Notes to Condensed Consolidated Financial
Statements
ORGANIZATION
Fuse Science, Inc.
(“
Company
”) was incorporated in Nevada on September 21, 1988. Since that time, the Company has engaged
in a number of businesses as a private and subsequently a publicly held company, including developing and marketing data communications
and networking infrastructure solutions for business, government and education (which business was sold in 2002) and as a “
business
development company
” under the Investment Company Act of 1940, from 2007 to 2009. Since April 2011, the Company
has been under new management with a singular focus on the development and commercialization of proprietary delivery technology
focused on redefining the way humans receive energy, nutrition and medications today and in the future.
2.
|
SIGNIFICANT ACCOUNTING POLICIES
|
CONSOLIDATION POLICY AND HISTORY OF BUSINESS
The consolidated financial
statements of the Company include the accounts of the Company and its wholly owned subsidiaries, Fuse Science, Inc. (“
FSR&D
”),
a Delaware Corporation, FSJV, LLC, a Florida limited liability company, FS Consumer Products Group, Inc., a Florida corporation
[and its 60% owned subsidiary, Ultimate Social Network, Inc. (“
USN
”)]. All significant intercompany balances
and transactions have been eliminated in consolidation.
BASIS OF PRESENTATION
The unaudited condensed consolidated financial
statements included herein have been prepared by the Company, without audit, according to the rules and regulations of the Securities
and Exchange Commission (“SEC”). Certain information and footnote disclosures normally included in financial statements
prepared in accordance with accounting principles generally accepted in the United Stated of America (“GAAP”) have
been condensed or omitted pursuant to such rules and regulations. The information set forth in these interim condensed consolidated
financial statements for the three and six months ended March 31, 2014 and 2013, is unaudited and reflects all adjustments, which
include only normal recurring adjustments and which in the opinion of management are necessary to make the interim condensed consolidated
financial statements not misleading. The September 30, 2013 year-end condensed consolidated balance sheet data was derived from
audited financial statements, but does not include all disclosures required by GAAP. The Report of Independent Registered Public
Accounting Firm on the September 30, 2013 consolidated financial statements contained an explanatory paragraph expressing substantial
doubt about the company’s ability to continue as a going concern. It is suggested that these condensed consolidated financial
statements be read in conjunction with these financial statements and the notes thereto included in the Company’s latest
stockholder’s annual report (Form 10-K) which were prepared assuming the Company will continue as a going concern.
USE OF ESTIMATES
The preparation of financial statements
in conformity with accounting principles generally accepted in the United States of America requires management to make estimates
and assumptions that affect the amounts reported in the financial statements and accompanying disclosures. Although these estimates
are based on management’s best knowledge of current events and actions the Company may undertake in the future, actual results
could differ from these estimates.
REVENUE RECOGNITION
The Company records
revenue net of discounts and allowances from the sale of Enerjel™, Powerfuse™ and Electrofuse™ , when all of
the following have occurred: (1) persuasive evidence of an arrangement exists, (2) product has been shipped or delivered,
(3) the sales price to the customer is fixed or determinable, and (4) collectability is reasonably assured. The Company’s
customers may return ordered items for a refund. The Company also provides customers incentives to purchase products at a discount.
For the three months ended March 31, 2014, we have recorded sales discounts, credits, coupons, and return and allowances of $6,604.
For the six months ended March 31, 2014, we have recorded sales discounts, credits, coupons and returns and allowances of $252,695,
which is netted against sales.
CASH CONCENTRATIONS
From time to time,
the Company maintains cash with financial institutions in excess of federally insured limits.
ACCOUNTS RECEIVABLE
Accounts receivable are uncollateralized
customer obligations due under normal trade terms. The carrying amount of accounts receivable may be reduced by an allowance that
reflects management's best estimate of the amounts that will not be collected. Management individually reviews all accounts receivable
balances and based on assessment of current credit worthiness, estimates the portion, if any, of the balance that will not be collected.
All accounts or portions thereof determined to be uncollectible are written off to the allowance for doubtful accounts. No allowance
for doubtful accounts was recorded as of March 31, 2014 and September 30, 2013.
SHIPPING AND HANDLING
Shipping and handling billed to customers
is included in net sales and shipping and handling costs are recorded as a component of cost of sales.
INVENTORIES
Inventories consist
of finished goods, which are manufactured by a contracted manufacturer on behalf of the Company, for resale, and raw materials.
Inventories are valued at average cost and adjusted to reflect lower of cost or market. Provisions for inventory obsolescence are
determined based upon the specific facts and circumstances and market conditions. During the three and six months ended March 31,
2014, $125,000 of Enerjel™ inventories were expensed for marketing and promotion activities. As of March 31, 2014 and September
30, 2013, no obsolescence reserves were considered necessary.
FIXED ASSETS
Fixed assets are recorded
at cost and depreciated using the straight-line method over the estimated useful life of 3-10 years. Repairs and maintenance are
charged to expense as incurred.
FAIR VALUE MEASUREMENTS
Fair value is defined as the price that
the Company would receive to sell an investment or pay to transfer a liability in a timely transaction with an independent counter-party
in the principal market or in the absence of a principal market, the most advantageous market for the investment or liability.
A three-tier hierarchy is established to distinguish between (1) inputs that reflect the assumptions market participants would
use in pricing an asset or liability developed based on market data obtained from sources independent of the reporting entity (observable
inputs) and (2) inputs that reflect the reporting entity’s own assumptions about the assumptions market participants would
use in pricing an asset or liability developed based on the best information available in the circumstances (unobservable inputs);
and establishes a classification of fair value measurements for disclosure purposes.
The hierarchy is summarized in the three broad levels listed
below:
Level 1
|
-
|
quoted prices in active markets for identical assets and liabilities
|
Level 2
|
-
|
other significant observable inputs (including quoted prices for similar assets and liabilities, interest rates, credit risk, etc.)
|
Level 3
|
-
|
significant unobservable inputs (including the Company’s own assumptions in determining the fair value of assets and liabilities).
|
In accordance with Accounting Standards Codification (“
ASC”)
815, the Company’s warrant derivative liability is measured at fair value on a recurring basis, and is a level 3 measurement
in the three-tier fair value hierarchy.
There were no transfers between the levels of the fair value
hierarchy during the six months ended March 31, 2014 and 2013.
FAIR VALUE OF FINANCIAL INSTRUMENTS
The following methods and assumptions were
used by the Company in estimating the fair values of each class of financial instruments disclosed herein:
Warrant Derivative Liability - These financial
instruments are carried at fair value.
Notes Payable - Based upon the interest
rates, current economic conditions, risk characteristics, collateral and other factors, the carrying amount of these financial
instruments approximate market value (level 2 measurement).
DERIVATIVE LIABILITY
The Company issued warrants to purchase
the Company’s common stock in connection with the issuance of convertible debt, which contain certain ratchet provisions
that reduce the exercise price of the warrants in certain circumstances. The Company determined that the warrants did not qualify
for a scope exception under ASC 815 as they were determined not to be indexed to the Company’s stock and accordingly are
accounted for as derivatives and are recorded on the balance sheet at fair value with the changes in the fair value recognized
in the consolidated statement of operations. Fair values are measured using a Black-Scholes valuation model, which approximates
a binomial lattice valuation methodology utilizing Level 3 inputs.
INTELLECTUAL PROPERTY
Intellectual property
is evaluated for impairment whenever events or changes in business circumstances indicate that the carrying value of our intellectual
property may not be recoverable. Intellectual property is amortized on a straight-line basis over its estimated economic
life of 15 years. We believe that the straight-line method of amortization reflects an appropriate allocation of the
cost of the intangible assets to earnings in proportion to the amount of economic benefits obtained annually by the Company.
IMPAIRMENT OF LONG-LIVED ASSETS
The Company evaluates
its long-lived assets and intangible assets for impairment whenever events change or if circumstances indicate that the carrying
amount of any assets may not be recoverable. Recoverability of assets to be held and used is measured by a comparison
of the carrying amount of the asset to the future net undiscounted cash flows expected to be generated by the asset. If
such assets are considered to be impaired, the impairment to be recognized is the excess of the carrying amount over the fair value
of the asset
INCOME TAXES
The Company accounts for income taxes under
the liability method whereby deferred tax assets and liabilities are provided for the future tax consequences attributable to temporary
differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases.
Deferred tax assets and liabilities are measured using enacted rates expected to apply to taxable income in the years in which
those temporary differences are expected to be recovered or settled.
Deferred tax assets, net of a valuation
allowance, are recorded when management believes it is more likely than not that the tax benefits will be realized. Realization
of the deferred tax assets is dependent upon generating sufficient taxable income in the future. The amount of deferred tax asset
considered realizable could change in the near term if estimates of future taxable income are modified.
The Company assesses its tax positions in
accordance with "Accounting for Uncertainties in Income Taxes" as prescribed by the Accounting Standards Codification,
which provides guidance for financial statement recognition and measurement of uncertain tax positions taken or expected to be
taken in a tax return for open tax years (generally a period of three years from the later of each return's due date or the date
filed) that remain subject to examination by the Company's major tax jurisdictions. Generally, the Company is no longer subject
to income tax examinations by major taxing authorities for years before September 30, 2010.
The Company assesses its tax positions and
determines whether it has any material unrecognized liabilities for uncertain tax positions. The Company records these liabilities
to the extent it deems them more likely than not to be incurred. Interest and penalties related to uncertain tax positions, if
any, would be classified as a component of income tax expense in the accompanying consolidated statements of income.
The Company believes that it does not have
any significant uncertain tax positions requiring recognition or measurement in the accompanying consolidated financial statements.
MARKETING, ADVERTISING AND PROMOTION COSTS
Marketing, advertising and promotion costs
are charged to operations as incurred and are included in sales and marketing expenses in the accompanying consolidated statements
of operations. The amount charged for the three months ended March 31, 2014 and 2013 were approximately $336,299 and $1,237,822
respectively. The amounts charged for the six months ended March 31, 2014 and 2013 were approximately $889,484 and $1,986,140,
respectively.
NON-CONTROLLING INTEREST
Non-controlling interest in the Company’s
consolidated financial statements represents the 40% interest not owned by the Company in USN. USN had no operations during the
six months ended March 31, 2014.
CONCENTRATION OF CREDIT RISK
One customer accounted for approximately
97% of the Company’s net sales for the three and six months ended March 31, 2014. The Company obtains principally all of
its inventory from one vender. In the event of loss of this supplier, it is reasonably possible that the Company would incur significant
disruption to its operations, which could have a material adverse impact on the Company's financial position.
STOCK-BASED COMPENSATION
The Company accounts for stock options granted
to employees and directors using the accounting guidance in ASC 718 “Stock Compensation” (“ASC 718”) and
for stock options granted to consultants and endorsers using the accounting guidance included in ASC 505-50 “Equity-Based
Payments to Non-Employees” (“ASC 505-50”). In accordance with ASC 718, we estimate the fair value of service
based options and performance based options on the date of grant, using the Black-Scholes pricing model. In accordance with ASC
505-50, we estimate the fair value of service based options and performance based options at each reporting period until a measurement
date is reached using the Black-Scholes pricing model.
The Black-Scholes option
valuation model was developed for use in estimating the fair value of traded options that have no vesting restrictions and are
fully transferable. In addition, option valuation models require the input of highly subjective assumptions including the expected
stock price volatility. Because the Company’s options would have characteristics significantly different from those of traded
options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in management’s
opinion, the existing models may not necessarily provide a reliable single measure of the fair value of the Company’s options,
although they provide the best estimate currently.
LOSS PER SHARE
The Company’s
loss per share is computed by dividing net loss by the weighted average number of common shares outstanding. Diluted losses per
share reflects the potential dilution that could occur if stock options and or other contracts to issue common stock were exercised
or converted into common stock or resulted in the issuance of common stock that then shared in the losses of the Company. All outstanding
options and warrants are not included in the calculation of diluted loss per share as their effect would be antidilutive.
As described in Note
7 –Payable, the Company had convertible notes and warrants outstanding during the three and six months ended March 31, 2014.
The convertible notes are reflected in the calculation of diluted earnings per share for the corresponding periods by application
of the “if converted” method to the extent their effect is dilutive.
The following is a
reconciliation of the numerator and denominator used for the computation of basic and diluted net loss per common shares:
|
|
For the Three Months ended
March 31,
|
|
|
|
2014
|
|
|
2013
Restated
|
|
Numerator:
|
|
|
|
|
|
|
|
|
Net loss available to stockholders
|
|
$
|
(3,243,170
|
)
|
|
$
|
(13,633,753
|
)
|
|
|
|
|
|
|
|
|
|
Denominator:
|
|
|
|
|
|
|
|
|
Weighted average number of common shares – Basic
|
|
|
401,030,925
|
|
|
|
190,368,357
|
|
Weighted average number of common shares – Diluted
|
|
|
401,030,925
|
|
|
|
190,368,357
|
|
|
|
|
|
|
|
|
|
|
Net loss per common share:
|
|
|
|
|
|
|
|
|
Basic
|
|
$
|
(0.01
|
)
|
|
$
|
(0.07
|
)
|
Diluted
|
|
$
|
(0.01
|
)
|
|
$
|
(0.07
|
)
|
|
|
For the Six Months ended
March 31,
|
|
|
|
2014
|
|
|
2013
Restated
|
|
Numerator:
|
|
|
|
|
|
|
|
|
Net loss available to stockholders
|
|
$
|
(8,054,357
|
)
|
|
$
|
(17,698,237
|
)
|
|
|
|
|
|
|
|
|
|
Denominator:
|
|
|
|
|
|
|
|
|
Weighted average number of common shares – Basic
|
|
|
388,580,925
|
|
|
|
186,026,466
|
|
Weighted average number of common shares – Diluted
|
|
|
388,580,925
|
|
|
|
186,026,466
|
|
|
|
|
|
|
|
|
|
|
Net loss per common share:
|
|
|
|
|
|
|
|
|
Basic
|
|
$
|
(0.02
|
)
|
|
$
|
(0.10
|
)
|
Diluted
|
|
$
|
(0.02
|
)
|
|
$
|
(0.10
|
)
|
3.
|
RESTATEMENT OF THE MARCH 31, 2013 BALANCES
|
As a result of
certain adjustments affecting quarters of the fiscal year ended September 30, 2013, that were made as of September 30, 2013,
the previously reported condensed consolidated statements of operations for the three and six months ended March 31, 2013 and
the consolidated statement of cash flow for the six months ended March 31, 2013 have been restated. The restatements are a
result of the following:
|
·
|
Certain warrants with price protection
features as described in Note 8, were not accounted for as derivatives for the three and six months ended March 31, 2013. This
resulted in an understatement of expense by $8,149,794 and $9,822,598, respectively.
|
|
·
|
The Company incorrectly calculated the
expense related to the issuance of stock options for the three and six months ended March 31, 2013. This resulted in an aggregate
understatement of general and administrative and sales and marketing expenses of $998,283 and $1,284,789.
|
|
·
|
The company incorrectly recorded $1,006,244
of interest expense as beneficial conversion feature of convertible notes payable for the three and six months ended March 31,
2013.
|
|
·
|
The company did not record an expense
as inducement of warrants exchange of $1,283,103 for the three and six months ended March 31, 2013.
|
Detailed below are the account balances,
which were restated to reflect the accounting for the previously described transactions.
|
|
Three Months
Ended
March 31, 2013
Restated
|
|
|
Three Months
Ended
March 31, 2013
(Originally Issued)
|
|
|
Effect of the
Change
|
|
General and administrative expense
|
|
$
|
(1,824,426
|
)
|
|
$
|
(1,304,261
|
)
|
|
$
|
(520,165
|
)
|
Sales and marketing
|
|
$
|
(1,237,822
|
)
|
|
$
|
(759,704
|
)
|
|
$
|
(478,118
|
)
|
Interest expense
|
|
$
|
(1,167,726
|
)
|
|
$
|
(161,482
|
)
|
|
$
|
(1,006,244
|
)
|
Expense on issuance of derivative liabilities
|
|
$
|
(1,283,103
|
)
|
|
$
|
-
|
|
|
$
|
(1,283,103
|
)
|
Change in fair value of warrant derivative liabilities
|
|
$
|
(8,149,794
|
)
|
|
$
|
-
|
|
|
$
|
(8,149,794
|
)
|
Beneficial conversion features of convertible notes payable
|
|
$
|
-
|
|
|
$
|
(1,006,244
|
)
|
|
$
|
1,006,244
|
|
Net loss
|
|
$
|
(13,633,753
|
)
|
|
$
|
(3,202,573
|
)
|
|
$
|
(10,431,180
|
)
|
Loss per share, basic and diluted
|
|
$
|
(0.07
|
)
|
|
$
|
(0.02
|
)
|
|
$
|
(0.05
|
)
|
|
|
Six Months
Ended
March 31, 2013
Restated
|
|
|
Six Months
Ended
March 31, 2013
(Originally Issued)
|
|
|
Effect of the
Change
|
|
General and administrative expense
|
|
$
|
(3,300,945
|
)
|
|
$
|
(2,494,274
|
)
|
|
$
|
(806,671
|
)
|
Sales and marketing
|
|
$
|
(1,986,140
|
)
|
|
$
|
(1,508,022
|
)
|
|
$
|
(478,118
|
)
|
Interest expense
|
|
$
|
(1,362,682
|
)
|
|
$
|
(356,448
|
)
|
|
$
|
(1,006,244
|
)
|
Expense on issuance of derivative liabilities
|
|
$
|
(1,283,103
|
)
|
|
$
|
-
|
|
|
$
|
(1,283,103
|
)
|
Change in fair value of warrant derivative liabilities
|
|
$
|
(9,822,598
|
)
|
|
$
|
-
|
|
|
$
|
(9,822,598
|
)
|
Beneficial conversion features of convertible notes payable
|
|
$
|
-
|
|
|
$
|
(1,006,244
|
)
|
|
$
|
1,006,244
|
|
Net loss
|
|
$
|
(17,698,237
|
)
|
|
$
|
(5,307,746
|
)
|
|
$
|
(12,390,481
|
)
|
Loss per share, basic and diluted
|
|
$
|
(0.10
|
)
|
|
$
|
(0.03
|
)
|
|
$
|
(0.07
|
)
|
Additionally, the impact of the restatements to the March 31,
2013 balance sheet would be increases to warrant derivative liabilities and total stockholder’s deficit of approximately
$2,500,000.
The Company has not established sources
of revenue sufficient to fund the development of the business, projected operating expenses and commitments for the next twelve
months and may be unable to obtain sufficient debt or equity financing. The Company has incurred net losses since inception, had
a net loss of $ (8,054,357) and used $(1,475,309) in cash from operating activities during the six month period ended March 31,
2014. At March 31, 2014, current assets were $1,323,708 and current liabilities were $2,832,337. Further, at March 31, 2014, the
accumulated deficit and total stockholder’s deficit amounted to $52,536,754 and $3,711,153, respectively. These conditions
raise substantial doubt about the Company’s ability to continue as a going concern. No adjustments have been made as a result
of this uncertainty.
The Company has taken several steps to address its liquidity
requirements. In addition to reducing the amount of operating expenses that it incurs on a monthly basis, the Company is
reducing its pricing to increase the demand for its products and is seeking additional debt or equity financing. The Company
is also evaluating what strategic alternatives might be available.
In April 2011, the
Company completed its acquisition of all the outstanding common stock of the Delaware corporation now known as FSR&D, which
was a development stage company with no prior operations. As of March 31, 2014 and September 30, 2013 unamortized intellectual
property relating to this acquisition amounted to $92,539 and $78,698, respectively.
Fixed Assets consisted of the following
at March 31, 2014 and September 30,2013:
|
|
March 31, 2014
|
|
|
September 30, 2013
|
|
Equipment
|
|
$
|
108,821
|
|
|
$
|
108,821
|
|
Website
|
|
|
13,750
|
|
|
|
13,750
|
|
Display cases
|
|
|
42,245
|
|
|
|
42,245
|
|
Fixed assets
|
|
|
164,816
|
|
|
|
164,816
|
|
Less: Accumulated depreciation
|
|
|
(32,149
|
)
|
|
|
(21,369
|
)
|
Fixed assets (net)
|
|
$
|
132,667
|
|
|
$
|
143,447
|
|
Depreciation and amortization expense amounted
to $6,021 and $4,086 for the three months ended March 31, 2014 and 2013 respectively. Depreciation and amortization expense amounted
to $12,041 and $7,548 for the six months ended March 31, 2014 and 2013 respectively.
The Company had the following notes payable
at March 31, 2014 and September 30, 2013.
|
|
March 31,
|
|
|
September,30
|
|
|
|
2014
|
|
|
2013
|
|
|
|
|
|
|
|
|
|
|
Convertible notes payable with interest at 12% (the “January 2014 Notes”)
|
|
$
|
750,000
|
|
|
$
|
-
|
|
Convertible notes payable with interest at 10% ( the “November 2013 Notes”)
|
|
|
775,000
|
|
|
|
-
|
|
Convertible notes payable with interest at 12% (the “March 2013 Notes”)
|
|
|
5,000
|
|
|
|
5,000
|
|
5% Six month secured promissory note due October 9, 2013
|
|
|
112,086
|
|
|
|
174,395
|
|
|
|
$
|
1,642,086
|
|
|
$
|
179,395
|
|
|
|
March 31,
|
|
|
September 30,
|
|
|
|
2014
|
|
|
2013
|
|
Current
|
|
$
|
892,086
|
|
|
$
|
179,395
|
|
Long term
|
|
|
750,000
|
|
|
|
-
|
|
Total
|
|
$
|
1,642,086
|
|
|
$
|
179,395
|
|
January 2014 Notes
On January 3, 2014,
we entered into a securities purchase agreement (the “
Purchase Agreement
”) with two investors pursuant to which
Fuse issued and sold 12% senior secured convertible notes in the aggregate original principal amount of $1,000,000 (the “
Notes
”)
and warrants to purchase up to 75,000,000 shares of Fuse’s common stock (the “
Warrants
”). The indebtedness
evidenced by the Notes bears interest at 12% per year, and accrues and is payable together with principal on January 2, 2019. The
Notes may be converted, at the option of the holder, into the Company’s common stock, at any time following issuance
at an initial conversion price(the “Fixed Conversion Price”) of $0.02 per share (subject to adjustment as provided
in the Note). From and after the sixth month anniversary of the issuance of the Notes, the conversion price of the Notes will be
equal to the lower of (i) the Fixed Conversion Price and (ii) sixty percent of the lowest weighted average price our common
stock on any trading day for the sixty trading days immediately preceding any conversion of the Senior Notes (the “Alternative
conversion Price,” and together with the Fixed Conversion Price, the “Conversion Price”). The Conversion Price
is also subject to anti-dilution adjustments as provided for the Senior Notes. The Notes are secured by a first lien on substantially
all of Fuse’s assets pursuant to a pledge and security agreement (the “
Security Agreement
”) among the
parties.
As per
the agreement, $550,000 of the Notes was received at the closing. $200,000 of the principal amount of the notes was received
in two monthly installments during February 2014 and March 2014. The remaining $250,000 of the Notes will be received in the
next two monthly installments. In recording the transaction, the Company recorded a discount for the full face value of the
Notes and recorded a derivative liability at fair value for the warrants and the debt conversion feature of $1,189,428,
resulting in an expense of $439,428 upon recording the derivative liability. The discount is amortized over the life of the
notes using the interest method.
Under the terms of
the Warrants, the Holders are entitled to exercise the Warrants for a period of five (7) years from issuance at a price of $0.0259
per share (subject to adjustment as provided in the Warrant).
The fair value of the
warrants and the debt conversion feature on the issue date was estimated using the Black-Scholes valuation model with the following
assumptions:
Expected term
|
18 months - 5 years
|
Expected average volatility
|
117.00 % - 121.00%
|
Expected dividend yield
|
0 %
|
Risk-free interest rate
|
.23 %
|
The securities were
issued pursuant to the exemption from registration afforded by Section 4(a)(2) of the Securities Act and Regulation D thereunder.
In connection with these transactions, Fuse will pay a placement agent fee of $43,400 and will issue to the placement agent and
their respective designees, placement agent warrants to purchase 7% of the number of shares of common stock that are issuable pursuant
to the Notes and Warrants.
November 2013 Notes
On November 7, 2013, we entered into a securities purchase agreement
(the “
Purchase Agreement
”) with a group of investors pursuant to which Fuse issued and sold 10% senior secured
convertible notes in the aggregate original principal amount of $775,000 (the “
Notes
”) and warrants to purchase
up to 25,830,750 shares of Fuse’s common stock (the “
Warrants
”). The investor group consists of MusclePharm
Corporation, Barry Honig, Michael Brauser, Melechdavid, Inc., Frost Gama Investments Trust, Jonathan Manela and Brian Tuffin, our
Chief Executive Officer.
The indebtedness evidenced
by the Notes bears interest at 10% per year, and accrues and is payable together with principal on the 60
th
day
after Closing. The Notes may be converted, at the option of the holder, (i) into the Company’s common stock, at
any time following issuance at an exercise price of $0.065 per share (subject to adjustment as provided in the Note) or (ii) if
the Company consummates a subsequent financing generating gross proceeds of not less than $4,000,000 (a “
Subsequent Financing
”),
into the securities sold in the Subsequent Financing at a specified discount from the offering price of such securities. The Notes
are secured by a first lien on substantially all of Fuse’s assets pursuant to a pledge and security agreement (the “
Security
Agreement
”) among the parties.
Under the terms of
the Warrants, the Holders are entitled to exercise the Warrants for a period of five (5) years following Closing at a price of
$0.065 per share (subject to adjustment as provided in the Warrant). The Company recorded a debt discount of $275,309 and recorded
the warrant derivative liability at fair value. The discount is amortized over the life of the notes using the interest method
The fair value of
the warrants on the due date was estimated using the Black-Scholes valuation model with the following assumptions:
Expected term
|
|
|
1
year
|
|
Expected average volatility
|
|
|
106.00
|
%
|
Expected dividend yield
|
|
|
0
|
%
|
Risk-free interest rate
|
|
|
.12
|
%
|
In connection with
the financing, Fuse granted piggy-back page registration rights to the Holders with respect to the shares of common stock issuable
upon conversion of the Notes and exercise of the Warrants.
The securities were
issued pursuant to the exemption from registration afforded by Section 4(a)(2) of the Securities Act and Regulation D thereunder.
In connection with these transactions, Fuse will pay a placement agent fee of $43,400 to Dawson James Securities and will issue
to the placement agent and their respective designees, placement agent warrants to purchase 7% of the number of shares of common
stock that are issuable pursuant to the Notes and Warrants.
March 2013 Notes
On March 7, 2013,
we sold (i) $2,050,000 in combined principal amount of senior convertible and senior subordinated convertible notes (the “
March
2013 Notes
”) and (ii) warrants (the “
March 2013 Warrants
”), consisting of (a) series A warrants to
purchase an aggregate of 12,058,828 (prior to conversion rate adjustment) shares of common stock (the “
Series A Warrants
”)
and (b) series B warrants to purchase an aggregate of 12,058,828 (prior to conversion rate adjustment) shares of common stock
(the “
Series B Warrants
”) at a purchase price of $2,050,000, in a private placement to a group of institutional
and accredited investors pursuant to a Securities Purchase Agreement, dated as of March 4, 2013. Prior to remeasurement, the March
2013 Notes are convertible into shares of the Company’s common stock at a conversion rate of $0.17, and are entitled to
earn interest which may be paid in cash or in shares of common stock. The March 2013 Warrants are exercisable into shares of common
stock and have been accounted for as derivatives (See Note 7).
The March 2013 Notes
are one (1) year senior convertible notes with an aggregate principal amount of $1,500,000 (“
Series A Notes
”)
and one (1) year senior subordinated convertible notes with an aggregate principal amount of $550,000 (the “
Series B
Notes
”). The March 2013 Notes will accrue interest at a rate of five percent (5%) per annum. The interest accrued is
payable in interest shares, although the Company may, at its option and upon written notice to each note holder of the March 2013
Notes, make such interest payments in cash or in a combination of cash and interest shares.
The Series A Warrants
have a term of five (5) years from the Closing Date and the Series B Warrants have a term of seven (7) months from the Closing
Date. Each of the Series A Warrants and the Series B Warrants is immediately exercisable upon issuance into an aggregate of 12,058,828
(prior to remeasurement of the conversion rate) fully paid and non-assessable shares at an initial exercise price of $0.21 per
share in the case of the Class A Warrants and $0.17 per share in the case of the Class B Warrants.
Any holder of the
March 2013 Notes is entitled to convert the notes into conversion shares at any time by delivery of a notice of conversion to
the Company. On or before the third trading day after receipt of the conversion notice, the Company must deliver to the note holder
such number of conversion shares to which the note holder is entitled pursuant to the conversion. The number of conversion shares
the note holder will receive upon conversion of the Notes will be determined by dividing the amount of principal being converted
plus any accrued and unpaid interest by the conversion price effective at the time of the conversion. The March 2013 Notes have
an initial conversion price of $0.17 however it is subject to reset after a measurement period commencing upon effectiveness of
a registration statement (Registration No. 333-187491) covering the shares underlying such securities. The registration statement
was declared effective on May 22, 2013. As a result, this triggered a remeasurement of the conversion rate if the stock price
falls below the initial conversion rate of $0.17 on the tenth (10th) consecutive trading day following the registration statement
and 80% of the average of the volume-weighted average prices for each of the preceding ten (10) complete consecutive trading days.
On June 6, 2013,
the Company recomputed the conversion rate based on the 80% of the Company’s stock trading value for the 10 preceding days.
As a result of the revision, the conversion rate was reduced to $0.094. The exercise price of the Series A Warrants and Series
B Warrants was also remeasured to $0.149 and $0.094, respectively. The remeasured conversion rate and exercise price increased
the shares available for conversion to 21,808,510.
The Company received
net proceeds in the amount of approximately $1,794,000 after offering costs of $256,000. In recording the transaction, the Company
recorded a debt discount for the full face value of the Notes, and recorded the Series A and B Warrants as Derivative Liabilities
at fair market value. The discount associated with the warrants is amortized over the life of the March 2013 Notes using the interest
method. The value of the warrants was calculated using the Black-Scholes valuation model and totaled $3,333,103 at issuance, resulting
in a $1,283,103 loss upon recording the warrant derivative liability.
During the quarter
ending June 30, 2013, the noteholders of the March 2013 Notes converted substantially all the outstanding March 2013 Notes, reducing
the Company debt associated with such convertible notes from $2,105,000 to $5,000 in exchange for approximately 22 million shares.
With respect to the
March 2013 financing, the Company paid the co-placement agents a placement fee of $164,000 and issued to the co-placement agents
and their designees, five-year warrants to purchase an aggregate of 1,266,175 shares of common stock at an exercise price of $0.21
per share and seven-month warrants to purchase an aggregate of 1,266,175 shares of common stock at an exercise price of $0.17
per share. The total fair value of warrants and shares issued was approximately $368,000. The conversion rate adjustment increased
the shares issued to the Placement Agent. The series A Warrants increased to 1,818,253 and the series B Warrant increased to 2,299,873.
The fair value of
each warrant on the date issued was estimated using the Black-Scholes valuation model. The following assumptions were used for
the calculation of the warrants granted in March 2013.
|
|
(Series A Warrants)
|
|
|
(Series B Warrants)
|
|
Expected term
|
|
|
1
year
|
|
|
|
7
months
|
|
Expected average volatility
|
|
|
120.00
|
%
|
|
|
120.00
|
%
|
Expected dividend yield
|
|
|
0
|
%
|
|
|
0
|
%
|
Risk-free interest rate
|
|
|
.80
|
%
|
|
|
.12
|
%
|
|
8.
|
DERIVATIVE LIABILITIES
|
The Company has warrants and debt conversion features issued
in connection with its convertible notes payable with price protection provisions that allow for the reduction in the exercise
price of the warrants and conversion price of the debt in the event the Company subsequently issues stock or securities convertible
into stock at a price lower than the exercise or conversion price. Simultaneously with any reduction to the exercise price of
the warrants, the number of shares of common stock that may be purchased upon exercise of each of these warrants shall be increased
or decreased proportionately, so that after such adjustment the aggregate exercise price payable for the adjusted number of warrants
shall be the same as the aggregate exercise price in effect immediately prior to such adjustment. The Company accounted for its
warrants and debt conversion features with price protection in accordance with FASB ASC Topic 815.
The Company’s derivative instruments have been measured
at fair value at March 31, 2014 using the Black-Scholes model, which approximates a binomial or lattice model. The liability is
revalued at each reporting period and changes in fair value are recognized currently in the consolidated statements of operations.
The initial recognition and subsequent changes in fair value of the warrant derivative liability have no effect on the Company’s
cash flows.
The recognition and revaluation of the derivatives at each
reporting period resulted in the recognition of an expense of $3,735,868 and $9,224,437 for the six months ended March 31, 2014
and 2013, respectively. The fair value of the derivatives at March 31, 2014 is $2,390,229, which is reported on the consolidated
balance sheet under the caption “Derivative Liabilities”.
Fair Value Assumptions Used in Accounting for Derivative
Liabilities
The Company has determined its derivative liabilities to be
a Level 3 fair value measurement and has used the Black-Scholes pricing model to calculate the fair value as of March 31, 2014.
The Black-Scholes model requires six basic data inputs: the exercise or strike price, time to expiration, the risk free interest
rate, the current stock price, the estimated volatility of the stock price in the future, and the dividend rate. Changes to these
inputs could produce a significantly higher or lower fair value measurement. The key inputs used in the March 31, 2014 fair value
calculations were as follows:
Stock Price
|
|
$
|
0.02
|
|
Volatility
|
|
|
122%-137
|
%
|
Strike Price
|
|
$
|
0.029 - 0.12
|
|
Risk-free Rate
|
|
|
0.10%-0.13
|
%
|
Dividend Rate
|
|
|
0
|
%
|
Expected Life
|
|
|
6 months – 5 years
|
|
At March 31, 2014, the estimated fair values of the liabilities
measured on a recurring basis are as follows:
|
|
Fair Value Measurements at March 31, 2014
|
|
|
|
Balance at
March 31, 2014
|
|
|
Significant
Unobservable Inputs
(Level 3)
|
|
Warrant derivative liabilities
|
|
$
|
2,390,229
|
|
|
$
|
2,390,229
|
|
The following tables present the activity
for liabilities measured at estimated fair value using unobservable inputs for the year ended March 31, 2014:
|
|
Fair Value Measurements
Using
Significant
Unobservable
Inputs
(Level 3)
|
|
|
|
Derivative Liabilities
|
|
Beginning balance at September 30, 2013
|
|
$
|
252,810
|
|
Issuance of derivative liabilities
|
|
|
1,500,700
|
|
Changes in estimated fair value
|
|
|
3,735,868
|
|
Reclassification of derivative liability to additional
paid-in capital
|
|
|
(3,098,549
|
)
|
Ending balance at March 31, 2014
|
|
$
|
2,390,229
|
|
On January 3, 2014,
we repurchased outstanding Advisory Warrants (the “Advisory Warrants”) from the holders through an exchange offer.
These advisory warrants were originally issued in 2011 and 2012 for investment banking services. Under the exchange agreement,
the holders of Advisory Warrants to purchase an aggregate of 828,249 shares of our common stock agreed to exchange their Advisory
Warrants for an aggregate of 24,000,000 shares of our common stock. The Exchange Shares are being issued to the holders pursuant
to the exemption from registration afforded by Section 3(a) (9) of the Securities Act of 1933, as amended (the “Securities
Act”).
As a result of the
warrants exchange, an expense of $480,000 was recorded as expense on inducement of warrant exchange.
On December 2, 2013,
we concluded an exchange offer pursuant to which we repurchased our outstanding Series A Warrants (the “
Series A Warrants
”)
and Exchange Warrants (the “
Exchange Warrants
”) from the holders thereof (the “
Holders
”).
These Series A Warrants were originally issued on March 7, 2013 pursuant to a Securities Purchase Agreement dated March 4, 2013,
among the Company and certain investors and were scheduled to expire on March 7, 2018. The Exchange Warrants were issued in a
private exchange offer completed on March 14, 2013 and were scheduled to expire on March 14, 2018. The exchange offer reflects
Fuse’s ongoing efforts to reduce market overhang.
Under Exchange Agreements
entered into between the Company and the Holders, the Holders of Series A Warrants to purchase an aggregate of 19,808,930 shares
of our common stock and Exchange Warrants to purchase an aggregate of 8,601,814 shares of our common stock agreed to exchange
their Series A Warrants and/or their Exchange Warrants for an aggregate of 81,729,116 shares of our common stock (the “
Exchange
Shares
”).
As a result of the exchange, the warrant
derivative liability related to the Series A warrants was reduced by $3,098,549. An expense on inducement of warrant exchange
in the amount of $170,616 was recorded as a result of the exchange of the Exchange Warrants.
The Company recorded no income tax benefit
or expense for the losses for the three months and six months ended March 31, 2014 and 2013 since management has determined that
the realization is not assured and has created a valuation allowance for the full amount of deferred tax assets.
|
11.
|
STOCKHOLDERS’ EQUITY (DEFICIT)
|
Preferred stock
At March 31, 2014,
the Company had 10,000,000 shares authorized and no shares issued and outstanding of its $0.001 par value preferred stock.
Common stock
At March 31, 2014
and September 30, 2013, the Company had 800,000,000 and 400,000,000 shares authorized and 402,215,464 and 276,944,231 shares issued
and outstanding, respectively, of its $0.001 par value common stock. On March 19, 2014 the board of directors approved an amendment
to the Company’s Articles of Incorporation to increase the number of shares of common stock authorized to be issued by the
Company from 400,000,000 to 800,000,000.The board of directors of the Company also voted to effect a reverse stock split of the
Company’s common stock by a ratio of not less than 1-for-50 and not more than 1-for-200, with the board of directors of
the Company having the discretion as to whether or not the reverse split is to be effected, and with the exact ratio of any reverse
split to be set at a whole number within the above range as determined by the Company’s board of directors in its discretion.
Transactions during the six months
ended March 31, 2014
Common Stock
During the six months ended March 31, 2014,
the Company issued 19,275,000 shares of common stock to athletes and consultants for endorsement and consulting services valued
at approximately $690,000.
Warrants
During the three months
ended March 31, 2014, the holders of the Advisory Warrants exercised 828,249 Advisory Warrants for 24,000,000 shares of common
stock which generated loss in inducement of warrants of $480,000.
During the three months
ended December 31, 2013, the holders of the March 2013 Notes exercised 267,117 of series B Warrants issued in connection therewith
for common stock which generated $14,691 in cash.
On December 13, 2013,
the Company reached agreements with the holders of the series A Warrants that were issued in conjunction with the March 2013 Notes,
and the holders of the exchange warrants. The terms of the agreements resulted in the exchange of the 19,808,930 series A Warrants
and 8,601,814 exchange warrants for approximately 81,729,000 shares of common stock (see Note 9).
Transactions
during the six months ended March 31, 2013
Common Stock
During the six months
ended March 31, 2013, the Company issued 1,881,423 shares of common stock upon conversion of convertible notes payable with a
principal balance and accrued interest totaling $206,735.
During the six months
ended March 31, 2013, the company issued 1,350,000 shares of common stock to athletes and consultants for endorsement and consulting
services valued at approximately $592,000..
Warrants
During the six months
ended March 31, 2013, the holders of the February 2012 Notes exercised approximately 13,830,216 of series B Warrants issued in
connection therewith for common stock which generated $1,521,324 in cash. In addition, during the period there were cashless exercises
in the amount of 919,018 shares from our series A warrants issued in connection with the February 2012 Notes.
On March 14, 2013,
the Company reached agreements with the holders of the series A Warrants that were issued in conjunction with the February 2012
Notes. The terms of the agreements resulted in the exchange of the 26,884,044 series A Warrants for approximately 46,729,000 shares
of common stock and 8,601,814 new five-year Warrants having an exercise price of $.30 per share.
Options
During the six months
ended March 31, 2013, a former employee and several consultants exercised their stock options for 1,364,502 shares, which generated
cash in the amount of $99,778.
|
12.
|
COMMITMENTS AND CONTINGENCIES
|
Consulting agreement
- The Company entered into a consulting agreement with Mr. Durschlag in April 2010 under which he may receive royalty payments
in accordance with the terms of his patent assignment and technology transfer agreement. The Company is currently in litigation
proceedings with Mr. Durschlag as it does not believe that any of its products use the technology specified in the patent assignment
and technology transfer agreement. If it is determined that Mr. Durschlag is entitled to royalties on Fuse Science, Inc. sales
payment would be as follows:
Sales Range
|
|
Commission
Rate
|
|
$0 - $100,000
|
|
|
0.00
|
%
|
$100,001 - $10,000,000
|
|
|
5.00
|
%
|
$10,000,001 - $50,000,000
|
|
|
2.50
|
%
|
Employment agreements
- The Company currently has an employment agreement with Brian Tuffin.
Effective December
28, 2012 the Company entered into a settlement agreement with the Company’s former Chief Marketing Officer and Chief Information
Officer, Aitan Zacharin for approximately 1,000,000 options to acquire common stock at exercise prices from $0.12 to $0.21 and
$58,000 over a period of seven months commencing January 1, 2013.
Endorsement agreements
–
Several of our endorsement agreements require share or option compensation to be issued annually. In addtition, additional
shares may be granted in the event of certain performance milestones.
The Company also
issued stock options as compensation under certain other endorsement agreements. These agreements have a term of one
to five years with Company options to extend the agreements for one to three years at mutually agreeable terms.
In May 2014, $195,000 of the November
2013 notes and associated accrued interest had been presented for conversion into equity of the Company in exchange for 32,598,025
shares of the Company's common stock.