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STAFFING 360 SOLUTIONS, INC. - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations(Edgar Glimpses Via Acquire Media NewsEdge) The following discussion and analysis of our results of operations and financial condition should be read in conjunction with our financial statements and related notes appearing elsewhere in this Quarterly Report. The discussion should be read along with our financial statements and notes thereto. This section includes a number of forward-looking statements that reflect our current views with respect to future events and financial performance. Forward-looking statements are often identified by words like believe, expect, estimate, anticipate, intend, project and similar expressions, or words which, by their nature, refer to future events. You should not place undue certainty on these forward-looking statements. These forward-looking statements are subject to certain risks and uncertainties that could cause actual results to differ materially from our predictions. Overview The Company was incorporated in the State of Nevada on December 22, 2009, with the name "Golden Fork Corporation". On March 16, 2013, the Company filed an Amendment to change its name from "Golden Fork Corporation" to "Staffing 360 Solutions, Inc." On July 31, 2012, the Company formed Staffing Alliance. In September 2012, Staffing Alliance commenced operations. In October 2012, Staffing Alliance began generating revenue. Staffing Alliance is a wholly-owned subsidiary of the Company. The Company ceased operations in Staffing Alliance during fiscal 2014. On April 26, 2013, the Company consummated the The Revolution Group ("TRG") acquisition, pursuant to the TRG Purchase Agreement dated March 21, 2013, entered into by and among the Company, TRG and the shareholders of TRG. As a result of the acquisition, TRG became a wholly-owned subsidiary of the Company and now operates under the name of "Cyber 360 Solutions." See "Note 13 - Acquisitions" of the financial statements in the Company's most recent Annual Report on Form 10-K, filed with the SEC on September 15, 2014, for a more complete description of this transaction. On June 28, 2013, the Company filed a Certificate of Amendment to its Articles of Incorporation with the State of Nevada (the "2013 Amendment"), whereby increasing the number of shares of Common Stock that the Company is authorized to issue from 75,000,000 to 200,000,000. The 2013 Amendment also allowed the Company to issue 20,000,000 shares of blank check preferred stock, having such rights, designations, preferences and privileges as the Board of Directors determines from time to time in their sole discretion. On November 4, 2013, the Company consummated the acquisition of 100% of the issued and outstanding stock of CSI pursuant to a definitive stock purchase agreement dated August 14, 2013 by and among the Company, NCSI, and the shareholders of NCSI. See "Note 13 - Acquisitions" of the financial statements in the Company's most recent Annual Report on Form 10-K, filed with the SEC on September 15, 2014, for a more complete description of this transaction. On January 3, 2014, the Company consummated the acquisition of 100% of the issued and outstanding stock of Staffing 360 Solutions (UK) Limited (formerly Initio International Holdings Limited) and its respective subsidiaries, including but not limited to Monroe Staffing Services LLC. The acquisition was completed pursuant to that certain share purchase agreement, dated October 30, 2013, as amended by Amendment No. 1 to the share purchase agreement, dated December 10, 2013, by and among the Company and the shareholders of Initio. See "Note 13 - Acquisitions" of the financial statements in the Company's most recent Annual Report on Form 10-K, filed with the SEC on September 15, 2014, for a more complete description of this transaction. On February 28, 2014, the Company purchased from Poolia UK substantially all of Poolia UK's business and assets, including but not limited to contracts, business information, records, book debts and goodwill. The acquisition was completed pursuant to that certain asset purchase agreement, dated February 28, 2014. See "Note 13 - Acquisitions" of the financial statements in the Company's most recent Annual Report on Form 10-K, filed with the SEC on September 15, 2014, for a more complete description of this transaction. On May 17, 2014, the Company consummated the acquisition of 100% of the issued and outstanding stock of PeopleSERVE, Inc. pursuant to a definitive stock purchase agreement dated May 17, 2014 by and among the Company and the shareholder of PeopleSERVE, Inc. See "Note 13 - Acquisitions" of the financial statements in the Company's most recent Annual Report on Form 10-K, filed with the SEC on September 15, 2014, for a more complete description of this transaction. On May 17, 2014, the Company consummated the acquisition of 49% of the issued and outstanding stock of PeopleSERVE, PRS pursuant to a definitive stock purchase agreement dated May 17, 2014 by and among the Company and the shareholders of PeopleSERVE, PRS. See "Note 13 - Acquisitions" of the financial statements in this Annual Report on Form 10-K, filed with the SEC on September 15, 2014, for a more complete description of this transaction. 39 Operating History To date, the Company purchased five operating businesses: The Revolution Group, Control Solutions Inc., Staffing 360 Solutions (UK), Poolia (UK), PeopleSERVE, Inc., and 49% of PeopleSERVE, PRS Inc. Our business plan is to continue to grow the Company organically and pursue acquisition prospects. The Company generated revenue of approximately $648,000 in fiscal 2013. Primarily through acquisitions, the Company increased reported revenue to nearly $46 million in fiscal 2014. Our business plan is subject to certain inherent risks associated with a small, high-growth enterprise, including access to capital resources, execution risks, possible rejection of our business model and/or sales methods, and cost overruns. Going concern Through August 2012, the Company was presented as a development stage company. Activities during the development stage included organizing the business and raising capital. In September 2012, Staffing Alliance commenced operations and the Company began to generate revenue in October 2012. In April 2013, Cyber 360 Solutions was purchased and began generating revenue. In November 2013, CSI was purchased and began generating revenue. In January 2014, Staffing UK was purchased and began generating revenue. In February 2014, Poolia UK commenced operations and began generating revenue. In May 2014, PeopleSERVE, Inc. and PeopleSERVE, PRS commenced operations and began generating revenue. Since inception, the Company has been able to operate under a going concern audit opinion and meet its financial obligations. Since the Company has incurred losses and currently has negative working capital, these consolidated financial statements have been prepared on a going concern basis, which assumes these factors raise substantial doubt regarding the Company's ability to continue as a going concern and the outcome of these uncertainties cannot be predicted. Realization value may be substantially different from carrying values as shown and these consolidated financial statements do not include any adjustments to the recoverability and classification of recorded asset amounts and classification of liabilities that might be necessary if the Company is unable to continue as a going concern. As of August 31, 2014, the Company had a working capital deficiency of $10,102,693, and had an accumulated deficit of $21,105,179 and for the three (3) months ended August 31, 2014 had net losses and net cash used in operations of $4,663,398 and $1,977,786, respectively. The continuation of the Company as a going concern is dependent upon the continued financial support from its major shareholders, the ability of the Company to obtain necessary financing to continue operations, and through profitable operations from existing subsidiaries and additional acquisitions. These factors raise substantial doubt regarding the Company's ability to continue as a going concern and the outcome of these uncertainties cannot be predicted. Currently, we do not have sufficient working capital to fund the expansion of our operations and to provide working capital necessary for our ongoing operations and obligations. We will need to raise significant additional capital to fund our operating expenses, pay our obligations, and acquire additional entities. In order to continue as a going concern and achieve a profitable level of operations, the Company will require additional capital resources. Management's plan to continue as a going concern includes raising working capital through increased sales and additional debt and equity financings. The Company anticipates it will require approximately $4.0 million over the next twelve (12) months for working capital. This amount does not include capital that may be needed to fund additional acquisitions or re-pay outstanding debt. However, management cannot provide any assurances that the Company will be successful in accomplishing any of its plans. The ability of the Company to continue as a going concern is dependent upon the successful implementation of the plans described above, including securing additional sources of financing and attaining profitable operations. Management also cannot provide any assurance that unforeseen circumstances that could occur at any time within the next twelve months or thereafter will not increase the need for the Company to raise additional capital on an immediate basis. These matters raise substantial doubt about the Company's ability to continue as a going concern. The accompanying consolidated financial statements do not include any adjustments that might be necessary should the Company be unable to continue as a going concern. Through August 31, 2014, the Company raised capital by conducting financings through debt and equity transactions. During the fiscal quarter ended August 31, 2014, the Company conducted a note offering (See Note 5 to the financial statements filed with this Quarterly Report), whereby the Company raised $100,000 for the issuance of a 12% convertible promissory note. In April, 2014, the Company commenced its best efforts private offering (the "Series A Bond Offering") of 12% Convertible Bonds (the "Series A Bonds") with certain accredited investors (the "Purchasers"). On July 29, 2014, the Company completed the Series A Bond Offering for an aggregate of $4,058,500. These Series A Bonds mature on October 15, 2014, unless voluntarily converted. In addition to the Series A Bonds, each Purchaser of the Bonds received equity consideration at a rate of 5,000 shares (the "Equity Consideration") of Common Stock for each $50,000 investment for a total of 405,850 shares of common stock. From April 21, 2014 through May 27, 2014, the Company also conducted a note offering, whereby the Company raised approximately $950,000 from 2 accredited investors through the issuance of five (5) short-term 12% convertible promissory notes (the "April Notes"). The purchaser of the April Notes received an aggregate of 150,000 shares of common stock. From May 14, 2014 through May 19, 2014, the Company conducted an additional note offering whereby the Company raised approximately $600,000 from 5 accredited investors through the issuance of five (5) short-term 12% convertible promissory notes (the "May Notes"). The purchasers of the May Notes received an aggregate of 120,000 shares of restricted common stock. On May 27, 2014, the Company conducted an additional note offering whereby the Company raised approximately $50,000 from one accredited investor through the issuance of a short-term 12% convertible promissory note (the "May 27 Note"). The purchaser of the May 27 Note received an aggregate of 10,000 shares of restricted common stock. On June 23, 2014, the Company conducted an additional note offering whereby the Company raised $100,000 from one accredited investor through the issuance of a short-term 12% convertible promissory note (the "June 23 Note"). The purchaser of the June 23 Note received an aggregate of 20,000 shares of restricted common stock. In June, 2014, the Company issued a promissory note in the amount of $100,000 to a Company owned by Robert Mayer, a director and shareholder of the Company. The promissory note was non-interest bearing and due upon demand. The Company issued 5,000 shares to the note holder as additional consideration. This note was paid in full in June 2014. In July 2014, the Company issued three non-interest bearing promissory notes in the aggregate amount of $280,000 to three related parties. The promissory notes were due upon demand. The first note was issued on July 16, 2014 to Trilogy Capital Partners, which is owned by the Company's President, Alfonso J. Cervantes, in the amount of $30,000. This note was repaid in full in July 2014. The second note was issued on July 17, 2014 to Jeff Mitchell, the Company's CFO, in the amount of $150,000. The Company issued 10,000 shares of common stock to Mr. Mitchell as additional consideration. This note was repaid in full in July 2014. The third note was issued on July 8, 2014 to a company owned by Robert Mayer, a director and shareholder of the Company, in the amount of $100,000. This note was repaid in full in July 2014. The Company issued 7,000 shares to the note holder as additional consideration. In August 2014, the Company issued a short-term 12% promissory note in the amount of $150,000 to Barry Cervantes, a brother of the Company's President, Alfonso J. Cervantes. The promissory note is due upon demand. The Company issued 15,000 shares to Barry Cervantes as additional consideration. In August 2014, the Company issued a non-interest bearing promissory note in the amount of $125,000 to a company owned by Robert Mayer, a director and shareholder of the Company. The promissory note is due upon demand. The Company issued 7,500 shares to the note holder as additional consideration. This note was repaid in full in August 2014. In July and August 2014, the Company issued promissory notes to Sterling National bank for consideration totaling $625,000. These notes bear interest at 18% per annum and are due upon demand. The Sterling notes were repaid in full in September 2014. On August 22, 2014, the Company commenced its Series B Bond Offering of 12% Convertible Series B Bonds (the "Series B Bonds") for up to $8 million with certain accredited investors. On October 3, 2014 the Company completed the first closing of its Series B Bonds offering. The Company issued Series B Bonds for an aggregate of $475,000 with five (5) accredited investors. As a result, the Company issued 47,500 as equity consideration to the bondholders. In addition, the Company issued 2,850 to the placement agent for services rendered. (See Note 14 to the financial statements with this Quarterly Report). 40 In total, for the fiscal quarter ended August 31, 2014, the Company raised an aggregate of $2,440,000 in capital by conducting financings through debt and equity transactions. In addition, from September 1, 2014 through the date of this filing, the Company raised an aggregate of $475,000. The Company intends to continue to conduct additional short-term note financings to provide necessary working capital to the Company, as needed. On October 15, 2014, certain Series A bond holders elected to convert a portion of the outstanding Series A Bonds totaling $3,253,500 in principal and $165,539 in accrued interest into 3,419,039 shares of Common Stock at a rate of $1.00 per share. In addition the conversion included warrants exercisable until October 15, 2017 at $2.00 per share of Common Stock for a total of 1,709,520 warrants. In addition, pursuant to the October 15, 2014 Maturity Date as outlined in the terms of the Series A Bond Purchase Agreement, the Company has converted the remaining outstanding Series A Bonds totaling $805,000 in principal and $42,381 in accrued interest into 564,921 shares of Common Stock at a rate of $1.50 per share. As a result, the Company will record a modification expense which will comprise the value of the warrants and additional shares received as a result of the favorable conversion price. Results of Operations For the three months ended August 31, 2014 as compared to the three months ended August 31, 2013 The Company is still in the early stages of its development and continues to fully integrate the five (5) staffing acquisitions. As a result of the integration, the Company generated a loss of $4,663,398 for the three (3) months ended August 31, 2014 of which approximately $2,890,181 relates to non-cash amortization and depreciation charges. The Company generated $33,439,373 in revenue for the three (3) months ended August 31, 2014, which is consistent with what is expected on a quarterly basis going forward prior to any incremental amount from additional acquisitions. The Company believes the acquisitions consummated during fiscal year 2014 are performing as expected or better. We believe that as these businesses continue to grow that they will allow us to attract additional acquisitions in line with our stated strategic plan of $300 million of annualized revenue. The Company is vigilantly managing its operations and has developed a "Pathway to Profitability" program that is being constantly monitored. This Pathway to Profitability includes overhead control, operational reviews, cash management, adequate capitalization and our M&A program. Young, high-growth consolidated strategy companies often confront struggles with integration and financing. We invested for our future in building a strong corporate team which allows stronger financial reporting, compliance and commercial management. This investment has contributed to our losses in the short-term but we believe we would not need material additions as we grow, either organically and through acquisition. The following table sets forth the results of operations for the three (3) months ended August 31, 2014 and 2013: Three Months Ended August 31, 2014 2013 Service revenues $ 33,439,373 $ 1,343,375 Direct cost of services 27,529,559 82 % 950,609 71 % Gross profit 5,909,814 18 % 392,766 29 % Operating expenses 7,339,455 22 % 806,467 60 % Loss from operations (1,429,641 ) (4 )% (413,701 ) (31 )% Other expenses (3,296,371 ) (10 )% (13,790 ) (1 )% Net loss $ (4,663,398 ) (14 )% $ (427,491 ) (32 )% 41 Service revenue We began generating revenue in October 2012. As of August 31, 2014, the Company had six operating entities - Cyber 360, Control Solutions International (CSI), Staffing (UK), Poolia (UK), PeopleSERVE, Inc. and PeopleSERVE PRS. Cyber 360 was acquired on April 26, 2013. Cyber 360 primarily provides IT and information security temporary staffing services for an array of large institutions. They also provide permanent placement and consulting services. Contingent staffing and consulting revenue are recognized when services are rendered by the Company's contingent employees and consultants. The Company pays all related costs of employment, including workers' compensation insurance, state and federal unemployment taxes, social security and certain fringe benefits. Permanent placement revenue is recognized when employment candidates start their first day of work. The Company offers its clients a 30/60/90 day guarantee. If the employee is terminated or leaves voluntarily during this period, a pro-rated refund is provided. Fees to clients are typically calculated as a percentage of the new employee's annual compensation. For the three (3) months ended August 31, 2014 and August 31, 2013, Cyber 360 had revenue of $864,372 and $1,256,188, respectively. The decrease in revenue is a result of Cyber 360 dedicating its time and resources to qualification under the General Services Administration for the U.S. Government ("GSA") schedule over the past couple of quarters. Having now been awarded this qualification, the Company expects Cyber 360 revenue to begin to rebound and have more opportunity for growth in the future. Control Solutions International ("CSI") was acquired on November 4, 2013. CSI provides consulting and risk advisory services principally in the U.S. and Canada but also has a network of affiliated entities across 33 countries through which services are provided. Revenue is recognized ratably over the period in which the service is provided. The costs of the service are recognized as the cost and time are incurred. For the three (3) months ended August 31, 2014, CSI reported revenue of $1,096,330. Staffing UK (including its subsidiary Monroe Staffing Services LLC) was acquired on January 3, 2014. It provides temporary staffing and permanent placement services in the U.S. and the U.K. Revenues are derived from gross billings, which are based on (i) the payroll cost of its worksite employees; and (ii) a mark-up computed as a percentage of the payroll cost. The gross billings are invoiced concurrently with each periodic payroll of its worksite employees. For the three (3) months ended August 31, 2014, Staffing UK collectively reported revenue of $24,389,145. Certain assets and liabilities of Poolia UK were acquired on February 28, 2014. Poolia UK provides professional staffing services from its office in London with an emphasis on providing temporary, contract and permanent qualified professionals to various banking, financial and commercial clients across the United Kingdom. For the three (3) months ended August 31, 2014, Poolia UK reported revenue of $1,681,079. PeopleSERVE, Inc. was acquired on May 17, 2014. It provides temporary staffing and permanent placement services primarily in the IT sector. Revenue is derived from gross billings, which are based on (i) the payroll cost of its worksite employees; and (ii) a mark-up computed as a percentage of the payroll cost. The gross billings are invoiced concurrently with each periodic payroll of its worksite employees. For the three (3) months ended August 31, 2014, PeopleSERVE, Inc. reported revenue of $2,993,694. The Company acquired forty-nine percent (49%) of PeopleSERVE PRS, Inc. on May 17, 2014. It provides temporary staffing and payrolling services primarily in the IT sector. Revenue is derived from gross billings, which are based on (i) the payroll cost of its worksite employees; and (ii) a mark-up computed as a percentage of the payroll cost. The gross billings are invoiced concurrently with each periodic payroll of its worksite employees. For the three (3) months ended August 31, 2014, PeopleSERVE PRS, Inc. reported revenue of $2,414,754. For the three months ended August 31, 2014 and 2013, the Company, on a consolidated basis, had net revenue of $33,439,373 and $1,343,375, respectively. The dramatic increase in revenue is largely derived from the impact of the most recent five (5) acquisitions. Direct cost of services The Company's cost of revenue includes the cost of labor and other overhead costs (payroll wages, taxes and related insurance) as they relate to employees (temporary and permanent), as well as sub-contractors and consultants. For the three (3) months ended August 31, 2014 and August 31, 2013, cost of revenue was $27,529,559 and $950,609 respectively. The increase is related to the cost of revenue of the most recent five (5) acquisitions, which took place after August 31, 2013. Gross profit and gross margin The Company's gross profit for the three (3) months ended August 31, 2014 and August 31, 2013 was $5,909,814 and $392,766 respectively, representing gross margin of 18% and 29% respectively. The decrease is related to the gross profit margin of the Company's six (6) acquisition, five (5) of which took place after August 31, 2013 as compared to the gross profit of its two (2) subsidiaries in 2013. Operating expenses For the three months ended August 31, 2014 and 2013, operating expenses amounted to $7,339,455 and $806,467, respectively, an increase of $6,532,988. For the three months ended August 31, 2014 and 2013, operating expenses consisted of the following: 42 Three Months Ended August 31, 2014 2013 General and administrative $ 1,494,317 $ 150,226 Compensation 4,047,298 278,214 Director and Consulting fees - related parties 186,758 116,250 Depreciation and amortization 695,187 65,233 Professional fees 915,895 196,544 Total operating expenses $ 7,339,455 $ 806,467 For the three (3) months ended August 31, 2014 and 2013, the increase in our operating expenses was primarily attributable to: · An increase of $1,344,091 in general and administrative expenses. The increase is primarily attributable to the implementation of the Company's business plan in relation to costs incurred for adding five acquisitions as well as office expenses related to the Company's subsidiaries, four of which did not exist prior to August 2013. · An increase of $3,769,084 in compensation expense. The Company has increased its workforce due to the increase related to the acquisitions made in November 2013 and January, February and May 2014. In 2013, the Company hired a president of the Company as well as two senior vice presidents. The increase in compensation primarily relates to the compensation of the employees working for the Company's acquired subsidiaries. · An increase of $70,508 in director and consulting fees to related parties incurred is primarily attributable to the compensation to the Company's board of directors for their services as board members and members of committees formed on the Company's behalf. · A total of $656,737 in amortization expense. Amortization expense relates to the amortization of intangible assets related to the acquisitions of Cyber 360 on April 26, 2013, Control Solutions International on November 4, 2013, Staffing UK on January 3, 2014, Poolia on February 28, 2014 and PeopleSERVE, Inc. and PeopleSERVE PRS, Inc. on May 17, 2014. The Company's intangible assets are being amortized on a straight line basis over the estimated life of the asset of four years except for Trade Names which are being amortized over fifteen years. · A total of $38,450 in depreciation expense. The increase relates to the fixed assets of the Company's subsidiaries and the fixed assets the Company acquired. · An increase of $719,351 in professional fees. The increase primarily relates to increases in accounting, consulting and legal fees relating to the implementation of the Company's business plan, specifically due diligence (legal and accounting) of potential acquisition targets, as well as, legal and auditing costs associated with the completion of the acquisitions. This is expected to continue as the Company continues to acquire new businesses. The increase also relates to the professional fees relating to running public companies (accounting, auditing, legal, transfer agent, and filing fees). Other Expenses For the three (3) months ended August 31, 2014 and 2013, the Company incurred interest and financing expense of $3,296,371 and $13,790, respectively, relating to interest from convertible notes, accounts receivable financing, amortization of beneficial conversion feature, debt discount and amortization of deferred financing costs. Net Loss As a result of the factors described above, the Company's net losses for the three (3) months ended August 31, 2014 and 2013 were $4,663,398 and $427,491, respectively, or a net loss per common share of $0.14 and $0.03 (basic and diluted), respectively. Liquidity and Capital Resources Liquidity is the ability of a company to generate funds to support its current and future operations, satisfy its obligations, and otherwise operate on an ongoing basis. We have been funding our operations through promissory notes, the sale of the Company's Common Stock through private offerings and from loans from our majority shareholders/officers/directors. 43 Through October 2012, the Company was presented as a development stage company. Activities during the development stage included organizing the business and raising capital. In October 2012, Staffing Alliance commenced operations and the Company began to generate revenue. In April 2013, Cyber 360 Solutions was acquired and began generating revenue. In November 2013, CSI was acquired and began generating revenue. In January 2014, Staffing UK was acquired and began generating revenue. In February 2014, Poolia UK was acquired and began generating revenue. In May 2014, PeopleSERVE, Inc. and PeopleSERVE PRS, Inc. were acquired and began generating revenue. Since the Company has incurred losses and currently has negative working capital, these consolidated financial statements have been prepared on a going concern basis, which implies the Company will continue to meet its obligations and continue its operations for the next fiscal year. Realization value may be substantially different from carrying values as shown and these consolidated financial statements do not include any adjustments to the recoverability and classification of recorded asset amounts and classification of liabilities that might be necessary if the Company is unable to continue as a going concern. As of August 31, 2014, the Company had a working capital deficiency of $10,102,693, an accumulated deficit of $21,105,179, a net loss of $4,663,398, and net cash used in operations of $1,977,786. The continuation of the Company as a going concern is dependent upon the continued financial support from its major shareholders, the ability of the Company to obtain necessary financing to continue operations, and profitable operations from existing subsidiaries and the acquisition of additional accretive and positive cash flowing entities. These factors raise substantial doubt regarding the Company's ability to continue as a going concern and the outcome of these uncertainties cannot be predicted. Our primary uses of cash have been expended in growing the business, implementing our business plan and funding operations. The following trends are reasonably likely to result in a material decrease in our liquidity over the near to long term: · An increase in working capital requirements to finance targeted acquisitions, · Addition of administrative and sales personnel as the business grows, · Increases in advertising, public relations and sales promotions for existing and new brands as we expand within existing markets or enters new markets, · The cost of being a public company, and · Capital expenditures to add technologies. In October 2012, the Company began to generate revenue. At August 31, 2014, the cash balance was $787,943. Operations have been funded by the following: · On January 17, 2013, the Company signed a promissory note with a lender in the principal amount of $750,000. The promissory note bears interest at a rate of 12% per annum. · During the period from March 2013 through February 2014, the Company entered into promissory notes with various parties in the aggregate principal amount of $425,000. The notes bear interest at the rate of 12% per annum. · During the year ended May 31, 2013, the Company entered into note agreements with various shareholders/directors/officers of the Company in the aggregate amount of $56,500. These notes are unsecured, bear interest at 5.0% and are due one year from the respective note date. · During the year ended May 31, 2013, the Company entered into an agreement under which it borrows money under an accounts receivable financing arrangement. The Company receives an advance of 90% of the face value of an eligible receivable. Upon collection of the receivable, the advance is repaid and the remaining funds are remitted to the Company. The borrowings carry interest at a rate of .025% per day (9% per annum). At August 31, 2014, $2,958,790 was recorded (including interest) to the accounts receivable financing liability. · During the year ended May 31, 2013, the Company completed a closing of a private offering for total gross proceeds of $1,050,000. Pursuant to a subscription agreement, the Company issued to the purchasers units each consisting of (i) 27,778 shares of common stock and (ii) a three year warrant to purchase 13,889 shares of common stock at an exercise price of $1.80 per share, for a purchase price of $25,000 per unit. In total, the Company sold 42 units totaling 1,166,676 common shares and 583,338 warrants. In addition, on July 2, 2013 the Company completed a closing of a second private offering for total gross proceeds of $565,000. The terms of the second offering mirror the first offering. In the second offering, the Company sold 22.6 units totaling 627,783 common shares and 313,892 warrants. · On August 28, 2013, a related party loaned the Company $155,000 for short term obligations. This loan was non-interest bearing and was repaid on September 3, 2013. 44 · During the year ended May 31, 2014, the Company issued promissory notes to four investors for a total of $340,000. The loans bear interest at 12% per annum and were due at the earlier of the completion of the Company's $1.75 million bridge financing or 90 days from the date of the note. These notes were repaid in fiscal 2014. · During the year ended May 31, 2014 the Company raised $1,655,000 in the form of convertible promissory notes relating to its $1.75 million bridge financing. The loans bear interest at 12% per annum and are due within 10 days following the closing of a $10 million private placement financing or February 28, 2014 (the "Maturity Date"). In April 2014, the Company converted $1,655,000 of principal and $72,044 of interest and issued 1,727,044 shares (1,655,000 relating to principal and 72,044 relating to accrued interest). · Through February 28, 2014, in connection with the Company's private placement offering of units for up to $10,000,000 the Company raised $9,144,000 for a total of 365.76 units. Each unit consisting of (i) 25,000 shares of common stock priced at $1.00 per share and (ii) warrants to purchase 12,500 shares, at an exercise price of $2.00 per share. In connection with such unit offering, as of May 31, 2014, the Company issued a total of 9,144,000 shares of common stock and 4,572,000 warrants. On March 13, 2014, the Company successfully completed the sale of the remaining unit offering of the maximum amount of $10,000,000. · From April 2014 through June, 2014, the Company also conducted a note offering, whereby the Company raised $1,700,000 through the issuance of short-term 12% convertible promissory notes. The purchasers of the short-term 12% convertible promissory notes received an aggregate of 325,000 shares of restricted common stock as additional consideration. During the quarter ended August 31, 2014, the Company repaid $300,000 in cash and converted $600,000 into 400,000 shares. The balance at August 31, 2014 was $800,000. · In April 2014, the Company commenced its Bond Offering of 12% Convertible Bonds with certain accredited investors. Through May 31, 2014, the Company issued Bonds for an aggregate of $2,998,500. The purchasers of the 12% Convertible Bonds received an aggregate of 299,850 shares of restricted common stock as additional consideration. On July 29, 2014, the company completed the Bond Offering for an aggregate of $4,058,500. · In June, July and August, 2014, the Company issued promissory notes in the amount of $655,000. The promissory notes were non-interest bearing and due upon demand. The Company issued 34,500 shares to the note holders as additional consideration. During the quarter ended August 31, 2014, the Company repaid $405,000 in cash. The balance at August 31, 2014 was $150,000. · In July and August 2014, the Company issued promissory notes to Sterling National bank for consideration totaling $625,000. These notes bear interest at 18% per annum and are due upon demand. During the quarter ended August 31, 2014, the Company repaid $450,733 in cash. The balance at August 31, 2014 was $174,267. These notes were paid in full in September 2014. · On August 22, 2014, the Company commenced its Series B Bond Offering of 12% Convertible Series B Bonds with certain accredited investors. On October 3, 2014, the Company issued Bonds for an aggregate of $475,000 to five (5) accredited investors. (See Note 14 to the financial statements with this Quarterly Report). As a result, the Company issued 47,500 as equity consideration to the bondholders. In addition, the Company issued 2,850 to the placement agent for services rendered. · On October 15, 2014, certain Series A bond holders elected to convert a portion of the outstanding Series A Bonds totaling $3,253,500 in principal and $165,539 in accrued interest into 3,419,039 shares of Common Stock at a rate of $1.00 per share. In addition, the conversion included warrants exercisable until October 15, 2017 at $2.00 per share of Common Stock for a total of 1,709,520 warrants. · On October 15, 2014, the Company converted the remaining outstanding Series A Bonds totaling $805,000 in principal and $42,381 in accrued interest into 564,921 shares of common stock at a rate of $1.50 per share. Currently, we do not have sufficient working capital to fund the expansion of our operations or provide working capital necessary for on-going operations and obligations. We will need to raise significant additional capital to fund our operating expenses, pay our obligations, and grow the company. Therefore, our future operations will be dependent on our ability to secure additional financing. We estimate that based on current plans and assumptions, that our available cash will not be sufficient to satisfy our cash requirements under our present operating expectations, without further financing, for to the next twelve (12) months. Financing transactions may include the issuance of equity or debt securities, obtaining credit facilities, or other financing mechanisms. However, the trading price of our Common Stock and a downturn in the U.S. equity and debt markets could make it more difficult to obtain financing through the issuance of equity or debt securities. Even if we are able to raise the funds required, it is possible that we could incur unexpected costs and expenses, fail to collect amounts owed to us, or experience unexpected cash requirements that would force us to seek alternative financing. Furthermore, if we issue additional equity or debt securities, stockholders may experience additional dilution or the new equity securities may have rights, preferences or privileges senior to those of existing holders of our common stock. Currently, dilutive common share equivalents totaling 15,811,334 shares consisting of shares issuable upon the conversion of existing convertible notes and the exercise of stock options and warrants. If we are unable to obtain additional financing, we will likely be required to curtail our marketing and development plans and possibly cease our operations. 45 We anticipate that depending on market conditions and our current state of operations, we will incur additional operating losses in the foreseeable future. Therefore, our auditors have raised substantial doubt about our ability to continue as a going concern. Our liquidity may be negatively impacted by the significant costs associated with our public company reporting requirements, costs associated with newly applicable corporate governance requirements, including requirements under the Sarbanes-Oxley Act of 2002 and other rules implemented by the Securities and Exchange Commission. We expect all of these applicable rules and regulations to significantly increase our legal and financial compliance costs and to make some activities more time consuming and costly. Operating activities For the three (3) months ended August 31, 2014, net cash used in operations of $1,977,786 was primarily attributable to the net loss of $4,663,398 offset by changes in operating assets and liabilities totaling $2,685,611, which primarily relates to accounts receivable of $2,038,605, prepaid expenses of $98,101, deferred finance costs of $147,095, other assets of $6,869, accounts payable and accrued expenses of $700,613, accounts payable and accrued expenses - related parties of $43,580, accrued payroll and taxes of $425,632 and other current liabilities of $36,388, non-cash adjustments to depreciation and amortization totaling $3,720,064 and share based compensation totaling $147,204. For the three (3) months ended August 31, 2013, net cash used in operations of $409,474 was primarily attributable to the net loss of $427,491 offset by adjustments totaling $18,017, which primarily relates to increase in accounts receivable of $76,322, increase in prepaid expenses of $4,508, net increase in accounts payable - related parties, accounts payable and accrued expenses of $30,947, non-cash adjustments of $65,233 of depreciation and amortization and share based compensation totaling $2,667. Investing activities For the three (3) months ended August 31, 2014, net cash flows used in investing activities was $1,489,874 and was attributable to the purchase of fixed assets of $53,844, $1,308,009 due to sellers of acquisitions and the payments of $128,021 made for the earn-out agreement relating to the acquisition of Cyber 360 on April 26, 2013 and CSI on November 3, 2013. For the three (3) months ended August 31, 2013, net cash flows used in investing activities was $65,040 and was attributable to the payment made for the earn-out agreement relating to the acquisition of Cyber 360 on April 26, 2013. Financing activities For the three (3) months ended August 31, 2014, net cash flows provided by financing activities totaled $1,624,046 and was attributable to proceeds relating to accounts receivable financing of $2,142,330, proceeds of $100,000 from the issuance of convertible promissory notes, proceeds of $1,280,000 from the issuance of promissory notes and proceeds of $1,060,000 from the issuance of Series A convertible bonds. In addition, the Company repaid $300,000 in convertible notes and repaid $1,350,275 in promissory notes. For the three (3) months ended August 31, 2013, net cash flows provided by financing activities totaled $442,549 and was attributable to proceeds relating to accounts receivable financing of $72,549, proceeds of $155,000 from a shareholder and $215,000 relating to proceeds from the sale of Common Stock. Off-Balance Sheet Arrangements We have no off-balance sheet arrangements. Critical Accounting Policies and Estimates Our significant accounting policies are fully described in Note 3 to our unaudited consolidated financial statements for the fiscal quarter ended August 31, 2014 contained herein. Recent Accounting Pronouncements Accounting standards that have been issued or proposed by FASB that do not require adoption until a future date are not expected to have a material impact on the financial statement presentation or disclosure upon adoption. In June 2014, the Financial Accounting Standards Board ("FASB") issued new authoritative guidance related to share-based payments where performance targets can be achieved subsequent to the requisite service period. The guidance, effective in fiscal year ended 2015, is not expected to have a material impact on its results of operations, financial position or cash flows. 46 |