Certain information and
footnote disclosures required under accounting principles generally accepted in the United States of America have been condensed
or omitted from the following consolidated financial statements pursuant to the rules and regulations of the Securities and Exchange
Commission (the “SEC”). It is suggested that the following consolidated financial statements be read
in conjunction with the financial statements and notes thereto included in the annual financial statements included on Form 10-K/A
for Vape Holdings, Inc. for the fiscal year ended September 30, 2015.
[A] Stock-based compensation was $2,457 and
$0, and $34,800 and $140,886 for the three and six months ended March 31, 2016 and 2015, respectively.
[B] Stock-based
compensation was $465 and $0, and $35,265 and $636,683 for the three and six months ended March 31, 2016 and 2015, respectively.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL
STATEMENTS
NOTE 1. DESCRIPTION OF
BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BUSINESS
Vape Holdings, Inc. (“VAPE,”
the “Company,” “we,” “us,” “our,” “our company”) is a holding company
with its primary focus in the manufacturing and distribution of healthy and sustainable vaporization products. The Company designs,
markets and distributes ceramic vaporization products under a unique brand. The Company has introduced a nonporous, non-corrosive,
chemically inert medical-grade ceramic vaporization element as a healthy, sustainable alternative to traditional titanium and
quartz vaporization materials, as well as lower-grade ceramic found in traditional electronic cigarettes and vaporizers. This
material can be used for a wide range of applications, including stand-alone vaporization products and "E-cigs." Electronic
cigarettes come in a variety of designs ranging from those that look vastly like traditional cigarettes, to larger vaporizer units
which are capable of vaporizing liquid with varying viscosity. The process of vaporization is believed to eliminate the smoke,
tar, ash, and other byproducts of traditional smoking by utilizing lower temperatures in a controlled electronic environment.
HIVE CERAMICS
HIVE Ceramics (“HIVE”)
is the premier brand under the VAPE umbrella. HIVE manufactures and distributes a proprietarily blended ceramic vaporization element
for torched, electronic and portable vaporizers with countless design and product crossover capabilities in existing and emerging
markets. HIVE is dedicated to bringing the healthiest and cleanest vaporization experience possible to the market. The HIVE product
line currently consists of over 15 distinct ceramic elements, including the 2 piece domeless, domeless direct inject, and HIVE’s
signature domeless elements covering 10mm, 14mm and 18mm applications as well as regular elements, the HIVE Flower Cup, the HIVE
Carb Cap, HIVE Stinger Dabber, the 14mm HIVE x Quave - Club Banger, the HIVE x Brothership Honey Bucket and the HIVE x D-Nail
16mm and 20mm attachments.
The Company intends to
rely on a combination of trademark, copyright, trade secret and patent laws in the United States as well as confidentiality procedures
and contractual provisions to protect future proprietary technology and its brands, as they are developed. The Company
has created or acquired and continues in the process of creating and/or acquiring proprietary vaporizers and e-cigarettes, and
various trademarks, patents and copyrights for brands which are developed or in development. The Company is actively
engaged in improving and expanding lines of branded products through business alliances and acquisitions, as well as developing
its branded retail business expansion. VAPE and its business units are organized and directed to operate strictly in
accordance with all applicable state and federal laws.
REVIVAL PRODUCTS
On December 28, 2015, the
Company created a new wholly-owned subsidiary, Revival Products, LLC (“Revival”), which is in the business of portable
vaporization devices. Revival will sell disposable cartridges that complement HIVE Ceramic’s product lines utilizing its
sales and distribution channels and via its own designated e-commerce site at
www.revivalvapes.com
. Revival launched three
signature products, The Calloway, The Cleo, and The Charleston in January 2016.
BETTERCHEM
On July 1, 2015, the Company
entered into a Share Exchange Agreement with BetterChem Consulting, Inc. (“BetterChem”), a Pennsylvania corporation,
and its sole shareholder and the Company’s current Chief Science Officer Dr. Mark Scialdone (“Dr. Scialdone”),
whereby the Company acquired a controlling 80% interest in BetterChem from Dr. Scialdone in exchange for up to 400,000 shares
of the Company’s restricted common stock. In consideration for the issuance of the shares to Dr. Scialdone, the Company
acquired 80 shares of the common stock of BetterChem which represents 80% of the issued and outstanding shares of BetterChem.
Dr. Scialdone retained a 20% interest in BetterChem. The Share Exchange Agreement transaction closed concurrently with its execution
on July 1, 2015 and was approved by Unanimous Written Consent of the Board of Directors (the “Board”) of the Company
on the same date. At closing, the Company issued 250,000 shares of its common stock valued at $67,500 to BetterChem. BetterChem
had no identifiable assets and liabilities upon closing, and no significant revenues.
On January 12, 2016, the
Company unwound the transaction and curtailed the subsidiary’s operations in order to reduce overhead costs and focus on
HIVE Ceramics. An impairment of the acquisition of BetterChem of $69,250 was recorded during the year ended September 30, 2015.
VAPE is organized and directed
to operate strictly in accordance with all applicable state and federal laws.
GOING
CONCERN
VAPE’s consolidated
financial statements reflect a net loss of $5,300,461 during the six months ended March 31, 2016. As of March 31, 2016, we had
cash of $52,111 and a working capital deficit of $4,574,844. VAPE has suffered an accumulated deficit of $33,467,206 and during
the six months ended March 31, 2016, the Company took steps to curtail its Offset, HIVE Glass and HIVE Supply business lines to
focus more on consumer vaporization products including the launch of “Revival” discussed above. The Company also curtailed
its THE HIVE retail store in order to reduce overhead costs and focus on HIVE Ceramics. Moreover, the Company curtailed
its exploration into providing real estate, management and consulting solutions to the legal cannabis industry in states where
such cannabis cultivation and extraction is legal. The Company was never able to execute on any of these plans and ultimately determined
that the Company’s capital reserves for such projects as well as the risks inherent in each project due to the current regulatory
environment surrounding the cannabis industry made this line of business too difficult to pursue. All of which have resulted in
losses and opportunity costs. In addition, the ongoing need to obtain financing to fund operations also raise substantial doubt
about the ability of Vape to continue as a going concern. Management is skeptical that VAPE will obtain funding for operations
for the foreseeable future; there are no assurances that the Company will obtain such funding. VAPE’s financial statements
do not include any adjustments to reflect the possible effects on recoverability and classification of assets or the amounts and
classification of liabilities that may result from the inability to continue as a going concern. See Note 10 for subsequent events
regarding financing activities.
VAPE
is currently involved in litigation with 2 convertible promissory note holders seeking the specific performance of VAPE’s
issuance of shares underlying denied conversion notices. VAPE is also currently negotiating with a third noteholder threatening
similar litigation. VAPE shall vigorously defend the lawsuits; however, if these noteholders are allowed to convert their respective
notes VAPE shareholders will experience substantial dilution.
NOTE 2. ACCOUNTING POLICIES
AND BASIS OF PRESENTATION
BASIS OF PRESENTATION
The accompanying unaudited
interim consolidated financial statements have been prepared by the Company pursuant to the rules and regulations of the SEC.
Certain information and disclosures normally included in the annual financial statements prepared in accordance with the accounting
principles generally accepted in the United States of America have been condensed or omitted pursuant to such rules and regulations.
In the opinion of management, all adjustments and disclosures necessary for a fair presentation of these consolidated financial
statements have been included. Such adjustments consist of normal recurring adjustments. The current results are not an indication
of the full year.
CONSOLIDATION
The consolidated financial
statements include the assets, liabilities, and operating results of the Company and its wholly-owned subsidiaries, Revival and
Nouveau after elimination of all material inter-company accounts and transactions.
USE OF ESTIMATES
The preparation of consolidated
financial statements in conformity with accounting principles generally accepted in the United States requires management 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 and the reported amounts of revenues and expenses during
the reporting period. Actual results could differ from those estimates. Significant estimates and assumptions include losses for
warrant contingencies and the valuation of conversion features in notes.
FAIR VALUE OF FINANCIAL INSTRUMENTS
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 as of the measurement date.
Applicable accounting guidance provides an established hierarchy for inputs used in measuring fair value that maximizes the use
of observable inputs and minimizes the use of unobservable inputs by requiring that the most observable inputs be used when available.
Observable inputs are inputs that market participants would use in valuing the asset or liability and are developed based on market
data obtained from sources independent of the Company. Unobservable inputs are inputs that reflect the Company’s assumptions
about the factors that market participants would use in valuing the asset or liability. There are three levels of inputs that
may be used to measure fair value:
|
Level
1 - Observable inputs that reflect quoted prices (unadjusted) for identical assets or liabilities in active markets.
|
|
Level
2 - Include other inputs that are directly or indirectly observable in the marketplace.
|
|
Level
3 - Unobservable inputs which are supported by little or no market activity.
|
The fair value hierarchy
also requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair
value. Derivative instruments include the convertible notes payable warrant liability (Level 2). Derivative instruments are valued
using standard calculations/models that are primarily based on observable inputs, including volatilities and interest rates. Therefore,
derivative instruments are included in Level 2.
Fair-value estimates discussed
herein are based upon certain market assumptions and pertinent information available to management as of March 31, 2016 and September
30, 2015. The respective carrying value of certain on-balance-sheet financial instruments approximated their fair values. These
financial instruments include cash, prepaid expenses, accounts payable, accrued liabilities, and notes payable. Fair values for
these items were assumed to approximate carrying values because of their short-term nature or they are payable on demand.
The following table presents
the Company’s fair value hierarchy for assets measured at fair value on a recurring basis at March 31, 2016:
|
|
Level 1
|
|
|
Level 2
|
|
|
Level 3
|
|
|
Total
|
|
Assets
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash and cash
equivalents
|
|
$
|
52,111
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
52,111
|
|
Total assets measured at fair value
|
|
$
|
52,111
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
52,111
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Liabilities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Derivative instruments
|
|
$
|
-
|
|
|
$
|
3,796,083
|
|
|
$
|
-
|
|
|
$
|
3,796,083
|
|
Total liabilities measured at fair value
|
|
$
|
-
|
|
|
$
|
3,796,083
|
|
|
$
|
-
|
|
|
$
|
3,796,083
|
|
The following table presents
the Company’s fair value hierarchy for assets and liabilities measured at fair value on a recurring basis at September 30,
2015:
|
|
Level 1
|
|
|
Level 2
|
|
|
Level 3
|
|
|
Total
|
|
Assets
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash and cash
equivalents
|
|
$
|
273,904
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
273,904
|
|
Total assets measured at fair value
|
|
$
|
273,904
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
273,904
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Liabilities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Derivative instruments
|
|
$
|
-
|
|
|
$
|
1,704,127
|
|
|
$
|
-
|
|
|
$
|
1,704,127
|
|
Total liabilities measured at fair value
|
|
$
|
-
|
|
|
$
|
1,704,127
|
|
|
$
|
-
|
|
|
$
|
1,704,127
|
|
CONCENTRATION
Credit Risk
At times, the Company maintains
cash balances at a financial institution in excess of the FDIC insurance limit. In addition, at we extend credit to customers
in the normal course of business, after we evaluate the credit worthiness. The Company does not expect to take any unnecessary
credit risks causing significant write-offs of potentially uncollectible accounts.
Customers
Three (3) customers accounted
for 70% of our accounts receivable as of March 31, 2016. One (1) customer accounted for 37% of our accounts receivable as of September
30, 2015. The loss of these customers would have a significant impact on the Company’s financial results.
Suppliers
Two (2) suppliers accounted
for 73% and 74% of our purchases during the three and six months ended March 31, 2016. Two (2) suppliers and one (1) supplier
accounted for 79% and 70% of our purchases during the three and six months ended March 31, 2015. The loss of these suppliers would
have a significant impact on the Company’s financial results.
REVENUE RECOGNITION
The Company recognizes
revenues from product sales when (a) persuasive evidence that an agreement exists; (b) the products have been delivered; (c) the
prices are fixed and determinable and not subject to refund or adjustment; and (d) collection of the amounts due is reasonably
assured. Revenue is generally recorded when sales orders are shipped.
INVENTORY
Inventory is valued at
the lower of cost or market, as determined primarily by the average cost inventory method, and are stated using the first-in,
first-out (FIFO) method. Management will record a provision for loss for obsolete or slow moving inventory to reduce carrying
amounts to net realizable value.
We purchase product sourced
from China which we are required to pay 50% upon placing the order. Amounts paid for products, which have not been received, are
recorded as prepaid inventory. There are no amounts paid which are in dispute or considered impaired.
FIXED ASSETS
Fixed assets are recorded
at cost and depreciation is provided over the estimated useful lives of the related assets using the straight-line method for
financial statement purposes. The estimated life of tooling related to our ceramic products is two (2) years. The estimated life
of our leasehold improvements is the lesser of the term of the related lease and useful life of the asset.
IMPAIRMENT OF LONG-LIVED AND PURCHASED INTANGIBLE
ASSETS
The Company has adopted
Accounting Standards Codification (“ASC”) 350 “Intangibles - Goodwill and Other.” The Statement requires
that long-lived assets and certain identifiable intangibles held and used by the Company be reviewed for impairment whenever events
or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Events relating to recoverability
may include significant unfavorable changes in business conditions, recurring losses, or a forecasted inability to achieve break-even
operating results over an extended period. The Company evaluates the recoverability of long-lived assets based upon forecasted
undercounted cash flows. Should impairment in value be indicated, the carrying value of intangible assets will be adjusted, based
on estimates of future discounted cash flows resulting from the use and ultimate disposition of the asset. ASC 350 also requires
assets to be disposed of be reported at the lower of the carrying amount or the fair value less costs to sell.
Long-lived assets, such
as fixed assets and purchased intangibles subject to amortization, are reviewed for impairment whenever events or changes in circumstances
indicate that the carrying amount of an asset may not be recoverable. Recoverability of the asset is measured by comparison of
its carrying amount to undiscounted future net cash flows the asset is expected to generate. If such assets are considered to
be impaired, the impairment to be recognized is measured as the amount by which the carrying amount of the asset exceeds its fair
market value. Estimates of expected future cash flows represent management's best estimate based on currently available information
and reasonable and supportable assumptions. Any impairment recognized is permanent and may not be restored. During the three and
six months ended March 31, 2016 and 2015, the Company did not record any impairment of its trademarks as its expected future cash
flows are in excess of their carrying amounts.
RESEARCH AND DEVELOPMENT
Research and development costs
are expensed as incurred. The costs of materials and equipment that will be acquired or constructed for research and development
activities, and that have alternative future uses, both in research and development, marketing or sales, will be classified as
fixed assets and depreciated over their estimated useful lives. To date, research and d
evelopment
costs include the research and development expenses related to prototypes of the Company’s products. During the three and
months ended March 31, 2016 and 2015, research and development costs were $11,099 and $200, and $46,698 and $52,053, respectively.
CONVERTIBLE
DEBT
Convertible
debt is accounted for under the guidelines established by ASC 470-20 “Debt with Conversion and Other Options.” ASC
470-20 governs the calculation of an embedded beneficial conversion, which is treated as an additional discount to the instruments
where derivative accounting (explained below) does not apply. The amount of the value of warrants and beneficial conversion feature
may reduce the carrying value of the instrument to zero, but no further. Many of the conversion features embedded in the Company's
notes are variable and are adjusted based on a discount to market prices which could cause an unlimited number of common stock
to be issued. In these cases, we record the embedded conversion feature as a derivate instrument, at fair value. The
embedded conversion features are recorded as discounts when the notes become convertible. The excess of fair value of the embedded
conversion feature over the carrying value of the debt is recorded as an immediate charge to operations. Each reporting
period, the Company will compute the estimated fair value of derivatives and record changes to operations. The discounts relating
to the initial recording of the derivatives or beneficial conversion features are accreted over the term of the debt using the
effective interest method.
The
Company has lost the ability to increase the share reserves due to the significantly increased outstanding held by convertible
noteholders and a shareholder vote is required to increase the authorized amount of shares the Company may issue. Further, the
combination of limited capital and depleted share reserves have severely damaged the Company’s ability to find continued
finance, properly run the Company, and proceed with business to include any mergers or acquisitions or any transactions that would
require available stock.
DERIVATIVE FINANCIAL INSTRUMENTS
Derivative financial instruments,
as defined in ASC 815, “Accounting for Derivative Financial Instruments and Hedging Activities”, consist of financial
instruments or other contracts that contain a notional amount and one or more underlying (e.g. interest rate, security price or
other variable), require no initial net investment and permit net settlement. Derivative financial instruments may be free-standing
or embedded in other financial instruments. Further, derivative financial instruments are initially, and subsequently, measured
at fair value and recorded as liabilities or, in rare instances, assets.
The Company does not use
derivative financial instruments to hedge exposures to cash-flow, market or foreign-currency risks. However, the Company has issued
financial instruments including senior convertible notes payable and freestanding stock purchase warrants with features that are
either (i) not afforded equity classification, (ii) embody risks not clearly and closely related to host contracts, or (iii) may
be net-cash settled by the counterparty. As required by ASC 815, in certain instances, these instruments are required to be carried
as derivative liabilities, at fair value, in our consolidated financial statements.
The Company estimates the
fair values of derivative financial instruments using various techniques (and combinations thereof) that are considered to be
consistent with objectively measuring fair values. In selecting the appropriate technique, consideration is given to, among other
factors, the nature of the instrument, the market risks that it embodies and the expected means of settlement. For less complex
derivative instruments, such as free-standing warrants, the Company generally uses the Black-Scholes option valuation technique
because it embodies all of the requisite assumptions (including trading volatility, estimated terms and risk free rates) necessary
to fair value these instruments. Estimating fair values of derivative financial instruments requires the development of significant
and subjective estimates that may, and are likely to, change over the duration of the instrument with related changes in internal
and external market factors. In addition, option-based techniques are highly volatile and sensitive to changes in the trading
market price of our common stock, which has a high-historical volatility. Since derivative financial instruments are initially
and subsequently carried at fair values, the Company's operating results will reflect the volatility in these estimate and assumption
changes.
EARNINGS (LOSS) PER COMMON SHARE
Basic earnings (loss) per
common share is computed by dividing net income (loss) available to common shareholders by the weighted-average number of common
shares outstanding during the reporting period. Diluted earnings per common share is computed by dividing net income available
to common shareholders by the combination of dilutive common share equivalents, comprised of shares issuable under the Company’s
share-based compensation plans and the weighted-average number of common shares outstanding during the reporting period. Dilutive
common share equivalents include the dilutive effect of in-the-money share equivalents, which are calculated, based on the average
share price for each period using the treasury stock method. Under the treasury stock method, the exercise price of an award,
if any, the amount of compensation cost, if any, for future service that the Company has not yet recognized, and the estimated
tax benefits that would be recorded in paid-in capital, if any, when an award is settled are assumed to be used to repurchase
shares in the current period. In the event of losses, such common share equivalents are excluded as their effects are antidilutive.
The following is a summary
of outstanding securities that would have been included in the calculation of diluted shares outstanding since the exercise prices
did not exceed the average market value of the Company’s common stock if the Company generated net income for the three
and six months ended March 31, 2016:
|
|
For the Three Months Ended
|
|
|
For the Six Months Ended
|
|
|
|
March 31,
|
|
|
March 31,
|
|
|
|
2016
|
|
|
2016
|
|
Series A Preferred stock
|
|
|
500,000
|
|
|
|
500,000
|
|
Common stock warrants
|
|
|
1,184,726
|
|
|
|
1,184,726
|
|
Convertible notes
|
|
|
631,560,394
|
|
|
|
631,560,394
|
|
|
|
|
633,245,120
|
|
|
|
633,245,120
|
|
The
following is a summary of outstanding securities which have been included in the calculation of diluted net income per share and
reconciliation of net income to net income available to common stock holders:
|
|
For
the Three Months
Ended
|
|
|
For
the Six Months
Ended
|
|
|
|
March
31,
2015
|
|
|
March
31,
2015
|
|
Weighted
average common shares outstanding used in calculating basic earnings per share
|
|
|
11,148,666
|
|
|
|
10,918,103
|
|
Effect
of preferred stock
|
|
|
500,000
|
|
|
|
500,000
|
|
Effect
of convertible notes payable
|
|
|
2,025,679
|
|
|
|
2,025,679
|
|
Effect
of options and warrants
|
|
|
197,143
|
|
|
|
161,264
|
|
Weighted
average common and common equivalent shares used in calculating diluted earnings per share
|
|
|
13,871,488
|
|
|
|
13,605,046
|
|
|
|
|
|
|
|
|
|
|
Net
income as reported
|
|
$
|
85,145
|
|
|
$
|
668,055
|
|
Add
- interest on convertible notes payable
|
|
|
100,075
|
|
|
|
323,506
|
|
Net
income available to common stockholders
|
|
$
|
185,220
|
|
|
$
|
991,561
|
|
The
Company excluded 751,250 and 502,500 options from the computation for the three and six months ended March 31, 2015, as their
exercise prices were in excess of the average closing market price of the Company’s common stock, causing their effects
to be anti-dilutive using the treasury stock method.
STOCK-BASED
COMPENSATION
ASC
718, “Share-Based Payment” requires that compensation cost related to share-based payment transactions be recognized
in the consolidated financial statements. Share-based payment transactions within the scope of ASC 718 include stock options,
restricted stock plans, performance-based awards, stock appreciation rights, and employee share purchase plans.
The
Company adopted ASC 718, which requires disclosure of the fair value and other characteristics of stock options and more prominent
disclosure about the effects of an entity’s accounting policy decisions with respect to stock-based compensation on reported
net loss. The Company has reflected the expense of such stock based compensation based on the fair value at the grant date for
awards consistent with the provisions of ASC 718.
In
connection with the adoption of ASC 718, the fair value of our share-based compensation has been determined utilizing the Black-Scholes
pricing model. The fair value of the options granted is amortized as compensation expense on a straight line basis over the requisite
service period of the award, which is generally the vesting period. The fair value calculations involve significant judgments,
assumptions, estimates and complexities that impact the amount of compensation expense to be recorded in current and future periods.
Upon option exercise, the Company issues new shares of stock.
The
following weighted average variables were used in the Black Scholes model for all option issuances valued during the six months
ended March 31, 2016 and 2015:
Six
Months
Ended
March,
|
|
Stock
Price at
Grant Date
|
|
|
Dividend
Yield
|
|
|
Exercise
Price
|
|
|
Risk
Free
Interest Rate
|
|
|
Volatility
|
|
|
Average
Life
|
|
2016
|
|
|
n/a
|
|
|
|
n/a
|
|
|
|
n/a
|
|
|
|
n/a
|
|
|
|
n/a
|
|
|
|
n/a
|
|
2015
|
|
$
|
0.73
|
|
|
|
n/a
|
|
|
$
|
0.73
|
|
|
|
2.2
|
%
|
|
|
380
|
%
|
|
|
10.0
|
|
The
Company's accounting policy for equity instruments issued to consultants and vendors in exchange for goods and services follows
the provisions of Emerging Issues Task Force (“EITF”) 96-18, “Accounting for Equity Instruments That are Issued
to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or Services”, codified into ASC 505-50. The
measurement date for the fair value of the equity instruments issued is determined at the earlier of (i) the date at which a commitment
for performance by the consultant or vendor is reached or (ii) the date at which the consultant or vendor's performance is complete. In
the case of equity instruments issued to consultants, the fair value of the equity instrument is recognized over the term of the
consulting agreement. Prepaid stock-based compensation is recorded when shares are issued based on the value on the grant date,
but vest over the contractual period at which time the prorated expense will be recorded.
RECENT
ACCOUNTING PRONOUNCEMENTS
In
April 2015, the FASB issued Accounting Standard Update ("ASU") 2015-03 Simplifying the Presentation of Debt Issuance
Costs. This update requires capitalized debt issuance costs to be classified as a reduction to the carrying value of debt rather
than a deferred charge, as is currently required. This update will be effective for the Company for all annual and interim periods
beginning after December 15, 2015 and is required to be adopted retroactively for all periods presented, and early adoption is
permitted. The Company adopted the policy during the quarter ending March 31, 2016.
In
May 2014, the FASB issued Accounting Standards Update No. 2014-09, “Revenue from Contracts with Customers”, which
supersedes most of the current revenue recognition requirements. The core principle of the new guidance is that an entity should
recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration
to which the entity expects to be entitled in exchange for these goods or services. New disclosures about the nature, amount,
timing and uncertainty of revenue and cash flows arising from contracts with customers are also required. This guidance is effective
for the Company in the first quarter of fiscal year 2018 and early application is not permitted. Entities must adopt the new guidance
using one of two retrospective application methods. The Company is currently evaluating the standard but does not expect it to
have a material impact on our financial position, results of operations or cash flows.
In
August 2014, the FASB issued ASU 2014-15, which provides guidance on determining when and how to disclose going-concern uncertainties
in the financial statements. The new standard requires management to perform interim and annual assessments of an entity’s
ability to continue as a going concern within one year of the date the financial statements are issued.2 An entity must provide
certain disclosures if “conditions or events raise substantial doubt about the entity’s ability to continue as a going
concern.” The ASU applies to all entities and is effective for annual periods ending after December 15, 2016, and interim
periods thereafter, with early adoption permitted.
The
Financial Accounting Standards Board issues Accounting Standard Updates (“ASUs”) to amend the authoritative literature
in Accounting Standards Codification (“ASC”). There have been a number of ASUs to date that amend the original text
of ASC. The Company believes those issued to date either (i) provide supplemental guidance, (ii) are technical corrections, (iii)
are not applicable to the Company or (iv) are not expected to have a significant impact on the Company.
RISKS
AND UNCERTAINTIES
Although
forward-looking statements in this Quarterly Report reflect our good faith judgment, such statements can only be based on facts
and factors currently known by us. Consequently, forward-looking statements are inherently subject to risks and uncertainties
and actual results and outcomes may differ materially from the results and outcomes discussed in or anticipated by the forward-looking
statements. Factors that could cause or contribute to such differences in results and outcomes include without limitation those
discussed under the heading “Risk Factors” below, as well as those discussed elsewhere in this Quarterly Report. Readers
are urged not to place undue reliance on these forward-looking statements, which speak only as of the date of this Quarterly Report.
We undertake no obligation to revise or update any forward-looking statements in order to reflect any event or circumstance that
may arise after the date of this Quarterly Report. Readers are urged to carefully review and consider the various disclosures
made in this Quarterly Report, which attempt to advise interested parties of the risks and factors that may affect our business,
financial condition, results of operations and prospects.
NOTE
3. FIXED ASSETS
The
following is a summary of fixed assets as of March 31, 2016 and September 30, 2015:
|
|
March 31,
2016
|
|
|
September 30,
2015
|
|
Molds and Tooling
|
|
$
|
218,490
|
|
|
$
|
176,015
|
|
Leasehold improvements
|
|
|
-
|
|
|
|
29,795
|
|
Accumulated depreciation
|
|
|
(134,221
|
)
|
|
|
(87,483
|
)
|
|
|
$
|
84,269
|
|
|
$
|
118,327
|
|
During the six months
ended March 31, 2016 and 2015, depreciation expense included in cost of revenue were $76,533 and $29,815, respectively.
NOTE
4. ACCRUED EXPENSES
The
following is a summary of accrued expenses as of March 31, 2016 and September 30, 2015:
|
|
March 31,
2016
|
|
|
September 30,
2015
|
|
Accrued interest
|
|
$
|
120,529
|
|
|
$
|
46,337
|
|
Accrued interest - related party
|
|
|
33,554
|
|
|
|
24,538
|
|
Accrued wages and taxes
|
|
|
121,122
|
|
|
|
112,322
|
|
Other
|
|
|
14,373
|
|
|
|
24,411
|
|
|
|
$
|
289,578
|
|
|
$
|
207,608
|
|
As
of March 31, 2016, $25,000 for Kyle Tracey, $16,667 for Joe Andreae, $33,742 for Mike Cook, $11,055 for Allan Viernes, $11,055
for Benjamin Beaulieu, and $10,807 for Justin Braune are recorded in accrued wages.
NOTE
5. THIRD PARTY DEBT
CONVERTIBLE
NOTES PAYABLE
In connection with
the Third Party Debt Conversions, each of the Company’s convertible noteholders is entitled to a “share reserve”
per their agreements with the Company which entitle them to reserve a certain allotment of common stock out of the authorized but
unissued common stock of the Company for future conversions of their notes. The Company is further obligated under the agreements
to increase the Company’s authorized share count to accommodate for a sufficient amount of share reserves. Due to the declining
market price of the Company’s common stock, the noteholders have reserve claims in excess of the common stock authorized
at this time. The Company has determined at this time not to increase the authorized share count and is instead in discussions
with its convertible noteholders about a consolidation, restructuring and/or buy-out of their notes to resolve these issues. The
position taken by the Company may be considered a technical violation of their agreements with the noteholders but none of the
noteholders have called a default under the terms of the notes at this time. The Company’s ability to issue common stock
other than those presently allocated to noteholders is restricted during this time.
The Company has
lost the ability to increase the share reserves due to the significantly increased outstanding held by convertible noteholders
and a shareholder vote is required to increase the authorized amount of shares the Company may issue. Further, the combination
of limited capital and depleted share reserves have severely damaged the Company’s ability to find continued finance, properly
run the Company, and proceed with business to include any mergers or acquisitions or any transactions that would require available
stock.
The Company has
entered into discussions with its convertible noteholders about a consolidation, restructuring and/or buy-out of their notes to
resolve these issues. The position taken by the Company may be considered a technical violation of their agreements with the noteholders
but none of the noteholders have called a default under the terms of the notes at this time. The Company’s ability to issue
common stock other than those presently allocated to noteholders is restricted during this time. The position taken by the Company
may be considered a technical violation of their agreements with the noteholders but none of the noteholders have called a default
under the terms of the notes at this time. The Company’s ability to issue common stock other than those presently allocated
to noteholders is restricted during this time.
The
Company is currently involved in litigation with 2 noteholders seeking the specific performance of VAPE’s issuance of shares
underlying denied conversion notices. VAPE is also currently negotiating with a third noteholder threatening similar litigation.
If the noteholders are allowed to convert their respective notes VAPE shareholders will experience substantial dilution.
The Company’s
denial of the conversion notices has triggered a technical default on its convertible notes and have presented amounts due as current
liabilities other than those subsequently converted and began accruing interest at their default interest rates.
Further, our funding
partner may not commit to purchasing the balance of the notes currently outstanding due to the declining stock market price of
the Company’s common stock.
Securities
Purchase Agreement
On
December 3, 2014, the Company entered into a securities purchase agreement (the “Securities Purchase Agreement”) with
an accredited investor (the “Investor”) pursuant to which the Company agreed to sell, and the Investor agreed to purchase,
an unsecured convertible promissory note (the “Note”) in the principal amount of $560,000 less an original issue discount
(“OID”) of $50,000 and transaction expenses of $10,000 for a total purchase price of $500,000. The Company also paid
a finder’s fee in the amount of $25,000 in connection with this transaction, which was recorded as a discount to the note
as it was paid from the proceeds. The closing under the Securities Purchase Agreement occurred on December 3, 2014. The Company
received $475,000 net proceeds after transactions costs. On December 10, 2015, the Company and the Investor entered into a forbearance
agreement regarding the Investor’s convertible note and added $105,000 to the principal and charged to interest expense
during the three months ended December 31, 2015. On February 26, 2016, the note was assigned to an accredited investor and $21,874
was added to the principal balance and charged to interest expense during the three and six months ended March 31, 2016.
We amortized $8,333
and $8,333, and $16,667 and $11,111 of the original issue discount to interest expense during the three and six months ended March
31, 2016 and 2015, respectively. In addition, the Company recorded $45,940 in debt issuance costs as a discount on the note and
amortized $7,656 and $7,657, and $15,312 and $10,209 to interest expense during the three and six months ended March 31, 2016 and
2015, respectively. As of March 31, 2016, the Company had unamortized current and long-term debt issuance costs of $584 and $4,521,
respectively. The original issue discount and debt issuance costs are amortized through the maturity date.
On August 26, 2015,
the Company and Investor entered into an Amendment whereby the conversion rate of the note was amended to 55% of the lowest price
of the prior fifteen (15) trading days and conversion floor removed which amendment was triggered by the dilutive issuances of
the August 2015 convertible note financing thereby entitling Investor to the lowest conversion rate granted during the year ended
September 30, 2015 per the terms of the Securities Purchase Agreement. On August 26, 2015, the Company recorded the note as a derivative
liability at fair value of $830,921, a derivative discount of $332,666, and the excess in fair value of $498,254 to loss on debt
extinguishment. The total loss on debt extinguishment on this note was $582,254. During the three and six months ended March 31,
2016, the Company amortized $124,750 and $249,500 of the derivative discount to interest expense, recorded a loss on the change
in fair value of the derivative liability of $655,426 and $862,269, and allocated the fair value of $424,596 and $663,353 of the
conversions below to additional paid-in capital and a reduction in the derivative liability, respectively. As of March 31, 2016,
the derivative liability was $711,523.
Between
October 2015 and March 31, 2016, the Company issued the following conversions for payment towards Investor:
Conversion Date
|
|
Principal
Converted
|
|
|
Accrued Interest Converted
|
|
|
Total Converted
|
|
|
Conversion Rate
|
|
|
Common Shares Issued
|
|
October 8, 2015
|
|
$
|
21,000
|
|
|
$
|
-
|
|
|
$
|
21,000
|
|
|
$
|
0.012
|
|
|
|
1,818,182
|
|
October 16, 2015
|
|
|
18,900
|
|
|
|
-
|
|
|
|
18,900
|
|
|
$
|
0.012
|
|
|
|
1,636,364
|
|
October 22, 2015
|
|
|
25,800
|
|
|
|
-
|
|
|
|
25,800
|
|
|
$
|
0.011
|
|
|
|
2,333,786
|
|
October 29, 2015
|
|
|
22,460
|
|
|
|
-
|
|
|
|
22,460
|
|
|
$
|
0.011
|
|
|
|
2,031,660
|
|
November 11, 2015
|
|
|
33,500
|
|
|
|
-
|
|
|
|
33,500
|
|
|
$
|
0.007
|
|
|
|
4,649,549
|
|
November 18, 2015
|
|
|
24,000
|
|
|
|
-
|
|
|
|
24,000
|
|
|
$
|
0.006
|
|
|
|
4,195,804
|
|
November 30, 2015
|
|
|
30,000
|
|
|
|
-
|
|
|
|
30,000
|
|
|
$
|
0.005
|
|
|
|
5,741,627
|
|
December 11, 2015
|
|
|
22,000
|
|
|
|
-
|
|
|
|
22,000
|
|
|
$
|
0.002
|
|
|
|
9,090,909
|
|
December 28, 2015
|
|
|
22,500
|
|
|
|
-
|
|
|
|
22,500
|
|
|
$
|
0.002
|
|
|
|
9,297,521
|
|
January 7, 2016
|
|
|
20,000
|
|
|
|
-
|
|
|
|
20,000
|
|
|
$
|
0.002
|
|
|
|
10,101,010
|
|
January 20, 2016
|
|
|
12,500
|
|
|
|
-
|
|
|
|
12,500
|
|
|
$
|
0.001
|
|
|
|
10,330,579
|
|
February 2, 2016
|
|
|
13,200
|
|
|
|
-
|
|
|
|
13,200
|
|
|
$
|
0.001
|
|
|
|
10,909,091
|
|
March 2, 2016
|
|
|
10,627
|
|
|
|
-
|
|
|
|
10,627
|
|
|
$
|
0.001
|
|
|
|
10,169,800
|
|
March 10, 2016
|
|
|
11,184
|
|
|
|
-
|
|
|
|
11,184
|
|
|
$
|
0.001
|
|
|
|
10,702,619
|
|
March 17, 2016
|
|
|
8,272
|
|
|
|
-
|
|
|
|
8,272
|
|
|
$
|
0.001
|
|
|
|
6,539,200
|
|
March 29, 2016
|
|
|
22,797
|
|
|
|
-
|
|
|
|
22,797
|
|
|
$
|
0.002
|
|
|
|
12,191,000
|
|
March 31, 2016
|
|
|
22,347
|
|
|
|
-
|
|
|
|
22,347
|
|
|
$
|
0.002
|
|
|
|
11,950,000
|
|
|
|
$
|
341,087
|
|
|
$
|
-
|
|
|
$
|
341,087
|
|
|
|
|
|
|
|
123,688,701
|
|
Subsequent
to quarter end, the Investor also enacted the following conversions:
Conversion Date
|
|
Principal
Converted
|
|
|
Accrued Interest Converted
|
|
|
Total Converted
|
|
|
Conversion Rate
|
|
|
Common Shares Issued
|
|
April 4, 2016
|
|
$
|
25,140
|
|
|
$
|
-
|
|
|
$
|
25,140
|
|
|
$
|
0.002
|
|
|
|
13,444,000
|
|
April 7, 2016
|
|
|
21,019
|
|
|
|
-
|
|
|
|
21,019
|
|
|
$
|
0.002
|
|
|
|
11,240,000
|
|
April 13, 2016
|
|
|
35,664
|
|
|
|
-
|
|
|
|
35,664
|
|
|
$
|
0.002
|
|
|
|
14,737,000
|
|
April 19, 2016
|
|
|
36,711
|
|
|
|
-
|
|
|
|
36,711
|
|
|
$
|
0.002
|
|
|
|
15,170,000
|
|
April 20, 2016
|
|
|
18,244
|
|
|
|
-
|
|
|
|
18,244
|
|
|
$
|
0.002
|
|
|
|
7,538,666
|
|
|
|
$
|
136,778
|
|
|
$
|
-
|
|
|
$
|
136,778
|
|
|
|
|
|
|
|
62,129,666
|
|
As
a result, as of March 31, 2016, $13,230 and $102,379, net of total unamortized discounts of $4,445 and $34,399 are classified
as current and long-term on the accompanying consolidated balance sheet. As of March 31, 2016, there is $27,869 in accrued interest
expense related to this note and the Company recorded $9,328 and $14,000, and $17,924 and $18,356 in interest expense during the
three and months ended March 31, 2016 and 2015, respectively.
$2M
Securities Purchase Agreement
On
February 10, 2015, the Company entered into a securities purchase agreement (the “February 2015 Securities Purchase Agreement”)
with an accredited investor pursuant to which the Company agreed to sell, and the investor agreed to purchase, an unsecured convertible
promissory note (the “$2M Note”) in the principal amount of $2,000,000 less an OID of $182,000 and transaction expenses
of $10,000 for a total purchase price of $1,808,000. The closing under the February 2015 Securities Purchase Agreement occurred
on February 10, 2015. During the year ended September 30, 2015, the Company received $800,000 toward the $2M Note with an original
issue discount of $148,600 and transaction costs for net proceeds of $651,395, respectively. On February 23, 2016, the note was
assigned to an accredited investor the same accredited investor as the Security Purchase Agreement was and $36,038 was added to
the principal balance and charged to interest expense during the three and six months ended March 31, 2016.
On August 13, 2015,
the Company entered into an Amendment, Waiver and Modification Agreement (the “Amendment”) to its $2M Securities Purchase
Agreement and related Transaction Documents with Redwood Management, LLC including any designees and or assignees thereto.
Under the terms of the Amendment, the parties agreed to reduce the $2,000,000 outstanding balance of the $2M Note to $800,000 to
reflect the total amount funded under the note, to terminate the offsetting investor note securing the additional unfunded balance
and to waive any past claims of default or offsetting interest on the $2M Note or investor note. In addition, the conversion rate
of the note was amended to 55% of the lowest price of the prior fifteen (15) trading days and conversion floor removed which amendment
was triggered by the dilutive issuances of the August 2015 convertible note financing thereby entitling Investor to the lowest
conversion rate granted during the year ended September 30, 2015 per the terms of the $2M Securities Purchase Agreement. As a result,
we expensed the unamortized discount of $40,000 to loss on debt extinguishment. On August 13, 2015, the carrying value on the note
was $655,816, net of unamortized discounts of $94,184. The Company recorded the note as a derivative liability at fair value of
$970,956, a derivative discount of $655,816, and the excess in fair value of $315,140 to loss on debt extinguishment. The total
loss on debt extinguishment on this note was $369,324. During the three and six months ended March 31, 2016, the Company amortized
$47,405 and $472,628 of the derivative discount to interest expense, recorded a loss on the change in fair value of the derivative
liability of $312,467 and $323,873, and allocated the fair value of $0 and $324,055 of the conversions below as additional paid-in-capital
and a reduction in the derivative liability, respectively. As of March 31, 2016, the derivative liability was $419,321.
The
following is summary of conversions by the $2M Note holder (including its assignees) during the six months ended March 31, 2016:
Conversion Date
|
|
Principal Converted
|
|
|
Accrued Interest Converted
|
|
|
Total Converted
|
|
|
Conversion Rate
|
|
|
Common Shares Issued
|
|
October 1, 2015
|
|
$
|
10,000
|
|
|
$
|
-
|
|
|
$
|
10,000
|
|
|
$
|
0.0148
|
|
|
|
675,676
|
|
October 5, 2015
|
|
|
10,000
|
|
|
|
-
|
|
|
|
10,000
|
|
|
$
|
0.0148
|
|
|
|
675,676
|
|
October 6, 2015
|
|
|
13,262
|
|
|
|
-
|
|
|
|
13,262
|
|
|
$
|
0.0138
|
|
|
|
961,000
|
|
October 7, 2015
|
|
|
10,000
|
|
|
|
-
|
|
|
|
10,000
|
|
|
$
|
0.0115
|
|
|
|
865,801
|
|
October 9, 2015
|
|
|
11,728
|
|
|
|
-
|
|
|
|
11,728
|
|
|
$
|
0.0116
|
|
|
|
1,011,000
|
|
October 9, 2015
|
|
|
10,000
|
|
|
|
-
|
|
|
|
10,000
|
|
|
$
|
0.0115
|
|
|
|
865,801
|
|
October 12, 2015
|
|
|
14,680
|
|
|
|
-
|
|
|
|
14,680
|
|
|
$
|
0.0115
|
|
|
|
1,271,000
|
|
October 13, 2015
|
|
|
11,601
|
|
|
|
-
|
|
|
|
11,601
|
|
|
$
|
0.0116
|
|
|
|
1,000,052
|
|
October 15, 2015
|
|
|
14,680
|
|
|
|
-
|
|
|
|
14,680
|
|
|
$
|
0.0115
|
|
|
|
1,271,000
|
|
October 19, 2015
|
|
|
17,400
|
|
|
|
-
|
|
|
|
17,400
|
|
|
$
|
0.0116
|
|
|
|
1,500,000
|
|
October 19, 2015
|
|
|
15,000
|
|
|
|
-
|
|
|
|
15,000
|
|
|
$
|
0.0116
|
|
|
|
1,298,701
|
|
October 20, 2015
|
|
|
16,650
|
|
|
|
-
|
|
|
|
16,650
|
|
|
$
|
0.0111
|
|
|
|
1,500,000
|
|
October 21, 2015
|
|
|
17,500
|
|
|
|
-
|
|
|
|
17,500
|
|
|
$
|
0.0115
|
|
|
|
1,515,152
|
|
October 23, 2015
|
|
|
20,000
|
|
|
|
-
|
|
|
|
20,000
|
|
|
$
|
0.0115
|
|
|
|
1,731,602
|
|
October 26, 2015
|
|
|
24,420
|
|
|
|
-
|
|
|
|
24,420
|
|
|
$
|
0.0111
|
|
|
|
2,200,000
|
|
October 29, 2015
|
|
|
26,640
|
|
|
|
-
|
|
|
|
26,640
|
|
|
$
|
0.0111
|
|
|
|
2,400,000
|
|
November 2, 2015
|
|
|
29,970
|
|
|
|
-
|
|
|
|
29,970
|
|
|
$
|
0.0111
|
|
|
|
2,700,000
|
|
November 2, 2015
|
|
|
20,000
|
|
|
|
-
|
|
|
|
20,000
|
|
|
$
|
0.0111
|
|
|
|
1,809,136
|
|
November 5, 2015
|
|
|
32,190
|
|
|
|
-
|
|
|
|
32,190
|
|
|
$
|
0.0111
|
|
|
|
2,900,000
|
|
November 10, 2015
|
|
|
28,800
|
|
|
|
-
|
|
|
|
28,800
|
|
|
$
|
0.0096
|
|
|
|
3,000,000
|
|
November 12, 2015
|
|
|
23,930
|
|
|
|
-
|
|
|
|
23,930
|
|
|
$
|
0.0072
|
|
|
|
3,323,611
|
|
November 17, 2015
|
|
|
16,500
|
|
|
|
-
|
|
|
|
16,500
|
|
|
$
|
0.0060
|
|
|
|
2,727,273
|
|
November 19, 2015
|
|
|
1,640
|
|
|
|
11,225
|
|
|
|
12,865
|
|
|
$
|
0.0056
|
|
|
|
2,316,013
|
|
November 23, 2015
|
|
|
23,111
|
|
|
|
-
|
|
|
|
23,111
|
|
|
$
|
0.0056
|
|
|
|
4,127,000
|
|
November 27, 2015
|
|
|
24,750
|
|
|
|
-
|
|
|
|
24,750
|
|
|
$
|
0.0055
|
|
|
|
4,500,000
|
|
December 2, 2015
|
|
|
18,450
|
|
|
|
-
|
|
|
|
18,450
|
|
|
$
|
0.0041
|
|
|
|
4,500,000
|
|
December 8, 2015
|
|
|
18,000
|
|
|
|
-
|
|
|
|
18,000
|
|
|
$
|
0.0036
|
|
|
|
5,000,000
|
|
December 11, 2015
|
|
|
13,368
|
|
|
|
-
|
|
|
|
13,368
|
|
|
$
|
0.0024
|
|
|
|
5,570,000
|
|
December 16, 2015
|
|
|
14,181
|
|
|
|
-
|
|
|
|
14,181
|
|
|
$
|
0.0024
|
|
|
|
5,860,000
|
|
December 22, 2015
|
|
|
15,488
|
|
|
|
-
|
|
|
|
15,488
|
|
|
$
|
0.0024
|
|
|
|
6,400,000
|
|
December 29, 2015
|
|
|
17,666
|
|
|
|
|
|
|
|
17,666
|
|
|
$
|
0.0024
|
|
|
|
7,300,000
|
|
|
|
$
|
541,605
|
|
|
$
|
11,225
|
|
|
$
|
552,830
|
|
|
|
|
|
|
|
82,775,494
|
|
As a result, as
of March 31, 2016, $91,024 is classified as current on the accompanying consolidated balance sheet. During the three and six months
ended March 31, 2016 and 2015, the Company amortized $5,279 and $3,200, and $30,713 and $3,200 of the original issue discount to
interest expense, respectively. As of March 31, 2016, there is $41,845 in accrued interest expense related to this note and the
Company recorded $3,811 and $4,389, and $8,592 and $4,389 in interest expense during the three and six months ended March 31, 2016
and 2015, respectively.
Convertible
Note Financing
On
August 5, 2015, the Company entered into a series of convertible note financings with several accredited investors totaling an
aggregate of $541,000 in aggregate proceeds raised less certain fees and costs as set forth in the financing documents known as
the “August 2015 Notes”. The financing was disclosed on the Company’s Current Report on Form 8-K filed on August
11, 2015 and is incorporated herein by reference. The Company recorded an original issue discount of $12,500 along with these
notes. On March 7, 2016, $112,000 of these notes were assigned to the same accredited investor previously mentioned and $7,806
was added to the principal balance and recorded as interest expense during the three and six months ended March 31, 2016.
August
2015 Notes
On August 5, 2015,
the carrying value on the notes were $419,626, net of unamortized original issue discounts of $9,374. In six months when the note
became convertible, the Company recorded the note as a derivative liability at fair value of $1,181,732, a derivative discount
of $419,626, and the excess in fair value of $762,106 to excess of fair value of embedded conversion feature. The Company amortizes
the derivative discount over the expected life of the related debt. During the three and six months ended March 31, 2016, the Company
amortized $107,736 of the derivative discount to interest expense and recorded a loss on the change in fair value of the derivative
liability of $396,268. As of March 31, 2016, the derivative liability was $1,578,000. During the three and six months ended March
31 2016, the Company amortized $1,563 and $3,126 of original issue discounts to interest expense. During the three and six months
ended March 31 2016, the Company amortized $17,964 and $35,928 of debt issuance costs to interest expense. As of March 31, 2016,
$83,773 is classified as current on the accompanying consolidated balance sheet, net of total unamortized discounts of $345,227.
As of March 31, 2016, there is $29,434 in accrued interest expense related to these notes and the Company recorded $17,514 and
$23,137 in interest expense during the three and six months ended March 31, 2016, respectively.
Additional
Funding Under August 2015 Note
On
December 15, 2015, an accredited investor provided the Company with $50,000 in additional proceeds under the same terms of their
original convertible note with a term of two years. A one-time interest charge of $11,600 was added to the principal of the note.
The Company also recorded $4,000 of debt issuance costs as a discount. During the three and six months ended March 31 2016, the
Company amortized $500 debt issuance costs to interest expense. As a result, as of March 31, 2016, $58,100 is classified as current
on the accompanying consolidated balance sheet, net of total unamortized discounts of $3,500. As of March 31, 2016, there is default
interest of $1,848 in accrued interest expense related to these notes and the Company recorded $1,848 during the three and six
months ended March 31, 2016, respectively. The Company will record an embedded conversion feature at estimated fair value as a
derivative liability at fair value in six months if and when the notes become convertible.
Assigned
2015 Notes
On August 5, 2015,
the carrying value on an assigned note was $112,000. In six months when the note became convertible, the Company recorded the note
as a derivative liability at fair value of $400,722, a derivative discount of $112,000, and the excess in fair value of $288,722
to loss on debt extinguishment. During the three and six months ended March 31, 2016, the Company amortized $37,333 of the derivative
discount to interest expense and recorded a loss on the change in fair value of the derivative liability of $293,003. As of March
31, 2016, the derivative liability was $693,725. During the three and six months ended March 31 2016, the Company amortized $3,429
and $8,571 of debt issuance costs to interest expense.
Subsequent
to quarter end, the Company enacted the following conversions:
Conversion Date
|
|
Principal
Converted
|
|
|
Accrued Interest Converted
|
|
|
Total Converted
|
|
|
Conversion Rate
|
|
|
Common Shares Issued
|
|
April 20, 2016
|
|
$
|
16,117
|
|
|
$
|
-
|
|
|
$
|
16,117
|
|
|
$
|
0.0024
|
|
|
|
6,660,000
|
|
April 25, 2016
|
|
|
46,349
|
|
|
|
-
|
|
|
|
46,349
|
|
|
$
|
0.0029
|
|
|
|
15,900,000
|
|
May 5, 2016
|
|
|
37,744
|
|
|
|
-
|
|
|
|
37,744
|
|
|
$
|
0.0025
|
|
|
|
15,250,000
|
|
May 18, 2016
|
|
|
19,597
|
|
|
|
1,594
|
|
|
|
21,191
|
|
|
$
|
0.0020
|
|
|
|
10,413,268
|
|
|
|
$
|
119,867
|
|
|
$
|
1,594
|
|
|
$
|
121,401
|
|
|
|
|
|
|
|
48,223,268
|
|
As
a result, as of March 31, 2016, $45,140 is classified as long-term on the accompanying consolidated balance sheet, net of total
unamortized discounts of $74,667. As of March 31, 2016, there is $10,937 in accrued interest expense related to these notes and
the Company recorded $5,412 and $8,847 in interest expense during the three and six months ended March 31, 2016, respectively.
On
August 12, 2015, the Company entered into an additional convertible note financing transaction with an accredited investor in
the principal amount of $105,000 less fees and costs. The same accredited investor was assigned mentioned above was assigned this
note and $20,000 was added to the principal balance and recorded as interest expense during the three and six months ended March
31, 2016. The closing under the financing occurred concurrently with the execution of the financing documents on August 12, 2015.
The convertible note bears interest at the rate of 8% per annum and is convertible into common stock of the Company at any time
after 180 days from issuance of the note at a conversion price per share equal to 58% of the average of the lowest trading price
of the common stock in the thirteen (13) trading days immediately preceding the applicable conversion date. The Company has the
option to prepay the convertible note in the first 180 days from closing subject to a prepayment penalty of 150% of principal
plus interest. The maturity date of the convertible note is June 12, 2016 subject to the noteholder’s right to extend maturity
an additional nine (9) month period. The Company recorded an original issue discount of $5,000 along with this note. In six months
when the note became convertible, the Company recorded the note as a derivative liability at fair value of $110,669, a derivative
discount of $103,000, and the excess in fair value of $7,669 to loss on debt extinguishment. During the three and six months ended
March 31, 2016, the Company amortized $34,333 of the derivative discount to interest expense and recorded a loss on the change
in fair value of the derivative liability of $275,424. As of March 31, 2016, the derivative liability was $386,093. During the
three and six months ended March 31 2016, the Company amortized $1,500 and $3,000 of original issue discounts to interest expense.
During the three and six months ended March 31 2016, the Company amortized $4,920 and $9,840 of debt issuance costs to interest
expense. As a result, as of March 31, 2016, $52,053 is classified as current on the accompanying consolidated balance sheet, net
of total unamortized discounts of $72,947. As of March 31, 2016, there is $8,597 in accrued interest expense related to these
notes and the Company recorded $5,307 and $7,453 in interest expense during the three and six months ended March 31, 2016, respectively.
The foregoing descriptions
of the August 12, 2015 note financing and related documentation do not purport to be complete and are qualified in their entirety
by reference to the full text of the documents, which are filed as exhibits to this Quarterly Report on Form 10-K/A and are incorporated
herein by reference.
NOTE
6. RELATED PARTY DEBT
Related
Party Note
The
Company had outstanding accounts payable balance to a related party (shareholder of the Company) in the amount of $15,000 as of
September 30, 2013. This payable was converted into a note payable on December 7, 2013. The note payable bears interest
of 6% per annum with a maturity date of December 1, 2016. As of March 31, 2016, there is $2,102 in accrued interest expense related
to this note and the Company recorded $228 and $458 in interest expense related to this note during the three and six months ended
March 31, 2016.
Related
Party Convertible Notes Payable
On
December 10, 2015, the Company entered into two Secured Series B Preferred Stock Convertible Notes (the “Series B Notes”)
for an aggregate principal of $300,000 including 1) $50,000 from Hive Ceramics, LLC in new capital to the Company and 2) an amended
and restated note for Hive Ceramics LLC in the amount of $250,000 for capital previously contributed which is soon to be due and
payable.
The
Series B Notes accrue interest at eight percent (8%) per annum, mature one (1) year from issuance and are secured by all of the
assets and property of the Company. Upon the election of the noteholder, the Series B Notes are convertible into newly created
Series B Preferred Stock on a one-for-one (1:1) basis into shares of common stock of the Company at a fixed price per share of
$0.01.
Concurrently,
the Company filed a Certificate of Designation with the Delaware Secretary of State on the Series B Preferred Stock which provides,
in pertinent part, for the following rights and privileges:
Authorized
Amount of Series B Preferred Stock
: There are authorized 30,000,000 shares of Series B Preferred Stock, subject to the Certificate
of Designation. There shall be no additional Series B Shares authorized or issued.
Voting
Rights
: Each share of Series B shall be entitled to five (5) votes for every one (1) vote entitled to each share of Common
Stock.
Rank
:
All shares of Series B shall rank (i) senior to the Company’s Common Stock, (ii)
pari passu
with all other series
of preferred stock whether currently outstanding or hereafter created, including the Series A Preferred Stock, and specifically
ranking, by its terms, on par with Series B, and (iii) junior to any class or series of capital stock of the Company hereafter
created specifically ranking, by its terms, senior to the Series B, in each case as to the distribution of assets upon liquidation,
dissolution or winding up of the Company, whether voluntary or involuntary.
During
the three and six months ended March 31, 2016, the Company recorded $4,550 and $8,558 of interest expense related to the notes.
As of December 31, 2015, $300,000 of the Series B Notes along with $31,452 of accrued interest are outstanding. The Board of Directors
authorized the designation of the Series B Preferred Stock pursuant to the authority of the Certificate of Incorporation, which
confers said authority on the Board, and the issuance of the Series B Notes pursuant to a unanimous written consent of the Board
dated December 10, 2015. The value ascribed to the Series B Notes were based on the fixed conversion price of the instruments
into common stock and such no beneficial conversion feature was recorded.
NOTE
7. COMMITMENTS AND CONTINGENCIES
Office
Lease
As of March 31, 2016,
the Company leases a 2,500 square foot office in Agoura Hills, California for approximately $2,500 per month which expires in
December 2017.
Warrant
Liability
The Company recorded
the estimated settlement liability as of March 31, 2016 for the Warrant Shares issued and the Warrants that remain outstanding
and unexercised that would be entitled to the same settlement based on the number of shares expected to be issued and the market
price of the Company’s common stock on the dates of the actual settlements from $4.72 per share to $7.25 per share, and market
price of the first settlement of $7.25 for the unsettled claims. We believe the issuance of convertible notes in the three months
ended March 31, 2016 triggered the full ratchet anti-dilution adjustment; before the provision was triggered, the fair value of
the warrant liability was not significant as the exercise was so far out of the money. As a result of the above settlements with
warrant holders, the Company recorded a loss on settlement of warrants of $29,528,844 during the six months ended March 31, 2016
and a long-term warrant liability of $29,430,022 as of March 31, 2016 based on 4,407,200 shares of common stock under the settlement
at the Company’s closing stock prices discussed above. As of March 31, 2016, the estimated settlement liability is $7,422
based on the fair market value of 1,184,727 remaining warrants and therefore the Company recorded a gain (loss) on the change in
warrant liability of ($2,745) and $414,654, and $23,979 and 1,824,479 during the three and six months ended March 31, 2016 and
2015, respectively.
Settlement
of Company Legal Claims
On December 15, 2014, the
Company recorded a gain on settlement of $257,930 for a confidential settlement by and between the Company and certain shareholders
and related parties as settlement for certain potential legal claims held by the Company. As a result of the settlement, the Company
received net proceeds of $62,930 and vendor credits of $200,000 during the three months ended December 31, 2014. A total of $325,000
in vendor credits has been received in connection with the settlement and no further credits will be given. In January 2015, the
Company received 440,625 shares from the settlement that was assigned to officers of the Company. The officers decided it was
in the best interest of the Company to return these shares to the Company to be used for future strategic issuances. Accordingly,
the 440,625 shares valued at $367,531 were recorded as treasury stock as of March 31, 2015. The Company recorded a gain on settlement
of $0 and $367,531, and $0 and $625,461 during the three and six months ended March 31, 2016 and 2015, respectively.
NOTE
8. STOCKHOLDERS’ DEFICIT
COMMON
STOCK
On
November 27, 2013, the Board and shareholders approved an increase in the authorized number of shares of common and preferred
stock which may be issued by the Company to 1,000,000,000 shares and 100,000,000 shares, respectively. On December
3, 2013, the certificate of amendment was filed with the Secretary of State of Delaware to reflect the increase in authorized.
PREFERRED
STOCK
On
April 1, 2014, the Board formally approved the filing of a Preferred Stock Designation in connection with the commitment of 500,000
Series A Shares to HIVE on March 27, 2014 pursuant to its authority to issue blank check preferred stock as provided in the Company’s
Certificate of Incorporation. Per the Certificate of Designation (the “Designation”), there are 100,000,000
shares of preferred stock authorized by the Company’s Certificate of Incorporation. The Company is authorized to issue 500,000
shares of Series A Shares pursuant to the Designation. As provided in the Designation (and as set forth in the HIVE
Asset Purchase Agreement), Series A Shares are entitled to vote at a 15-1 ratio to Common Stock. Each share of preferred
stock shall initially be convertible into one share of common stock (500,000 shares of common stock in the aggregate). On
the two year anniversary of the transaction of HIVE, the preferred stock conversion ratio shall be adjusted as follows: a one-time
pro rata adjustment of up to ten-for-one (10-1) based upon the Company generating aggregate gross revenues over the two years
of at least $8,000,000 (e.g. If the Company generates only $4,000,000 in aggregate gross revenues over the two year period then
the convertible ratio will adjust to 5-1). In no event will the issuance convert into more than 5,000,000 shares of common
stock of the Company.
On
June 19, 2014, the Company formally issued the 500,000 Series A Shares to HIVE.
The
value ascribed to the Series A Shares was based on the historical costs of the assets acquired on March 27, 2014 from HIVE since
the transfer of assets was made among entities under common control.
On
December 10, 2015, the Company approved the filing of a Preferred Stock Designation for up to 30,000,000 shares of Series B Preferred
Stock. No Series B Preferred Stock are issued or outstanding. See discussion of designation of Series B Preferred Stock in Note
6.
COMMON
STOCK ISSUED FOR ACCRUED WAGES
On
October 22, 2015, the Company’s Board of Directors issued 2,083,333 shares of restricted common stock each to Kyle Tracey
at $0.024 per share for payment of $50,000 in accrued wages. On October 22, 2015, the Company’s Board of Directors issued
555,555 shares of restricted common stock each to Kyle Tracey at $0.024 per share for payment of $13,333 in accrued wages. On October
22, 2015, the Company’s Board of Directors issued 1,250,000 shares of restricted common stock each to Michael Cook at $0.024
per share for payment of $3,000 in accrued wages.
In February 2016,
Justin Braune elected to take $15,000 of wages as common stock. The shares will formally be issued once the debt conversions and
capital structure restrictions have been resolved.
On
March 31, 2016, the Company’s Board of Directors issued 250,000 shares of restricted common stock to Justin Braune at $0.01
per share for payment of $2,375 in accrued wages.
To
date, the Company has issued but not delivered 28,702,167 shares of common stock to Justin Braune in accrued wages.
COMMON
STOCK ISSUED FOR BONUSES
On
October 22, 2015, the Company’s Board of Directors issued bonus stock grants of 600,000 shares of restricted common stock
each to Allan Viernes and Benjamin Beaulieu at $0.024 per share. In addition, the Company issued 300,000 shares of restricted
common stock to employees at $0.024 per share. These issuances were based on the fair market value on the date of issuance immediately
vested and resulted in $36,000 being charged to general and administrative expense during the three months ended December 31,
2015.
On
October 22, 2015, the Company’s Board of Directors issued bonus stock grants of 1,250,000 shares of restricted common stock
an outside sales consultant at $0.024 per share. The issuance was based on the fair market value on the date of issuance immediately
vested and resulted in $30,000 being charged to sales and marketing expense during the three months ended December 31, 2015.
COMMON
STOCK ISSUED FOR SERVICES
On
November 25, 2015, the Company’s Board of Directors issued stock grants of 49,760 shares of restricted common stock a business
development consultant at $0.011 per share. These issuances were based on the fair market value on the date of issuance immediately
vested and resulted in $547 being charged to general and administrative expense during the three months ended December 31, 2015.
On
December 23, 2015, the Company’s Board of Directors issued stock grants of 142,857 shares of restricted common stock a business
development consultant at $0.008 per share. These issuances were based on the fair market value on the date of issuance immediately
vested and resulted in $1,143 being charged to general and administrative expense during the three months ended December 31, 2015.
COMMON
STOCK SURRENDERS
On
October 22, 2015, Joe Andreae surrendered 130,000 shares of restricted common stock valued at $3,120 and were recorded as treasury
stock. In addition, on October 22, 2015, an employee also surrendered 30,000 shares valued at $360, which was recorded as treasury
stock.
On
December 20, 2015, Kyle Tracey surrendered 130,000 shares of restricted common stock valued at $1,170 and were recorded as treasury
stock.
On
December 21, 2015, the Allan Viernes and Benjamin Beaulieu each surrendered 30,000 shares of restricted common stock valued at
$420, which was recorded as treasury stock.
EQUITY
INVESTMENT BY THE INVESTOR
On
December 10, 2015, the Investor purchased $90,000 in common stock at a purchase price equal to 90% of the average of the closing
prices of the common stock for the three (3) trading days immediately preceding the date that is 6 months from the date of the
agreement. As of December 31, 2015, proceeds of $90,000 have been recorded as common stock to be issued.
WARRANTS
The
table below summarizes the Company’s warrant activity during the six month period ended March 31, 2016:
|
|
Shares
|
|
|
Weighted Average
Price
|
|
|
Weighted Average Remaining Contractual Term
|
|
|
Aggregate Intrinsic
Value
|
|
Warrants outstanding at September 30, 2015
|
|
|
1,184,726
|
|
|
$
|
0.114
|
|
|
|
0.9
|
|
|
$
|
739,812
|
|
Warrants issued
|
|
|
-
|
|
|
|
-
|
|
|
|
|
|
|
|
|
|
Warrants exercised
|
|
|
-
|
|
|
|
-
|
|
|
|
|
|
|
|
|
|
Cancelled/forfeited/expired
|
|
|
-
|
|
|
|
-
|
|
|
|
|
|
|
|
|
|
Warrants outstanding at March 31, 2016
|
|
|
1,184,726
|
|
|
$
|
0.003
|
|
|
|
0.1
|
|
|
$
|
11,179
|
|
The
Company’s warrants above are accounted for as derivative liabilities in the accompanying consolidated balance sheets.
NOTE
9. INTELLECTUAL PROPERTY
The
Company plans to rely on a combination of trademark, copyright, trade secret and patent laws in the United States as well as confidentiality
procedures and contractual provisions to protect future proprietary technology and its brands, as they are developed. The
Company has begun to execute on this plan with the acquisition of the patent pending HIVE Ceramic vaporization product and the
HIVE trademark as well as several pending trademark applications. The Company intends to continue to create or acquire
proprietary vaporizers and e-cigarettes, and various trademarks, patents and/or copyrights for brands which are developed.
TRADEMARKS
On
March 27, 2014, the Company and Stone Arch Studio, LLC entered into a Trademark Assignment Agreement whereby the Company acquired
all right, title, priority and interest to the HIVE trademark U.S. Registration No. 44513069 as registered with the U.S. Patent
and Trade Office (“USPTO”). This acquisition further protects the Company’s HIVE Ceramics brand vaporization
line. In addition, the Company has filed for trademark protection with the USPTO on several additional trademarks and tradenames
to be utilized by the Company in the future as the marks register. As of March 31, 2016, the Company has capitalized $123,150
in costs related to the trademarks.
PATENTS
On
March 27, 2014, the Company formally closed its acquisition of the patent pending HIVE Ceramics vaporization technology. The Company
has already begun exploiting this technology and intends to prosecute the patent application to completion. As of March 31, 2016,
the Company has no patent costs capitalized.
The
Company is engaged in developing proprietary rights of the type that may be awarded patents for enhancements to its core HIVE
product line as well as proprietary rights in related product lines. The Company also expects that from time to time it is in
discussions to acquire additional patented technology from third parties to further grow and develop branded product lines in
the vaporization market. See Note 1 regarding BetterChem unwind and rights to related patents.
NOTE
10. SUBSEQUENT
EVENTS
See Note 5 regarding
subsequent conversions.