject to the conditions and other terms hereof, in shares of common stock or cash on the stated value of such shares of Series A Preferred Stock at the dividend rate of two percent (2%) per annum, which shall be cumulative and shall continue to accrue and compound monthly whether or not declared. Holders of shares of Series A Preferred Stock, shall be entitled to vote on any proposals voted on by the common shareholders.
Series B – Preferred Stock
On November 3, 2017, the Company designated 1,750,001 shares of preferred stock as “0% Series B Convertible Preferred Stock” in connection with the filing of the Certificate of Designation with the Secretary of State of the State of Nevada.
The shares of Series B Preferred Stock are convertible into shares of common stock based on a conversion calculation equal to the stated value of the Series B Preferred Stock, plus all accrued and unpaid dividends, if any, on such Series B Preferred Stock, as of such date of determination, divided by the conversion price. The stated value of each share of Series B Preferred Stock is $6.80 and the initial conversion price is $6.80 per share, each subject to adjustment for stock splits, stock dividends, recapitalizations, combinations, subdivisions or other similar events.
The holders of Series B Preferred Stock are entitled to receive dividends if and when declared by the Company's board of directors. The Series B Preferred Stock will participate on an “as converted” basis, with all dividends declared on the Company's common stock. Such dividends will be paid by the Company out of funds legally available therefor, payable, subject to the conditions and other terms hereof, in cash on the stated value of such Series B Preferred Stock.
The Company is prohibited from effecting a conversion of the Series B Preferred Stock to the extent that, as a result of such conversion, the holder would beneficially own more than 4.99% percent of the number of shares of common stock outstanding immediately after giving effect to the issuance of shares of common stock upon conversion of the Series B Preferred Stock, which beneficial ownership limitation may be increased by the holder up to, but not exceeding, 9.99% percent. Each holder is entitled to vote on all matters submitted to stockholders of the Company, and will have the number of votes equal to the number of shares of common stock issuable upon conversion of such holder's Series B Preferred Stock.
The Series B Preferred Stock contains a blocker pursuant to which, if the Company has not obtained the approval of its shareholders in accordance with NASDAQ Listing Rule 5635(d), then the Company may not issue upon conversion of the Series B Preferred Stock a number of shares of common stock, which, when aggregated with any other shares of common stock underlying the Series B Preferred Stock issued pursuant to the Agreement would exceed 19.99% of the shares of common stock issued and outstanding as of the date of the Agreement, subject to adjustment for reverse and forward stock splits, stock dividends, stock combinations and other similar transactions of the common stock that occur after the date of the Agreement.
On December 21, 2017, the Company amended the Certificate of Designation of Rights, Powers, Preferences, Privileges and Restrictions of 0% Series B Convertible Preferred Stock (the “Amendment”) in order to remove the voting rights of the Series B Preferred Stock.
Subsequent to the November 3, 2017 issuance of the Series B Preferred Stock, holders of 292,000 Series B Preferred Shares elected to convert those shares for 292,000 shares of the Company's Common Stock as provided in the agreements. As of December 31, 2017, 1,458,001 shares of Series B Preferred Stock were outstanding.
During the year ended December 31, 2018, holders of 1,353,505 Series B Preferred Shares elected to convert those shares to 1,353,505 shares of the Company’s common stock under their original terms. On November 30, 2018, the Company canceled 91,496 shares of its Series B Preferred Stock with a value at issuance of $5.31 per share, or $486,050. As of December 31, 2018, 13,000 shares of Series B Preferred Stock were outstanding.
Riot Blockchain, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
2018 Transactions:
Common Stock -
On January 4, 2018, the Company issued 19,533 shares of common stock upon the exercise of an employee stock-option.
On January 25, 2018, the Company issued 2,754 shares of common stock at fair value for consulting services at $7.26 per share.
On February 14, 2018, the Company issued 100,000 shares of common stock for the exercise of 100,000 warrants issued in March 2017. The Company received $350,000 from the exercise of the warrants.
On April 20, 2018, the Company issued 18,000 shares of the Company’s common stock for consulting services at an average fair value of $14.33 per share.
During August 2018, the Company issued 50,000 shares of the Company’s common stock at an average fair value of $5.31 per share, as consideration for the Waiver under the BMSS Purchase Agreement. See Note 4.
On December 18, 2018, the Company issued 22,523 shares of common stock at a fair value of $5.55 per share, related to a settlement fee for consulting services.
During the year ended December 31, 2018, holders of 1,353,505 Series B preferred shares elected to convert those shares to 1,353,505 shares of the Company’s common stock under its original terms.
During the year ended December 31, 2018, warrants to purchase 13,009 shares of common stock were exercised on a cashless basis for 3,215 shares of common stock.
Common Stock issued in Asset Acquisition -
On February 21, 2018, the Company issued 1,000,000 shares of common stock at fair value in connection with the Prive asset purchase agreement, with 200,000 of these shares deposited into an escrow account with Corporate Stock Transfer, Inc.
Restricted Common Stock -
During the years ended December 31, 2018 and 2017, 327,416 and 174,082, respectively, shares of common stock related to fully vested shares of restricted common stock were delivered for services performed.
2017 Transactions:
Common Share Private Placement offering -
In March 2017, the Company completed a common stock unit financing private placement totaling $2,250,000, with certain accredited investors. The purchase price was $2.50 per unit (the “Units”). Each Unit consisted of one share of the Company's common stock and a three-year warrant to purchase one share of the Company's common stock at an exercise price of $3.50 per share. The fair value of the 900,000 warrants was estimated to be approximately $2,114,000, using the Black-Scholes option-pricing model using the assumptions of a three-year term, expected price volatility of 114%, dividend yield of 0% and a risk-free interest rate of 1.66%. The Company sold 900,000 units consisting of an aggregate of 900,000 shares of common stock and 900,000 warrants, of which 400,000 units for $1,000,000 were released to the respective parties in March 2017, and the balance of 500,000 units for $1,250,000 were released in May 2017. The offering net of $336,491 of offering expenses, resulted in proceeds of $1,913,509 recorded as additional equity.
In connection with the private placement, the Company also entered into a Registration Rights Agreement, with the investors. On December 21, 2017, investors holding a majority of the outstanding securities registrable pursuant to the agreement, agreed on behalf of all investors to waive the requirement for the filing of a registration statement and terminate the registration rights agreements. The investors further waived any and all damages, penalties and defaults related to the Company's not filing the registration statement by the filing date and any damages, penalties and defaults related to the Company not having a registration statement be declared effective by the specified date (as such terms are originally defined in the Unit Registration Rights Agreement).
Riot Blockchain, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
Common stock escrow forfeiture -
During the year ended December 31, 2017, under an agreement between the Company and one of the selling shareholders from the Company's 2016 acquisition of BDI, rights to 32,801 common shares held in escrow on behalf of the selling shareholder were waived by the shareholder and returned to the Company where they were cancelled. Under the agreement each party mutually released each other from any and all claims that might relate to or arise from the acquisition of BDI. As a result of this cancellation, $134,812, which was the estimated fair market value of the 32,801 common shares, based upon $4.11 per share, was recorded as a gain in the BDI discontinued operations and a reduction in common stock. The Company considered ASC 805-20-25-27 accounting for indemnification assets at closing of the BDI acquisition and at subsequent reporting periods and determined that no value for the shares held in escrow was recordable, until the settlement agreement was agreed to.
Equity rights termination redemptions -
During the year ended December 31, 2017, the Company negotiated and executed agreements with holders of stock rights (stock options and restricted shares) to have such holders waive their rights to the stock rights in exchange for a one-time cash payment. The majority of the holders had previously terminated from the Company or the agreements were made as part of separation agreements upon the individuals' termination from the Company. Under the agreements, a total of 553,911 rights were forfeited, consisting of; 515,578 stock options under the Company's 2002 Stock Incentive Plan (the “2002 Plan”), 37,500 non-qualified options issued outside of the 2002 Plan and 833 restricted common shares. The total consideration under the agreements was $399,513. For financial reporting purposes the amounts paid to each holder was compared to the fair value of the stock rights forfeited using a Black-Scholes valuation and to the extent the amount paid exceeded the value of the stock rights forfeited, the payment amount was charged to stock-based compensation. For purposes of the Black-Scholes valuation, the Company assumed a dividend yield of 0%, expected price volatility of 49% to 99% risk free interest rates of 0.8% to 2.3% and expected terms based upon the remaining lives of the instruments. Of the total amount paid, $392,007 was charged to stockholders' equity and $7,506 was charged to compensation expense.
Common Stock issued for Acquisition -
On October 20, 2017, the Company issued 75,000 shares of Common Stock in connection with the majority acquisition of Tess. The issuance of the shares was completed as a private placement transaction. In connection with the transaction, the Company and Tess entered into a Registration Rights Agreement pursuant to which the Company agreed to file a registration statement within three months to register the resale of 25,000 shares (of 75,000 shares) of Common Stock issued to Tess. See Note 4.
Cash Dividend -
On October 2, 2017, the Company's Board of Directors approved a cash dividend pursuant to which the holders of the Company's common stock and Series A Preferred Stock, would receive $1.00 for each share of Common Stock held, including each share of Common Stock that would be issuable upon conversion of the Series A Preferred Stock, on an as converted basis. The cash dividend, accounted for as a return of capital, totaled approximately $9,562,000 with a record date of the close of business on October 13, 2017 and payment date of October 18, 2017.
Temporary Reduction in Warrant Exercise Prices -
On October 10, 2017, the Company's Board of Directors approved a temporary reduction in the exercise price of warrants issued in the March 2017 private offerings to $3.00 per share. The approval covered any of the 2,800,000 outstanding warrants which would be exercised by their holders from October 10, 2017 through October 20, 2017, for cash. During that period 620,000 warrants were exercised for cash, resulting in $1,860,000 in proceeds to the Company. Any such warrant holder who exercised such warrants for cash at the reduced price shall not be entitled to the benefit of any cashless exercise feature on such exercised warrants. The fair value of the temporary modification of the reducing the exercise price was recorded as an additional expense and a credit to capital in the period of exercise. The fair value was computed to be $173,867, based upon the increase in fair value of the warrants immediately before and immediately after the reduction in exercise price times the 620,000 warrants actually exercised.
Cashless Exercise of Common Stock Purchase Warrants -
During the year ended December 31, 2017, warrant holders of 2,244,147 common share rights elected to exercise their warrants on a net cashless basis and were issued a net of 1,335,408 shares of common stock in exchange for termination of the warrants. Warrants issued in the May 2013 private offering at an exercise price of $10.88 per common share for 184,147 share rights were surrendered for the issuance of 106,719 common shares. Warrants issued in the March 2017 private offering of common stock at an exercise price of $3.50 per common share for 360,000 share rights were surrendered for the issuance of 214,851 common shares. Warrants issued in the Mach 2017 private offering of convertible notes at an exercise price of $3.56 per common share for 1,700,000 share rights were surrendered for the issuance of 1,013,838 common shares. The Company evaluated the provisions of ASC 815 Derivatives and Hedging regarding the accounting for these cashless warrant exercises. Based upon the fact that no changes were made to the terms of the warrants following their issuance and the exceptions to derivative instruments under ASC 815-15-74 for contracts issued by the reporting entity that are indexed in the entity's own stock and classified in stockholders' equity, it was determined that no expense recognition is required.
During the year ended December 31, 2018, no warrants were exercised on a net cashless basis.
Riot Blockchain, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
Restricted Common Stock Awards -
During the year ended December 31, 2017, 863,000 restricted common stock awards were granted to directors and officers under the Company's equity incentive plans, of which 40,000 were terminated upon the individuals' separation from the Company. As of December 31, 2017, 326,848 restricted common shares had vested and 174,082 had been issued.
During the year ended December 31, 2017, the Company issued 138,067 restricted common shares to consultants for services recorded at a value of approximately $1,178,200.
Common Share Private Placement offering -
On December 21, 2017, the Company closed on the sale of approximately $36,537,543 of units, net of approximately $500,000 in offering expenses of its securities and issued 1,646,113 shares of Common Stock and warrants to purchase up to 1,646,113 shares of Common Stock (the “Units”) pursuant to separate purchase agreements (the “Securities Purchase Agreements”) with accredited investors (the “Investors”), at a purchase price of $22.50 per Unit. Each Unit consists of one share (the “Shares”) of the Company's common stock, no par value per share (the “Common Stock”), and a three-year warrant (the “Warrants”) to purchase one share of Common Stock, at an exercise price of $40.00 per share (such sale and issuance, the “Private Placement”).
The Warrants are exercisable, at any time on or after the sixth month anniversary of the closing date of the Private Placement, at a price of $40.00 per share, subject to adjustment, and expire three years therefrom. The holders may, subject to certain limitations, exercise the Warrants on a cashless basis. The Company is prohibited from effecting an exercise of any Warrant to the extent that, as a result of any such exercise, the holder would beneficially own more than 9.99% of the number of shares of Common Stock outstanding immediately after giving effect to the issuance of shares of Common Stock upon exercise of such Warrant.
The Company entered into separate registration rights agreements (the “Registration Rights Agreement”) with each of the Investors, pursuant to which the Company will undertake to file a registration statement to register the Common Stock issued as part of the Units and the Common Stock issuable upon exercise of the Warrants, within fourteen days following the closing, to cause such registration statement to be declared effective by the Securities and Exchange Commission within ninety days of the filing date and to maintain the effectiveness of the registration statement until all of such shares of Common Stock registered have been sold or are otherwise able to be sold pursuant to Rule 144. In the event the Company fails to file, or obtain effectiveness of, such registration statement with the given period of time, the Company will be obligated to pay liquidated damages to the Investors for every thirty-days during which such filing is not made and/or effectiveness obtained, such fee being subject to certain exceptions.
The registration rights agreement required that the securities would be registered by March 5, 2018, the effectiveness date, and the registration statement was not declared effective by March 5, 2018. The Company accounted for registration rights agreements in accordance with ASC 825-20, “Registration Payment Arrangements.” ASC 825-20 addresses an issuer’s accounting for registration payment arrangements. This pronouncement specifies that the contingent obligation to make future payments or otherwise transfer consideration under a registration payment arrangement, whether issued as a separate agreement or included as a provision of a financial instrument, should be separately recognized and accounted for as a contingency in accordance with ASC 450-20 “Loss Contingencies”. The Company recorded approximately $1,358,000 for this contingency in other expenses for the year ended December 31, 2018. This contingency was recorded as a liability as a component of accrued expenses as of December 31, 2018.
Note 11. Stock options, warrants and restricted common stock:
The Company currently provides stock-based compensation to employees, directors and consultants, both under the Company's 2017 Equity Incentive Plan, as approved by the Company's shareholders on August 21, 2017 (the “Plan”) and non-qualified options and warrants issued outside of the Plan. The Company's previous 2002 Stock Incentive Plan, as amended was replaced by the 2017 Plan with the 2002 Stock Incentive Plan continuing to govern outstanding grants and awards for 10,251 shares of restricted common stock, but no additional grants are to be made. The 2017 Plan was approved reserving 895,000 common shares under the Plan. The Company estimates the fair value of the share-based awards on the date of grant using the Black-Scholes option-pricing model (the “Black-Scholes model”). Using the Black-Scholes model, the value of the award that is ultimately expected to vest is recognized over the requisite service period in the statement of operations. Option forfeitures are estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. The Company attributes compensation to expense using the straight-line single option method for all options granted.
Stock-based Compensation:
The Company’s stock-based compensation expenses recognized during the years ended December 31, 2018 and 2017, were attributable to selling, general and administrative expenses, which are included in the accompanying consolidated statements of operations.
Riot Blockchain, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
The Company recognized total stock-based compensation expense during the years ended December 31, 2018 and 2017, from the following categories:
| | Years Ended December 31, | |
| | 2018 | | | 2017 | |
Restricted stock awards under the Plan | | $ | 3,971,916 | | | $ | 1,714,116 | |
Stock option awards under the Plan | | | 688,490 | | | | 875,696 | |
Total stock-based compensation | | $ | 4,660,406 | | | $ | 2,589,812 | |
Restricted common stock awards:
A summary of the Company's restricted stock activity in the years ended December 31, 2018 and 2017 is as follows:
| | Number of Shares | | | Weighted Average Grant-Date Fair Value | |
Unvested at January 1, 2017 | | | - | | | $ | - | |
Granted | | | 863,000 | | | $ | 5.39 | |
Vested | | | (326,848 | ) | | $ | 4.87 | |
Forfeited | | | (40,000 | ) | | $ | 3.13 | |
Unvested at December 31, 2017 | | | 496,152 | | | $ | 5.97 | |
Granted | | | 431,000 | | | $ | 10.46 | |
Vested | | | (530,065 | ) | | $ | 7.61 | |
Forfeited | | | (301,148 | ) | | $ | 7.68 | |
Unvested at December 31, 2018 | | | 95,939 | | | $ | 12.49 | |
During the year ended December 31, 2018, a total of 431,000 shares of restricted common stock were granted, consisting of, 418,500 shares granted to officers, employees and non-employee directors of the Company, and 12,500 shares granted to a consultant for services. The total grant date fair value of restricted common stock granted during the year ended December 31, 2018 was approximately $4.5 million.
During the year ended December 31, 2018, forfeitures of restricted common stock totaled 301,148, which consisted of 293,481 shares forfeited due to the termination of the Company’s employees and officers, and 7,667 shares forfeited due to the resignation of a member of the Company’s board of directors.
The value of restricted common stock grants are measured based on their fair market value on the date of grant and amortized over their respective vesting periods. As of December 31, 2018, there was approximately $1,176,000 of unrecognized compensation cost related to unvested restricted common stock, which is expected to be recognized over a remaining weighted-average vesting period of approximately 1.0 year.
During the year ended December 31, 2017, the Company granted 863,000 restricted shares to members of its Board of Directors, Advisory Board members and officers. As of December 31, 2017, of the 326,848 restricted shares which had vested, 174,082 had been issued with 152,766 vested rights remaining to be issued. Upon the separation of two Directors, 40,000 restricted shares were subsequently forfeited, including 833 restricted shares that were re-acquired by the Company as part of the equity rights terminations (see Note 10). The weighted-average grant date fair value of restricted shares granted during the year ended December 31, 2017 was $5.39 per share based upon the share price as of the date of grant. The total fair value of restricted stock granted, net of approximately $125,000 of forfeitures, during the year ended December 31, 2017 was approximately $4.7 million, including approximately $1.6 million which vested in the period.
Riot Blockchain, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
Stock incentive Plan options:
The Company's determination of the estimated fair value of share-based payment awards on the date of grant under the Plan is affected by the following variables and assumptions:
• | The grant date exercise price – the closing market price of the Company's common stock on the date of the grant; |
• | Expected option term – based on historical experience with existing option holders estimated at 3-5 years; |
• | Estimated dividend rates – based on historical and anticipated dividends over the life of the option; |
• | Legal term of the option – grants have legal lives of 10 years; |
• | Risk-free interest rates – with maturities that approximate the expected life of the options granted; |
• | Calculated stock price volatility – calculated over the expected life of the options granted, which is calculated based on the daily closing price of the Company's common stock over the period commencing in mid-2017 when the Company changed its strategic focus; and |
• | Option exercise behaviors – based on actual and projected employee stock option exercises and forfeitures. |
• | The Company accounts for forfeitures as they occur. |
The Company currently provides stock-based compensation to employees, directors and consultants under the Plan. The Company utilized assumptions in the estimation of fair value of stock-based compensation for the years ended December 31, 2018 and 2017, as follows:
| Years Ended December 31, |
| 2018 | | 2017 |
Dividend yield | 0% | | 0% |
Expected price volatility | 152% - 159% | | 15% - 95% |
Risk free interest rate | 2.49% - 2.96% | | 1.92-1.99% |
Expected term | 5 years | | 5 years |
A summary of stock option activity under the Plan for options to employees, officers, directors, and consultants, for the years ended December 31, 2018 and 2017, is presented below:
| | Shares Underlying Options | | | Weighted Average Exercise Price | | | Weighted Average Remaining Contractual Term (Years) | | | Aggregate Intrinsic Value | |
Outstanding at January 1, 2017 | | | 566,747 | | | $ | 20.46 | | | | | | | |
Granted | | | 120,000 | | | $ | 9.00 | | | | | | | |
Exercised | | | (50,800 | ) | | $ | 2.94 | | | | | | | |
Forfeited | | | (516,414 | ) | | $ | 22.16 | | | | | | | |
Outstanding at December 31, 2017 | | | 119,533 | | | $ | 9.02 | | | | 9.8 | | | $ | 2,316,000 | |
Granted | | | 62,000 | | | $ | 15.71 | | | | | | | | | |
Exercised | | | (19,533 | ) | | $ | 4.02 | | | | | | | | | |
Forfeited | | | (100,000 | ) | | $ | 10.00 | | | | | | | | | |
Outstanding at December 31, 2018 | | | 62,000 | | | $ | 15.71 | | | | 9.2 | | | $ | - | |
| | | | | | | | | | | | | | | | |
Exercisable at December 31, 2018 | | | 57,836 | | | $ | 15.51 | | | | 9.2 | | | $ | - | |
The aggregate intrinsic value in the table above represents the total intrinsic value (the difference between the Company's closing stock price on December 31, 2018 and 2017, and the exercise price, multiplied by the numberor stockholders (or groups of in-the-money options) that would have been received by the option holders, had all option holders been able to, and in fact had, exercised their options on December 31, 2018 and 2017, respectively.
Riot Blockchain, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
During the year ended December 31, 2018, the Company granted 62,000 stock options. Included in the 62,000 options granted were 50,000 stock options granted to an employee of the Company at an average exercise price of $18.50 per share, which vest monthly over a twelve month term, and 12,000 stock options granted to a consultant at an average exercise price of $4.09 per share, which vested at grant date. During the year ended December 31, 2017, 120,000 options were granted to directors and officers of the Company with a weighted average exercise price at grant date of $9.00 per option. Included in the 120,000 options issued, were 20,000 options at an average exercise price of $4.02 per share which vest monthly over a twenty-four-month period and 100,000 options at an exercise price of $10.00 per share which were vested at grant date. All options were granted under the Company's Plan and expire ten years from the grant date.
During the year ended December 31, 2018, 19,533 vested options granted under the Plan were exercised for cash proceeds of $78,522.
During the year ended December 31, 2017, 50,800 options outstanding under the Plan were exercised for cash proceeds of $149,136. The intrinsic value of the options exercised during the years ended December 31, 2018 and 2017, was approximately $51,000 and $171,000, respectively.
During the year ended December 31, 2018, 100,000 vested stock options granted to an officer of the Company were forfeited. During the year December 31, 2017, a total of 516,414 options granted under the Plan were forfeited with 515,578 forfeited as part of the equity rights terminations as described in Note 10 and 836 options terminated at the end of their term. Of the total forfeited, 459,414 options were vested, exercisable at an average exercise price of $24.55 and 57,000 were unvested, exercisable at an average exercise price of $2.92.
As of December 31, 2018, total stock-based compensation expense related to unvested options not yet recognized totaled approximately $58,000, which will be fully amortized in the first quarter of 2019.
Other common stock purchase warrants:
As of December 31, 2018, the Company had outstanding 1,671,113 warrants issued in connection with offerings. The following is a summary of the change in outstanding warrants during the years ended December 31, 2018 and 2017:
| | Shares Underlying Options/Warrants | | | Weighted Average Exercise Price | | | Weighted Average Remaining Contractual Term (Years) | | | Aggregate Intrinsic Value | |
Outstanding at January 1, 2017 | | | 527,003 | | | $ | 13.36 | | | | | | | |
Granted | | | 4,451,113 | | | $ | 17.03 | | | | | | | |
Exercised for cash | | | (620,000 | ) | | $ | 3.00 | | | | | | | |
Exercised on a cashless basis | | | (2,244,147 | ) | | $ | - | | | | | | | |
Forfeited | | | (169,074 | ) | | $ | 18.62 | | | | | | | |
Outstanding at December 31, 2017 | | | 1,944,895 | | | $ | 35.06 | | | | 2.7 | | | $ | 6,135,000 | |
Granted | | | - | | | $ | - | | | | | | | | | |
Exercised | | | (113,009 | ) | | $ | 3.50 | | | | | | | | | |
Forfeited | | | (160,773 | ) | | $ | 10.88 | | | | | | | | | |
Outstanding at December 31, 2018 | | | 1,671,113 | | | $ | 39.47 | | | | 2.0 | | | $ | - | |
| | | | | | | | | | | | | | | | |
Exercisable at December 31, 2018 | | | 1,671,113 | | | $ | 39.47 | | | | 2.0 | | | $ | - | |
During the year ended December 31, 2018, 13,009 of the warrants issued in the May 2013 private offering were exercised on a cashless basis for the issuance of 3,215 shares of common stock, 100,000 warrants issued in March 2018, were exercised for cash proceeds of $350,000 and 160,773 warrants were forfeited.
The aggregate intrinsic value in the table above represents the total intrinsic value (the difference between the Company's closing stock price on December 31, 2018 and the exercise price, multiplied by the number of in-the-money options) that would have been received by the option holders, had all option holders been able to, and in fact had, exercised their options on December 31, 2018.
During the year ended December 31, 2017, a total of 169,074 options and warrants that were granted outside of the Plan were forfeited. Of the total forfeited, 71,574 warrants expired under their terms and 60,000 options lapsed (15,000 vested and 45,000 unvested) due to the holders' terminations from the Company. The 60,000 options which lapsed were exercisable at an average of $3.78 per share. The remaining 37,500, which were forfeited resulted from negotiated payments made to each holder to waive their rights to the outstanding options.
Riot Blockchain, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
Note 12. Animal Health License Agreements:
Ceva License Agreement
In July 2012, the Company entered into an exclusive license agreement (the “License Agreement”) with Ceva Santé Animale S.A. (“Licensee”), under which the Company granted the Licensee an exclusive royalty-bearing license, until December 31, 2028, to the Company's intellectual property and other assets, including both (a) the Company’s patent rights and know-how, relating to recombinant single chain reproductive hormone technology for use in non-human mammals (the “Company's Animal Health Assets”) and (b) the technology licensed to the Company by Washington University in St. Louis (“WU”). The License Agreement contains termination provisions as defined in the License Agreement.
Under the License Agreement, the Licensee obtained a worldwide exclusive license to develop, seek regulatory approval for and offer to sell, market, distribute, import and export luteinizing hormone ('LH') and/or follicle-stimulating hormone (“FSH”) products for bovine (cattle), equine and swine in the field of the assistance and facilitation of reproduction in bovine, equine and swine animals. The Company also granted the Licensee an option and right of first refusal to develop additional animal health products outside of the licensed field of use or any diagnostic pregnancy detection tests for non-human mammals.
Under the License Agreement as of December 31, 2018, the Company would be entitled to receive future payments if Ceva achieves certain regulatory approvals as outlined in the License Agreement, summarized as follows:
● | Payments, totaling up to a potential of $1.1 million in the aggregate, based on the satisfactory conclusion of conditions as defined in the License Agreement; |
● | Potential for payments of up to an additional $2 million for development and receipt of regulatory approval for additional licensed products; and |
● | Royalties, at low double-digit rates, based on sales of licensed products. |
The upfront license fees received from the License Agreement have been recorded as deferred revenue and are amortized over the term of the License Agreement. License fees revenue totaling a net of approximately $1,556,000 commenced being amortized in July 2012. As of December 31, 2018, deferred revenue of $96,698 has been classified as a current liability and $871,919 has been classified as a long-term liability. The current liability represents the next twelve months' portion of the license fees revenue. For each of the years ended December 31, 2018 and 2017, approximately $97,000, was recorded as the amortized license fee revenue.
Washington University License Agreement
During 2004 WU and Riot Blockchain entered into an exclusive license agreement which grants Riot Blockchain exclusive license and right to sublicense WU's technology (as defined under the WU License Agreement) for veterinary products worldwide, except where prohibited. The term of the WU License Agreement continues until the expiration of the last of WU's patents (as defined in the WU License Agreement) expire in 2019. Riot Blockchain has agreed to pay minimum annual royalties, creditable against future royalties and royalties payable to WU for covered product sales by Riot Blockchain carrying a mid-single digit royalty rate and for sublicense fees received by Riot Blockchain carrying a low double-digit royalty rate. No royalty payments were made during the years ended December 31, 2018 and 2017.
Riot Blockchain, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
Note 13. Discontinued Operations:
During the quarter ended March 31, 2017, the Company made the decision to discontinue the operations of its wholly-owned subsidiary BDI. BDI had developed a proprietary Enhanced Surface Plasmon Resonance technology platform for the detection of molecular interactions. The decision to adopt this plan was made following an evaluation by the Company's Board of Directors in January 2017 of the estimated results of operations projected during the near to mid-term period for BDI, including consideration of product development required and updated sales forecasts, and estimated additional cash resources required. The Company substantially disposed of the assets and operations during 2017 by selling the assets and licensing the intellectual property rights. The Company has recognized the exit of BDI in accordance with ASC 205-20, Discontinued Operations. As such, the historical results of BDI, following its 2016 acquisition, have been classified as discontinued operations.
The Company's historical financial statements have been revised to present the operating results of the BDI business as a discontinued operation. Assets and liabilities related to the discontinued operations of BDI are approximately as follows as of December 31, 2018 and 2017:
Current Liabilities | | December 31, 2018 | | | December 31, 2017 | |
Accounts payable | | $ | 16,000 | | | $ | 16,000 | |
Accrued expenses | | | - | | | | 28,000 | |
Deferred revenue | | | - | | | | 137,000 | |
Total current liabilities | | $ | 16,000 | | | $ | 181,000 | |
Summarized results of the discontinued operation are as follows for the years ended December 31, 2018 and 2017:
| | Years Ended December 31, | |
| | 2018 | | | 2017 | |
Revenue | | $ | 137,000 | | | $ | 37,000 | |
Cost of revenue | | | 41,000 | | | | 6,000 | |
Gross margin | | | 96,000 | | | | 31,000 | |
Operating expenses | | | - | | | | 955,000 | |
Operating income (loss) | | | 96,000 | | | | (924,000 | ) |
Escrow forfeiture gain | | | - | | | | 135,000 | |
Impairment loss | | | - | | | | (2,754,000 | ) |
Income (loss) from discontinued operations, net of tax | | $ | 96,000 | | | $ | (3,543,000 | ) |
Included in the impairment loss recognized for the year ended December 31, 2017 on the discontinuance of BDI are impairment losses recognized on inventories of $453,000, equipment and furnishings of $29,000, identifiable intangible assets of $1,833,000, goodwill of $430,000, and a $9,000, net expense from all other items, all associated with the assets and operations of BDI. Additional costs associated with the exit of operations of the Company's subsidiary BDI may be incurred as final wrap-up of BDI's operations are completed.
In December 2017, BDI entered an asset purchase agreement with a privately held third party (the “Buyer”), pursuant to which BDI sold its rights to its intellectual property, technology rights and know-how associated with the business to the Buyer in exchange for future payments when and if the technology generates cash flow. Should the Buyer decide to pursue development of the acquired rights and if they successfully commercialize a product using the acquired rights, BDI would be entitled to receive future earn-out payments based upon a low single digit percentage of such defined sales. Such earn-out payments are subject to certain per product sale limitations and a cumulative payment ceiling (not to exceed total payments of low single-digit millions of dollars). Based upon the Company's assessment of the current low likelihood receiving future payments under this agreement, no revenue has been recognized.
Note 14. Income taxes:
On December 22, 2017, the U.S. government enacted comprehensive tax legislation commonly referred to as the Tax Cuts and Jobs Act (the “Tax Act”), which makes broad and complex changes to the U.S. tax code. Certain of these changes may be applicable to the Company, including but not limited to, reducing the U.S. federal corporate tax rate from 34 percent to 21 percent, creating a new limitation on deductible interest expense, eliminating the corporate alternative minimum tax (“AMT”), modifying the rules related to uses and limitations of net operating loss carryforwards generated in tax years ending after December 31, 2017, and changing the rules pertaining to the taxation of profits earned abroad. Changes in tax rates and tax laws are accounted for in the period of enactment. The Tax Act reduces the corporate tax rate to 21 percent, effective January 1, 2018. Consequently, we have recorded a decrease of approximately $14.0 million, related to deferred tax assets, exclusive of the corresponding change in the valuation allowance, for the year ended December 31, 2017. Due to the full valuation allowance on the deferred tax assets, there is no net adjustment to deferred tax expense or benefit due to the reduction of the corporate tax rate. A transition tax is based on total post-1986 earnings and profits which were previously deferred from U.S. income taxes. At December 31, 2018 and 2017, the Company did not have any undistributed earnings of our foreign subsidiaries. As a result, no additional income or withholding taxes have been provided for. The Company does not anticipate any impacts of the global intangible low taxed income (“GILTI”) and base erosion anti-abuse tax (“BEAT”) and as such, the Company has not recorded any impact associated with either GILTI or BEAT.
The components of the loss from continuing operations before income taxes for the years ended December 31, 2018 and 2017 are as follows:
| | For the years ended December 31, | |
| | 2018 | | | 2017 | |
Domestic | | $ | (56,452,693 | ) | | $ | (17,682,428 | ) |
Foreign | | | (4,554,967 | ) | | | (354,540 | ) |
Loss from Continuing Operations before Income Taxes | | $ | (61,007,660 | ) | | $ | (18,036,968 | ) |
Riot Blockchain, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
The components of income tax expense (benefit) are as follows:
| | As of December 31, | |
| | 2018 | | | 2017 | |
Current: | | | | | | |
US Federal | | $ | - | | | $ | - | |
US State | | | - | | | | - | |
Foreign | | | - | | | | - | |
Total current benefit | | | - | | | | - | |
Deferred: | | | | | | | | |
US Federal | | | 495,221 | | | | 1,312,704 | |
US State | | | 111,779 | | | | 296,296 | |
Foreign | | | 92,000 | | | | - | |
Total deferred benefit | | | 699,000 | | | | 1,609,000 | |
Total benefit for income taxes | | $ | 699,000 | | | $ | 1,609,000 | |
The tax effects of temporary differences and tax loss and credit carry forwards that give rise to significant portions of deferred tax assets and liabilities at December 31, 2018 and 2017 are comprised of the following:
| | As of December 31, | |
| | 2018 | | | 2017 | |
Deferred income tax assets: | | | | | | |
Net operating loss carryforwards | | $ | 30,745,000 | | | $ | 25,837,000 | |
Research and development credit carryforwards | | | 989,000 | | | | 989,000 | |
Stock option expense | | | 1,384,000 | | | | 252,000 | |
Impairment of mining related assets and other | | | 8,779,000 | | | | 14,000 | |
Total deferred tax assets | | | 41,897,000 | | | | 27,092,000 | |
Valuation allowance | | | (41,897,000 | ) | | | (27,092,000 | ) |
Net deferred tax assets | | | - | | | | - | |
Deferred income tax liabilities: | | | | | | | | |
Indefinite life intangible assets | | | (142,709 | ) | | | (699,000 | ) |
Net deferred tax liabilities | | $ | (142,709 | ) | | $ | (699,000 | ) |
The Company has approximately $117.4 million of federal and state tax Net Operating Losses (“NOL”s) that may be available to offset future taxable income, if any. The federal net operating loss carryforwards of $100.3 million, if not utilized, will expire in 2037. The federal and state net operating loss carryforwards of $19.1 million generated in 2018 are subject to an 80% limitation on taxable income, do not expire and will carry forward indefinitely. The foreign NOLs available are $2.0 million and begin to expire in 2037.
Furthermore, as a result of changes in the ownership of our common stock and changes in our business operations, our ability to use our federal NOLs may be limited under Internal Revenue Code Section 382 and 383. State NOLs are subject to similar limitations in many cases. As a result, our substantial NOLs may not have any value to us.
The federal and state tax returns beginning with the year ended December 31, 2006 are currently open for examination under the applicable federal and state income tax statues of limitations. The foreign tax returns for the years ended December 31, 2017 and 2018 are open for examination.
In assessing the realization of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the period in which those temporary differences become deductible. Management considers the scheduled reversal of deferred tax liabilities, projected future taxable income and taxing strategies in making this assessment. In case the deferred tax assets will not be realized in future periods, the Company has provided a valuation allowance for the full amount of the deferred tax assets at December 31, 2018. The valuation allowance increased by approximately $14.8 million as of December 31, 2018.
Riot Blockchain, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
The expected tax expense (benefit) based on the U.S. federal statutory rate is reconciled with actual tax expense (benefit) as follows:
| | For the years ended December 31, | |
| | 2018 | | | 2017 | |
Statutory federal income tax expense (benefit) | | $ | (12,791,000 | ) | | $ | (7,307,000 | ) |
State taxes, net of federal tax expense (benefit) | | | (2,887,000 | ) | | | (647,000 | ) |
Federal tax rate change | | | - | | | | 13,617,000 | |
Stock compensation and other non-deductible expenses | | | 174,000 | | | | 3,118,000 | |
Change in valuation allowance | | | 14,805,000 | | | | (10,390,000 | ) |
Income taxes benefit | | $ | (699,000 | ) | | $ | (1,609,000 | ) |
The Company has not identified any uncertain tax positions requiring a reserve as of December 31, 2018 and 2017. The Company’s policy is to recognize interest and penalties that would be assessed in relation to the settlement value of unrecognized tax benefits as a component of income tax expense. The Company did not accrue either interest or penalties for the years ended December 31, 2018 and 2017.
The Company’s major tax jurisdictions are the United States, Oklahoma and Canada. The Company has not been under tax examination in any jurisdiction for the years ended December 31, 2018 and 2017.
Note 15. Commitments and contingencies:
Commitments:
Oklahoma Lease Agreement.
On February 27, 2018, Kairos entered into a lease agreement (the “Lease”) with 7725 Reno #1, LLC (the “Landlord”), pursuant to which Kairos leases an approximately 107,600 square foot warehouse located in Oklahoma City, Oklahoma, including improvements thereon. Pursuant to the terms of the Lease, the initial term of one year terminates on February 15, 2019, unless terminated earlier pursuant to the terms of the Lease, subject to Kairos’ options to renew the Lease. Kairos has the right to operate from the premises on a 24 hour/seven day a week basis. At least three months, but no more than six months, prior to the expiration of the initial Lease term or renewal term, as applicable, Kairos shall give Landlord written notice of its intent to exercise the applicable renewal option, which also includes incremental payment for additional electric capacity delivery. If Kairos does not elect to exercise a renewal option, all remaining renewal options, if any, shall terminate.
Base rent for the premises during the period from inception to the first amendment is equal to $55.95/kW per month for a total of 4 Megawatts (MW) of available electrical power, or $223,800 per month.
On March 26, 2018, Kairos entered into a first amendment to the above lease, whereby the Landlord agreed to increase the electrical power available for Kairos’s use from 6MW to 12MW, and the base rent under the lease was increased to approximately $664,760 per month, effective as of the date when such additional power is available.
Effective November 29, 2018, Kairos entered into the second amendment to the lease which provides the following:
| · | extends the initial term of the lease through August 19, 2019; |
| · | monthly base rent of $235,000 for December 2018, $230,000 for January and $190,000 per month thereafter for the duration of the lease, including any renewals, |
| · | changes the monthly electricity usage charges and |
| · | Kairos shall have the option to renew the lease for up to two, three month periods after expiration of the initial term. |
Corporate Lease Agreement
On April 9, 2018, the Company entered into a commercial lease covering 1,694 rentable square feet of office space in Fort Lauderdale, Florida, with a third-party. The lease is for an initial term of thirty-nine months, with one five-year option to renew. The lease requires initial monthly rent of approximately $7,000, including base rent and associated operating expenses.
Riot Blockchain, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
Ingenium International LLC Consulting Agreement
On February 21, 2018, the Company entered into a Consulting Agreement with Ingenium International LLC (the “Consultant”) to provide consulting services related to the Company’s business for a twelve-month period. Pursuant to the Consulting Agreement, Consultant’s services are defined as follows: complete the installation and deployment of 8,000+ ASIC digital currency miners, which included the Prive Equipment and the BMSS Equipment; assist in managing and monitoring the operation of the 8,000+ digital currency miners on an ongoing basis; promptly responding to and troubleshooting any issues as they arise in the management and monitoring of the operations; continuing the buildout of up to 40 Megawatts of energy capacity, with the ultimate goal to secure the power and build the location for up to 80 Megawatts of energy capacity; and to make strategic introductions to other digital currency business opportunities and contacts in the sector. In connection with the Consulting Agreement the Company made a lump sum payment of $4,000,000 to the Consultant. The Company recorded the $4,000,000 as a prepaid expense on February 21, 2018 and was amortizing the total cost over the one-year life of the agreement. However, the Company determined that as of December 31, 2018, the Consultants had provided substantially all the agreed upon services under the Consulting Agreement and therefore, recorded any remaining prepaid balance to selling, general and administrative expense on the accompanying statement of operations.
The controlling principals of Ingenium International LLC. are shareholders in the Company by virtue of the previous acquisitions of Kairos and Prive.
Synapse Financial Technologies, Inc. Agreement
On October 23, 2018, the Company, through its wholly-owned subsidiary, Logical Brokerage entered into an agreement (the “SynapseFi Agreement”) with Synapse Financial Technologies, Inc. (“SynapseFi”) to secure Synapse’s services to support the launch of the Company’s planned branded digital currency exchange, in the United States. SynapseFi is an industry leader in the provision of Application Program Interfaces (“API”) to the financial services industry. SynapseFi’s APIs provide a secure and stable means of communication between users and financial institutions, while providing security and compliance assurances to the financial institutions themselves, which are of paramount importance to the Company and the users of its planned digital currency exchange.
Under the terms of the SynapseFi Agreement, SynapseFi will engage Evolve Bancorp, Inc., through its subsidiary, Evolve Bank & Trust (collectively, “Evolve”), or any successor financial institution designated by SynapseFi, to provide Logical Brokerage with all bank services directly. SynapseFi API will allow Logical to easily communicate user requests to Evolve, while assisting Evolve with managed risks and compliance concerns associated with the exchange of digital currencies. Pursuant to the terms of the SynapseFi Agreement, Logical Brokerage has also agreed to submit to periodic security, compliance and risk reviews and audits performed by SynapseFi on behalf of Evolve as a means of ensuring continued compliance and reliability for Evolve, SynapseFi, the Company, and its end users. The SynapseFi Agreement is effective, unless otherwise terminated by the parties according to the rules and procedures laid out in the Agreement, for an initial term running from January 1, 2019, through December 31, 2019, and shall automatically renew for successive twelve (12) month periods until such a time as the SynapseFi Agreement is not renewed by the parties.
For the year ended December 31, 2018, there were no material expenses incurred related to the SynapseFi Agreement.
Shift Markets, Ltd. Agreement
On November 21, 2018, RiotX Holdings Inc (“RiotX”), entered into an agreement with Shift Markets, Ltd. (“Shift”) to provide RiotX with its crypto exchange platform. The agreement will enable RiotX to execute its plan to launch a U.S. focused digital currency exchange and offer a robust trading interface for real time trading of crypto assets.
Logical Brokerage Regulatory Compliance
Logical Brokerage is presently registered as an Introducing Broker (“IB”), is a member of the National Futures Association (“NFA”), and is registered with the Commodity Futures Trading Commission (“CFTC”). Logical Brokerage is subject to NFA's regulatory oversight and examinations. Logical Brokerage has no customers and has done no business since the Company acquired it on March 23, 2018 though the date these consolidated financial statements have been issued. As a registered IB, Logical Brokerage is subject to the CFTC's Minimum Capital Requirement's Regulation 1.17, which requires the adjusted net capital, as defined, to be equal to or in excess of $45,000. As of December 31, 2018, Logical Brokerage's adjusted net capital was in excess of CFTC's regulatory requirements.
Contingencies:
The Company, and its subsidiaries, are subject at times to various claims, lawsuits and governmental proceedings relating to the Company’s business and transactions arising in the ordinary course of business. The Company cannot predict the final outcome of such proceedings. Where appropriate, the Company vigorously defends such claims, lawsuits and proceedings. Some of these claims, lawsuits and proceedings seek damages, including, consequential, exemplary or punitive damages, in amounts that could, if awarded, be significant. Certain of the claims, lawsuits and proceedings arising in ordinary course of business are covered by the Company’s insurance program. The Company maintains property, and various types of liability insurance in an effort to protect the Company from such claims. In terms of any matters where there is no insurance coverage available to the Company, or where coverage is available and the Company maintains a retention or deductible associated with such insurance, the Company may establish an accrual for such loss, retention or deductible based on current available information. In accordance with accounting guidance, if it is probable that an asset has been impaired or a liability has been incurred as of the date of the financial statements, and the amount of loss is reasonably estimable, then an accrual for the cost to resolve or settle these claims is recorded by the Company in the accompanying consolidated balance sheets. If it is reasonably possible that an asset may be impaired as of the date of the financial statement, then the Company discloses the range of possible loss. Paid expenses related to the defense of such claims are recorded by the Company as incurred and paid and included in the accompanying consolidated statements of operations. Management, with the assistance of outside counsel, may from time to time adjust such accruals according to new developments in the matter, court rulings, or changes in the strategy affecting the Company’s defense of such matters. On the basis of current information, the Company does not believe there is a reasonable possibility that, other than with regard to the Class Action described below, any material loss, if any, will result from any claims, lawsuits and proceedings to which the Company is subject to either individually, or in the aggregate.
Riot Blockchain, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
On February 17, 2018, Creighton Takata filed an action asserting putative class action claims on behalf of the Company's shareholders in the United District Court for the District of New Jersey, Takata v. Riot Blockchain Inc., et al., Case No. 3: 18-cv-02293. The complaint asserts violations of federal securities laws under Section 10(b) and Section 20(a) of the Securities Exchange Act of 1934 on behalf of a putative class of shareholders that purchased stock from November 13, 2017 through February 15, 2018. The complaint alleges that the Company and certain of its officers and directors made, caused to be made, or failed to correct false and/or misleading statements in press releases and public filings regarding its business plan in connection with its cryptocurrency business. The complaint requests damages in unspecified amounts, costs and fees of bringing the action, and other unspecified relief.
Two additional, nearly identical complaints were subsequently filed by Richard Roys and Bruce Greenawalt in the United District States Court for the Southern District of Florida (Roys v. Riot Blockchain Inc., et al., Case No. 9:18-cv-80225) and the United States District Court for the District of Colorado (Greenawalt v. Riot Blockchain Inc., et al., Case No. 1:18-cv-00440), respectively. On March 27, 2018, the court closed the Roys case for administrative purposes. On April 2, 2018, Mr. Greenawalt filed a notice of voluntary dismissal of his action, which the court entered on the same date.
On April 18, 2018, Joseph J. Klapper, Jr., filed a complaint against Riot Blockchain, Inc., and certain of its officers and directors in the United District Court for the District of New Jersey (Klapper v. Riot Blockchain Inc., et al., Case No. 3: 18-cv-8031). The complaint contained substantially similar allegations and the same claims as those filed by Mr. Takata, and requests damages in unspecified amounts, costs and fees of bringing the action, and other unspecified relief. On November 6, 2018, the court in the Takata action issued an order consolidating Takata with Klapper into a single putative class action. The court also appointed Dr. Golovac as Lead Plaintiff and Motely Rice as Lead Counsel of the consolidated class action.
Lead Plaintiff filed a consolidated complaint on January 15, 2019. Defendants filed motions to dismiss on March 18, 2019. The briefing on the motions to dismiss will be completed in June 2019. Subject to the outcome of the pending motions, defendants intend to continue to vigorously contest Lead Plaintiff’s allegations. Because this litigation is still at this early stage, we cannot reasonably estimate the likelihood of an unfavorable outcome or the magnitude of such an outcome, if any.
Shareholder Derivative Cases
On April 5, 2018, Michael Jackson filed a shareholder derivative complaint on behalf of the Company in the Supreme Court of the State of New York, County of Nassau, against certain of the Company's officers and directors, as well as against an investor (Jackson v. Riot Blockchain, Inc., et al., Case No. 604520/18). The complaint contains similar allegations to those contained in the shareholder class action complaints and seeks recovery for alleged breaches of fiduciary duty, unjust enrichment, waste of corporate assets, abuse of control and gross mismanagement. The complaint seeks unspecified monetary damages and corporate governance changes. At the preliminary conference, the court adjourned the conference until September 9, 2019 in lieu of staying the action. Defendants do not anticipate any other activity on this case until the next preliminary conference.
On May 22, 2018, two additional shareholder derivative complaints were filed on behalf of the Company in the Eighth Judicial District Court of the State of Nevada in and for the County of Clark (Kish v. O'Rourke, et al., Case No. A-18-774890-B & Gaft v. O'Rourke, et al., Case No. A-18-774896-8). The two complaints make identical allegations, which are similar to the allegations contained in the shareholder class action complaints. The shareholder derivative plaintiffs also seek recovery for alleged breaches of fiduciary duty, unjust enrichment, waste of corporate assets, and aiding abetting a breach of fiduciary duty. The complaints seek unspecific monetary damages and corporate governance changes.
On September 24, 2018, the court entered an order consolidating the Gaft and Kish actions, which is now styled as In re Riot BlockChain, Inc. Shareholder Derivative Litigation, Case No. A-18-774890-B. The plaintiffs filed a consolidated complaint on March 15, 2019. The consolidated action has been temporarily stayed until the resolution of the motion(s) to dismiss in the securities class action pending in the United District Court for the District of New Jersey.
On October 9, 2018, another shareholder derivative complaint was filed on behalf of the Company in the United District Court for the Eastern District of New York (Rotkowitz v. O'Rourke, et al., Case No. 2:18-cv-05632). As with the other shareholder derivative actions, the shareholder plaintiff alleges breach of fiduciary duty, waste of corporate assets, and unjust enrichment against certain of the Company's officers, directors, and an investor. The complaint's allegations are substantially similar to those made in the other securities class action and shareholder derivative complaints filed in 2018. The complaint seeks unspecific monetary damages and corporate governance changes. The parties filed a motion with the court to temporarily stay this action until the resolution of the motion(s) to dismiss in the securities class action pending in the United District Court for the District of New Jersey. In response, the court dismissed the action without prejudice with leave to refile a complaint following the resolution of the motion(s) to dismiss in the securities class action pending in the United District Court for the District of New Jersey.
On October 22, 2018, a fifth shareholder derivative complaint was filed on behalf of the Company in the United District Court for the Southern District of New York (Finitz v. O'Rourke, et al., Case No. 1: 18-cv-09640). The shareholder plaintiffs allege breach of fiduciary duty, waste of corporate assets, and unjust enrichment against certain of the Company's officers, directors, and an investor. The complaint's allegations are substantially similar to those made in the other securities class action and shareholder derivative complaints filed in 2018. The complaint seeks unspecific monetary damages and corporate governance changes. Upon the parties' stipulation, the court issued an order temporarily staying this action until the resolution of the motion(s) to dismiss in the securities class action pending in the United District Court for the District of New Jersey.
Riot Blockchain, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
Defendants intend to vigorously contest plaintiffs’ allegations in the shareholder derivative actions and plaintiffs’ right to bring the action in the name of Riot Blockchain. But because this litigation is still at this early stage, we cannot reasonably estimate the likelihood of an unfavorable outcome or the magnitude of such an outcome, if any.
SEC Subpoena
During 2018 the Company received several comment letters (the “Comment Letters”) from the Division of Corporation Finance and the Division of Investment Management of the Securities and Exchange Commission (“SEC”). The Comment Letters have been issued on the Company’s periodic reports on Form 10-Q for the quarter ended March 31, 2018, Annual Report on Form 10-K for the fiscal year ended December 31, 2017, amendment to Annual Report on Form 10-K/A for the fiscal year ended December 31, 2017 and current report on Form 8-K filed October 4, 2017. The comments raise matters related to, among other things, the unsettled nature of accounting treatment for the Company’s digital currency mining and the fair value method selected by the Company (as opposed to intangible accounting methods proposed by some experts) and applicability to the Company of the Investment Company Act of 1940, particularly as relates to the Company’s minority interest in goNumerical, Inc. a/k/a Coinsquare. The Company continues to engage in conversations with the staff of the Division of Enforcement, Division of Investment Management, Division of Corporation Finance, and Office of the Chief Accountant regarding the issues raised in the comment letters.
On July 30, 2018, the Company received a letter from the SEC (the “Letter”) that the Commission has issued an Order Directing Examination and Designating Officers Pursuant to Section 8(e) of the Securities Act of 1933 with respect to the following registration statements: (1) a Form S-8 filed on July 19, 2017 (File No. 333-219357); (2) a Form S-3 initially filed January 5, 2018 and subsequently amended on February 7, 2018 (File No. 333-222450); and (3) a Form S-3 filed on July 10, 2018 (File No. 333-226111). The Letter stated, “while the Section 8(e) examination is pending, the Division of Corporation Finance will not take any further action on the Registration Statements, and all communications with regard to the Registration Statements and the Section 8(e) examination should be made to the Commission’s Division of Enforcement.”
On October 12, 2018, the Company filed for withdrawal of the Form S-3 registration statement initially filed on January 5, 2018 and amended on February 7, 2018 (File No. 333-222450); and terminated the Form S-8 registration statement filed on July 19, 2017 (File No. 333-219357).
On October 22, 2018, the Company was notified by SEC staff that the SEC had terminated the Section 8(e) examination with respect to the above-referenced registration statements. The previously disclosed SEC investigation associated with the subpoena received by the Company on April 9, 2018 is still ongoing. The SEC has continued to request information from the Company and the Company has been fully cooperating with the SEC in that investigation.
Beneficial Ownership
Pursuant to the rules of the Securities and Exchange Commission (the “SEC”), the Company has consistently reported its beneficial ownership positions in its proxy and other filings where beneficial ownership disclosures are presented, for certain beneficial owners with respect to any person (including any “group” as that term is used in section 13(d)(3) of the Securities and Exchange Act of 1934 (the “Exchange Act”) who is known to the Company to be the beneficial owner of more than 5% of the Company’s common stock. The Company has relied on each person who has reported to the SEC beneficial ownership of more than 5% of our common stock to provide complete and accurate information regarding their ownership, based on the reports filed by these persons.
On September 7, 2018, a complaint was filed by the SEC (Case 1:18-cv-08175) (the “Complaint”) against, among others, a number of individuals and entities some of whom the Company has previously disclosed as its beneficial owners, as well as, Mr. John O’Rourke III, the Company’s former chairman of the board of directors and chief executive officer who resigned from the Company on September 8, 2018, as disclosed in the Current Periodic Report on Form 8-K filed September 10, 2018. Other persons named in the Complaint have previously reported that they were beneficial owners of the Company’s common stock, however, the Company has no basis to determine whether any such persons may have operated as a control group, collectively beneficiallystockholders) owning more than 5% of the Company’s outstanding common stock.
Riot Blockchain, Inc.stock, or any immediate family members of such persons (collectively a “Related Party”), has a direct or indirect material interest. Our audit committee reviews and Subsidiaries
Notesapproves any transaction with a Related Party we propose to Consolidated Financial Statements
enter into. Our audit committee charter details the policies and procedures relating to transactions that may present actual, potential or perceived conflicts of interest and may raise questions as to whether such transactions are consistent with the best interest of our company and our stockholders. Such transactions will be entered into only if found to be in the best interest of the Company and approved in accordance with the Company's Code of Ethics, which are available on the Company's web site.
Other Actions/Investigation
On May 31, 2018, M. Reese EversonAs previously reported by us, per Schedules 13D filed a direct action against the Company in the United District Court for the District of Columbia (Everson v. Riot Blockchain Inc., Case No. 1: 18-cv-01292-CRC). The complaint alleges that the Company's Proposal 4 included with the 2018 Proxy Statement violated Section 14(a) of the Securities Exchange Act of 1934, and sought to enjoin the stockholder's vote on Proposal 4 in advance of the annual meeting scheduled for June 15, 2018. On June 8, 2018, the Company issued a press release stating that it resolved to withdraw the portion of the 2018 Proxy Statement related to Proposal 4 and will no longer solicit votes for Proposal 4. Plaintiff filed a notice of voluntarily dismissal of the action on June 8, 2018 after being notified of the Company's press release.
On April 9, 2018, the Company received a subpoena requesting document from the U.S. Securities and Exchange Commission. We have and intend to fully cooperate with the SEC inquiry.
Note 16. Other Related Party Transactions:
Each of Barry Honig (together with other group members) and Catherine Johanna DeFrancesco during a portion of 2017Commission, certain persons reported that they had beneficially owned greater than 10% of the dispositive and voting power of the Company’sCompany's common stock. Mr. Honigstock in 2017, however no person so reported beneficial ownership of approximately 11.2%more than 4.99% of the dispositive and voting power of the Company’s common stock as of January 5, 2017 and Ms. DeFrancesco reported beneficial ownership of approximately 11.45%in 2018.
Since the beginning of the Company’s common stock as of January 10, 2017. Mr. Honig invested $1,750,000last fiscal year, no transactions with a Related Party were approved by the Audit Committee. Other than the compensation arrangements described under the section entitled “Executive Compensation” herein, and standard indemnification agreements with our directors and officers, there were no transactions with a Related Party in which a Related Party had or will have a direct or indirect material interest in the Company’s March 2017 Convertible Note Private Placement. GRQ Consultants, Inc., a related party of Mr. Honig, received a cash payment of $50,000 for diligence services in connection with the Company’s September 2017 investment in Coinsquare. Each of Mr. Honig and Ms. DeFrancesco was a shareholder of Kairos at the time of its acquisition by the Company, with Mr. Honig having owned approximately 8.6% of Kairos and Ms. DeFrancesco having owned approximately 6.3% of Kairos. Each of Mr. Honig and Ms. DeFrancesco invested in the December 2017 Common Share Private Placement, with Mr. Honig investing $500,000 and Ms. DeFrancesco investing $360,000.Company.
Note 17. Subsequent Events:Director Independence
Senior Secured Convertible Promissory Notes
On January 28, 2019,Information about the Company issued a seriesindependence of Senior Secured Convertible Promissory Notes (the “Notes”), to investors for an aggregate principal amount of $3,358,333 and an equal value of warrants for the purchase of shares of the Company’s common stock. The Notes are convertible into shares of the Company’s common stock at any time after the issuance date, provided that at no time, the Company will be required to issue shares in excess of the aggregate number of shares of its commons stock outstanding. The Notes mature twelve months from date of issuance and accrue interest at a rate of 8% per annum, with twelve months of interest guaranteed. The notes are subject to prepayment penalties, default conditions and other terms and conditions, as further defined in the agreements. As additional consideration for the investment, the Company issued a total of 150,000 restricted common shares to the three investors.
In connection with the Notes, the Company entered into registration rights agreement with the investors. The Company has agreed to file with the SEC a registration statement covering the equity rights and any other shares issuable in connection with the Notes on or before March 14, 2019 and use its best efforts to have the registration statement become effective on or before April 29, 2019.
Sale of Digital Currencies
In January 2019, the Company sold 240 bitcoin and 3,110 litecoin generating total cash proceeds of approximately $1,004,000.
Termination of Arrangement
On February 15, 2019, Cresval Capital Corp., terminated its definitive agreement with Tess due to Tess’s inability to complete one of the closing conditions of the agreement. The Company owns greater than 50% of Tess.
Issuance of Restricted Common Stock
Subsequent to December 31, 2018, 93,751 shares of restricted common stock related to fully vested shares of restricted stock were issued to certain of the Company’s formerour non-employee directors and officers.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
Not applicable.
ITEM 9A. CONTROLS AND PROCEDURES
Evaluationthe composition of Disclosure Controls and Procedures
We maintain disclosure controls and procedures (as such term is defined in Rule 13a-15(e) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) that are designed to ensure that information required to be disclosed in our reports filed or submitted to the SEC under the Exchange Act is recorded, processed, summarized and reported within the time periods specified by the SEC's rules and forms, and that information is accumulated and communicated to management, including our Chief Executive Officer (principal executive officer) and Chief Financial Officer (principal financial officer) as appropriate, to allow timely decisions regarding required disclosures. Our Chief Executive Officer and Chief Financial Officer evaluated the effectiveness of our disclosure controls and procedures as of December 31, 2018, pursuant to Rule 13a-15(b) under the Exchange Act. Based on that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that, as of the end of the period covered by this report, the Company's disclosure controls and procedures were not effective due to material weaknesses in internal control over financial reporting described below.
Management's Report on Internal Control over Financial Reporting
Management is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a-15(f) under the Exchange Act. The Exchange Act defines internal control over financial reporting as a process designed by, or under the supervision of, our principal executive and principal financial officers and effected by our board of directors, management and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with accounting principles generally accepted in the United States (“GAAP”) and includes those policies and procedures that:
| • | | Pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of our assets; |
| • | | Provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with GAAP, and that our receipts and expenditures are being made only in accordance with authorizations of our management and our directors; and |
| • | | Provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of our assets that could have a material effect on the financial statements. |
A system of controls, no matter how well designed and operated, cannot provide absolute assurance that the objectives of the system of controls are met, and no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within a company have been detected. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions or that the degree of compliance with the policies or procedures may deteriorate.
Management assessed the effectiveness of our internal control over financial reporting as of December 31, 2018. In making this assessment, we used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control — Integrated Framework. A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of our annual or interim financial statements will not be prevented or detected on a timely basis. Based on our assessment, as of December 31, 2018, we concluded that our internal control over financial reporting contained the following material weaknesses:
| 1) | We did not implement or properly maintain control activities at either the entity or activity level that were designed or were operating effectively to identify and address (i) all significant risks that could have a material adverse impact on the Company’s ongoing operations and (ii) all likely sources that could result in a material misstatement to the financial statements. |
| 2) | We did not design or maintain effective general information technology (“IT”) controls over certain information systems that are relevant to the mitigation of the risk pertaining to the misappropriation of assets and to the preparation of the consolidated financial statements. Specifically, we did not design and implement: |
| a. | User access controls to ensure appropriate segregation of duties that would adequately restrict user and privileged access to the financially relevant systems and data to the appropriate Company personnel; |
| b. | Program change management controls for certain financially relevant systems to ensure that IT program and data changes affecting the Company’s (i) financial IT applications, (ii) digital currency mining equipment, (iii) digital currency hardware wallets, and (iv) underlying accounting records, are identified, tested, authorized and implemented appropriately; and |
| c. | Physical security controls to ensure that the (i) digital currency hardware wallets, (ii) digital currency hardware wallet master seed phrases, (iii) digital currency hardware wallet pin codes, and (iv) the digital currency mining equipment were safeguarded, monitored, validated, and restorable, both physically and electronically. |
The Company’s independent registered public accounting firm, Marcum LLP has issued an adverse audit report on the effectiveness of the Company’s internal control over financial reporting as of December 31, 2018, which appears in Item 9a of this Annual Report.
As a result of the identification of the material weaknesses, and prior to filing this Annual Report, we performed further analysis and completed additional procedures intended to ensure our consolidated financial statements for the year ended December 31, 2018 were prepared in accordance with GAAP. Based on these procedures and analysis, and notwithstanding the material weaknesses in our internal control over financial reporting, our management has concluded that our consolidated financial statements and related notes thereto included in this Annual Report have been prepared in accordance with GAAP. Our Chief Executive Officer and Chief Financial Officer have certified that, based on each such officer’s knowledge, the financial statements, as well as the other financial information included in this Annual Report, fairly present in all material respects the financial condition, results of operations and cash flows of the Company as of, and for, the periods presented in this Annual Report. In addition, Marcum LLP has issued an unqualified opinion on our consolidated financial statements, which is included in Item 8 of this Annual Report, and we have developed a remediation plan for the material weakness, which is described below.
Remediation
Our management has been implementing and continues to implement measures designed to ensure that control deficiencies contributing to the material weakness are remediated, such that these controls are designed, implemented, and operating effectively. The remediation actions include: (i) creating and filling an information technology compliance oversight function; (ii) developing a training program addressing ITGCs and policies, including educating control owners concerning the principles and requirements of each control, with a focus on those related to user access and change-management over information technology systems impacting financial reporting; (iii) developing and maintaining documentation underlying ITGCs to enhance control knowledge across the entire IT organization; (iv) developing enhanced risk assessment procedures and controls related to changes in information technology systems; (v) implementing an information technology management review and testing plan to monitor ITGCs with a specific focus on systems supporting our financial reporting processes; and (vi) enhanced quarterly reporting on the remediation measures to the Audit Committee of the Board.
We believe that these actions will remediate the material weakness. The weakness will not be considered remediated, however, until the applicable controls operate for a sufficient period of time and our management has concluded, through testing, that these controls are operating effectively. We expect that the remediation of this material weakness will be completed prior to the end of fiscal 2019.
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
ON INTERNAL CONTROL OVER FINANCIAL REPORTING
To the Shareholders and Board of Directors of
Riot Blockchain, Inc.
Adverse Opinion on Internal Control over Financial Reporting
We have audited Riot Blockchain, Inc.’s (the “Company”) internal control over financial reporting as of December 31, 2018, based on criteria establishedCompensation Committee is set forth in Internal Control-Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. In our opinion, because of the effect of the material weaknesses described in the following paragraph on the achievement of the objectives of the control criteria, the Company has not maintained effective internal control over financial reporting as of December 31, 2018, based on criteria established in Internal Control-Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission.
A material weakness is a control deficiency, or combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the Company's annual or interim financial statements will not be prevented or detected on a timely basis. The following material weaknesses have been identified and included in “Management's Annual Report on Internal Control Over Financial Reporting”:
| 1) | The Company did not implement or properly maintain control activities at either the entity or activity level that were designed or were operating effectively to identify and address (i) all significant risks that could have a material adverse impact on the Company’s ongoing operations and (ii) all likely sources that could result in a material misstatement to the financial statements. |
| 2) | The Company did not design or maintain effective general information technology (“IT”) controls over certain information systems that are relevant to the mitigation of the risk pertaining to the misappropriation of assets and to the preparation of the consolidated financial statements. Specifically, the Company did not design and implement: |
| a. | User access controls to ensure appropriate segregation of duties that would adequately restrict user and privileged access to the financially relevant systems and data to the appropriate Company personnel; |
| b. | Program change management controls for certain financially relevant systems to ensure that IT program and data changes affecting the Company’s (i) financial IT applications, (ii) digital currency mining equipment, (iii) digital currency hardware wallets, and (iv) underlying accounting records, are identified, tested, authorized and implemented appropriately; |
| c. | Physical security controls to ensure that the (i) digital currency hardware wallets, (ii) digital currency hardware wallet master seed phrases, (iii) digital currency hardware wallet pin codes, and (iv) the digital currency mining equipment were safeguarded, monitored, validated, and restorable, both physically and electronically. |
These material weaknesses were considered in determining the nature, timing and extent of audit tests applied in our audit of the fiscal 2018 consolidated financial statements, and this report does not affect our report dated April 2, 2019 on those financial statements.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (“PCAOB”), the consolidated balance sheet as of December 31, 2018 and the related consolidated statements of operations, chamges in stockholders’ equity, and cash flows for the year then ended of the Company and our report, which includes an explanatory paragraph with regards to the Company’s ability to continue as a going concern, dated April 2, 2019 expressed an unqualified opinion on those financial statements.
Basis for Opinion
The Company's management is responsible for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying “Management Annual Report on Internal Control Over Financial Reporting”. Our responsibility is to express an opinion on the Company's internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
Definition and Limitations of Internal Control over Financial Reporting
A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements.
Because of the inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that degree of compliance with the policies or procedures may deteriorate.
/s/ Marcum LLP
Marcum llp
New York, NY
April 2, 2019
Changes in Internal Control over Financial Reporting
No changes were made to our internal control over financial reporting during our most recently completed fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. We are taking the remedial actions described above and we expect to implement them before December 31, 2019.
ITEM 9B. OTHER INFORMATION.
None.
PART III
ITEM 10. DIRECTORS, NAMED EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE.
Information required to be disclosed by this Item with respect to our executive officers is incorporated into this Annual Report on Form 10-K by reference from the section entitled10, “Directors, Named Executive Officers, and Corporate Governance” contained in our definitive proxy statement for our 2019 annual meeting of stockholders, which we intend to file within 120 days of the end of our fiscal year ended December 31, 2018.
herein.
ITEM 11. EXECUTIVE COMPENSATION.
30
Information required to be disclosed by this Item with respect to our executive officers is incorporated into this Annual Report on Form 10-K by reference from the section entitled “Executive Compensation” contained in our definitive proxy statement for our 2019 annual meeting of stockholders, which we intend to file within 120 days of the end of our fiscal year ended December 31, 2018.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCK HOLDER MATTERS.
Information required to be disclosed by this Item with respect to our executive officers is incorporated into this Annual Report on Form 10-K by reference from the section entitled “Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters” contained in our definitive proxy statement for our 2019 annual meeting of stockholders, which we intend to file within 120 days of the end of our fiscal year ended December 31, 2018.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE.
Information required to be disclosed by this Item with respect to our executive officers is incorporated into this Annual Report on Form 10-K by reference from the section entitled “Certain Relationships and Related Transactions, and Director Independence” contained in our definitive proxy statement for our 2019 annual meeting of stockholders, which we intend to file within 120 days of the end of our fiscal year ended December 31, 2018.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES.
Information requiredAudit Fees: Fees billed or expected to be disclosedbilled for professional services rendered by this Item with respect to our executive officers is incorporated into this Annual Report on Form 10-K by reference from the section entitled “Principal Accountant Fees and Services” contained in our definitive proxy statementMarcum LLP for our 2019 annual meeting of stockholders, which we intend to file within 120 daysits audit of the endCompany's consolidated financial statements as of ourand for the fiscal year ended December 31, 2018 were billed in 2019. Fees billed for professional services rendered by MNP LLP (the Company’s prior auditor) for the audit of the Company's financial statements as of and for the fiscal year ended December 31, 2017 and the reviews of the interim condensed consolidated financial statements included in the Company's Quarterly Reports on Form 10-Q for the first three quarters of 2018 were billed during 2018.
Aggregate fees were billed or expected to be billed for professional services for the years ended December 31, 2018 and 2017 in the following categories and amounts:
| | 2018 | | | 2017 | |
| | | | | | |
Audit Fees (1) | | $ | 564,000 | | | $ | 270,000 | |
Audit Related Fees (2) | | | 74,000 | | | | 40,000 | |
Tax Fees | | | — | | | | — | |
All Other Fees | | | — | | | | — | |
Total Fees | | $ | 638,000 | | | $ | 310,000 | |
| (1) | Audit fees relate to the financial statement audits, the quarterly reviews and related matters. Audit fees for 2018 include services rendered by Marcum LLP for the 2018 audit totaled $491,000 and services rendered by MNP LLP for their reviews of the interim condensed consolidated financial statements included in the Company's Form 10-Qs during the first three quarters of 2018 totaled $73,000. Audit fees for 2017 include services rendered by MNP LLP for the 2017 audit totaling $184,000 and services rendered by EisnerAmper LLP (the Company’s prior auditor) for their reviews of the interim condensed consolidated financial statements included in the Company's Form 10-Qs during the first three quarters of 2017 totaled $86,000. |
| (2) | Audit related fees include services reasonably related to the performance of audit and review of the consolidated financial services, including services related to the review of our registration statements. Audit related services rendered by MNP LLP, EisnerAmper LLP and Crowe LLP (the Company’s prior auditor) for 2018 totaled $4,000, $67,000 and $3,000, respectively. Audit related services rendered by EisnerAmper LLP and Crowe LLP for 2017 totaled $25,000 and $15,000, respectively. |
Our principal accountant (through its full-time employees) performed all work regarding the audit of our financial statements for the most recent fiscal year.
The Company's Audit Committee currently has a policy in place that requires its review and pre-approval of all audit and permissible non-audit services provided by its independent auditors. These services requiring pre-approval by the Audit Committee may include audit services, audit related services, tax services and other services. All of the services performed by the independent registered public accounting firm were approved by the Company's Audit Committee and prior to performance. The Audit Committee has determined that the payments made to its independent accountants for these services are compatible with maintaining such auditors' independence.
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES.
3. Certificate of Incorporation and Bylaws.
4. Instruments Defining the Rights of Security Holders, Including Indentures.
31. Certifications.
101 | Interactive data files pursuant to Rule 405 of Regulation S-T: (i) the Balance Sheets, (ii) the Statements of Operations, (iii) Statements of Stockholders Equity, (iv) the Statement of Cash Flows and (v) the Notes to the Financial Statements * |
____________________
* Filed herewith.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf on April 2,23, 2019, by the undersigned thereunto duly authorized.
| RIOT BLOCKCHAIN, INC. |
| |
| /s/ Jeffrey G. McGonegal |
| Jeffrey G. McGonegal, Chief Executive Officer |
| |
| /s/ Robby Chang |
| Robby Chang, Chief Financial Officer |
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KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints Jeffrey G. McGonegal and Robby Chang, each and individually, as his or her true and lawful attorney-in-fact and agent, with full power of substitution and re-substitution, for them and in their name, place and stead, in any and all capacities, to sign any and all amendments to this Annual Report on Form 10-K, and to file the same, with all exhibits thereto, and other documents in connection therewith, with the Securities and Exchange Commission, and generally to do all such things in their names and behalf in their capacities as officers and directors to enable the Company to comply with the provisions of the Securities Exchange Act of 1934 and all requirements of the Securities and Exchange Commission, granting unto each said attorney-in-fact and agent full power and authority to do and perform each and every act and thing requisite and necessary to be done in connection therewith, as fully to all intents and purposes as he or she might or could do in person, ratifying and confirming all that said attorney-in-fact and agent, or their or his or her substitutes or substitute, may lawfully do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant on April 2,23, 2019 in the capacities indicated.
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| /s/ Jeffrey G. McGonegal |
| Jeffrey G. McGonegal Chief Executive Officer (principal executive officer) |
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| /s/ Robby Chang |
| Robby Chang, Chief Financial Officer (principal financial officer) |
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| /s/ Remo Mancini |
| Remo Mancini, Director |
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| /s/ Jason Les |
| Jason Les, Director |
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| /s/ Benjamin Yi |
| Benjamin Yi, Director |
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