NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2014
(UNAUDITED)
NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Evolucia Inc. (“Evolucia”, the “Company”, “we”, “our”, “us”) was formed in 2007 through a reverse merger whereby the Company acquired Sun Energy Solar, Inc., our accounting predecessor, which developed energy-efficient technologies in solar energy and infrared. The Company has exited the solar and infrared businesses. The Company’s solar subsidiary, Sunovia Solar, Inc. has not had operations since June 2010 and is not anticipated to have operations in the foreseeable future.
Evolucia is in the business of designing, manufacturing, marketing and distributing light emitting diode (LED) lighting fixtures. Evolucia also maintains a portfolio of various LED lighting patents. Our business focuses primarily on the design and development of our patented Aimed LED Lighting™ technology that demonstrates that less overall light is needed if the light is correctly focused on the target area.
We have identified an immediate opportunity, particularly in the outdoor lighting market, to supply high quality energy-efficient lighting solutions through our patented technology. We have developed several LED lighting products, primarily for the outdoor lighting industry, that utilize our Aimed Optics™ technology that we sell directly to customers and through a network of manufacturer’s representatives in the U.S. and other countries. In addition, the Company has other lighting products that do not utilize the Aimed Optics™ technology that complement the Company’s portfolio and provide lighting solutions for other areas, such as parking garages. We continue to develop and refine our products to serve the market and are actively pursuing alliances and strategies that will allow us to drive down the production cost of our products.
We also continue developing and reengineering our patents. We have identified the need to continue to reduce costs to be able to offer a competitive product to our customers. This requires an ongoing review of our patents and how to improve the technology and costs associated with the product. We have also recently engaged DLA Piper to assist the Company in maximizing our potential licensing revenues as well as protecting our intellectual property.
U
Basis of Consolidation
The accompanying unaudited consolidated financial statements include the accounts of the Company and its subsidiaries. All material inter-company accounts, transactions and profits have been eliminated. In the opinion of management, these consolidated financial statements reflect all adjustments (consisting of normal recurring adjustments) that are necessary for a fair presentation of the results for and as of the periods shown.
Basis of presentation
The accompanying consolidated financial statements have been prepared in conformity with United States generally accepted accounting principles. However, certain information or footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to the rules and regulations of the Securities and Exchange Commission. The results of operations for such periods are not necessarily indicative of the results expected for 2014 or for any future period. These financial statements should be read in conjunction with the financial statements and related notes included in our Annual Report on Form 10-K for the year ended December 31, 2013, filed with the Securities and Exchange Commission.
Reclassifications
Certain amounts for the period ended March 31, 2013, have been reclassified in the comparative financial statements to be comparable to the presentation for the period ended March 31, 2014. These reclassifications had no effect on net loss as previously reported.
Use of Estimates
The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires us to make certain estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements. The reported amounts of revenues and expenses during the reporting period may be affected by the estimates and assumptions we are required to make. Estimates that are critical to the accompanying consolidated financial statements relate principally to the adequacy of our inventory allowances, our deferred income tax assets, derivative financial instruments and stock based compensation. Estimates and assumptions are reviewed periodically and the effects of revisions are reflected in the period that they are determined to be necessary. It is at least reasonably possible that the Company’s estimates could change in the near term with respect to these matters.
Accounts Receivable
The Company extends credit to its customers based upon a written credit policy. Accounts receivable are recorded at the invoiced amount and do not bear interest. The allowance for doubtful accounts is the Company’s best estimate for the amount of probable credit losses in the Company’s existing accounts receivable. The Company establishes an allowance for doubtful accounts based upon factors surrounding the credit risk of specific customers, historical trends, and other information. Receivable balances are reviewed on an aged basis and account balances are charged off against the allowance after all means of collection have been exhausted and the potential for recovery is considered remote. The Company does not require collateral on accounts receivable.
The Company determined an allowance for uncollectible accounts was not required at March 31, 2014 and December 31, 2013.
Inventory
Inventory consists of various electronic and other components used in the assembly of LED lighting fixtures. Inventory is stated at the lower of cost or market. Cost is determined by the first-in, first-out method.
Inventory consists of the following:
|
|
March 31, 2014
|
|
|
December 31, 2013
|
|
Materials and components
|
|
$
|
1,647,898
|
|
|
$
|
2,107,145
|
|
Inventory reserve
|
|
|
(1,375,000
|
)
|
|
|
(1,375,000
|
)
|
|
|
$
|
272,898
|
|
|
$
|
732,145
|
|
At December 31, 2013, the Company established a reserve of $1,375,000 for the possible effects of the Company’s restructuring of its operations. Management evaluated the reserve at March 31, 2014 and determined no adjustment is needed as of March 31, 2014.
Share-Based Payments
ASC 718,
Stock Compensation
requires that all stock-based compensation be recognized as an expense in the financial statements and that such cost be measured at the grant date fair value of the award.
We record the grant date fair value of stock-based compensation awards as an expense over the vesting period of the related stock options. In order to determine the fair value of the stock options on the date of grant, we use the Black-Scholes option-pricing model. Inherent in this model are assumptions related to expected stock-price volatility, option life, risk-free interest rate and dividend yield. Although the risk-free interest rates and dividend yield are less subjective assumptions, typically based on factual data derived from public sources, the expected stock-price volatility, forfeiture rate and option life assumptions require a greater level of judgment which makes them critical accounting estimates.
We use an expected stock price volatility assumption that is based on historical volatilities of our common stock and we estimate the forfeiture rate and option life based on historical data related to prior option grants, as we believe such historical data will be similar to future results.
Loss Per Share
Basic loss per share is calculated by dividing net loss available to common stockholders by the weighted average number of shares of common stock outstanding for the period. Diluted loss per share is calculated by dividing net loss by the weighted average number of shares of common stock outstanding for the period, adjusted for the dilutive effect of common stock equivalents, using the treasury stock method. Common stock equivalents that are anti-dilutive are excluded. The total number of shares not included in the calculation at March 31, 2014 and 2013, because they were anti-dilutive, was approximately 414,600,000 and 321,100,000, respectively.
Fair Value Measurements
Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. The established fair value hierarchy requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The standard describes three levels of inputs that may be used to measure fair value:
Level 1: Observable inputs such as quoted prices (unadjusted) in active markets for identical assets or liabilities.
Level 2: Inputs other than quoted prices that are observable for the asset or liability, either directly or indirectly. These include quoted prices for similar assets or liabilities in active markets; quoted prices for identical or similar assets or liabilities that are not active; and model-driven valuations whose inputs are observable or whose significant value drivers are observable. Valuations may be obtained from, or corroborated by, third-party pricing services.
Level 3: Unobservable inputs to measure fair value of assets and liabilities for which there is little, if any market activity at the measurement date, using reasonable inputs and assumptions based upon the best information at the time, to the extent that inputs are available without undue cost and effort.
The Warrants issued in our 2013 private placement and in conjunction with our October 28, 2013 financing are classified within Level 3 of the fair value hierarchy as they are valued using unobservable inputs including significant assumptions of the Company and other market participants. Significant unobservable inputs used in the fair value measurement of the Warrants included the probability that the Warrant holders will exercise their put option and require the Company to redeem the Warrants for cash and an estimate of the put price if the Warrant holder exercises their put option. Generally an increase (decrease) in the probability of the put option being exercised or the estimated put price would result in a higher (lower) fair value measurement. Changes in the fair value of derivative warrants are reported as “Change in fair value of derivative instruments, net" in the accompanying consolidated statements of operations.
The reconciliation of our derivative liabilities measured at fair value on a recurring basis using significant unobservable inputs (Level 3) as of March 31, 2014 is as follows:
Beginning balance, January 1, 2014
|
|
$
|
1,305,298
|
|
Cancelled Derivative warrants
|
|
|
(680,647
|
)
|
Total (gains) or losses included in earnings
|
|
|
(270,166
|
)
|
Ending balance, March 31, 2014
|
|
$
|
354,485
|
|
Fair Value of Financial Instruments
The Company’s financial instruments, including cash and cash equivalents, receivables, accounts payable and accrued liabilities and notes and debentures payable, are carried at cost, which approximates their fair value due to the relatively short maturity of these instruments.
The carrying value of the Company’s long-term debt approximates fair value based on borrowing rates currently available to the Company for loans with similar terms.
NOTE B – LIQUIDITY AND GOING CONCERN
Our consolidated financial statements are prepared using accounting principles generally accepted in the United States of America applicable to a going concern, which contemplates the realization of assets and liquidation of liabilities in the normal course of business. We have incurred net losses of $1,704,683 during the three months ended March 31, 2014, and have working capital and stockholder deficits of $4,330,216 and $10,060,482 at March 31, 2014.
Management intends to continue to finance operations through debt and equity as well as to seek potential acquisitions that have positive cash flows; however, there can be no assurance of successful financing or acquisition activity in the future.
The Company may incur operating losses for the foreseeable future and there can be no guarantee that we will be successful securing funding. In the event we are unable to fund our operations by positive operating cash flows or additional funding, we will be forced to reduce our expenses and may have to cease operations. During the period ended March 31, 2014, the Company’s Chief Executive Officer, who was also the Chief Financial Officer, resigned. In addition, the company is restructuring its organization for greater efficiencies, and is aggressively pursuing sale opportunities, which continue to present themselves to the company. The company is working with distributors and end users in order to maximize potential sales. As a result of the Company scaling back current operations, substantially all of the Company’s employees were terminated. The Company will continue to rely on its relationship with its partner, Leader Electronics, Inc., and optimize its strong industry relationship as it continues to concentrate on its legacy Aimed Optics™ products. It will also continue to supports its development, reengineering, and building its current patent portfolio, which includes the continuing effort to reduce costs in an effort to become a more affordable option in the industry.
Our consolidated financial statements do not include any adjustments relating to the recoverability and classification of recorded asset amounts or the amounts and classification of liabilities that might be necessary should we be unable to continue as a going concern.
NOTE C - STOCKHOLDERS' EQUITY (DEFICIT)
Common Stock
During the period ended March 31, 2014, the Company issued 7,412,057 shares to employees as compensation. The fair value of the shares based on the trading price of the Company’s common stock was $66,052, which was charged to operations.
During the period ended March 31, 2014, the Company issued 8,016,541 shares to former employees to settle unpaid compensation. The fair value of the shares based on the trading price of the Company’s common stock was $69,629, which was charged to operations.
During the period ended March 31, 2014, the Company issued 81,062,535 shares to several consultants for services. The fair value of the shares based on the trading price of the Company’s common stock was $810,625, which was charged to operations.
During the period ended March 31, 2014, the Company issued 2,020,000 shares to a note holder to satisfy the outstanding debt.
During the period ended March 31, 2014, 10,000,000 shares were returned to the Company for no consideration and were cancelled.
Shares of common stock issued for services are valued at the trading price of the Company’s common stock at the time the services are agreed to.
At December 31, 2013, the Company’s outstanding common shares and its commitments to issue common shares, excluding warrants valued as derivative obligations, exceeded the number of common shares authorized by approximately 95,000,000 shares. The fair value of these shares of $840,000 was reclassified to a liability at December 31, 2013.
As of March 31, 2014, the Company’s outstanding common shares and its commitment to issue common shares, excluding warrants valued as derivative obligations, exceeded the number of common shares by 170,055,383 shares. The fair value of these shares of $840,000 has been reclassified as a liability at March 31, 2014.
NOTE D - COMMITMENTS AND CONTINGENCIES
Manufacturing, development and investment agreement
LEI
On July 12, 2012 (the “Effective Date”), the Company entered into a manufacturing, development and investment agreement with Leader Electronics, Inc. (“LEI”).
Pursuant to the agreement, LEI will (i) collaborate in the next generation design of the
Company’s
Products, (ii) design and implement LEI power supplies into the Products as provided in the Specifications, (iii) invest $1,000,000 in the Company, (iv) lease for the Company’s use equipment representing a value of $2,000,000 which will include manufacturing, test and product equipment and tooling mentioned below to be more specifically identified by the parties, (v) manufacture the Products (A) at a 10% discount to the market rate against non-cancellable purchase orders from the Company for one year following the initial purchase orders and thereafter at a 5% discount to the market rate until $8,000,000 in discounts have been earned by the Company and (B) provide working capital to manufacture all Products with net payment terms of 45 days, (vi) LEI will acquire all needed tooling, and (vii) serve as an exclusive distributor for the Asia Territory.
In addition, the Company will (i) appoint LEI as the exclusive manufacturer for the Products sold in the Asia Territory, (ii) appoint LEI as an exclusive distributor for the Asia Territory and (iii) provide non-cancellable and irrevocable stand-by Letters of Credit for the benefit of LEI prior to the shipment of Product or provide payment for the Product prior to shipment.
LEI purchased 12,500,000 shares of common stock (the “Shares”) of the Company for an aggregate purchase price of $1,000,000. In the event the Company does not place orders for the Products within five years from the Effective Date (the “Order Date”), then LEI will be entitled to sell to the Company the lesser of (i) Shares it has not resold as of the Order Date or (ii) the portion of Shares representing the amount of Products that the Company has not ordered. For example, in the event the Company has placed orders for 80% of the Products, then LEI will be entitled to sell back to the Company as of the Order Date the lesser of the number of Shares that have not been resold by LEI or 20% of the Shares. The per share price will be $0.08. LEI invested the $1,000,000 on July 20, 2012 and this investment has been classified as a liability in the Company’s financial statements because of the contingency related to the share repurchase agreement.
SETE
On March 20, 2013, the Company entered into a joint venture with Sunovia Energy Technologies Europe Sp. z o.o. (SETE), a Polish corporation which is unaffiliated with the Company. The agreement called for the payment of $11 million to Evolucia by August 31, 2013, which has not been received, in exchange for the manufacture and distribution rights to specified European markets. Under the joint venture agreement, a new entity called Evolucia Europe Sp. z o.o. will be created, with Evolucia Inc. holding a 51% ownership share and SETE holding the remaining 49% ownership. The joint venture agreement provides exclusive manufacturing rights to Evolucia Europe for the European markets.
We have had no recent correspondence and expect to formally terminate the relationship in the near future.
The $11 million payment has not been made and the Company is presently negotiating a resolution and/or restructuring with SETE.
Litigation
The Company is defending a lawsuit brought by a supplier of a component part of its LED lighting fixtures. The suit alleges that the Company owes a re-stocking fee of approximately $100,000 for the return of certain parts. The Company believes it has substantial defenses to this suit and intends to vigorously defend it. The lawsuit is in the early stages of pleadings, and the outcome is uncertain. No significant legal fees have been incurred in this case to date.
Through December 31, 2013, the Company made advances to Affineon Lighting aggregating $636,000 for Affineon to purchase inventory. These advances were to be repaid upon sale of Affineon’s products, however no amounts were repaid. The Company is attempting to collect the advances but has reserved the entire balance at December 31, 2013, and March 31, 2014. In addition, the Company’s former Principal Accounting Officer has been appointed as the Principal Executive Officer at Affineon subsequent to his terminating his employment with the Company. The Company is uncertain as to what additional actions, if any, it will take against Affineon or its former Principal Accounting Officer.
The Company’s Board is reviewing certain vendors, financial obligations, stock based compensation arrangements and contractual obligations committed to by its former Principal Accounting Officer, former Chief Executive Officer and other former employees. The Company’s Board is uncertain as to what additional actions, if any, it will take.
The Company has determined that there may be instances where certain shares of common stock issued pursuant to a Form S-8 were issued in violation of certain provisions of the use of Form S-8. In addition, the Company has been informed by one of its note holders that $50,000 of proceeds received pursuant to a private placement were not authorized by the note holder to be released from escrow. The Company’s board is investigating these items.
NOTE E - RISKS AND UNCERTAINTIES
Our operating results may be affected by a number of factors. The Company depends upon a number of major inventory and intellectual property suppliers. Presently, the Company does not have formal arrangements with any supplier. In the future, if the Company is unable to obtain satisfactory supplier relationships, or a critical supplier has operational problems, or cease making material available, operations could be adversely affected.
Concentrations
During the three months ended March 31, 2014 and 2013, the Company had 75% of sales to two customers and 63% of sales to one customer, respectively, which sales individually represented in excess of 10% of the Company’s total sales.
At March 31, 2014, approximately 92% of net accounts receivable was due from two customers and, at December 31, 2013, 63% of net accounts receivable was due from one customer.
NOTE F – STOCK OPTIONS
On May 1, 2008, the Company adopted the 2008 Incentive Stock Plan (“the Plan”) designed to retain directors, employees, executives and consultants and reward them for making major contributions to the success of the Company. The Plan was approved by the Company’s shareholders in November 2010. The following is a summary of the Plan and does not purport to be a complete description of all of its provisions.
The Plan is administered by the board of directors. The plan does not have any individual caps other than the limitation of granting incentive stock options to employees and the exercise of no more than $100,000 per year in fair market value of stock per year per employee. The Plan permits the grant of restricted stock and non-statutory options to participants where appropriate. The maximum number of shares issuable under the Plan is 30,000,000. The Plan will terminate ten years from the date it was adopted. The board of directors may, as permitted by law, modify the terms of any grants under the Plan, and also amend, suspend, or extend the Plan itself.
In addition, the Board is authorized to issue options outside of the plan.
During the three months ended March 31, 2014, the Company granted options to employees, consultants and officers to purchase 31,175,000 common shares at exercise prices of $0.01 to $0.04 per share for a period of five years and which vest immediately. The fair value of the options was estimated on the date of grant using the Black-Scholes option pricing model with the following assumptions: risk-free interest rates of 1.0% to 2.0%, expected volatility of 120% and expected lives of five years. No dividends were assumed in the calculations. The fair value of the options aggregated $265,827 of which $265,827 was charged to operations during the three months ended March 31, 2014. During the three months ended March 31, 2014, an aggregate of $326,462 was charged to operations related to options granted during prior years.
At March 31, 2014, there was an aggregate of $1,728,074 of unrecognized expense related to stock options that vest in future periods. A summary of stock options is as follows:
|
|
Shares
|
|
Options outstanding at January 1, 2014
|
|
|
327,351,660
|
|
Options granted
|
|
|
31,175,000
|
|
Options exercised
|
|
|
-
|
|
Options cancelled
|
|
|
(34,910,913
|
)
|
Outstanding at March 31, 2014
|
|
|
323,615,747
|
|
|
|
|
|
|
Exercisable at March 31, 2014
|
|
|
235,824,601
|
|
NOTE G – CONVERTIBLE NOTES PAYABLE
|
|
March 31, 2014
|
|
|
December 31, 2013
|
|
9% convertible notes due July 2013 (in default)
|
|
$
|
-
|
|
|
$
|
50,000
|
|
8% convertible notes due December 2016
|
|
|
3,169,526
|
|
|
|
450,000
|
|
Less: Discount
|
|
|
(1,440,351
|
)
|
|
|
|
|
|
|
|
1,729,175
|
|
|
|
500,000
|
|
Less current portion
|
|
|
-
|
|
|
|
(50,000
|
)
|
|
|
$
|
1,729,175
|
|
|
$
|
450,000
|
|
9% convertible notes
On June 10, 2011, the Company completed an offering to 10 existing shareholders of 9% convertible notes (the “Notes”), maturing on July 1, 2012, in the aggregate principal amount of $1,000,000. Interest on the Notes is payable on the earlier of the Notes’ conversion to common stock or the maturity date. The Notes were originally convertible at a conversion price of $0.06 per share. The Notes are secured by a lien on all of the assets of the Company.
During March and April 2012, holders of an aggregate of $900,000 in principal of the Notes restructured their Notes by extending the maturity date to July 1, 2013. In connection with that extension, each of these holders converted 50% of the principal amount of their Notes to common stock at $0.01 per share, which was the trading price of the shares on the conversion date. The Company modified the terms of all the remaining debt to allow conversion at $0.01 per share and to increase the interest rate to 10% per annum. The Company issued an aggregate of 45,000,000 shares of common stock to the holders of the Notes for the conversion of $450,000 of the principal to common stock. After conversion, $550,000 of the principal amount of the Notes remained outstanding. In connection with the modification and conversion of the Notes, the Company recorded a debt conversion inducement expense of $300,000, reflecting the cost of reducing the conversion price from $0.06 to $0.01 per share.
In 2013, $300,000 of the remaining Notes, together with accrued interest of $80,237, were converted into the offering of 14% notes payable described in Note H below. A further $100,000 of the Notes were repaid in cash. An additional $100,000 of the Notes, together with accrued interest thereon of $27,028, were converted into common shares which were valued at the current market price of $0.01 per share; the company issued 12,702,740 shares to convert the balance of $127,028 to common stock. In conjunction with this conversion the Company recorded a charge of $83,000 related to the reduction of the conversion price of the debt.
During the period ended March 31, 2014, the remaining $50,000 of the Notes, together with accrued interest of $20,042, was converted into the 8% convertible notes described below.
8% convertible notes
In October 2013, the Company began offering a maximum of $10,000,000 of 8% secured convertible notes on a best efforts basis. Each note is convertible by the holder at a conversion price of $0.01 per share, subject to the Company increasing its authorized shares of common stock to permit conversion. The notes bear interest at 8% per annum, payable at maturity in either cash or common stock, and are due 36 months from the issuance dates. The Notes are secured by the assets of the Company and may be prepaid in whole or in part at any time without the consent of the holder. Through
March 31, 2014
, the Company sold an aggregate of $
500,000
pursuant to this private placement.
In addition, the holders of $290,641 of the 10% notes payable described in Note H below exchanged their notes for the 8% convertible notes. Holders of $2,080,237 of the 14% notes payable described in Note H below exchanged their notes, together with accrued interest of $228,606, for the 8% convertible notes.
NOTE H – NOTES PAYABLE
|
|
March 31, 2014
|
|
|
December 31, 2013
|
|
|
|
|
|
|
|
|
10% notes payable due July 2013 (in default)
|
|
$
|
198,326
|
|
|
$
|
498,968
|
|
14% notes due April, May and August 2016
|
|
|
1,074,950
|
|
|
|
3,155,187
|
|
- less debt discount
|
|
|
(1,041,177
|
)
|
|
|
(2,671,398
|
)
|
12.5% note due February 2015 due to an affiliate
|
|
|
593,062
|
|
|
|
560,000
|
|
10% note due February 2015
|
|
|
40,000
|
|
|
|
-
|
|
15% note due February 2015 due to an affiliate
|
|
|
610,000
|
|
|
|
-
|
|
Non-interest bearing advance from affiliate
|
|
|
87,500
|
|
|
|
10,000
|
|
15% demand notes payable to affiliate
|
|
|
93,731
|
|
|
|
96,779
|
|
9% note due April 2014 to a former officer
|
|
|
359,537
|
|
|
|
359,537
|
|
|
|
|
2,015,929
|
|
|
|
2,009,073
|
|
Less: current portion
|
|
|
(739,094
|
)
|
|
|
(664,642
|
)
|
|
|
$
|
1,276,835
|
|
|
$
|
1,344,431
|
|
10% notes payable
From December 2009 through December 2010, the Company borrowed an aggregate of $828,968 from certain shareholders. The borrowings were evidenced by notes which bear interest at 10% per annum and which were due between 12 months and 24 months from the date of issuance. During 2010, 2011 and 2012, $265,000 of the borrowings were repaid and $563,968 remained outstanding at December 31, 2012. In March 2012, the holders of the outstanding notes agreed to extend the due date of the notes to July 1, 2013. In 2013, a further $65,000 was repaid. The outstanding balance as of December 31, 2013 was $498,968.
In February 2014, holders of 10% notes payable with an outstanding principal balance totaling $290,642 chose to roll their outstanding balances into PPM #2. The restructuring was within the scope of ASC 470-60-55 Accounting for Troubled Debt Restructuring, which states that if a Company is experiencing financial difficulties and a concession is granted, troubled debt restructuring accounting should be applied. The Company has concluded that it is experiencing financial difficulties and the creditor has granted a concession as the effective borrowing rate for the restructured debt is less than the effective rate of the 10% notes payable prior to the restructuring. No gain or loss was recognized because the total cash outflows required under the restructured debt were greater than the carrying amount of the debt prior to the restructuring. Accordingly, the carrying amount of the debt was used to calculate interest expense over the remaining term of the restructured debt.
14% notes payable
On November 27, 2012, the Company initiated the sale of up to $5,000,000 of 14% Callable Promissory Notes (PPM #1 Notes) in a private placement memorandum (PPM) offering made pursuant to Regulation D to accredited investors only. The Notes are secured by the assets of the company, subject to the security interests of the 9% convertible notes (see Note G) and the Purchase Order Lines of Credit
(See Note I).
The PPM #1 Notes were offered in Units of $50,000 each. PPM #1 is subject to a minimum sale of 40 Units ($2,000,000) and a maximum of 100 Units. The PPM #1 Notes mature in 36 months. Interest accrues for the first 12 months and is payable monthly starting in month 13. Principal plus accrued interest is payable in month 36. Each Unit includes a Common Stock Purchase Warrant (the “2013 Warrants”) to purchase 2,395,542 shares of common stock at an exercise price of $0.025 per share. Through December 31, 2013, the Company sold 55.5 units for aggregate proceeds of $2,774,950. The Company closed on the sale of those units between April 2013 and August 2013. As of March 31, 2014, the total outstanding principal and accrued interest on the PPM #1 Notes was $1,230,992 and $155,742, respectively.
The PPM #1 Warrants are exercisable for a period of five years from the date of issuance at an exercise price of $0.025 per share on a cash basis only, subject to the Company increasing its authorized shares of common stock or implementing a reverse stock split of the outstanding shares of the Company's common stock to provide for the issuance of all shares of common stock upon exercise of all PPM #1 Warrants issued. In the event the Company closes a Capital Transaction (as defined below) and the Company does not have sufficient authorized shares in order for the Warrant holder to exercise the Warrants, the Warrant holder may, by notice to the Company (a "Put Notice"), elect to sell to the Company, at the Repurchase Price (as defined below) all or such number of the Warrants held by the holder then outstanding as is specified in the Put Notice. Capital Transaction means any of the following: (i) any sale or other disposition of all or substantially all of the assets of the Company or any of its subsidiaries in any single transaction or series of related transactions; (ii) any transfer or other disposition in any single transaction or series of related transactions of the Company’s common stock representing in excess of 80% of the issued and outstanding shares of common stock or all of its subsidiary’s common stock; (iii) the closing of the Company’s underwritten public offering pursuant to an effective registration statement under the Securities Act covering the offer and sale of shares of common stock in which not less than $30,000,000 of gross proceeds are received by the Company for the account of the Company; (iv) the liquidation or dissolution of the Company or any of its material subsidiaries; or (v) a merger or consolidation of the Company or any of its material subsidiaries in which the Company or such material subsidiary, as applicable, is not the surviving entity. The Repurchase Price per share means the difference of (i) the quotient of the purchase price paid in connection with the Capital Transaction divided by the number of shares outstanding as of the date of the Capital Transaction plus the number of shares of common stock issuable upon exercise of all Warrants subject to a Put Notice plus all other shares of common stock issuable upon conversion or exercise of other derivative securities as of the date of the Capital Transaction less the (ii) the exercise price.
Due to the put provision, as well as certain price ratchet provisions which may require net cash settlement and the lack of sufficient authorized shares, the PPM #1 Warrants did not meet the criteria for equity classification under ASC 815 because they did not meet the definition for financial instruments indexed to a company’s own stock. Accordingly, they required derivative liability accounting and measurement at fair value at inception and each subsequent reporting period.
During the quarter ended March 31, 2014, a portion of the accredited investors that participated in the PPM #1 offering agreed to exchange their PPM #1 securities, representing an aggregate of $2,308,843 in principal and accrued interest, and PPM #1 Warrants to acquire an aggregate of 99,665,910 shares of common stock, for 8% Secured Convertible Promissory Notes (the "Replacement Notes") with a face value of $2,308,843
(See Note G).
The Replacement Notes mature three years from the date of issuance and the Notes are convertible into shares of common stock at a conversion price of $0.01 per share subject to the Company increasing its authorized shares of common stock. Interest is due and payable on the maturity date. The Replacement Notes are secured by the assets of the Company and can be prepaid in whole or in part at any time without the consent of the holder.
The Company considered whether the exchange of the PPM #1 Notes and PPM #1 Warrants was within the scope of ASC 470-60-55 Accounting for Troubled Debt Restructuring, which states that if a Company is experiencing financial difficulties and a concession is granted, troubled debt restructuring accounting should be applied. The Company has concluded that it is experiencing financial difficulties and the creditor has granted a concession as the effective borrowing rate for the restructured debt is less than the effective rate of the PPM #1 Notes prior to restructuring. ASC 470 requires that the effects of any sweeteners be considered when determining the cash flows for the restructured debt. As such, the fair value of the cancelled PPM #1 Warrants of approximately $681,700 was considered when determining whether a concession had been granted. Because the total cash outflows required under the restructured debt were greater than the carrying amount of the debt prior to the restructuring, no gain or loss was recognized and there was no adjustment to the carrying amount of the debt. Rather, the carrying amount of the debt will be used to calculate interest expense over the remaining term of the restructured debt so that any unamortized deferred costs from the original debt financing continue to be recognized as interest expense over the remaining term of the restructured debt. Subsequent to the restructurings, the effective interest rates on the debt ranged from approximately 32% to 47%.
15% note payable due to an affiliate
During 2013, a shareholder and director of the Company advanced an aggregate of $560,000 to the Company. These advances include $400,000, $100,000 and $60,000 cash advances. On October 28, 2013, the Company issued a $400,000 Promissory Note bearing interest at 15% as further discussed below. On January 7, 2014, the Company issued a Promissory Note for $560,000, which includes the $400,000 Promissory Note issued October 28, 2013 and the $60,000 advance in 2013. On January 7, 2014, the Company issued another Promissory Note, which included the $100,000 advance in 2013 noted above.
On October 28, 2013, the Company issued a $400,000 Promissory Note which bears interest at 15% per annum. The Promissory Note is due and payable in full upon the earlier of i) December 31, 2013 or ii) an investment by Leader Electronics, Inc., or its affiliates, in Evolucia, Inc. or iii) upon the maker raising capital pursuant to its private offering of Secured Convertible Promissory Notes. Any principal and interest not paid when due bears interest at 18% per annum from the due date to the date paid. The Promissory Note is subject to various default provisions, and the occurrence of an event of default will cause the outstanding principal amount under the Promissory Note, together with accrued and unpaid interest to become immediately due and payable to the Holder. In January 2014, this Promissory Note was refinanced with a new Promissory Note maturing February 7, 2015 and bearing interest at 8%.
The October 28, 2013 promissory note was issued with Warrants to purchase 40,000,000 shares of common stock (the “October 2013 Warrants”). The October 2013 Warrants are exercisable for a period of five years from the date of issuance at an exercise price of $0.01 per share on a cash basis only, subject to the Company increasing its authorized shares of common stock or implementing a reverse stock split of the outstanding shares of the Company's common stock to provide for the issuance of all shares of common stock upon exercise of the October 2013 Warrants. Due to the lack of sufficient authorized shares, the Warrants did not meet the criteria for equity classification under ASC 815. Accordingly, they required derivative liability accounting and measurement at fair value at inception and each subsequent reporting period.
A summary of the allocation of proceeds related to the October 28, 2013 financing is provided below. Current accounting concepts generally provide that the allocation is made, first to the instruments that are required to be recorded at fair value; that is, the October 2013 Warrants, and the remainder to the Promissory Notes. The fair value of the October 2013 Warrants exceeded the proceeds which resulted in a day-one derivative loss. The discount from the face amount of the Promissory Notes represented by the value initially assigned to the October 2013 Warrant liabilities is amortized over the period to the due date of the Promissory Note, using the effective interest method.
Derivative Warrants
|
|
$
|
504,000
|
|
15% Promissory Notes
|
|
|
--
|
|
Day-one derivative loss
|
|
|
(104,000
|
)
|
Total allocated gross proceeds
|
|
$
|
400,000
|
|
By December 31, 2013, the Promissory note was due in full. As such, the discount of $400,000 on the Promissory Note was fully accreted and a charge of $400,000 was included in interest expense.
During the period ended March 31, 2014, a private investor, shareholder and director provided additional advances of $523,648. The Company entered into four Promissory notes related to these in addition to the $560,000 advances made in 2013 and $100,000 advances related to the line of credit. The Company entered into two Promissory Notes on January 7, 2014 for $593,062 and $500,000; a third Promissory Note was agreed to on March 18, 2014 in the amount of $60,000; and a fourth Promissory Note was agreed to on March 31, 2014 in the amount of $73,648. Each of these Promissory Notes bear interest at 12.5% and mature one year from date of agreement.
During the period ended March 31, 2014, a second private investor, shareholder and director provided additional advances of $102,500. The Company entered into a Promissory note related to $35,000 of these advance in 2014 combined with $10,000 advances in 2013 on March 14, 2014 in the amount of $45,000. The Promissory Note bears interest at 12.5% and mature one year from date of agreement.
9% note payable to former officer
During March 2013, the Company settled a dispute related to an employment contract with a former officer by issuing a note payable for $359,537, bearing interest at 9% per annum and due in April 2014. Interest accrued on this note at March 31, 2014 was $32,358.
NOTE I – LINES OF CREDIT
|
|
March 31, 2014
|
|
|
December 31, 2013
|
|
14% Line of credit due to an affiliate
|
|
$
|
2,011,100
|
|
|
$
|
2,011,100
|
|
12.5% Line of credit due to an affiliate
|
|
|
648,710
|
|
|
|
746,852
|
|
|
|
|
2,659,810
|
|
|
|
2,757,952
|
|
Less current portion
|
|
|
( -
|
)
|
|
|
( -
|
)
|
|
|
$
|
2,659,810
|
|
|
$
|
2,757,952
|
|
A private investor, shareholder and director of the Company has made available to the Company a working capital and purchase order line of credit of $2.0 million, which was due during January 2014 and which may be increased at the investor’s discretion. In 2014, the private investor, shareholder and director of the Company extended the line of credit for one year. The line of credit is secured by substantially all of the Company’s assets. The line of credit may be drawn to purchase components for orders (Purchase Orders) of the Company’s products approved by the investor and that are used to fulfill specific customer orders. For advances made for the purpose of funding Purchase Orders, the line is secured to the extent of the specific customer accounts receivables that are related to the Purchase Order upon which the advance was made. Advances made against Purchase Orders bear interest at an annual rate of 12.5% and the principal amount of the draws, plus accrued interest, must be repaid within three business days of receipt of payment from the customer. Because interest is added to the line of credit, the outstanding balance may at times exceed $2.0 million. As of December 31, 2012, the investor made the entire line of credit available without restriction to the Company to use for both working capital purposes and for Purchase Orders. For that portion of the line of credit that is used for working capital purposes, the line of credit is unsecured and bears interest at an annual rate of 14.0%.
A second private investor, shareholder and director of the Company made available to the Company a purchase order line of credit of $750,000, which may be increased at the investor’s discretion and which, with the exception of $100,000 that was due in January, 2014, was due on demand. In 2014, the private investor, shareholder and director of the Company extended the line of credit for one year. The line of credit may be drawn to purchase components for orders (Purchase Orders) of the Company’s products approved by the investor. The line of credit bears interest at an annual rate of 12.5% and draws and interest must be repaid within three business days of receipt of payment from the customer. The line of credit is secured to the extent of the specific customer accounts receivables that are related to the Purchase Order upon which the advance was made. In January 2014, $100,000 of this amount was refinanced under a new Promissory Note maturing February 7, 2015 and bearing interest at 8%.
The lines of credits as noted in Note M above have been extended one year to February 2015 with all other terms remaining the same.
NOTE J – DERIVATIVE INSTRUMENTS
Due to the put features embedded in the PPM #1 Warrants, the Company concluded that the PPM #1 Warrants did not meet the conditions set forth in current accounting standards for equity classification. Accordingly, the Warrants are subject to the classification and measurement standards for derivative financial instruments and require liability classification at fair value. Also, the Warrants issued in conjunction with the October 28, 2013 financing did not meet the conditions for equity classification and require liability classification at fair value.
The PPM #1 Warrants and the October 28, 2013 Warrants were valued using a binomial lattice model which included certain assumptions, including the closing price of the underlying common stock, risk-free interest rates, volatility, expected dividend yield, expected life and, for the PPM #1 Warrants, the probability that the investors will require redemption of the PPM #1 Warrants due to the put provisions and the put price the Company would be required to pay upon exercise of the put. The option to put the PPM #1 Warrants back to the Company for cash is only available if the Company does not have sufficient authorized shares for the investors to exercise all their warrants and the Company enters into a capital transaction during the term of the Warrants. Management believes there is a minimal probability of this occurring and have assigned a probability of 5% that the Warrant holders will have the ability to exercise their put option. The put provisions associated with the PPM #1 Warrants were valued using a probability-weighting of put values based on management’s estimate of expected purchase prices.
Significant inputs and results arising from the lattice model are as follows for the Warrants classified in liabilities as of March 31, 2014:
|
PPM
|
|
October 2013
|
|
Warrants
|
|
Warrants
|
Quoted market price on valuation date
|
$0.005
|
|
$0.005
|
Contractual exercise price
|
$0.02500
|
|
$0.01
|
Expected term to maturity
|
4.06- 4.36 Years
|
|
4.58 Years
|
Dividend yield
|
0%
|
|
0%
|
Market volatility:
|
|
|
|
Range of volatilities
|
122% - 207%
|
|
124% - 203%
|
Equivalent volatility
|
145%- 148%
|
|
145%
|
Risk free interest:
|
|
|
|
Range of risk free interest rates
|
0.05% - 1.73%
|
|
0.07% - 1.73%
|
Equivalent risk free interest rates
|
0.45% - 0.56%
|
|
0.59%
|
Probability of put occurring
|
5.00%
|
|
n/a
|
Estimated value of put per share
|
De minimis
|
|
n/a
|
Equivalent amounts are an output from the lattice model which reflects the net results of multiple modeling iterations that the lattice model applies to underlying assumptions. For the risk-free rates of return, the Company used the published yields on zero-coupon Treasury Securities with maturities consistent with the remaining term of the warrants and volatility is based upon the Company’s expected stock price volatility over the remaining term. Option-based techniques (such as lattice models) are highly volatile and sensitive to changes in the assumptions underlying the valuation of the derivative financial instruments. The principal assumptions that have, in the Company’s view, the most significant effects are the Company’s trading market prices, volatilities, the probability the investors will have the ability to exercise their put option and the put value if the option is exercised. Because derivative financial instruments are initially and subsequently carried at fair value, our (income) loss will reflect the volatility in these estimate and assumption changes.
The following table reflects the changes in fair value of the PPM and October 2013 Warrants:
Beginning balance, January 1, 2014
|
|
$
|
1,305,298
|
|
Cancellation of Warrants upon rollover of PPM#1 Units into
PPM#2
|
|
|
(680,647
|
)
|
Fair value adjustments
|
|
|
(270,166
|
)
|
Ending balance, March 31, 2014
|
|
$
|
354,485
|
|
The decrease in the fair value of the Warrants from December 31, 2013 to March 31, 2014 was predominantly due to a decrease in the Company’s stock price.
NOTE K - RECENT ACCOUNTING PRONOUNCEMENTS
The Company does not believe that recently issued accounting pronouncements will have a material impact on its financial statements.
NOTE L – SUBSEQUENT EVENTS
At present, Evolucia has reduced its personnel and staff in order to eliminate excess overhead and to refocus on the business’ core fundamentals: the protection and monetization of the Aimed Optics intellectual property and the commercialization and sale of the company’s core products that are manufactured through the partnership with Leader Electronics. Based on the company’s performance under his leadership, the Board accepted Mel Interiano’s resignation in April 2014; and the company has employed Thomas Seifert as Interim CEO.