Hyperscale Data, Inc. 10-Q

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS In this quarterly report, the “Company,” “AAI,” “we,” “us” and “our” refer to Ault Alliance, Inc., a Delaware corporation. AAI is a diversified holding company pursuing growth by acquiring undervalued businesses and disruptive technologies with a global impact. Through our wholly and majority owned subsidiaries and strategic investments, we own and operate a data center at which we mine Bitcoin and offer colocation and hosting services for the emerging artificial intelligence ecosystems and other industries, and provide mission-critical products that support a diverse range of industries, including metaverse platform, oil exploration, crane services, defense/aerospace, industrial, automotive, medical/biopharma, consumer electronics, hotel operations and textiles. In addition, we own and operate hotels and extend credit to select entrepreneurial businesses through a licensed lending subsidiary. Recent Events and Developments On January 23, 2023, we filed a Certificate of Elimination with the Secretary of State of the State of Delaware with respect to our Series C convertible redeemable preferred stock (“Series C Preferred Stock”) which, effective upon filing, eliminated the Series C Preferred Stock. On February 8, 2023, we entered into a Share Exchange Agreement (the “Agreement”) with ROI and the other signatories thereto. The Agreement provides that, subject to the terms and conditions set forth therein, ROI will acquire all of the outstanding shares of capital stock of our then subsidiary, BitNile.com, Inc. (“BitNile.com”), of which we owned approximately 86%, and the remaining 14% was owned by minority shareholders (the “Minority Shareholders”), as well as Ault Iconic, (formerly Ault Media Group) and the securities of Earnity beneficially owned by BitNile.com (which represented approximately 19.9% of the outstanding equity securities of Earnity as of the date of the Agreement), in exchange for the following: (i) 8,637.5 shares of newly designated Series B Convertible Preferred Stock of ROI to be issued to our company (the “Series B Preferred”), and (ii) 1,362.5 shares of newly designated Series C Convertible Preferred Stock of ROI to be issued to the to the Minority Shareholders (the “Series C Preferred,” and together with the Series B Preferred, the “Preferred Stock”). The Series B Preferred and the Series C Preferred each have a stated value of $10,000 per share (the “Stated Value”), for a combined stated value of the Preferred Stock to be issued by ROI of $100 million, and subject to adjustment, are convertible into an aggregate of 13.3 million shares of common stock of ROI (the “ROI Common Stock”). ROI received approval of the Series A Convertible Preferred Stock transaction by its’s shareholders and the Nasdaq Stock Market to exceed the 19.9% beneficial ownership limitation. Pursuant to the Certificates of Designations of the Rights, Preferences and Limitations of the Series B Preferred and the Series C Preferred (collectively, the “Preferred Stock Certificates”), each share of Preferred Stock will be convertible into a number of shares of ROI Common Stock determined by dividing the Stated Value by $7.50 (the “Conversion Price”), or 1,333 shares of ROI Common Stock. The Conversion Price will be subject to certain adjustments, including potential downward adjustment if ROI closes a qualified financing resulting in at least $25 million in gross proceeds at a price per share that is lower than the Conversion Price then in effect. The holders of Preferred Stock will be entitled to receive dividends at a rate of 5% of the Stated Value per annum from issuance until February 7, 2033 (the “Dividend Term”). During the first two years of the Dividend Term, dividends will be payable in additional shares of Preferred Stock rather than cash, and thereafter dividends will be payable in either additional shares of Preferred Stock or cash as each holder may elect. If ROI fails to make a dividend payment as required by the Preferred Stock Certificates, the dividend rate will be increased to 12% for as long as such default remains ongoing and uncured. Each share of Preferred Stock will also have an $11,000 liquidation preference in the event of a liquidation, change of control event, dissolution or winding up of ROI, and will rank senior to all other capital stock of ROI with respect thereto, except that the Series B Preferred and Series C Preferred shall rank pari passu. Each share of Series B Preferred was originally entitled to vote with the ROI Common Stock at a rate of 10 votes per share of Common Stock into which the Series B Preferred is convertible, but that provision was subsequently eliminated. Other than certain rights granted to the Company relating to amendments or waiver of various negative covenants, the terms, rights, preferences and limitations of the Preferred Stock Certificates are essentially identical. The Agreement closed on March 6, 2023. On March 28, 2023, we entered into a securities purchase agreement (the “Purchase Agreement”) with certain sophisticated investors (the “Investors”), pursuant to which we agreed to issue and sell, in a private placement, an aggregate of 100,000 shares of our preferred stock, with each such share having a stated value of $100.00 and consisting of (i) 83,000 shares of Series E Convertible Preferred Stock (the “Series E Preferred Stock”), (ii) 1,000 shares of Series F Convertible Preferred Stock (the “Series F Preferred Stock”) and (iii) 16,000 shares of Series G Convertible Preferred Stock (the “Series G Preferred Stock” and collectively, the “Preferred Shares”). 1 Each share of Series E Preferred Stock and Series F Preferred Stock had a purchase price of $100.00, equal to each such share’s stated value. The purchase price of the Series E Preferred Stock and the Series F Preferred Stock was paid for by the Investors’ canceling outstanding secured promissory notes in the principal amount of $8.4 million, whereas the purchase price of the shares of Series G Preferred Stock consisted of accrued but unpaid interest on these notes, as well as for other good and valuable consideration. Each Preferred Share is convertible into shares of our common stock at a conversion price equal to 85% of the closing sale price of our common stock on the trading day prior to the date of conversion, subject to a floor price of $0.10. The Preferred Shares are convertible at the option of the holder at any time following our receipt of stockholder approval of the Reverse Split (as defined below). The private placement closed on March 30, 2023. On April 6, 2023, we issued a term note with a principal amount of $1.1 million, bearing an interest rate of 12% (the “Term Note”). The Term Note was issued at a discount, with net proceeds to us amounting to $1.0 million. The Term Note was scheduled to mature on June 5, 2023. We exercised the option to extend the maturity date by one month, by paying a $30,000 extension fee. Ault & Company guaranteed repayment of the Term Note. On May 1, 2023, we entered into a securities purchase agreement (the “Series C Agreement”) with Ault & Company, pursuant to which we agreed to sell to Ault & Company up to 40,000 shares of Series C convertible preferred stock and warrants to purchase up to 1.3 million shares of common stock for a total purchase price of up to $40 million. The consummation of the transactions contemplated by the Series C Agreement are subject to various customary closing conditions and the receipt of certain third party consents. In addition to customary closing conditions, the closing of the transaction is also conditioned upon the receipt by Ault & Company of financing in an amount sufficient to consummate the transaction, in whole or in part. The Series C Agreement contains customary termination provisions for Ault & Company under certain circumstances, and the Series C Agreement shall automatically terminate if the closing has not occurred prior to May 31, 2023, although such date may be extended by Ault & Company for a period of 90 days as set forth in the Series C Agreement. Our stockholders approved, at a special meeting of our stockholders called for such purpose, an amendment (the “Amendment”) to our certificate of incorporation to authorize a reverse split of our common stock (the “Reverse Split”). The Investors agreed in the Purchase Agreement to not transfer, offer, sell, contract to sell, hypothecate, pledge or otherwise dispose of the Preferred Shares until after the Reverse Split. Pursuant to the certificate of designation of the Series E Preferred Stock, the shares of Series E Preferred Stock have the right to vote on such Amendment on an as converted to common stock basis. In addition, pursuant to the certificate of designation of the Series F Preferred Stock, the shares of Series F Preferred Stock have the right to vote on such Amendment. Each Investor has separately agreed to vote the shares of the Series E Preferred Stock in favor of the Amendment and that the shares of the Series F Preferred Stock shall automatically be voted in a manner that “mirrors” the proportions on which the shares of our common stock and Series E Preferred Stock are voted on the Amendment. The Amendment requires the approval of the majority of the votes associated with our outstanding capital stock entitled to vote on the proposal. Because the Series F Preferred Stock will automatically and without further action of the purchaser be voted in a manner that “mirrors” the proportions on which the shares of common stock and Series E Preferred Stock are voted on the Reverse Split, abstentions by common stockholders will not have any effect on the votes cast by the holders of the Series F Preferred Stock. The Series G Preferred Stock does not carry any voting rights, except as required by law or expressly provided by its certificate of designation. On June 8, 2023, we entered into a loan agreement with Ault & Company as lender. The loan agreement provides for an unsecured, non-revolving credit facility in an aggregate principal amount of up to $10 million. All loans under the loan agreement are due within five business days after request by Ault & Company and Ault & Company is not obligated to make any further advances under the loan agreement after December 8, 2023. Advances under the loan agreement bear interest at the rate of 9.5% per annum and may be repaid at any time without penalty or premium. As of the date of this report, $4.7 million has been advanced under the loan agreement and not repaid. On June 9, 2023, we entered into an At-the-Market Issuance Sales Agreement with Ascendiant Capital Markets, LLC, as sales agent (“Ascendiant Capital”) to sell shares of our common stock having an aggregate offering price of up to $10,000,000 (the “Shares”) from time to time, through an “at the market offering” (the “2023 Common ATM Offering”). On July 12, 2023, we and Ascendiant Capital entered into an amendment to the At-The-Market issuance sales agreement to increase the size of the 2023 Common ATM Offering from $10.0 million to $20.0 million. Through August 14, 2023, we have sold an aggregate of 3.8 million shares of common stock pursuant to the 2023 Common ATM Offering for gross proceeds of $16.1 million. 2 On June 26, 2023, we established a record date for our initial distribution of TurnOnGreen securities. Stockholders as of this date were entitled to 40 shares of TurnOnGreen common stock, along with warrants to purchase 40 shares of TurnOnGreen common stock (the “TurnOnGreen Securities”) for every share of our common stock they held on the record date. The initial distribution was finalized in July 2023. We distributed 58.7 million TurnOnGreen Securities in the first distribution. On July 24, 2023, we established a record date for our second partial distribution of TurnOnGreen Securities. Stockholders as of this date were entitled to 15 shares of TurnOnGreen Securities for every share of the Company’s common stock they held on the record date. The second distribution was finalized on August 7, 2023, whereby we relinquished control of voting interests of TurnOnGreen. We distributed 56.4 million TurnOnGreen Securities in the second distribution. On July 19, 2023 we along with certain of our subsidiaries entered into a First Amendment and Joinder to Loan and Guarantee Agreement (the “Amendment”) with the institutional investors pursuant to which the (i) Loan and Guarantee Agreement, dated November 7, 2022, entered into between us and the institutional investors (the “Loan Agreement”) and (ii) Security Agreement, dated November 7, 2022, entered into between the institutional investors and Sentinum (the “Security Agreement”) was amended. Pursuant to the Amendment, we borrowed an additional $8.8 million. The net proceeds of the additional loan amount were $7.5 million. Effective August 3, 2023, we and the Investors entered into an Exchange Agreement (the “Exchange Agreement”) pursuant to which the Investors exchanged all of their Preferred Shares as well as their demand notes (the “Demand Notes”) issued to the Investors by us on or about May 20, 2023, with each Demand Note having a principal outstanding amount of approximately $0.8 million for two new 10% Secured OID Promissory Notes (the “Exchange Notes”), each with a principal face amount of $5.3 million, for an aggregate of amount owed of $10.5 million (the “Principal Amount”). We and Milton “Todd” Ault, III, our Executive Chairman, entered into guaranty agreements with the Investors guaranteeing repayment by Ault & Company, Inc., a related party (“Ault & Company”) of the Exchange Notes. Effective as of August 3, 2023, we assigned the Exchange Notes to Ault & Company. As consideration for Ault & Company assuming the Exchange Notes from us, we issued a 10% demand promissory note in the principal face amount of $10.5 million (the “First A&C Demand Note”) to Ault & Company. Effective as of August 10, 2023, we assigned the Term Note to Ault & Company. As consideration for Ault & Company assuming the Term Note from us, we issued a 12% demand promissory note in the principal face amount of $1.1 million (the “Second Demand Note”) to Ault & Company. On October 13, 2023 (the “Closing Date”), we entered into a note purchase agreement with Ault & Company, pursuant to which we sold to the Purchaser (i) a senior secured convertible promissory note in the principal face amount of $17.5 million (the “Note”) and warrants (the “Warrants”) to purchase shares of our common stock for a total purchase price of up to $17.5 million (the “Transaction”). The purchase price was comprised of the following: (i) cancellation of $4.6 million of cash loaned by Ault & Company to us since June 8, 2023 pursuant to the loan agreement; (ii) cancellation of $11.6 million of term loans made by us to Ault & Company in exchange for Ault & Company assuming liability for the payment of $11.6 million of secured notes; and (iii) the retirement of $1.25 million stated value of 125,000 shares of our Series B Convertible Preferred Stock (representing all shares issued and outstanding of that series) being transferred from Ault & Company to us. The Note has a principal face amount of $17.5 million and has a maturity date of October 12, 2028 (the “Maturity Date”). The Note bears interest at the rate of 10% per annum. Interest is payable, at the Purchaser’s option, in cash or shares of Common Stock at the applicable Conversion Price (as defined below). Accrued interest is payable on the Maturity Date, provided, however, that Ault & Company has the option, on not less than 10 calendar days’ notice to us, to require payment of accrued but unpaid interest on a monthly basis in arrears. The Note is convertible into shares of common stock at a conversion price equal to the greater of (i) $0.10 per share (the “Floor Price”), and (ii) the lesser of (A) $0.2952 or (B) 105% of the volume weighted average price of the common stock during the ten trading days immediately prior to the date of conversion (the “Conversion Price”). The Conversion Price is subject to adjustment in the event of an issuance of common stock at a price per share lower than the Conversion Price then in effect, as well as upon customary stock splits, stock dividends, combinations or similar events. The Floor Price shall not be adjusted for stock dividends, stock splits, stock combinations and other similar transactions. 3 The Warrants grant Ault & Company the right to purchase 47,685,988 shares of common stock. The Warrants have a five-year term, expiring on the fifth anniversary of the Closing Date, and become exercisable on the first business day after the six-month anniversary of the Closing Date. The exercise price of the Warrants is $0.1837, which is subject to adjustment in the event of customary stock splits, stock dividends, combinations or similar events. In addition, we and various of our subsidiaries granted Ault & Company a senior security interest in substantially all of our assets as collateral for the repayment of the Note, which is subordinated to the security interest granted to the holders of the outstanding secured promissory notes. On November 6, 2023, we entered into a securities purchase agreement (the “SPA”) with Ault & Company, pursuant to which we agreed to sell to Ault & Company up to 50,000 shares of Series C convertible preferred stock and warrants to purchase up to 370 million shares of common stock for a total purchase price of up to $50 million, of which up to $17.5 million of the Note may be tendered for cancellation. The consummation of the transactions contemplated by the SPA, specifically the conversion of the Series C convertible preferred stock and the exercise of the warrants in an aggregate number in excess of 19.99% on the execution date of the Agreement, are subject to various customary closing conditions as well as regulatory and stockholder approval. In addition to customary closing conditions, the closing of the financing is also conditioned upon the receipt by Ault & Company of financing to consummate the transaction. The SPA contains customary termination provisions for Ault & Company under certain circumstances, and the Agreement shall automatically terminate if the closing has not occurred prior to December 29, 2023, although such date may be extended by Ault & Company for a period of 90 days as set forth in the SPA. On November 15, 2023, we purchased from ROI 603.44 shares of ROI’s newly designated Series D Convertible Preferred Stock for a total purchase price of $15.1 million. The purchase price was paid by the cancellation of $15.1 million of cash advances made by us to ROI between January 1, 2023 and November 9, 2023. The preferred shares each have a stated value of $25,000 per share and each preferred share is convertible into a number of shares of ROI’s common stock determined by dividing the stated value by $0.51, or an aggregate of 29.6 million shares of ROI common stock, subject to adjustment in the event of an issuance of ROI common stock at a price per share lower than the conversion price, as well as upon customary stock splits, stock dividends, combinations or similar events. The preferred shares holders are entitled to receive dividends at a rate of 10% per annum from issuance until November 14, 2033. In addition, for as long as at least 25% of the Preferred Shares remain outstanding, ROI must obtain our consent with respect to certain corporate events, including reclassifications, fundamental transactions, stock redemptions or repurchases, increases in the number of directors, and declarations or payment of dividends, and further ROI is subject to certain negative covenants, including covenants against issuing additional shares of capital stock or derivative securities, incurring indebtedness, engaging in related party transactions, selling of properties having a value of over $50,000, altering the number of directors, and discontinuing the business of any subsidiary, subject to certain exceptions and limitations. Presentation of AGREE as Discontinued Operations In September 2023, we committed to a plan for our wholly owned subsidiary AGREE to list for sale its four recently renovated Midwest hotels, the Hilton Garden Inn in Madison West, the Residence Inn in Madison West, the Courtyard in Madison West, and the Hilton Garden Inn in Rockford. The decision to sell the hotels follows the decision to also list the multifamily development site in St. Petersburg, Florida and is driven by our desire to focus on our core businesses, Energy, Fintech and Sentinum. We plan to use the proceeds from the sales of the hotel properties to pay off debt and commit more capital to our core businesses. Our real estate properties, which include both hotels and land are currently listed for sale. In connection with the planned sale of AGREE assets, we concluded that the net assets of AGREE met the criteria for classification as held for sale. In addition, the proposed sale represents a strategic shift that will have a major effect on our operations and financial results. As a result, we have presented the results of operations, cash flows and financial position of AGREE as discontinued operations in the accompanying consolidated financial statements and notes for all periods presented. General As a holding company, our business objective is designed to increase stockholder value. Under the strategy we have adopted, we are focused on managing and financially supporting our existing subsidiaries and partner companies, with the goal of pursuing monetization opportunities and maximizing the value returned to stockholders. We have, are and will consider initiatives including, among others: public offerings, the sale of individual partner companies, the sale of certain or all partner company interests in secondary market transactions, or a combination thereof, as well as other opportunities to maximize stockholder value. We anticipate returning value to stockholders after satisfying our debt obligations and working capital needs. 4 From time to time, we engage in discussions with other companies interested in our subsidiaries or partner companies, either in response to inquiries or as part of a process we initiate. To the extent we believe that a subsidiary or partner company’s further growth and development can best be supported by a different ownership structure or if we otherwise believe it is in our stockholders’ best interests, we will seek to sell some or all of our position in the subsidiary or partner company. These sales may take the form of privately negotiated sales of stock or assets, mergers and acquisitions, public offerings of the subsidiary or partner company’s securities and, in the case of publicly traded partner companies, sales of their securities in the open market. Our plans may include taking subsidiaries or partner companies public through rights offerings and directed share subscription programs. We will continue to consider these (or similar) initiatives and the sale of certain subsidiary or partner company interests in secondary market transactions to maximize value for our stockholders. In recent years, we have provided capital and relevant expertise to fuel the growth of businesses in metaverse platform, oil exploration, crane services, defense/aerospace, industrial, automotive, medical/biopharma, consumer electronics, hotel operations and textiles. We have provided capital to subsidiaries as well as partner companies in which we have an equity interest or may be actively involved, influencing development through board representation and management support. We are a Delaware corporation with our corporate office located at 11411 Southern Highlands Pkwy, Suite 240, Las Vegas, NV 89141. Our phone number is 949-444-5464 and our website address is www.ault.com. Results of Operations Results of Operations for the Three Months Ended September 30, 2023 and 2022 The following table summarizes the results of our operations for the three months ended September 30, 2023 and 2022. For the Three Months Ended September 30, 2023 2022 Revenue $ 28,164,000 $ 27,031,000 Revenue, cryptocurrency mining 7,558,000 3,874,000 Revenue, crane operations 12,490,000 - Revenue, lending and trading activities (249,000 ) 13,360,000 Total revenue 47,963,000 44,265,000 Cost of revenue, products 20,425,000 20,193,000 Cost of revenue, cryptocurrency mining 10,228,000 5,255,000 Cost of revenue, crane operations 7,642,000 - Total cost of revenue 38,295,000 25,448,000 Gross profit 9,668,000 18,817,000 Total operating expenses 31,571,000 25,826,000 Loss from operations (21,903,000 ) (7,009,000 ) Other income (expense): Interest and other income 309,000 725,000 Interest expense (4,414,000 ) (2,367,000 ) Loss on extinguishment of debt (1,546,000 ) - Realized and unrealized gain on marketable securities 74,000 709,000 Loss on the sale of fixed assets (33,000 ) - Change in fair value of warrant liability (562,000 ) (3,000 ) Total other expense, net (6,172,000 ) (936,000 ) Loss before income taxes (28,075,000 ) (7,945,000 ) Income tax (benefit) provision (565,000 ) 144,000 Net loss from continuing operations (27,510,000 ) (8,089,000 ) Net income (loss) from discontinued operations (929,000 ) 93,000 Net loss (28,439,000 ) (7,996,000 ) Net loss attributable to non-controlling interest 6,668,000 725,000 Net loss attributable to Ault Alliance, Inc. (21,771,000 ) (7,271,000 ) Preferred dividends (413,000 ) (190,000 ) Net loss available to common stockholders $ (22,184,000 ) $ (7,461,000 ) Comprehensive loss Net loss available to common stockholders $ (22,184,000 ) $ (7,461,000 ) Other comprehensive loss Foreign currency translation adjustment (651,000 ) 306,000 Other comprehensive loss (651,000 ) 306,000 Total comprehensive loss $ (22,835,000 ) $ (7,155,000 ) 5 Revenues Revenues by segment for the three months ended September 30, 2023 and 2022 were as follows: For the Three Months Ended September 30, Increase 2023 2022 (Decrease) % GIGA $ 10,275,000 $ 7,781,000 $ 2,493,000 32 % TurnOnGreen 1,166,000 1,662,000 (496,000 ) -30 % SMC 15,931,000 17,114,000 (1,183,000 ) -7 % Sentinum Revenue, cryptocurrency mining 7,558,000 3,874,000 3,684,000 95 % Revenue, commercial real estate leases 333,000 273,000 61,000 22 % Fintech: Revenue, lending and trading activities (249,000 ) 13,360,000 (13,609,000 ) -102 % Other 18,000 201,000 (183,000 ) -91 % Energy 12,931,000 - 12,931,000 — Total revenue $ 47,963,000 $ 44,265,000 $ 3,698,000 8 % GIGA GIGA revenues were up $2.5 million for the three months ended September 30, 2023, including $0.4 million growth attributable to our acquisition of Giga-tronics Incorporated on September 8, 2022. Continued conflicts and tensions worldwide are driving defense-related investments in force protection technologies at GIGA across the United States, U.K., Europe, Asia, and the Middle East. Additionally, demand for key electronics solutions, particularly for customers in medicine and telecommunications, accelerated in the three months ended September 30, 2023. TurnOnGreen TurnOnGreen revenues were down $0.5 million for the three months ended September 30, 2023, compared to the three months ended September 30, 2022 due to the cancellation of large projects that contributed to revenue in 2022. SMC SMC revenues decreased by $1.2 million primarily due to timing of shipments to a large customer. Sentinum Revenues from Sentinum’s cryptocurrency mining operations increased $3.7 million as we increased our cryptocurrency mining activities from the prior period, and further increased by a 32% increase in the average Bitcoin price, partially offset an 84% increase in the average Bitcoin mining difficulty level in the current year period. Fintech Revenues from our lending and trading activities were negative $0.2 million. Revenue from lending and trading activities for the three months ended September 30, 2023 included an approximate $3.0 million unrealized losses from our investment in Alzamend, partially offset by realized gains from our investment portfolio for the three months ended September 30, 2023. During the three months ended September 30, 2022, Ault Lending generated income from appreciation of investments in marketable securities as well as shares of common stock underlying equity securities issued to Ault Lending in certain financing transactions. Ault Lending also generates revenue through origination fees charged to borrowers and interest generated from each loan. 6 Revenues from our trading activities for the three months ended September 30, 2023 included net losses on equity securities, including unrealized gains and losses from market price changes. These gains and losses have caused, and will continue to cause, significant volatility in our periodic earnings. Energy Energy revenues increased by $12.9 million for the three months ended September 30, 2023, due to the acquisition of the Circle 8 crane operations in December 2022. Gross Margins Gross margins decreased to 20% for the three months ended September 30, 2023, compared to 43% for the three months ended September 30, 2022. Our gross margins of 21% recognized during the three months ended September 30, 2023 were negatively impacted by unfavorable margins from our lending and trading activities and negative margins from our Sentinum cryptocurrency mining segment due to the significant increase in Bitcoin mining difficulty level. Excluding the effects of margin from our lending and trading activities and cryptocurrency mining operations, our adjusted gross margins for the three months ended September 30, 2023 and 2022 would have been 31% and 25%, respectively. Research and Development Research and development expenses increased by $1.2 million for the three months ended September 30, 2023, due to expenditures related to development work on ROI’s BitNile metaverse platform. Selling and Marketing Selling and marketing expenses were $8.0 million for the three months ended September 30, 2023, compared to $7.4 million for the three months ended September 30, 2022, an increase of $0.6 million, or 8%. The increase was primarily the result of higher advertising and promotion costs related to ROI’s BitNile metaverse platform, partially offset by a decline in employee related costs and consulting expenses. General and Administrative General and administrative expenses were $17.8 million for the three months ended September 30, 2023, compared to $15.4 million for the three months ended September 30, 2022, an increase of $2.4 million, or 16%. General and administrative expenses increased from the comparative prior period, mainly due to increases from new acquisitions: · general and administrative costs of $2.2 million from ROI, which was acquired in March 2023; · general and administrative costs of $2.0 million from Circle 8, which was acquired in December 2022; and · general and administrative costs of $0.7 million from GIGA, which was acquired in September 2022. The increases above were partially offset by a $2.4 million decrease performance bonus related to realized gains on trading activities. Impairment of Property and Equipment During the three months ended September 30, 2023, we recognized an impairment charge of $3.9 million related to property and equipment at ROI’s Agora and Bitstream Bitcoin mining operations as they have been unable to commence Bitcoin mining operations, either for themselves or from others through hosting arrangements. 7 Impairment of Deposit Due to Vendor Bankruptcy Filing During the three months ended September 30, 2022, Compute North Holdings, Inc. (along with its affiliated debtors, collectively, “Compute North”), filed for chapter 11 bankruptcy protection. We had a deposit of approximately $2.0 million with Compute North for services yet to be performed by Compute North. We assessed this financial exposure and recorded an impairment of the deposit totaling $2.0 million during the three months ended September 30, 2022. Impairment of Mined Cryptocurrency Impairment of mined cryptocurrency for the three months ended September 30, 2023 and 2022 was $0.1 million and $0.5 million, respectively. Impairment losses are attributable to the volatility of the Bitcoin market as market price of Bitcoin drops below our carrying value within the respective periods. The impairment of mined cryptocurrency for the three months ended September 30, 2023 is lower than the comparable prior year period as the average amount of digital currency held decreased during the three months ended September 30, 2023 as we generally sold our mined digital currency the next business day. Other Expense, Net Other expense, net was $6.2 million for the three months ended September 30, 2023, compared to $0.9 million for the three months ended September 30, 2022. Interest and other income was $0.3 million for the three months ended September 30, 2023, compared to $0.7 million for the three months ended September 30, 2022. The decrease in interest and other income is primarily due to the decline in ADRT’s cash and marketable securities held in the trust account as a result of redemptions that occurred in June 2023. Interest expense was $4.4 million for the three months ended September 30, 2023, compared to $2.4 million for the three months ended September 30, 2022. Interest expense increased due to higher levels of borrowing during the three months ended September 30, 2023 as compared to the three months ended September 30, 2023. Interest expense for the three months ended September 30, 2023 included contractual interest of $3.3 million, amortization of debt discount of $0.6 million, and forbearance and extension fees of $0.5 million. Interest expense for the three months ended September 30, 2022 consisted primarily of contractual interest. The $1.5 million loss on extinguishment of debt for the three months ended September 30, 2023 related to the August 2023 exchange of preferred stock liabilities for secured notes. The preferred stock liabilities were remeasured from their fair value prior to the exchange to the fair value of the secured notes at the date of the exchange. Income Tax (Benefit) Provision Benefit from income taxes was $0.6 million during the three months ended September 30, 2023 compared to a provision of $0.1 million during the three months ended September 30, 2022. The effective income tax benefit rate was 2.0% for the three months ended September 30, 2023 as compared to a provision of 1.8% for the three months ended September 30, 2022. 8 Results of Operations for the Nine Months Ended September 30, 2023 and 2022 The following table summarizes the results of our operations for the nine months ended September 30, 2023 and 2022. For the Nine Months Ended September 30, 2023 2022 Revenue $ 54,594,000 $ 43,539,000 Revenue, cryptocurrency mining 23,273,000 11,398,000 Revenue, crane operations 37,726,000 - Revenue, lending and trading activities 4,337,000 32,224,000 Total revenue 119,930,000 87,161,000 Cost of revenue, products 39,248,000 30,985,000 Cost of revenue, cryptocurrency mining 28,057,000 12,206,000 Cost of revenue, crane operations 22,671,000 - Cost of revenue, lending and trading activities 1,180,000 - Total cost of revenue 91,156,000 43,191,000 Gross profit 28,774,000 43,970,000 Total operating expenses 131,201,000 72,120,000 Loss from operations (102,427,000 ) (28,150,000 ) Other income (expense): Interest and other income 3,888,000 1,255,000 Interest expense (30,537,000 ) (32,063,000 ) Loss on extinguishment of debt (1,700,000 ) - Realized and unrealized (loss) gain on marketable securities (170,000 ) 1,016,000 Loss from investment in unconsolidated entity - (924,000 ) Impairment of equity securities (9,555,000 ) - (Loss) gain on the sale of fixed assets 2,728,000 - Change in fair value of warrant liability 2,655,000 (27,000 ) Total other expense, net (32,691,000 ) (30,743,000 ) Loss before income taxes (135,118,000 ) (58,893,000 ) Income tax provision 540,000 361,000 Net loss from continuing operations (135,658,000 ) (59,254,000 ) Net income (loss) from discontinued operations (5,862,000 ) (3,614,000 ) Net loss (141,520,000 ) (62,868,000 ) Net loss attributable to non-controlling interest 10,420,000 1,061,000 Net loss attributable to Ault Alliance, Inc. (131,100,000 ) (61,807,000 ) Preferred dividends (963,000 ) (239,000 ) Net loss available to common stockholders $ (132,063,000 ) $ (62,046,000 ) Comprehensive loss Net loss available to common stockholders $ (132,063,000 ) $ (62,046,000 ) Other comprehensive loss Foreign currency translation adjustment (1,001,000 ) (1,452,000 ) Other comprehensive loss (1,001,000 ) (1,452,000 ) Total comprehensive loss $ (133,064,000 ) $ (63,498,000 ) 9 Revenues Revenues by segment for the nine months ended September 30, 2023 and 2022 were as follows: For the Nine Months Ended September 30, Increase 2023 2022 (Decrease) % GIGA $ 27,723,000 $ 21,530,000 $ 6,193,000 29 % TurnOnGreen 2,766,000 3,853,000 (1,087,000 ) -28 % SMC 21,939,000 17,114,000 4,825,000 28 % Sentinum Revenue, cryptocurrency mining 23,273,000 11,398,000 11,875,000 104 % Revenue, commercial real estate leases 1,116,000 822,000 294,000 36 % Fintech: Revenue, lending and trading activities 4,337,000 32,224,000 (27,887,000 ) -87 % Other 63,000 220,000 (157,000 ) -71 % Energy 38,713,000 - 38,713,000 — Total revenue $ 119,930,000 $ 87,161,000 $ 32,769,000 38 % GIGA The $6.2 million increase in our GIGA segment revenue for the nine months ended September 30, 2023 included $1.6 million attributable to our acquisition of Giga-tronics Incorporated on September 8, 2022. Continued conflicts and tensions worldwide are driving defense-related investments in force protection technologies at GIGA across the United States, UK, Europe, Asia, and the Middle East. Additionally, demand for key electronics solutions, particularly for customers in medicine and telecommunications, accelerated in the nine months ended September 30, 2023. TurnOnGreen TurnOnGreen revenues were down $1.1 million for the nine months ended September 30, 2023, compared to the nine months ended September 30, 2022 due to the cancellation of large projects that contributed to revenue in 2022. SMC SMC revenues increased by $4.8 million primarily due to the acquisition of SMC in June 2022. Sentinum Revenues from Sentinum’s cryptocurrency mining operations increased $11.9 million as we increased our cryptocurrency mining activities from the prior period, partially offset by 17% lower average Bitcoin prices and a 66% increase in average Bitcoin mining difficulty level in the current year period. Fintech Revenues from our lending and trading activities were $4.3 million due to realized gains for the nine months ended September 30, 2023 from our investment portfolio. During the nine months ended September 30, 2022, Ault Lending generated income from realized gains from investments in marketable securities as well as shares of common stock underlying equity securities issued to Ault Lending in certain financing transactions. Revenue from lending and trading activities for the nine months ended September 30, 2023 included an approximate $3.6 million unrealized loss from our investment in Alzamend. Ault Lending also generates revenue through origination fees charged to borrowers and interest generated from each loan. Revenues from our trading activities for the nine months ended September 30, 2023 included net losses on equity securities, including unrealized gains and losses from market price changes. These gains and losses have caused, and will continue to cause, significant volatility in our periodic earnings. 10 Energy Energy revenues increased by $38.7 million for the nine months ended September 30, 2023, due to the acquisition of the Circle 8 crane operations in December 2022. Gross Margins Gross margins decreased to 24% for the nine months ended September 30, 2023, compared to 50% for the nine months ended September 30, 2022. Our gross margins of 24% recognized during the nine months ended September 30, 2023 were impacted by negative margins from our Sentinum cryptocurrency mining segment due to the decline in the price of Bitcoin coupled with an increase in Bitcoin mining difficulty level, offset by favorable margins from our lending and trading activities as compared to other segments. Excluding the effects of margin from our lending and trading activities and cryptocurrency mining operations, our adjusted gross margins for the nine months ended September 30, 2023 and 2022 would have been 32% and 29%, respectively. Research and Development Research and development expenses increased by $3.5 million for the nine months ended September 30, 2023, primarily due to expenditures related to development work on ROI’s BitNile metaverse platform. Selling and Marketing Selling and marketing expenses were $26.4 million for the nine months ended September 30, 2023, compared to $20.9 million for the nine months ended September 30, 2022, an increase of $5.5 million, or 26%. The increase was the result of $6.4 million higher advertising and promotion costs related to ROI’s BitNile metaverse platform, partially offset by a $2.6 million decline in employee related costs and consulting expenses. The increase is also attributable to $1.5 million increases in sales and marketing costs from SMC, which was acquired in June 2022. General and Administrative General and administrative expenses were $59.5 million for the nine months ended September 30, 2023, compared to $44.4 million for the nine months ended September 30, 2022, an increase of $15.2 million, or 34%. General and administrative expenses increased from the comparative prior period, mainly due to increases from new acquisitions: · general and administrative costs of $8.4 million from Circle 8, which was acquired in December 2022; · general and administrative costs of $5.3 million from SMC, which was acquired in June 2022; · general and administrative costs of $5.3 million from ROI, which was acquired in March 2023; · general and administrative costs of $4.3 million from GIGA, which was acquired in September 2022; and · general and administrative costs of $1.2 million from AVLP, which was acquired in June 2022. The increases above were partially offset by the following decreases in general and administrative expenses: · $6.5 million lower performance bonus related to realized gains on trading activities; and · $2.4 million lower corporate legal fees. Impairment of AVLP Goodwill and Intangible Assets Goodwill We test the recorded amount of goodwill for impairment on an annual basis on December 31 or more frequently if there are indicators that the carrying amount of the goodwill exceeds its carried value. We performed a goodwill impairment test as of June 30, 2023 related to AVLP as there were indicators of impairment related to certain unforeseen business developments and changes in financial projections. The valuation of the AVLP reporting unit was determined using a market and income approach methodology of valuation. 11 The income approach was based on the projected cash flows discounted to their present value using discount rates, that in the Company’s judgment, consider the timing and risk of the forecasted cash flows using internally developed forecasts and assumptions. Under the income approach, the discount rate used is the average estimated value of a market participant’s cost of capital and debt, derived using customary market metrics. The analysis included assumptions regarding AVLP’s revenue forecast and discount rates of 26.7% using a weighted average cost of capital analysis. The market approach utilized the guideline public company method. The results of the quantitative test indicated the fair value of the AVLP reporting unit did not exceed its carrying amounts, including goodwill, in excess of the carrying value of the goodwill. As a result, the entire $18.6 million carrying amount of AVLP’s goodwill was recognized as a non-cash impairment charge during the nine months ended September 30, 2023. Intangible Assets Due to indicators of impairment, AVLP intangible assets were tested for impairment as of June 30, 2023. Based on internally developed forecasts of undiscounted expected future cash flows, it was determined that the carrying amount of the assets were not recoverable and, based on an assessment of the fair value of the assets, impairment of $17.0 million was recognized as a non-cash impairment charge during the nine months ended September 30, 2023. The tradenames and patents/developed technology intangible assets were valued using the relief-from-royalty method. The relief-from-royalty method is one of the methods under the income approach wherein estimates of a company’s earnings attributable to the intangible asset are based on the royalty rate the company would have paid for the use of the asset if it did not own it. Royalty payments are estimated by applying royalty rates of 18% for patents and developed technology and 0.25% for trademarks. The resulting net annual royalty payments are then discounted to present value using a discount factor of 25.7%. Impairment of Property and Equipment During the nine months ended September 30, 2023, we recognized an impairment charge of $3.9 million related to property and equipment at ROI’s Agora and Bitstream Bitcoin mining operations as they have been unable to commence Bitcoin mining operations, either for themselves or from others through hosting arrangements. Impairment of Deposit Due to Vendor Bankruptcy Filing During the nine months ended September 30, 2022, Compute North filed for chapter 11 bankruptcy protection. We had a deposit of approximately $2.0 million with Compute North for services yet to be performed by Compute North. We assessed this financial exposure and recorded an impairment of the deposit totaling $2.0 million during the nine months ended September 30, 2022. Impairment of Mined Cryptocurrency Impairment of mined cryptocurrency for the nine months ended September 30, 2023 and 2022 was $0.4 million and $2.9 million, respectively. Impairment losses are attributable to the volatility of the Bitcoin market as market price of Bitcoin drops below our carrying value within the respective periods. The impairment of mined cryptocurrency for the nine months ended September 30, 2023 is lower than the comparable prior year period as the average amount of digital currency held decreased during the first half of 2023 as we generally sold our mined digital currency the next business day. Other Expense, Net Other expense, net was $32.7 million for the nine months ended September 30, 2023, compared to $30.7 million for the nine months ended September 30, 2022. Interest and other income was $3.9 million for the nine months ended September 30, 2023, compared to $1.3 million for the nine months ended September 30, 2022. The increase in interest and other income is primarily due to higher interest rates resulting in higher income from ADRT’s cash and marketable securities held in the trust account as a result of redemptions that occurred in June 2023. Interest expense was $30.5 million for the nine months ended September 30, 2023, compared to $32.1 million for the nine months ended September 30, 2022. Interest expense for the nine months ended September 30, 2023 included amortization of debt discount of $18.2 million, forbearance and extension fees of $7.3 million and contractual interest of $5.0 million. Interest expense for the nine months ended September 30, 2022 related primarily to amortization of debt discount of $26.4 million, contractual interest of $4.4 million, and forbearance and extension fees of $1.2 million. 12 The $1.5 million loss on extinguishment of debt for the nine months ended September 30, 2023 related to the August 2023 exchange of preferred stock liabilities for secured notes. The preferred stock liabilities were remeasured from their fair value prior to the exchange to the fair value of the secured notes at the date of the exchange. Loss from investment in unconsolidated entity was $0 for the nine months ended September 30, 2023, compared to $0.9 million for the nine months ended September 30, 2022, representing our share of losses from our equity method investment in AVLP prior to the June 1, 2022 acquisition. Cumulative downward adjustments for impairments for our equity securities without readily determinable fair values held at September 30, 2023 were $9.6 million. Income Tax Provision Provision for income taxes was $0.5 million during the three months ended September 30, 2023 compared to a provision of $0.4 million during the nine months ended September 30, 2022. The effective income tax provision rate was 0.4% for the nine months ended September 30, 2023 as compared to a provision of 0.6% for the nine months ended September 30, 2022. Liquidity and Capital Resources On September 30, 2023, excluding cash and cash equivalents from discontinued operations, we had cash and cash equivalents of $8.7 million (excluding restricted cash of $1.9 million), compared to cash and cash equivalents of $7.9 million (excluding restricted cash of $0.7 million) at December 31, 2022. The increase in cash and cash equivalents was primarily due to cash provided by operating activities and cash provided by financing activities related to the sale of common and preferred stock, as well as proceeds from convertible notes partially offset by the payment of debt, purchases of property and equipment and investments in equity securities. Net cash used in operating activities totaled $2.2 million for the nine months ended September 30, 2023, compared to net cash provided by operating activities of $21.9 million for the nine months ended September 30, 2022. Cash used in operating activities for the nine months ended September 30, 2023 included $71.2 million net cash provided by marketable securities from trading activities related to the operations of Ault Lending and $21.3 million proceeds from the sale of cryptocurrencies from our Sentinum Bitcoin mining operations, offset by operating losses and changes in working capital. Net cash used in operating activities for the nine months ended September 30, 2023 included $3.6 million cash used in operating activities from discontinued operations. Net cash used in investing activities was $22.9 million for the nine months ended September 30, 2023, compared to $115.4 million for the nine months ended September 30, 2022, which included $80.1 million of capital expenditures, primarily for Bitcoin mining equipment. Net cash used in investing activities for the nine months ended September 30, 2023 was primarily related to $8.7 million capital expenditures and the $10.7 million purchase of equity securities, partially offset by proceeds from the sale of fixed assets of $4.5 million. Net cash used in investing activities for the nine months ended September 30, 2023 included $6.1 million cash used in investing activities from discontinued operations. Net cash provided by financing activities was $23.8 million for the nine months ended September 30, 2023, compared to net cash provided by financing activities of $86.1 million for the nine months ended September 30, 2022, and primarily reflects the following transactions: · 2022 Common ATM Offering – During the nine months ended September 30, 2023, we sold an aggregate of 0.1 million shares of common stock pursuant to the 2022 Common ATM Offering for gross proceeds of $4.2 million and effective March 17, 2023, the 2022 Common ATM Offering was terminated; · 2022 Preferred ATM Offering – During the nine months ended September 30, 2023, we sold an aggregate of 162,175 shares of Series D Preferred Stock pursuant to the 2022 Preferred ATM Offering for net proceeds of $3.0 million and effective June 16, 2023, the 2022 Preferred ATM Offering was terminated; · 2023 Common ATM Offering –On June 9, 2023, we entered into the 2023 Common ATM Offering with Ascendiant Capital. During the nine months ended September 30, 2023, we sold an aggregate of 10.8 million shares of common stock pursuant to the 2023 Common ATM Offering for gross proceeds of $21.2 million; 13 · $58.1 million payments on notes payable, partially offset by $40.6 million proceeds from notes payable; and · $9.2 million proceeds from convertible notes payable, partially offset by $0.7 million payments on convertible notes payable. Net provided by financing activities for the nine months ended September 30, 2023 included $5.2 million cash provided by financing activities from discontinued operations. Financing Transactions Subsequent to September 30, 2023 Financing transactions subsequent to September 30, 2023 included the following: 2023 Common ATM Offering During the period between October 1, 2023 through November 17, 2023, we sold an aggregate of 54.2 million shares of common stock pursuant to the 2023 Common ATM Offering for gross proceeds of $10.0 million. Senior Secured Convertible Note, Related Party On October 13, 2023 (the “Closing Date”), we entered into a note purchase agreement with Ault & Company, pursuant to which we sold to the Purchaser (i) a senior secured convertible promissory note in the principal face amount of $17.5 million (the “Note”) and warrants (the “Warrants”) to purchase shares of our common stock for a total purchase price of up to $17.5 million (the “Transaction”). The purchase price was comprised of the following: (i) cancellation of $4.6 million of cash loaned by Ault & Company to us since June 8, 2023 pursuant to the loan agreement; (ii) cancellation of $11.6 million of term loans made by us to Ault & Company in exchange for Ault & Company assuming liability for the payment of $11.6 million of secured notes; and (iii) the retirement of $1.25 million stated value of 125,000 shares of our Series B Convertible Preferred Stock (representing all shares issued and outstanding of that series) being transferred from Ault & Company to us. The Note has a principal face amount of $17.5 million and has a maturity date of October 12, 2028 (the “Maturity Date”). The Note bears interest at the rate of 10% per annum. Interest is payable, at the Purchaser’s option, in cash or shares of Common Stock at the applicable Conversion Price (as defined below). Accrued interest is payable on the Maturity Date, provided, however, that Ault & Company has the option, on not less than 10 calendar days’ notice to us, to require payment of accrued but unpaid interest on a monthly basis in arrears. The Note is convertible into shares of common stock at a conversion price equal to the greater of (i) $0.10 per share (the “Floor Price”), and (ii) the lesser of (A) $0.2952 or (B) 105% of the volume weighted average price of the common stock during the ten trading days immediately prior to the date of conversion (the “Conversion Price”). The Conversion Price is subject to adjustment in the event of an issuance of common stock at a price per share lower than the Conversion Price then in effect, as well as upon customary stock splits, stock dividends, combinations or similar events. The Floor Price shall not be adjusted for stock dividends, stock splits, stock combinations and other similar transactions. The Warrants grant Ault & Company the right to purchase 47,685,988 shares of common stock. The Warrants have a five-year term, expiring on the fifth anniversary of the Closing Date, and become exercisable on the first business day after the six-month anniversary of the Closing Date. The exercise price of the Warrants is $0.1837, which is subject to adjustment in the event of customary stock splits, stock dividends, combinations or similar events. In addition, we and various of our subsidiaries granted Ault & Company a senior security interest in substantially all of our assets as collateral for the repayment of the Note, which is subordinated to the security interest granted to the holders of the outstanding secured promissory notes. 14 Series C Preferred Purchase Agreement, Related Party On November 6, 2023, we entered into a securities purchase agreement (the “SPA”) with Ault & Company, pursuant to which we agreed to sell to Ault & Company up to 50,000 shares of Series C convertible preferred stock and warrants to purchase up to 370 million shares of common stock for a total purchase price of up to $50 million, of which up to $17.5 million of the Note may be tendered for cancellation. The consummation of the transactions contemplated by the SPA, specifically the conversion of the Series C convertible preferred stock and the exercise of the warrants in an aggregate number in excess of 19.99% on the execution date of the Agreement, are subject to various customary closing conditions as well as regulatory and stockholder approval. In addition to customary closing conditions, the closing of the financing is also conditioned upon the receipt by Ault & Company of financing to consummate the transaction. The SPA contains customary termination provisions for Ault & Company under certain circumstances, and the Agreement shall automatically terminate if the closing has not occurred prior to December 29, 2023, although such date may be extended by Ault & Company for a period of 90 days as set forth in the SPA. Series D Preferred Purchase Agreement, Related Party On November 15, 2023, we purchased from ROI 603.44 shares of ROI’s newly designated Series D Convertible Preferred Stock for a total purchase price of $15.1 million. The purchase price was paid by the cancellation of $15.1 million of cash advances made by us to ROI between January 1, 2023 and November 9, 2023. The preferred shares each have a stated value of $25,000 per share and each preferred share is convertible into a number of shares of ROI’s common stock determined by dividing the stated value by $0.51, or an aggregate of 29.6 million shares of ROI common stock, subject to adjustment in the event of an issuance of ROI common stock at a price per share lower than the conversion price, as well as upon customary stock splits, stock dividends, combinations or similar events. The preferred shares holders are entitled to receive dividends at a rate of 10% per annum from issuance until November 14, 2033. In addition, for as long as at least 25% of the Preferred Shares remain outstanding, ROI must obtain our consent with respect to certain corporate events, including reclassifications, fundamental transactions, stock redemptions or repurchases, increases in the number of directors, and declarations or payment of dividends, and further ROI is subject to certain negative covenants, including covenants against issuing additional shares of capital stock or derivative securities, incurring indebtedness, engaging in related party transactions, selling of properties having a value of over $50,000, altering the number of directors, and discontinuing the business of any subsidiary, subject to certain exceptions and limitations. Critical Accounting Policies Variable Interest Entities The accounting guidance requires an enterprise to perform an analysis to determine whether the enterprise’s variable interest or interests give it a controlling financial interest in a variable interest entity; to require ongoing reassessments of whether an enterprise is the primary beneficiary of a Variable Interest Entity (“VIE”); to eliminate the solely quantitative approach previously required for determining the primary beneficiary of a VIE; to add an additional reconsideration event for determining whether an entity is a VIE when any changes in facts and circumstances occur such that holders of the equity investment at risk, as a group, lose the power from voting rights or similar rights of those investments to direct the activities of the entity that most significantly impact the entity’s economic performance; and to require enhanced disclosures that will provide readers of financial statements with more transparent information about an enterprise’s involvement in a VIE. For VIEs, the Company assesses whether it is the primary beneficiary as prescribed by the accounting guidance on the consolidation of a VIE. The Company evaluates its business relationships with related parties to identify potential VIEs under ASC 810, Consolidation. The Company consolidates VIEs in which it is considered to be the primary beneficiary. Entities are considered to be the primary beneficiary if they have both of the following characteristics: (i) the power to direct the activities that, when taken together, most significantly impact the VIE’s performance; and (ii) the obligation to absorb losses and right to receive the returns from the VIE that would be significant to the VIE. The Company’s judgment with respect to its level of influence or control of an entity involves the consideration of various factors including the form of its ownership interest, its representation in the entity’s governance, the size of its investment, estimates of future cash flows, its ability to participate in policy making decisions and the rights of the other investors to participate in the decision making process and to replace the Company as manager and/or liquidate the joint venture, if applicable. 15 Business Combination We allocate the purchase price of an acquired business to the tangible and intangible assets acquired and liabilities assumed based upon their estimated fair values on the acquisition date. Any excess of the purchase price over the fair value of the net assets acquired is recorded as goodwill. Acquired customer relations, technology, trade names and know how are recognized at fair value. The purchase price allocation process requires management to make significant estimates and assumptions, especially at the acquisition date with respect to intangible assets. Direct transaction costs associated with the business combination are expensed as incurred. The allocation of the consideration transferred in certain cases may be subject to revision based on the final determination of fair values during the measurement period, which may be up to one year from the acquisition date. We include the results of operations of the business that we have acquired in our consolidated results prospectively from the date of acquisition. If the business combination is achieved in stages, the acquisition date carrying value of the acquirer’s previously held equity interest in the acquire is re-measured to fair value at the acquisition date; any gains or losses arising from such re-measurement are recognized in profit or loss. 16 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Not applicable for a smaller reporting company.