NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS (UNAUDITED)
NOTE 1 – BUSINESS ORGANIZATION, NATURE OF OPERATIONS
Business Description
Notis Global, Inc., (formerly Medbox, Inc.) which is incorporated
in the state of Nevada (the “Company”), provides specialized services to the hemp and marijuana industry, distributes
hemp product processed by contractual partners and through June 30, 2016, owned independently and through affiliates, real property
and licenses that it leased and assigned or sublicensed to partner cultivators and operators in return for a percentage of revenues
or profits from sales and operations (Note 5). Prior to 2016, through its consulting services, Company worked with clients who
sought to enter the medical and cultivation marijuana markets in those states where approved. In 2015, the Company expanded into
hemp cultivation with the acquisition of a 320 acre farm in Colorado by the Company’s wholly owned subsidiary, EWSD 1, LLC.
The farm was operated by an independent farming partner until the relationship was terminated in May 2016 (Note 3). In addition,
through its wholly owned subsidiary, Vaporfection International, Inc. (“VII”), the Company sold a line of vaporizer
and accessory products online and through distribution partners. On March 28, 2016, the Company sold the assets of VII and exited
the vaporizer and accessory business. The Company is headquartered in Los Angeles, California.
Effective January 28, 2016, the Company changed its legal corporate
name from Medbox, Inc., to Notis Global, Inc. The name change was effected through a parent/subsidiary short-form merger pursuant
to Section 92A.180 of the Nevada Revised Statutes. Notis Global, Inc., the Company’s wholly-owned Nevada subsidiary
formed solely for the purpose of the name change, was merged with and into the Company, with Notis Global, Inc. as the surviving
entity. The merger had the effect of amending the Company’s Certificate of Incorporation to reflect the new legal name of
the Company. There were no other changes to the Company’s Certificate of Incorporation. The Company’s Board of Directors
approved the merger.
Notis Global, Inc., operates the business directly and through the
utilization of 5 primary operating subsidiaries, as follows:
|
•
|
EWSD
I, LLC, a Delaware corporation that owns property in Colorado.
|
|
•
|
Pueblo
Agriculture Supply and Equipment, LLC, a Delaware corporation that was established to own extraction equipment
|
|
•
|
Prescription
Vending Machines, Inc., a California corporation, d/b/a Medicine Dispensing Systems in the State of California (“MDS”),
which previously distributed our Medbox
™
product and provided related consulting services.
|
|
•
|
Vaporfection
International, Inc., a Florida corporation through which we distributed our medical vaporizing products and accessories. (all
the assets of which were sold during the three months ended March 31, 2016, see Note 6)
|
|
•
|
Medbox
Property Investments, Inc., a California corporation specializing in real property acquisitions and leases for dispensaries and
cultivation centers. This corporation currently owns no real property.
|
|
•
|
MJ
Property Investments, Inc., a Washington corporation specializing in real property acquisitions and leases for dispensaries and
cultivation centers in the state of Washington.
|
|
•
|
San
Diego Sunrise, LLC, a California corporation to hold San Diego, California dispensary operations. (as of June 30, 2016, the
Company has sold its interest in San Diego Sunrise, LLC, see Note 5)
|
On March 3, 2014, in order to obtain the license for one of
the Company’s clients, the Company registered an affiliated nonprofit corporation Allied Patient Care, Inc., in the State
of Oregon. Additionally, on April 21, 2014, the Company registered an affiliated nonprofit corporation Alternative Health
Cooperative, Inc. in the State of California. As a result of our sale of the Sunset and Portland dispensaries and related rights
and assets, the Company no longer owns the rights to these nonprofit corporations. (Note 5)
On April 15, 2016, at a special meeting of the shareholders
of the Company, the shareholders of the Company holding a majority of the total shares of outstanding common stock of the Company
voted to amend the Company’s Articles of Incorporation to increase the number of authorized shares of common stock of the
Company from 400,000,000 to 10,000,000,000 (the “Certificate of Amendment”). The Certificate of Amendment was filed
with the Nevada Secretary of State and was declared effective on April 18, 2016.
NOTE 2 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Going Concern
The condensed consolidated financial statements were prepared on
a going concern basis. The going concern basis assumes that the Company will continue in operation for the foreseeable future and
will be able to realize its assets and discharge its liabilities in the normal course of business. During the six months ended
June 30, 2016, the Company had net income of approximately $7.8 million, negative cash flow from operations of $2.6 million and
negative working capital of $19.7 million. During the year ended December 31, 2015, the Company had a net loss of approximately
$50.5 million, negative cash flow from operations of $9.6 million and negative working capital of $32.9 million. The Company
will need to raise capital in order to fund its operations. The Company is also in the process of obtaining final approval on a
settlement agreement in their Class action and Derivative lawsuits (Note 11) and recently received a Wells Notice from the SEC
(Note 11) in connection with misstatements by prior management in the Company’s financial statements for 2012, 2013 and the
first three quarters of 2014. On September 22, 2016, the Company received notice of an Event of Default and Acceleration from one
of its lenders regarding a Promissory Note issued on March 14, 2016. The Company has negotiated a 30 day forbearance on acceleration
of the note. The Company is unable to predict the outcome of these matters, however, a rejection of the settlement agreements or
adverse action of the SEC or legal action taken by the Company’s lenders could have a material adverse effect on the financial
condition, results of operations and/or cash flows of the Company and their ability to raise funds in the future. These factors,
among others, raise substantial doubt about the Company’s ability to continue as a going concern. The ability to continue
as a going concern is dependent on the Company’s ability to raise additional capital and implement its business plan. The
condensed consolidated financial statements do not include any adjustments that might be necessary if the Company is unable to
continue as a going concern.
Management’s plans include:
The Company has received approximately $1,266,000, net
of approximately $40,000 in withholdings, in additional closings under the June 30, 2016 funding (Note 7), subsequent to
June 30, 2016. Additionally, on September 30, 2016, the Company entered into a securities purchase agreement with a new
investor pursuant to which two wholly-owned subsidiaries of the Company, EWSD I, LLC (“
EWSD I
”) and
Pueblo Agriculture Supply and Equipment, LLC (“
Pueblo
”, and together with EWSD I,
the “
Subsidiaries
”) agreed to jointly sell, and the Investor agreed to purchase, an aggregate of up
to $3,350,000 in subscription amount of discounted promissory notes (that could raise approximately $2,000,000 in cash, of
which the Company has already received approximately $650,000) (Note 12).
The Company also expects that the acquisition of EWSD I, LLC (“EWSD”)
(Note 3), who owns a 320-acre farm in Pueblo, Colorado, will generate recurring revenues for the Company through farming hemp,
extracting and selling CBD oil, and collecting fees from production related to extracting CBD oil for other farmers, while controlling
the full production cycle to ensure consistent quality. Lastly, management is actively seeking additional financing over the next
few months to fund operations.
The Company will continue to execute on its business model by attempting
to raise additional capital through the sales of debt or equity securities or other means. However, there is no guarantee
that such financing will be available on terms acceptable to the Company, or at all. It is uncertain whether the Company can obtain
financing to fund operating deficits until profitability is achieved. This need may be adversely impacted by: unavailability of
financing, uncertain market conditions, the success of the crop growing season, the demand for CBD oil, the ability of the Company
to obtain financing for the equipment and labor needed to cultivate hemp and extract the CBD oil,, and adverse operating results.
The outcome of these matters cannot be predicted at this time.
On May 24, 2016, the Company received a notice from the
OTC Markets Group, Inc. (“OTC Markets”) that the Company’s bid price is below $.01 and does not meet
the Standards for Continued Eligibility for OTCQB as per the OTCQB Standards. If the bid price has not closed at or above
$.01 for ten consecutive trading days by November 20, 2016, the Company will be moved to the OTC Pink marketplace.
Additionally, on September 9
th
, the Company received notice from the OTC that OTC Markets would move the
Company’s listing from the OTCQB market to OTC Pink Sheets market, if the Company had not filed this Quarterly Report
on Form 10-Q for the period ended June 30, 2016 by September 30, 2016. On or about October 1, 2016, the Company moved to the
OTC Pink Sheets market. These actions might also impact the Company's ability to obtain funding.
Principles of Consolidation
The condensed consolidated financial statements include the accounts
of Notis Global, Inc. and its wholly owned subsidiaries, as named in Note 1 above. All intercompany transactions have been eliminated
in consolidation.
Use of Estimates
The preparation of condensed consolidated financial statements in
conformity with accounting principles generally accepted in the United States of America requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent liabilities at the
date of the condensed consolidated financial statements as well as the reported expenses during the reporting periods. The Company’s
significant estimates and assumptions include accounts receivable and note receivable collectability, inventory reserves, advances
on investments, the valuation of restricted stock and warrants received from customers, the amortization and recoverability of
capitalized patent costs and useful lives and recoverability of long-lived assets, the derivative liability, and income tax expense.
Some of these judgments can be subjective and complex, and, consequently, actual results may differ from these estimates. Although
the Company believes that its estimates and assumptions are reasonable, they are based upon information available at the time the
estimates and assumptions were made. Actual results could differ from these estimates.
Reclassification
The Company has reclassified certain prior fiscal year amounts in
the accompanying condensed consolidated financial statements to be consistent with the current fiscal year presentation.
Concentrations of Credit Risk
The Company maintains cash balances at several financial institutions
in the Los Angeles, California area and Iowa. Accounts at each institution are insured by the Federal Deposit Insurance Corporation
up to $250,000. The Company has not experienced any losses in such accounts and periodically evaluates the credit worthiness of
the financial institutions and has determined the credit exposure to be negligible.
Advertising and Marketing Costs
Advertising and marketing costs are expensed as incurred. The Company
incurred advertising and marketing costs of approximately $0 and $319,000 for the three months ended June 30, 2016 and 2015, respectively
and approximately $0 and $749,000 for the six months ended June 30, 2016 and 2015, respectively.
Fair Value of Financial Instruments
Pursuant to ASC No. 825,
Financial Instruments
, the
Company is required to estimate the fair value of all financial instruments included on its balance sheets. The carrying value
of cash, accounts receivable, other receivables, inventory, accounts payable and accrued expenses, notes payable, related party
notes payable, customer deposits, provision for customer refunds and short term loans payable approximate their fair value due
to the short period to maturity of these instruments.
Embedded derivative - The Company’s convertible notes payable
include embedded features that require bifurcation due to a reset provision and are accounted for as a separate embedded derivative
(see Note 7).
As of December 31, 2015, and for new issuances of convertible debentures
during the fourth quarter of fiscal 2015, the Company estimated the fair value of the conversion feature derivatives embedded in
the convertible debentures based on a Monte Carlo Simulation model (“MCS”). The MCS model was used to simulate the
stock price of the Company from the valuation date through to the maturity date of the related debenture and to better estimate
the fair value of the derivative liability due to the complex nature of the convertible debentures and embedded instruments. Management
believes that the use of the MCS model compared to the black Scholes model as previously used would provide a better estimate of
the fair value of these instruments. Beginning in the fourth quarter of 2015, using the MCS model, the Company valued these embedded
derivatives using a “with-and-without method,” where the value of the Convertible Debentures including the embedded
derivatives, is defined as the “with”, and the value of the Convertible Debentures excluding the embedded derivatives,
is defined as the “without.” This method estimates the value of the embedded derivatives by observing the difference
between the value of the Convertible Debentures with the embedded derivatives and the value of the Convertible Debentures without
the embedded derivatives. The Company believes the “with-and-without method” results in a measurement that is more
representative of the fair value of the embedded derivatives.
For each simulation path, the Company used the Geometric Brownian
Motion (“GBM”) model to determine future stock prices at the maturity date. The inputs utilized in the application
of the GBM model included a starting stock price, an expected term of each debenture remaining from the valuation date to maturity,
an estimated volatility, and a risk-free rate.
For the six months ended June 30, 2016, the Company estimated the
fair value of the conversion feature derivatives embedded in the convertible debentures based on an internally calculated adjustment
to the MCS valuation determined at December 31, 2015. This adjustment took into consideration the changes in the assumptions,
such as market value and expected volatility of the Company’s common stock, and the discount rate used in the December 31,
2015 valuation as compared to June 30, 2016. The valuation also took into consideration the term in the
debentures which limits the amounts converted to not result in the investor owning more than 4.99% of the outstanding common stock
of the Company, after giving effect to the converted shares. The Company believes this methodology results in a reasonable fair
value of the embedded derivatives for the interim period.
For the six months ended June 30, 2015, the Company estimated the
fair value of the conversion feature derivatives embedded in the convertible debentures based on weighted probabilities of assumptions
used in the Black Scholes pricing model. The key valuation assumptions used consists, in part, of the price of the Company’s
common stock, a risk free interest rate based on the average yield of a Treasury note and expected volatility of the Company’s
common stock all as of the measurement dates, and the various estimated reset exercise prices weighted by probability.
Warrants
The Company reexamined the determination made as of December 31,
2015 that they did not have sufficient authorized shares available for all of their outstanding warrants to be classified in equity
at June 30, 2016, and concluded there still were insufficient authorized shares (Note 7). Therefore, the Company recognized a Warrant
liability as of June 30, 2016. The Company estimated the fair value of the warrant liability based on a Black Scholes valuation
model. The key assumptions used consist of the price of the Company’s stock, a risk free interest rate based on the average
yield of a two or three year Treasury note (based on remaining term of the related warrants), and expected volatility of the Company’s
common stock over the remaining life of the warrants.
A three-tier fair value hierarchy is used to prioritize the inputs
in measuring fair value as follows:
|
Level 1
|
Quoted prices in active markets for identical assets or
liabilities.
|
|
Level 2
|
Quoted prices for similar assets or liabilities in active
markets, quoted prices for identical or similar assets or liabilities in markets that are not active, or other inputs that are
observable, either directly or indirectly.
|
|
Level 3
|
Significant unobservable inputs that cannot be corroborated
by market data.
|
The assets or liabilities’ fair value measurement within the
fair value hierarchy is based upon the lowest level of any input that is significant to the fair value measurement. The following table
provides a summary of the relevant assets and liabilities that are measured at fair value on a recurring basis:
|
|
Total
|
|
|
Quoted Prices
in Active
Markets for
Identical
Assets or
Liabilities
(Level 1)
|
|
|
Quoted Prices
for Similar
Assets or
Liabilities in
Active
Markets
(Level 2)
|
|
|
Significant
Unobservable
Inputs
(Level 3)
|
|
June 30, 2016
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Marketable securities
|
|
$
|
28,390
|
|
|
$
|
10,825
|
|
|
$
|
—
|
|
|
$
|
17,565
|
|
Total assets
|
|
$
|
28,390
|
|
|
$
|
10,825
|
|
|
$
|
—
|
|
|
$
|
17,565
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Warrant liability
|
|
|
5,552
|
|
|
|
|
|
|
|
|
|
|
|
5,552
|
|
Derivative liability
|
|
|
2,159,066
|
|
|
|
—
|
|
|
|
—
|
|
|
|
2,159,066
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total liabilities
|
|
$
|
2,164,618
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
2,164,618
|
|
|
|
Total
|
|
|
Quoted Prices
in Active
Markets for
Identical
Assets or
Liabilities
(Level 1)
|
|
|
Quoted Prices
for Similar
Assets or
Liabilities in
Active
Markets
(Level 2)
|
|
|
Significant
Unobservable
Inputs
(Level 3)
|
|
December 31, 2015
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Marketable securities
|
|
$
|
9,410
|
|
|
$
|
5,629
|
|
|
$
|
|
|
|
$
|
3,781
|
|
Total assets
|
|
$
|
9,410
|
|
|
$
|
5,629
|
|
|
$
|
—
|
|
|
$
|
3,781
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Warrant liability
|
|
|
940,000
|
|
|
|
|
|
|
|
|
|
|
|
940,000
|
|
Derivative liability
|
|
|
19,246,594
|
|
|
|
—
|
|
|
|
—
|
|
|
|
19,246,594
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total liabilities
|
|
$
|
20,186,594
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
20,186,594
|
|
The following table sets forth a summary of the changes in the fair
value of the Company’s Level 3 financial liabilities that are measured at fair value on a recurring basis:
|
|
For the six
months ended
June 30, 2016
|
|
|
|
Total
|
|
Beginning balance
|
|
$
|
20,186,594
|
|
Initial recognition of conversion feature
|
|
|
4,932,162
|
|
Change in fair value of conversion feature
|
|
|
(18,819,893
|
)
|
Reclassified to equity upon conversion
|
|
|
(3,199,797
|
)
|
Additions to warrant liability
|
|
|
62,673
|
|
Change in fair value of warrant liability
|
|
|
(997,121
|
)
|
|
|
|
|
|
Ending Balance
|
|
$
|
2,164,618
|
|
Revenue Recognition
Prior to 2015, the Company entered into transactions with clients
who are interested in being granted the right to have the Company engage exclusively with them in certain territories (which are
described as territory rights) to obtain the necessary licenses to operate a dispensary or cultivation center for the location,
and to consult in daily operations of the dispensary or cultivation center.
Terms for each transaction are varied and, prior to 2015, sales
arrangements typically included the delivery of our dispensing technology and dispensary location build-out and/or consultation
on the location, licensing, build out and operation of a cultivation center. Prior to 2015, the Company’s standard contracts
had a five year term, calling for an upfront, non-refundable consulting fee, and containing options including acquiring a Medbox
dispensary machine and having the Company perform the build-outs for the location, at set prices. The up-front fees under these
contracts are recognized over the five year term, and are included in deferred revenue. The Company has determined these optional
purchases each constituted a separate purchasing decision, and therefore are considered a separate arrangement for revenue recognition
purposes. Revenue on each of these options are evaluated for recognition when and if the customer decides to enter into the arrangement.
In 2015 and the first quarter of 2016, the Company concentrated
on revenue generating transactions to develop and set up dispensaries, including obtaining the conditional use permits (“CUP”)
that grant the dispensary the authorization to operate, as well as cultivation centers. The Company entered into joint ventures
and operating agreements, whereby separate unrelated party controls the operations of the dispensary or cultivation center, and
the Company receives an agreed upon percentage of the revenue or profits of the operating entity. The revenue in the second quarter
of 2016 consisted mainly of the recognition of previously deferred revenue and the sale of CBD oil.
Based on these contracts, and other auxiliary agreements, our revenue
model consisted of the following income streams:
Consulting fee revenues and build-outs
Prior to 2015, consulting fee revenues were a consistent component
of our revenues and were negotiated at the time the Company entered into a contract. Consulting revenue consisted of providing
ongoing consulting services over the life of the contract, to the established business in the areas of regulatory compliance, security,
operations and other matters to operate the dispensary. The majority of the consulting fees from prior to 2015 arose from the upfront,
non-refundable consulting fee in the Company’s standard contract, and were recognized using the straight line method over
the life of the contract. Consulting fee revenue is only recognized when the following four criteria are met: 1) persuasive evidence
of an arrangement exists, 2) delivery has occurred or services have been rendered, 3) sales price is fixed and determinable and
4) collectability is reasonably assured. Consulting fee revenue continues to be recognized in our income statement over the life
of the aforementioned contracts.
Due to the uncertainties inherent in the emerging industry, the
Company deferred recognition of revenue for sale of completed dispensaries with licenses until the issuance of a certificate of
occupancy by the municipality. The certificate of occupancy is the final approval to open a dispensary in the customer’s
community, at which time all criteria for revenue recognition, including delivery and acceptance, has been met. Additionally, at
the time of the issuance of the certificate of occupancy, under the contract terms, all payments owed by the customer have been
received by the Company. Similarly, recognition of revenue for the sale of a completed cultivation center is deferred until all
licensing and permitting is completed and approved.
Revenues from Operating Agreements
Under the foregoing business model, the Company entered into operating
agreements with independent parties, giving the operator the rights to control the operations of a dispensary or cultivation center
during the term of the agreement. In exchange, the Company earns a fee based on a percentage of the revenue or profit of the
dispensary or cultivation center. The Company has determined they are not the principal in the revenue sharing agreements
and recognizes revenue under these agreements on a net basis as the fees are earned and it has been concluded that collectability
is reasonably assured.
Revenues from Cannabidiol oil product
The Company recognizes revenue from the sale of Cannabidiol oil
products ("CBD oil") upon shipment when title passes and when collectability is reasonably assured.
Cost of Revenue
Cost of revenue consists primarily of expenses associated with the
delivery and distribution of our products and services. Under our prior business model, we only began capitalizing costs when
we have obtained a license and a site for operation of a customer dispensary or cultivation center. The previously capitalized
costs are charged to cost of revenue in the same period that the associated revenue is earned. In the case where it is determined
that previously inventoried costs are in excess of the projected net realizable value of the sale of the licenses, then the excess
cost above net realizable value is written off to cost of revenues. Cost of revenues also includes the rent expense on master
leases held in the Company’s name, which are subleased to the Company’s operators. In addition, cost of revenue
related to our vaporizer line of products consists of direct procurement cost of the products along with costs associated with
order fulfillment, shipping, inventory storage and inventory management costs.
Inventory
Inventory is stated at the lower of cost or market value. Cost is
determined on a cost basis that approximates the first-in, first-out (FIFO) method.
Capitalized agricultural costs
Pre-harvest agricultural costs, including irrigation, fertilization,
seeding, laboring, and other ongoing crop and land maintenance activities, are accumulated and capitalized as inventory and cease
to be accumulated when the crops reach maturity and is ready to be harvested. All costs incurred subsequent to the crops reaching
maturity will be expensed as incurred. The Company has reflected the capitalized agriculture costs as a current asset
as the growing cycle of the crops are estimated to be approximately six months.
Basic and Diluted Net Loss Per Share
Basic net income/loss per share is computed by dividing net income
(loss) available to common stockholders by the weighted average number of shares of common stock outstanding during the period.
The Company did not consider any potential common shares in the computation of diluted loss per share for the three and six months
ending June 30, 2016 and 2015, due to the net loss, as they would have an anti-dilutive effect on EPS.
As of March 31, 2015, the Company had 3,000,000 shares of Series
A preferred stock outstanding with par value of $0.001 that could have been converted into 15,000,000 shares of the Company’s
common stock. On August 24, 2015, 2,000,000 shares of Series A preferred stock were cancelled, leaving 1,000,000
shares outstanding, which were converted into common shares on November 16, 2015. There were no shares of Series A preferred
stock outstanding at June 30, 2016. Additionally, the Company had approximately 67,466,000 and 338,000 warrants to purchase common
stock outstanding as of June 30, 2016 and 2015, respectively, which were not included in the computation of diluted loss per share,
as based on their exercise prices they would all have an anti-dilutive effect on net loss per share. The Company also had outstanding
at June 30, 2016 and 2015 approximately $7,309,000 and $4,656,000 in convertible debentures, respectively, that are convertible
at the holders’ option at a conversion price of the lower of $0.75 or 51% to 60% of either the lowest trading price or the
VWAP over the last 20 to 30 days prior to conversion (subject to reset upon a future dilutive financing), whose underlying shares
were not included in a computation of diluted loss per share due to the net loss.
Accounts Receivable and Allowance for Bad Debts
The Company is subject to credit risk as it extends credit to our
customers for work performed as specified in individual contracts. The Company extends credit to its customers, mostly on an unsecured
basis after performing certain credit analyses. Prior to 2015, our typical terms required the customer to pay a portion of
the contract price up front and the rest upon certain agreed milestones. The Company’s management periodically reviews the
creditworthiness of its customers and provides for probable uncollectible amounts through a charge to operations and a credit to
an allowance for doubtful accounts based on our assessment of the current status of individual accounts. Accounts still outstanding
after the Company has used reasonable collection efforts are written off through a charge to the allowance for doubtful accounts.
As of June 30, 2016, the Company’s management considered all accounts outstanding fully collectible.
Property and Equipment
Property and equipment are recorded at cost. Expenditures for major
additions and improvements are capitalized and minor replacements, maintenance, and repairs are charged to expense as incurred.
When property and equipment are retired or otherwise disposed of, the cost and accumulated depreciation are removed from the accounts
and any resulting gain or loss is included in the results of operations for the respective period. Depreciation is provided
over the estimated useful lives of the related assets using the straight-line method for financial statement purposes. The Company
uses accelerated depreciation methods for tax purposes where appropriate. The estimated useful lives for significant property
and equipment categories are as follows:
Vehicles
|
|
5 years
|
Furniture and Fixtures
|
|
3 - 5 years
|
Office equipment
|
|
3 years
|
Machinery
|
|
2 years
|
Buildings
|
|
10 - 39 years
|
Income Taxes
The Company accounts for income taxes under the asset and liability
method. The Company recognizes deferred tax liabilities and assets for the expected future tax consequences of events that
have been included in the consolidated financial statements or tax returns. Under this method, deferred tax liabilities and assets
are determined based on the difference between the financial statement and tax bases of assets and liabilities using enacted tax
rates in effect for the year in which the differences are expected to reverse. The components of the deferred tax assets and
liabilities are classified as current and non-current based on their characteristics. A valuation allowance is provided for
certain deferred tax assets if it is more likely than not that the Company will not realize tax assets through future operations.
In addition, the Company’s management performs an evaluation
of all uncertain income tax positions taken or expected to be taken in the course of preparing the Company’s income tax returns
to determine whether the income tax positions meet a “more likely than not” standard of being sustained under examination
by the applicable taxing authorities. This evaluation is required to be performed for all open tax years, as defined by the
various statutes of limitations, for federal and state purposes.
Commitments and Contingencies
Certain conditions may exist as of the date the consolidated financial
statements are issued, which may result in a loss to the Company but which will only be resolved when one or more future events
occur or fail to occur. The Company’s management and its legal counsel assess such contingent liabilities, and such
assessment inherently involves an exercise of judgment. In assessing loss contingencies related to legal proceedings that
are pending against the Company or unasserted claims that may result in such proceedings, the Company’s legal counsel evaluates
the perceived merits of any legal proceedings or unasserted claims as well as the perceived merits of the amount of relief sought
or expected to be sought therein.
If the assessment of a contingency indicates that it is probable
that a material loss has been incurred and the amount of the liability can be estimated, then the estimated liability would be
accrued in the Company’s consolidated financial statements. If the assessment indicates that a potentially material
loss contingency is not probable, but is reasonably possible, or is probable but cannot be estimated, then the nature of the contingent
liability, together with an estimate of the range of possible loss if determinable and material, would be disclosed.
Loss contingencies considered remote are generally not disclosed
unless they involve guarantees, in which case the nature of the guarantee would be disclosed.
The Company accrues all legal costs expected to be incurred per
event. For legal matters covered by insurance, the Company accrues all legal costs expected to be incurred per event up to the
amount of the deductible.
Recent Accounting Pronouncements
In May 2014, the Financial Accounting Standards Board (“FASB”)
issued Accounting Standards Update (“ASU”) No. 2014-09, “Revenue from Contracts with Customers,” which
requires an entity to recognize the amount of revenue to which it expects to be entitled for the transfer of promised goods or
services to customers. ASU 2014-09 will replace most existing revenue recognition guidance in U.S. GAAP when it becomes effective.
The new standard is effective for annual reporting periods for public business entities beginning after December 15, 2017,
including interim periods within that reporting period. The new standard permits the use of either the retrospective or cumulative
effect transition method. The Company is currently evaluating the effect that ASU 2014-09 will have on its financial statements
and related disclosures. The Company has not yet selected a transition method nor determined the effect of the standard on its
ongoing financial reporting.
On July 22, 2015, the Financial Accounting Standards Board
(“FASB”) issued a new standard that requires entities to measure most inventory “at the lower of cost and net
realizable value,” thereby simplifying the current guidance under which an entity must measure inventory at the lower of
cost or market. The new standard will not apply to inventories that are measured by using either the last-in, first-out (LIFO)
method or the retail inventory method. The new standard will be effective for fiscal years beginning after December 15, 2016,
and interim periods in fiscal years beginning after December 15, 2016. The Company is in the process of evaluating the impact
of adoption on its consolidated financial statements.
In April 2015, the FASB issued a new standard that requires
an entity to determine whether a cloud computing arrangement contains a software license. If the arrangement contains a software
license, the entity would account for the fees related to the software license element in a manner consistent with how the acquisition
of other software licenses is accounted for. If the arrangement does not contain a software license, the customer would account
for the arrangement as a service contract. The new standard will be effective for fiscal years beginning after December 15,
2015, and interim periods in fiscal years beginning after December 15, 2016. The Company is in the process of evaluating the
impact of adoption on its consolidated financial statements.
In February 2016, the FASB issued “Leases (Topic 842)”
(ASU 2016-02). This update amends leasing accounting requirements. The most significant change will result in the recognition of
lease assets and lease liabilities by lessees for those leases classified as operating leases under current guidance. The new guidance
will also require significant additional disclosures about the amount, timing and uncertainty of cash flows from leases. ASU 2016-02
is effective for fiscal years and interim periods beginning after December 15, 2018, which for the Company is December 31,
2018, the first day of its 2019 fiscal year. Upon adoption, entities are required to recognize and measure leases at the beginning
of the earliest period presented using a modified retrospective approach. Early adoption is permitted, and a number of optional
practical expedients may be elected to simplify the impact of adoption. The Company is currently evaluating the impact of adopting
this guidance. The overall impact is that assets and liabilities arising from leases are expected to increase based on the present
value of remaining estimated lease payments at the time of adoption.
In March 2016, the FASB issued ASU 2016-09,
Improvements
to Employee Share-Based Payment Accounting
, which amends Accounting Standards Codification ("ASC") Topic 718,
Compensation
– Stock Compensation
. ASU 2016-09 simplifies several aspects of the accounting for share-based payment transactions,
including the income tax consequences, classification of awards as either equity or liabilities, and classification on the statement
of cash flows. ASU 2016-09 is effective for fiscal years beginning after December 15, 2016, and interim periods within those
fiscal years and early adoption is permitted. The Company is in the process of evaluating the impact of adoption on its consolidated
financial statements.
Management’s Evaluation of Subsequent Events
The Company evaluates events that have occurred after the balance
sheet date of June 30, 2016, through the date which the condensed consolidated financial statements were issued. Based upon the
review, other than described in Note 12 – Subsequent Events, the Company did not identify any recognized or non-recognized
subsequent events that would have required adjustment or disclosure in the condensed consolidated financial statements.
NOTE 3 – ASSET ACQUISITION
On July 24, 2015, the Company entered into an Agreement of
Purchase and Sale of Membership Interest (the “Acquisition Agreement”) with East West Secured Development, LLC (the
“Seller”) to purchase 100% of the membership interest of EWSD I, LLC (“EWSD”) which has entered into an
agreement with Southwest Farms, Inc. (“Southwest”) to purchase certain real property comprised of 320-acres of agricultural
land in Pueblo, Colorado (the “Acquired Property” or “the Farm”).
The purchase price to acquire EWSD consisted of (i) $500,000
paid by the Company as a deposit into the escrow for the Acquired Property, and (ii) the Company’s future payments to
Seller of a royalty of 3% of the adjusted gross revenue, if any, from operation of the Acquired Property (including sale of any
portion of or interest in the Acquired Property less any applicable expenses) for the three-year period beginning on January 1,
2016. Such royalty payments shall be payable 50% in cash and 50% in Company common stock (the “Royalty Payment”). The
Company determined that the royalty payments could not be estimated at the time of acquisition, and, therefore, the contingent
payments have not been recognized as part of the acquisition price. The contingent consideration will be re-measured to fair value
each subsequent period until the contingency is resolved, in this case, for the three year period beginning on January 1,
2016, with any changes in fair value recognized in earnings. Per the terms of the agreement, the closing is deemed to have occurred
when the Special Warranty Deed is recorded (which occurred on August 7, 2015) and all terms of the purchase agreement for
the Farm have been complied with, including the Farm closing, which also took place on August 7, 2015. Therefore, the acquisition
date has been determined to be August 7, 2015. There were no assets or liabilities of EWSD on the acquisition date.
In connection with EWSD’s purchase of the Acquired Property,
EWSD entered into a secured promissory note (the “Note”) with Southwest in the principal amount of $3,670,000 (Note
8). Interest on the outstanding principal balance of the Note shall accrue at the rate of five percent per annum. The Note
shall be payable by EWSD in thirty-five payments of principal and interest, which shall be calculated based upon an amortization
period of thirty years, commencing on September 1, 2015 and continuing thereafter on the first day of each calendar month
through and including July 1, 2018; and one final balloon payment of all unpaid principal and accrued but unpaid interest
on August 1, 2018. The Note is secured by a deed of trust, security agreement, assignment of rents and financing statement
encumbering the Acquired Property.
EWSD also entered into an unsecured promissory note (the “Unsecured
Note”) in the principal amount of $830,000 with the Seller (Note 8), in respect of payments previously made by Seller
to Southwest in connection with acquiring the Farm. Interest on the outstanding principal balance of the Unsecured Note shall accrue
at the rate of six percent per annum. The Unsecured Note shall be payable by EWSD in thirty-five payments of principal and
interest, which shall be calculated based upon an amortization period of thirty years, commencing on September 1, 2015 and
continuing thereafter on the first day of each calendar month through and including July 1, 2018; and one final balloon payment
of all unpaid principal and accrued but unpaid interest on August 1, 2018.
Farming Agreement
On December 18, 2015, the Company and its subsidiary EWSD I,
LLC (“EWSD”), entered into a Farming Agreement (the “Farming Agreement”) with Whole Hemp Company (“Whole
Hemp” now known as “Folium Biosciences”), pursuant to which Folium Biosciences would manufacture products from
hemp and cannabis crops it would grow on EWSD farmland, and the Company would build greenhouses for such activities up to an aggregate
size of 200,000 square feet. Folium Biosciences would pay all preapproved costs of such construction on or before September 30,
2017 as partial consideration for a revocable license to use the greenhouses and a separate 10 acre plot of EWSD farmland (the
“10 Acres”). EWSD would retain ownership of the greenhouses. For the first growing season commencing October 1,
2016, the Company would receive a percentage of gross sales of all Folium Bioscience's products on a monthly basis, and the Company’s
share would increase incrementally based on the extent of crops planted on EWSD farmland according to a mutually agreed schedule.
In addition, the Company would receive 50% of Folium Biosciences gross profits from the farming activities on the 10 Acres. The
Company planned to recognize all revenue from the Farming Agreement at the net amount received when it has been earned and determined
collectable.
Pursuant to the Farming Agreement, the Company also granted Folium
Biosciences a warrant to purchase 4,000,000 shares of Company common stock at an exercise price of $0.50 per share, exercisable
at any time within 5 years. The warrants were valued at $76,000, using a Black Scholes Merton Model, with key valuation assumptions
used that consist of the price of the Company’s stock at settlement date, a risk free interest rate based on the average
yield of a 5 year Treasury note and expected volatility of the Company’s common stock all as of the measurement date. The
fair value of the warrants is included in deferred costs and will be recognized over the life of the Farming Agreement. Due to
the termination of the Farming and Growers Distribution Agreements, as discussed below, as of June 30, 2016, this amount has been
fully amortized.
On March 11, 2016, the Company and EWSD entered into a First
Amended and Restated Farming Agreement with Whole Hemp, amending and restating in certain respects the Farming Agreement. The First
Amended and Restated Farming Agreement clarifies that EWSD, rather than the Company, would be responsible for the building of greenhouses
to be utilized by Whole Hemp for growing hemp and cannabis crops pursuant to the agreement, and that EWSD would be the recipient
of all payments by Whole Hemp (including all revenue sharing arrangements) under the agreement.
On or about May 7, 2016, the Company determined that Folium
Biosciences was in default of the Farming Agreement, principally because they abandoned their obligation to provide farming activities
under the First Amended and Restated Farming Agreement. On May 13, 2016, EWSD notified Folium Biosciences of its defaults
under the First Amended and Restated Farming Agreement and EWSD’s election to terminate the First Amended and Restated Farming
Agreement.
By its terms, the First Amended and Restated Farming Agreement may
be terminated at any time by either party, if the other party was in material breach of any obligation under the First Amended
and Restated Farming Agreement, which breach continued uncured for 30 days following written notice thereof.
On June 1, 2016, a complaint was filed by Whole Hemp on this matter,
naming Notis Global, Inc. and EWSD I, LLC, as defendants. See Whole Hemp Complaint, below.
Growers’ Distributor Agreement
On December 18, 2015, the Company also entered into a Growers’
Agent Agreement with Folium Biosciences, which was amended on March 11, 2016, to change the name of the agreement to Growers’
Distributor Agreement, (“Distributor Agreement”) as well clarify some terms. Pursuant to the Distributor Agreement,
the Company would provide marketing, sales, and related services on behalf of Folium Biosciences in connection with the sale of
its Cannabidiol oil product ("CBD oil"), from which the Company would receive a percentage of gross revenues (other than
the sale of such product generated from the EWSD 10 Acres and the Folium Biosciences 40 acre plot subject to the Farming Agreement).
The Growers’ Agent Agreement was effective until September 30, 2025. The Company would sell the product on behalf of Folium
Biosciences on a commission basis. The Company may not act as agent of any other grower, distributor or manufacturer of the same
product unless such other party agrees.
On March 11, 2016, the Company and EWSD entered into a First
Amended and Restated Grower’s Distributor Agreement with Whole Hemp, amending and restating in certain respects the Grower’s
Agent Agreement, including by substituting EWSD as a party in-place of the Company.
Because the Company believes Folium Biosciences is in default, principally
because they abandoned their obligation to provide farming activities under the First Amended and Restated Farming Agreement since
May 7, 2016, EWSD notified Whole Hemp on May 13, 2016 of its election to terminate the Restated Grower’s Distributor
Agreement.
By its terms, the Restated Grower’s Distributor Agreement
could be terminated at any time by either party, if the other party was in material breach of any obligation under the Restated
Grower’s Distributor Agreement, which breach continued uncured for 30 days following written notice thereof.
As the Company continued to navigate the nascent world of hemp and
CBD growing, cultivation, production and sales, it became clear that controlling all aspects of the business is the best strategy
to ensure that the Company’s goals are met. Again, the Company is taking action now to protect the investment all the stakeholders
have made in Notis Global.
Whole Hemp complaint
A complaint was filed by Whole Hemp Company, LLC d/b/a Folium Biosciences
(“Whole Hemp”) on June 1, 2016, naming Notis Global, Inc. and EWSD I, LLC (collectively, “Notis”), as defendants
in Pueblo County, CO district court. The complaint alleges five causes of action against Notis: misappropriation of
trade secrets, civil theft, intentional interference with prospective business advantage, civil conspiracy, and breach of contract.
All claims concern contracts between Whole Hemp and Notis for the Farming Agreement and the Distributor Agreement.
The court entered an
ex parte
temporary restraining order
on June 2, 2016, and a modified temporary restraining order on July 14, 2016, enjoining Notis from disclosing, using, copying,
conveying, transferring, or transmitting Whole Hemp’s trade secrets, including Whole Hemp’s plants. On June 13,
2016, the court ordered that all claims be submitted to arbitration, except for the disposition of the temporary restraining order.
On August 12, 2016, the court ordered that all of Whole Hemp’s
plants in Notis’ possession be destroyed, which occurred by August 24, 2016, at which time the temporary restraining order
was dissolved and the parties will soon file a motion to dismiss the district court action.
In light of the Whole Hemp plants all being destroyed per the court
order, the Company has immediately expensed all Capitalized agricultural costs as of June 30, 2016, as all costs as of that date
related to Whole Hemp plants.
Notis commenced arbitration in Denver, CO on August 2, 2016, seeking
injunctive relief and alleging breaches of the contracts between the parties. Whole Hemp filed is Answer and counterclaims
on September 6, 2016, asserting similar allegations that were asserted to the court.
On September 30, 2016, the arbitrator held an initial status conference
and agreed to allow EWSD and Notis to file a motion to dismiss some or all of Whole Hemp’s claims by no later than October
28, 2016. The parties were also ordered to make initial disclosures of relevant documents and persons with knowledge of relevant
information by October 21, 2016.
NOTE 4 – INVENTORY
Inventory is stated at the lower of cost or market value. Cost
is determined on a standard cost basis that approximates the first-in, first-out (FIFO) method.
Inventory at June 30, 2016 and December 31, 2015 consists of the
following:
|
|
June 30, 2016
|
|
|
December 31, 2015
|
|
Vaporizers and accessories
|
|
$
|
—
|
|
|
$
|
81,934
|
|
CBD Oil
|
|
|
32,300
|
|
|
|
35,889
|
|
Light Bulbs for cultivation centers
|
|
|
—
|
|
|
|
33,000
|
|
|
|
|
|
|
|
|
|
|
Total inventory, net
|
|
$
|
32,300
|
|
|
$
|
150,823
|
|
The Company did not write down any slow moving or obsolete
inventory during the six months ended June 30, 2016 and 2015.
NOTE 5 – DISPENSARIES
Portland
The Company held a license to operate a dispensary in Portland,
Oregon, and a master lease on the property in which the dispensary is located. In April 2015, the Company entered into an
Operating Agreement (“Original Agreement”) with an unrelated party (the “Operator”) in which the Operator
was to manage and operate the Dispensary. The Original Agreement also included an annual Licensor Fee of 5% of the annual Gross
Revenues, which would have begun after the additional fees related to the startup of the new venture had been paid in full.
On December 3, 2015 the Company replaced the original operator
of the Portland dispensary with another operator under a new Operator Agreement (the “Agreement”). Per the terms of
the Agreement, the Dispensary was “under the exclusive supervision and control of Operator, which shall be responsible for
the proper and efficient operation of the Dispensary”. The term of the Agreement includes an initial term of five years,
and a renewal term for an additional five years. The renewal term is at the discretion of the Operator. There is a License fee,
which is based on a flat 10% of Gross Revenues. The Company’s management has determined that under this Agreement they
do not hold the controlling financial interest in the Dispensary and are not the primary beneficiary, and therefore did not consolidate
the Dispensary in their consolidated financial statements.
On June 30, 2016, the Company entered into an Assignment Agreement
whereby they sold and assigned all of its rights in the Operating Agreement, including but not limited to the assets and liabilities
the Company held in relation to the Portland Dispensary, including the license to operate a dispensary in Portland, Oregon. The
assets consisted mainly of tenant improvements and other capitalized costs incurred in connection with the Portland dispensary,
categorized as Deferred Costs on the Company's Balance Sheet, at a carrying value of approximately $270,000. The gross consideration
paid for the assets and liabilities as stated in the agreement was $150,000, with approximately $58,000 of this amount paid to
the State of Oregon for outstanding sales taxes, resulting in net proceeds of approximately $92,000, providing for a net loss of
$178,000 on sale of assets.
Sunrise Property Investments, LLC
On December 3, 2015, the Company entered into an Operating
Agreement with PSM Investment Group, LLC (“PSM”), for the governance of Sunrise Property Investments, LLC (“Sunrise”). Pursuant
to the agreement, each of the two members contributed 50% of the capital of Sunrise. The Company’s contribution to the investment
was the conditional use permit for the location, which was determined to have a zero cost basis, based on its carrying value in
the Company’s financial statements. Sunrise acquired the property on which a dispensary will be located in San Diego on December 31,
2015. The Company has determined it should not consolidate the financial position and results of operations in its consolidated
financial statements as it does not hold greater than 50% voting interest or is able to exercise influence over the operations
and management in Sunrise. Instead, the Company accounts for Sunrise as an equity method investment. No income or loss has been
recognized from Sunrise for the year ending December 31, 2015.
Alternative Health Cooperative, Inc. (“Alternative”)
is a not-for-profit corporation, managed by an employee of Notis Global, which holds the conditional user permit (“CUP”)
to run the dispensary. On January 1, 2016, Sunrise entered into an Operator Agreement with Alternative for Sunrise to
operate the dispensary located on the Sunrise property. The Operator Agreement engages Sunrise to “supervise, direct
and control the management of the dispensary”. The Agreement also states that the operation of the dispensary shall
be under the exclusive supervision and control of Sunrise which shall be responsible for the proper and efficient operation of
the dispensary. The Company had determined that under the operating agreement neither it nor Alternative hold the controlling
financial interest in the dispensary, but that Sunrise is the controlling entity. Therefore, the Company did not consolidate
the dispensary in its consolidated financial statements.
The Company incorporated a new wholly owned subsidiary, San Diego
Sunrise, LLC (“San Diego Sunrise”), on February 22, 2016, in order to enter into a partnership agreement with
PSM Investments to create an entity which would control the dispensary operations. Thereafter, Sunrise Dispensary LLC (“Dispensary”)
was incorporated by PSM Investments and San Diego Sunrise on February 24, 2016, with each party holding a 50% ownership interest
in the new entity. Immediately after which, Sunrise assigned the Operating Agreement with Alternative to Dispensary. The Company
therefore indirectly held a 50% interest in the Sunrise Dispensary, through its subsidiary, San Diego Sunrise.
In February 2016, the Company sold 70% of its ownership interest
in San Diego Sunrise for approximately $299,000. As of June 30, 2016, the Company owned 50% of Sunrise and 30% of San
Diego Sunrise. These investments are accounted for under the equity method, with the Company’s proportionate share of
the income or losses of the investments reflected in the Company’s financial statements. There has been no activity,
aside from the sale of the Company’s ownership interests, in these investees as of, and for the three months ended, June
30, 2016.
On April 6, 2016, the Company sold its remaining 30% interest in
San Diego Sunrise, as well as all of its interest in Sunrise Property Investments, LLC, the entity that owns underlying real estate
related to the San Diego dispensary, for net proceeds of $331,000.
Sunrise Delivery
On November 24, 2015, the Company entered into a Management
Agreement (“the Agreement”) with Rise Industries (“the Operator”) for a delivery service to be called Sunrise
Delivery, operating under the conditional use permit awarded to the Sunrise Dispensary. The delivery service began operations
on December 19, 2015 and, due to the short period between commencement of operations and the year end, the results of operations
were not material for the year ended December 31, 2015.
Under the Agreement, the Operator is fully and solely responsible
to collect all revenue and pay all expenses arising from the delivery service, including acquisition of inventory. The Company’s
name is not being used in connection with any advertising, marketing, product or delivery services provided by the Operator. The
Company determined that under the Agreement they do not hold the controlling financial interest in the delivery service and the
Operator is the controlling entity. Therefore, the Company did not consolidate Sunrise Delivery in their financial statements. The
Company also evaluated whether the revenue earned from the delivery service should be recognized at the gross or net amount. As
the Company meets the three indicators of being an agent, the Company will report the earnings or losses from the delivery service
on a net basis, under the equity method of accounting.
On December 9, 2015, the Company provided a $60,000 loan to Sunrise
Delivery for working capital, with interest at prime and payable in one year and added an additional advance of $10,000 in the
first quarter of 2016. In connection with the sale of their interests in the San Diego dispensary, the Company wrote off the
loans totaling $70,000 as uncollectible at the end of the first quarter of 2016.
Washington
In the course of seeking licenses for new locations, the Company
has to enter into real estate purchase agreements in order to secure the sites to be developed for clients’ dispensaries
and cultivation centers. During the second quarter of 2014, one of the Company’s subsidiaries entered into a real estate
purchase agreement for a property in the State of Washington. The purchase transaction was closed during the third quarter of 2014
for a total purchase price of $399,594, partially financed by a promissory note for $249,000. The note was due January 30,
2015 and bore interest at twelve percent (12%). The Company did not repay the note on its maturity date, and therefore began incurring
interest at the default interest rate of eighteen percent (18%) per annum. On September 30, 2015, the Company, through its
subsidiary MJ Property Investments, and the seller of the property entered into an amendment to the Note Payable, whereby the maturity
date was extended to April 1, 2017, and the interest rate returned to twelve percent (12%) per annum (see Note 8). The Company
did not make their May or June interest payments, and on July 26, 2016 they were notified they were in default on the note, which
resulted in the Company incurring interest at the default interest rate of 18%, beginning in May 2016. The Company is in discussions
regarding settlement of this note.
NOTE 6 – VAPORFECTION INTERNATIONAL, INC.
The Company acquired certain intangible assets with its purchase
of 100% of the outstanding common stock of Vaporfection International Inc. (“VII”) on April 1, 2013. The
Company accounts for intangible assets acquired in a business combination, if any, under the purchase method of accounting at their
estimated fair values at the date of acquisition. Intangibles are either amortized over their estimated lives, if a definite
life is determined, or are not amortized if their life is considered indefinite.
On December 31, 2015, the Company re-evaluated the future value
of the intangible assets and determined none of the carrying value of the intangible assets were recoverable, and its carrying
value exceeded its fair value. Therefore, the Company recognized an impairment loss on Intangibles of $586,000.
On December 31, 2015, the Company also performed the first
step of the Goodwill impairment test, and, based on the same conclusions as above, determined there were indications of impairment
of the Goodwill and they had to perform the second step of the impairment test, which compares the carrying value of the Goodwill
to the implied Goodwill. The Company re-evaluated the fair value of all the associated assets of VII at December 31, 2015
and determined that there was no implied Goodwill. As there is no implied Goodwill, the impairment loss recognized was the entire
carrying value of Goodwill, approximately $1,260,000.
In light of these impairments, as discussed above, the Company wrote
down all other assets related to the business, such as fixed assets and costs to develop the website as of December 31, 2015, resulting
in a impairment of approximately $80,000. The Company also wrote down the Inventory of VII to its estimated fair value of
$82,000.
The Board made a decision the last week of January 2016, to
sell the assets of Vaporfection and exit the vaporizer business and sell the remaining inventory and related assets during the
first half of 2016. The Company analyzed if Vaporfection should be presented as a Discontinued Operation under the guidance
of ASC 205, Presentation of Financial Statements, 20, Discontinued Operations, (“ASC 205-20”), and determined the decision
to exit the Vaporfection business was not a strategic shift in the Company’s business, as the Board and management did not
consider the strategy for the business to be built around the sale of vape machines or peripherals.
On March 28, 2016, the Company sold the assets of the subsidiary
for $70,000, which was payable $35,000 at the closing and with a 6% Note Payable, due September 30, 2016. The Company recognized
approximately $6,000 as a gain on sale of the assets of their subsidiary for the six months ended June 30, 2016.
NOTE 7 – CONVERTIBLE NOTES PAYABLE AND DERIVATIVE LIABILITY
July and September 2014 Debentures
On July 21, 2014, as amended on September 19, 2014 and
October 20, 2014, the Company entered into a Securities Purchase Agreement whereby the Company agreed to issue convertible
debentures (“July 2014 Debentures”) in the aggregate principal amount of $3,500,000, in five tranches. The July 2014
Debentures bore interest at the rate of 10% per year. The debt was due July 21, 2015.
Also on September 19, 2014, as amended on October 20,
2014, the Company entered into a securities purchase agreement pursuant to which it agreed to issue convertible debentures (“September 2014
Debentures”) in the aggregate principal amount of $2,500,000, in two tranches. The September 2014 Debentures bore interest
at the rate of 5% per year. The debt was due September 19, 2015.
Both the original July 2014 Purchase Agreement Debentures and
September 2014 Debentures, prior to subsequent amendment, share the following significant terms:
All amounts are convertible at any time, in whole or in part, at
the option of the holders into shares of the Company’s common stock at a conversion price. The Notes were initially convertible
into shares of the Company’s common stock at the initial Fixed Conversion Price of $11.75 per share. The Fixed Conversion
Price is subject to adjustment for stock splits, combinations or similar events. If the Company makes any subsequent equity sales
(subject to certain exceptions), under which an effective price per share is lower than the Fixed Conversion Price, then the conversion
price will be reduced to equal such price. The Company may make the amortization payments on the debt in cash, prompting a 30%
premium or, subject to certain conditions, in shares of common stock valued at 70% of the lowest volume weighted average price
of the common stock for the 20 prior trading days.
The conversion feature of the July 2014 Debenture and the September 2014
Debenture meets the definition of a derivative and due to the reset provision to occur upon subsequent sales of securities at a
price lower than the fixed conversion price, requires bifurcation and is accounted for as a derivative liability, with a discount
created on the Debentures that would be amortized over the life of the Debentures using the effective interest rate method. The
fair value of the embedded derivative is measured and recognized at fair value each subsequent reporting period and the changes
in fair value are recognized in the Statement of Operations as Change in fair value of derivative liability. See Note 2 Fair value
of financial instruments for additional information on the fair value and gains or losses on the embedded derivative.
In connection with each of the purchase agreements, the Company
entered into a registration rights agreement with the respective investors, pursuant to which the Company agreed to file a registration
statement for the resale of the shares of common stock issuable upon conversion of, or payable as principal and interest on, the
respective debentures, within 45 days of the initial closing date under each agreement, and to have such registration statements
declared effective within 120 days of the initial closing dates of each purchase agreement. Through subsequent modifications of
the July 2014 Debentures and September 2014 Debentures, the required date to file the registration statement and the
effective date of the registration statement were modified, and the registration statement filed on April 9, 2015, and
became effective on June 11, 2015.
On January 30, 2015, the Company and certain of the Investors
entered into an Amendment, Modification and Supplement to the Purchase Agreement (the “Purchase Agreement Amendment”
or the “Modification”) pursuant to which the Investors agreed to purchase an additional $1,800,000 in seven Modified
Closings. The Modification also eliminated the amortization payments discussed above, and provided for accrued and unpaid interest
to be payable upon conversion or maturity rather than on specified payment dates. The Company was also required to open a new dispensary
in Portland, Oregon through a licensed operator during the first calendar quarter of 2015 (which was later modified to April 30,
2015). The Company also had to file the Registration Statement by March 8, 2015 (later amended), and it had to be declared
effective by June 15, 2015 in order to avoid default and acceleration under the Amended and Restated Debenture. As noted above,
the Registration Statement was filed on April 9, 2015, and became effective June 11, 2015.
As part of the January 30, 2015 Modification, the parties entered
into a Modified Debenture Agreement for the $200,000 that was funded at the Closing and agreed to use the same form of Modified
Debenture for each of the other foregoing Modified Closings (collectively, the “Modified Debentures”). The fixed conversion
price of the Modified Debenture on January 30, 2015 was the lower of $5.00 or 51% of the lowest volume weighted average price for
the 20 consecutive trading days prior to the applicable conversion date. This new fixed conversion price was a dilutive issuance
to the outstanding July 2014 and September 2014 Debentures, thereby triggering a reset of the older fixed conversion
price. As a result of the reset to the conversion price, at January 30, 2015, the derivative liability was re-measured to
a fair value of approximately $2,690,000, using a weighted probability model as estimated by management. A decrease in fair value
of the derivative liability of approximately $1,072,000 was recognized as a gain on the Statement of Consolidated Comprehensive
Loss, in the three months ended March 31, 2015.
The additional Modified Debentures under the July 2014 Debentures
as of closing dates had a fixed conversion price of the lower of $1.83 or 51% of the VWAP for the last 20 days prior to the conversion.
This new fixed conversion price was a dilutive issuance to the outstanding July 2014 and September 2014 Debentures, thereby
triggering a reset of the previous $5 fixed conversion price. This reset resulted in the derivative liability being revalued at
February 27, 2015, using a weighted probability model for a fair value of $2,720,000.
The additional Modified Debentures under the September 2014
Debentures closed on January 29, 2015 in the amount of $100,000 and February 24, 2015 in the amount of $100,000. These
Modified Debentures have a fixed conversion price of the lower of $5.00 or 51% of the VWAP for the last 20 days prior to the conversion.
This new fixed conversion price was a dilutive issuance to the outstanding September 2014 Debentures, thereby triggering a
reset of the previous $5.00 fixed conversion price. The resulting reset and re-measurement of the fair value of the derivative
liability is included in the amounts of the change to fair value discussed above.
The April 17, 2015 closing under the July 2014 Modified
Debentures contained a fixed conversion price of the lower of $0.88 or 51% of the VWAP for the last 40 days prior to the conversion.
This new fixed conversion price was a dilutive issuance to the outstanding July 2014 and September 2014 Debentures, thereby
triggering a reset of the previous $1.83 fixed conversion price. This reset resulted in the derivative liability being revalued
at April 17, 2015, using a weighted probability model for a fair value of $3,287,000, for a increase in fair value of approximately
$1,764,000, recognized as a loss on the Statement of Consolidated Comprehensive Loss.
There was additional funding of $1,300,000 of the September 2014
Modified Debentures under the closing schedule detailed above. These Modified Debentures all have a fixed conversion price of the
lower of $0.88 or 51% of the VWAP for the last 40 days prior to the conversion.
The Directors’ convertible debentures required under the March 23,
2015 Modification, issued in the first quarter of 2015, total $150,000, and have a three year term and an interest rate of 8% per
annum. They were originally convertible at a fixed conversion price of the lower of $1.83 or 51% of the VWAP for the last 20 days
prior to conversion. As with the Modified Debentures, the debentures included a reset provision, which resulted in the conversion
feature being bifurcated and accounted for as a derivative liability, with an initial fair value of $132,175. The director’s
convertible debentures also reset on February 27, 2015 and April 17, 2015, with the changes to fair value included in
the amounts disclosed above. The Directors debentures were all converted during the third quarter of 2015.
The Modified Debentures also included a warrant instrument granting
the Investor the right to purchase shares of common stock of the Company equal to the principal amount of the applicable Modified
Debenture divided by a price equal to 120% of the last reported closing price of the common stock on the applicable closing date
of the Modified Debenture, with a three year term.
August 2015 Debentures
On August 14, 2015, the Company entered into a Securities Purchase
Agreement whereby they agreed to issue convertible debentures in the aggregate principal amount of up to $3,979,877 to certain
Investors. The initial closing in the aggregate principal amount of $650,000 occurred on August 14, 2015. An additional 11
payments were made in the total amount of $2,434,143 through December 31, 2015. The August 2015 Debentures bear interest
at the rate of 10% per year. During the first quarter of 2016, an additional approximately $895,000 was funded.
On August 20, 2015, the Company also entered into a Securities
Purchase Agreement with another Investor in the aggregate principal amount of up to $1,500,000 (collectively the “August 2015
Debentures”), which was amended on September 19, 2015, to increase the principal by an additional $200,000.
The August 2015 Debentures contain the following significant
terms:
The debentures all mature in one year from the date of each individual
closing.
All amounts are convertible at any time, in whole or in part, at
the option of the holders into shares of the Company’s common stock at a fixed conversion price. The conversion price is
the lower of (a) $0.75, or (b) a 49% discount to the lowest daily VWAP (as reported by Bloomberg) of the Common Stock
during the 30 trading days prior to the conversion date. The Fixed Conversion Price is subject to adjustment for stock splits,
combinations or similar events. If the Company makes any subsequent equity sales (subject to certain exceptions), under which an
effective price per share is lower than the Fixed Conversion Price, then the conversion price will be reset to equal such price.
The Company may prepay the Debentures in cash, prompting a 30% premium or, subject to certain conditions, in shares of common stock
valued at 51% of the lowest volume weighted average price of the common stock of the Company for the 30 prior trading days. The
premium will be recognized at such time as the Company may choose to prepay the Debentures.
In connection with each of the purchase agreements, the Company
entered into a registration rights agreement with the respective Investors pursuant to which the Company agreed to file a registration
statement for the resale of the shares of common stock issuable upon conversion of, or payable as principal and interest on, the
respective debentures, within 45 days of the initial closing date under each agreement, and to have such registration statements
declared effective within 120 days of the initial closing dates of each purchase agreement. The pre-effective registration
statement was filed with the SEC on October 16, 2015.
The conversion feature of the August 2015 Debenture meets the
definition of a derivative and due to the reset provision to occur upon subsequent sales of securities at a price lower than the
fixed conversion price, requires bifurcation and is accounted for as a derivative liability. The derivatives related to all closings
on the August 2015 debentures were initially recognized at estimated fair values of approximately $11,205,000 and created a discount
on the Debentures that will be amortized over the life of the Debentures using the effective interest rate method. The fair value
of the embedded derivative is measured and recognized at fair value each subsequent reporting period and the changes in fair value
are recognized in the Statement of Comprehensive Income (Loss) as Change in fair value of derivative liability. For the year ended
December 31, 2014, and the interim periods through September 30, 2015, the Company estimated the fair value of the conversion
feature derivatives embedded in the convertible debentures based on weighted probabilities of assumptions used in the Black Scholes
pricing model. The key valuation assumptions used consists, in part, of the price of the Company’s common stock, ranging
from $8.81 down to $0.05; a risk free interest rate ranging from 0.41% to 0.12% and expected volatility of the Company’s
common stock, ranging from 196.78% to 106.38%, and the various estimated reset exercise prices weighted by probability.
As of December 31, 2015, and for new issuances of convertible
debentures during the fourth quarter of fiscal 2015, the Company estimated the fair value of the conversion feature derivatives
embedded in the convertible debentures based on a Monte Carlo Simulation model (“MCS”). The MCS model was used to simulate
the stock price of the Company from the valuation date through to the maturity date of the related debenture and to better estimate
the fair value of the derivative liability due to the complex nature of the convertible debentures and embedded instruments. Management
believes that the use of the MCS model compared to the black Scholes model as previously used would provide a better estimate of
the fair value of these instruments. Beginning in the fourth quarter of 2015, using the MCS model, the Company valued these embedded
derivatives using a “with-and-without method,” where the value of the Convertible Debentures including the embedded
derivatives, is defined as the “with”, and the value of the Convertible Debentures excluding the embedded derivatives,
is defined as the “without.” This method estimates the value of the embedded derivatives by observing the difference
between the value of the Convertible Debentures with the embedded derivatives and the value of the Convertible Debentures without
the embedded derivatives. The Company believes the “with-and-without method” results in a measurement that is more
representative of the fair value of the embedded derivatives.
For each simulation path, the Company used the Geometric Brownian
Motion (“GBM”) model to determine future stock prices at the maturity date. The inputs utilized in the application
of the GBM model included a starting stock price ranging from $0.03 to $0.10, an expected term of each debenture remaining from
the valuation date to maturity ranging from .24 years to 1.04 years, an estimated volatility of ranging from 193% to
219%, and a risk-free rate ranging from .20% to .70%. See Note 2 Fair value of financial instruments for additional information
on the fair value and gains or losses on the embedded derivative.
For the six months ended June 30, 2016, the Company estimated the
fair value of the conversion feature derivatives embedded in the convertible debentures based on an internally calculated adjustment
to the MCS valuation determined at December 31, 2015. This adjustment took into consideration the changes in the assumptions,
such as market value and expected volatility of the Company’s common stock, and the discount rate used in the December 31,
2015 valuation as compared to June 30, 2016. The valuation also took into consideration the term in the debentures which limits
the amounts converted to not result in the investor owning more than 4.99% of the outstanding common stock of the Company, after
giving effect to the converted shares. The Company believes this methodology results in a reasonable fair value of the embedded
derivatives for the interim period.
Entry into Security Agreement
In connection with entry into the August 20 Purchase Agreement
and August 14 Purchase Agreement, the Investors and the Company entered into a Security Agreement, dated August 21, 2015,
securing the amounts underlying the August 14 Debentures and the August 20 Debentures. The Security Agreement grants
a security interest in all assets and personal property of the Company, subject to certain excluded real property assets. The security
interests under the Security Agreement terminated following the date that the registration statement registering the shares underlying
the Convertible Debentures was declared effective, which occurred on December 15, 2015.
July 2015 Debenture
On July 10, 2015, another accredited Investor and affiliate
of the July 2014 Investor (the “July 2015 Investor”) purchased a separate Convertible Debenture (the “July 2015
Debenture”) in the aggregate principal amount of $500,000, that closed in five weekly tranches between July 10 and August 15,
2015. The July 2015 Debenture is in substantially the same form as the August 14 Debentures, and does not include issuance
of warrants. As such, the conversion feature was also determined to require bifurcation and derivative accounting. All amounts
related to the July 2015 derivative liability are included in amounts disclosed above for the August 2015 debentures.
On October 14, 2015, the August 2015 Investor assigned
the right to purchase August 2015 Debentures in the principal amount of $100,000 to the July 2015 Investor and the July 2015
Investor purchased such August 2015 Debentures on the same day.
October 2015 Debentures
On October 14, 2015, the Company issued seven debentures
in the aggregate of $2,000,000 to a service provider (the “October 2015 Investor”) as consideration for services
previously rendered to the Company on the same terms as the August 14 Debentures and August 14 Purchase Agreement (the
“October 2015 Debentures” and “October 2015 Purchase Agreement”, respectively) except that the
October 2015 Purchase Agreement does not provide for registration rights to the October 2015 Investor with regard to
the shares underlying the October 2015 Debentures. The service provider has agreed with the Company not to convert the October 2015
Debentures for any amount in excess of fees payable for services previously rendered to the Company at the time of conversion.
To the extent that the sale of shares underlying the October 2015 Debentures do not satisfy outstanding amounts payable to
the service provider, such amounts will remain payable to the service provider by the Company. In the three months ending June
30, 2016, funding closed on $425,000 of the October 2015 debentures.
December 28, 2015 Amendment and Restriction Agreement
On December 28, 2015, the Company, the August 14 Investor
and the August 20 Investor entered into a Debenture Amendment and Restriction Agreement (the “Agreement”), pursuant
to which (1) the August 14 Investor agreed to be restricted from converting any of its convertible debentures into common
stock until February 21, 2016, subject to certain limitations set forth below (the “Restriction”) and (2) the
August 14 Investor agreed to assign, as of the effective date of the Agreement approximately $390,000 of its convertible debentures
to the August 20 Investor in exchange for the amount of principal outstanding under such debenture plus a premium in cash
from the August 20 Investor (the “Assigned Debentures”). The accrued and unpaid interest under the Assigned Debentures
remained payable by the Company to the August 14 Investor.
The August 14 Investor also agreed to amend the terms of
each of its debentures (other than the debentures that were assigned) such that the debenture is convertible at a 40% discount
to the lowest trading price of the Company’s common stock during the 30 consecutive prior trading days rather than at a 49%
discount to the lowest ‘volume weighted-average price’ during the 30 consecutive prior trading days. This was not considered
to be a modification of the terms of the conversion feature, requiring evaluation of the debenture to determine if it was modified
or extinguished, as the conversion feature is separately accounted for as a derivative, and is outside of the scope of the guidance
on debt modifications. The change in the conversion price will be reflected in its fair value under derivative accounting.
As consideration for entering into the Agreement, the August 14
Investor was issued a promissory note from the Company in the principal amount of $700,000 (the “Promissory Note”).
The Promissory Note has a term of ten months, accrues interest at a rate of 10% per annum, and outstanding principal and accrued
interest under the Promissory Note may be pre-paid at any time by the Company without penalty. The Promissory Note is not convertible
other than in an event of default, in which case it is convertible on the terms of the other debentures held by the August 14
Investor. This conversion feature was considered to be a contingent conversion feature, and therefore the conversion feature would
not be bifurcated and accounted for as a derivative, as are the conversion features of all other debentures, until such time as
and if the Company is in an event of default. The Promissory Note is being accounted for as a finance expense of the December 28,
2015 transaction, similar to a debt discount, and will be amortized to financing expense over the ten month life of the note (Note
8).
The August 20 Investor shall also acquire from the August 14
Investor an additional $650,000 of the convertible debentures held by the August 14 Investor (1) upon the declaration of effectiveness
of a post-effective amendment (the “POSAM”) to the Company’s Registration Statement on Form S-1 originally filed
by the Company on October 16, 2015 and declared effective by the Securities and Exchange Commission on December 15, 2015
(the “Registration Statement”) reflecting the terms of the Agreement, or (2) at the option of the August 20 Investor
(the “Option”), at an earlier time. The August 14 Investor exercised the Option on January 25, 2016. The
POSAM was declared effective on February 3, 2016.
At March 31, 2016, the Company had not paid the principal due
of $9,600 on a convertible debenture which was due on March 27, 2016. The Company was in default and obtained a waiver from
the lender on May 11, 2016 waiving all rights relating to the nonpayment and extending the maturity date of the convertible
debenture to August 1, 2016. In the same waiver agreement, the terms of five additional convertible debentures with maturity
dates in May and June of 2016 totaling $122,084 were also extended to a maturity date of August 1, 2016.
At June 30, 2016, the Company had not paid the total principal
due of $225,700 on convertible debenture which was due on July 10, 2016. The Company was in default and obtained a waiver from
the lender on August 3, 2016 waiving all rights relating to the nonpayment and extending the maturity date of the convertible debenture
to October 31, 2016. In the same waiver agreement, the terms of thirteen additional convertible debentures with maturity dates
in July and August of 2016 totaling approximately $1,260,000 were also extended to a maturity date of October 31, 2016. (Note
12)
February 10, 2016 Financing
On February 10, 2016, the Company entered into a Note Purchase
Agreement (the “Purchase Agreement”) with an accredited investor (the “Investor”), pursuant to which the
Company agreed to sell, and the Investor agreed to purchase, a promissory note (the “Note”) in the aggregate principal
amount of $275,000. The closing occurred on February 11, 2016.
The Investor deducted a commitment fee in the amount of $25,000
at the closing. The Note bears interest at the rate of 10% per year and matures on October 31, 2016. The Company may prepay
all or any part of the outstanding balance of the Note at any time without penalty. In the event that the Company or any of its
subsidiaries becomes subject to bankruptcy, insolvency, liquidation, or similar proceedings or takes certain related corporate
actions, all outstanding principal and accrued interest under the Note will immediately and automatically become due and payable.
In addition, the Note identifies certain other events of default, the occurrence of which would entitle the Investor to declare
the outstanding principal and accrued interest immediately due and payable or to convert the Note, in whole or in part, into shares
of the Company’s common stock at a conversion price that is the lower of (a) $0.75, or (b) a 51% discount to the lowest daily
volume weighted average price of the Company’s common stock during the 20 trading days prior to the conversion date.
This conversion feature was considered to be a contingent conversion
feature, and therefore the conversion feature would not be bifurcated and accounted for as a derivative, as are the conversion
features of all other debentures, until such time as and if the Company is in an event of default. The balance of this note
is included with Notes Payable on the accompanying condensed consolidated Balance Sheet (Note 8).
February 18, 2016 Financing
On February 18, 2016, the Company entered into a securities
purchase agreement (the “Purchase Agreement”) with an accredited investor (the “Investor”) pursuant to
which the Company agreed to sell, and the Investor agreed to purchase, convertible debentures (the “Debentures”) in
the aggregate principal amount of $420,000, in two tranches.
The initial closing in the aggregate principal amount of $210,000
occurred on February 18, 2016. The second closing in the amount of $210,000 occurred on March 18, 2016 ($125,000) and
March 22, 2016 ($85,000). The Debentures bear interest at the rate of 10% per year and mature after one year and are subject
to a financing fee of 5%.
Each of the Debentures are convertible at the option of the
holders into shares of the common stock of the Company at a conversion price that is lower of (a) $0.75, or (b) a 40% discount
to the lowest traded price of the common stock of the Company during the 30 trading days prior to the conversion date. The
Company may prepay the Debentures in cash, prompting a 30% premium.
The conversion feature of the Debentures meets the definition
of a derivative and due to the reset provision to occur upon subsequent sales of securities at a price lower than the fixed conversion
price, requires bifurcation and is accounted for as a derivative liability.
March 15 2016 Financing
The Company entered into a Note Purchase Agreement, effective
as of March 14, 2016 (the “Effective Date”), with an Investor (the “March 15 Investor”) pursuant to
which the March 15 Investor purchased and the Company issued and sold a promissory note in the original principal amount of
$140,000 (the “First Promissory Note”), which matures on September 14, 2016.. Upon satisfaction of certain conditions
set forth in the Note Purchase Agreement, the Company will issue and sell a second promissory note in the original principal amount
of $137,500 (the “Second Promissory Note”). Each Promissory Note matures six (6) months after the date of its
issuance. The First Promissory Note carries an original issue discount of $12,500 (the “First Promissory Note OID”).
In addition, Company agreed to pay $5,000 towards the March 15 Investor’s legal fees incurred in connection with the
purchase and sale of the First Promissory Note and the Second Promissory Note, $2,500 of which was paid to the March 15 Investor
prior to the Effective Date and $2,500 of which amount (the “Carried Transaction Expense Amount”) is included in the
initial principal balance of the First Promissory Note. The purchase price of the First Promissory Note was $125,000, computed
as follows: $140,000 initial principal balance, less the First Promissory Note OID, less the Carried Transaction Expense Amount.
The Second Promissory Note, if issued, also carries an original issue discount of $12,500 (the “Second Promissory Note OID”).
The purchase price of the Second Promissory Note shall be $125,000, computed as follows: $137,500 initial principal balance, less
the Second Promissory Note OID (the “Second Promissory Note Purchase Price”).
On March 15, 2016, the Company issued and sold the First
Promissory Note to the March 15 Investor. Upon satisfaction of the terms (the “Mandatory Second Promissory Note Conditions”),
the Company shall issue and sell the Second Promissory Note to the March 15 Investor. The Mandatory Second Promissory Note
Conditions means that each of the following conditions has been satisfied on or before the date that is ninety (90) days from
the Effective Date: (i) the Share Reserve (as defined in the First Promissory Note) for the First Promissory Note shall have
been established; (ii) no Event of Default (as defined in the First Promissory Note) shall have occurred under the First Promissory
Note; (iii) the median daily dollar volume of the Common Stock on its principal market for the nineteen (19) Trading
Days (as defined in the First Promissory Note) immediately preceding the Share Reserve Date is greater than $75,000 per Trading
Day; and (iv) the Company has notified Investor in writing that it has elected to require that Investor pay the Second Promissory
Note Purchase Price. If the Mandatory Second Promissory Note Conditions are not satisfied as of the date that is ninety (90) days
from the Effective Date, then the March 15 Investor shall not be obligated to pay the Second Promissory Note Purchase Price
and the Second Promissory Note shall not be considered a valid, binding, or enforceable obligation of the Company, and, thereafter,
the Second Promissory Note shall only be issued and the Second Promissory Note Purchase Price will only be payable upon the mutual
written agreement of Company and the March 15 Investor. The First Promissory Note and/or the Second Promissory Note may be
prepaid at any time by the Company in the sole discretion of the Company at a 25% premium to the outstanding balance under the
applicable Promissory Note.
In the event that the First Promissory Note and/or the Second
Promissory Note is not paid in full on or before maturity by the Company, then the March 15 Investor shall have the right
at any time thereafter until such time as the First Promissory Note and/or the Second Promissory Note is paid in full, at the March 15
Investor’s election, to convert (each instance of conversion being a “Conversion”) all or any part of the outstanding
balance into shares (“Conversion Shares”) of fully paid and non-assessable Common Stock of the Company as per the following
conversion formula: the number of Conversion Shares equals the amount being converted divided by 50% multiplied by the lowest daily
volume weighted average price of the Common Stock in the twenty (20) Trading Days immediately preceding the applicable Conversion.
At any time and from time to time after the March 15 Investor becoming aware of the occurrence of any event of default, the
March 15 Investor may accelerate the First Promissory Note and/or the Second Promissory by written notice to the Company,
with the outstanding balance of the respective Note becoming immediately due and payable in cash at 125% of the outstanding balance.
This conversion feature was considered to be a contingent conversion
feature, and therefore the conversion feature would not be bifurcated and accounted for as a derivative, as are the conversion
features of all other debentures, until such time as and if the Company is in an event of default. The balance of the First
Promissory Note is included with Notes Payable on the accompanying condensed consolidated Balance Sheet (Note 8).
The Company is currently in default on the March 15 note (Note
12).
April 2016 Financing
On April 13, 2016, the Company entered into a note purchase
agreement (the “Purchase Agreement”) with an accredited investor (the “Investor”) pursuant to which the
Company agreed to sell, and the Investor agreed to purchase, a convertible promissory note (the “Note”) in the aggregate
principal amount of $225,000.
The Note bears interest at the rate of 5% per year and matures
on July 13, 2016. The Note is convertible at any time, in whole or in part, at the option of the holders into shares of the common
stock of the Company at a conversion price that is the lower of (a) $0.75, or (b) a 49% discount to the lowest traded price of
the common stock of the Company during the 20 trading days prior to the conversion date. The Company may prepay the Note in cash,
prompting a 30% premium.
The Company will, within thirty (30) days, grant a security
interest to the Investor and its affiliates over the Company’s assets, including its stock ownership in its subsidiary, ESWD
I, LLC (but not the assets of ESWD I, LLC). Furthermore, in connection with the next $1.5 million of equity capital raised by the
Company, the Company shall use one third of such funds to make principal repayment of amounts owed to the Investor, plus a redemption
premium of 30% of such amounts.
March 15, 2016 Financing – Second Promissory Note
On or about April 20, 2016 it was mutually determined by the
parties involved that the median daily dollar volumes requirement of the Mandatory Second Promissory Note Conditions was not met
and the Second Promissory Note would not be issued.
May 2016 Financings
The Company received an additional $100,000 through the issuance
of two convertible debentures of $50,000 each, on May 13, 2016 and May 20, 2016. The Notes bears interest at the rate of 10% per
year and mature on July 13, 2016 and July 20, 2016, respectively. The Notes are convertible at any time, in whole or in part, at
the option of the holders into shares of the common stock of the Company at a conversion price that is the lower of (a) $0.75,
or (b) a 40% discount to the lowest traded price of the common stock of the Company during the 20 trading days prior to the conversion
date. The remaining terms of the debentures are the same as all other convertible debentures, and have also been determined to
require derivative accounting. The Company may prepay the Note in cash, prompting a 30% premium.
June 22, 2016 Financing
Entry into Securities Purchase Agreement and Equity Purchase
Agreement
On June 22, 2016, 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 Investors agreed to purchase, convertible debentures (the “Convertible Bridge
Debentures”) in the aggregate principal amount of $240,000, in two tranches. The initial closing in the aggregate principal
amount of $120,000 occurred on June 22, 2016, and the second closing in the aggregate principal amount of $120,000 was scheduled
to occur on July 8, 2016 . As of the date these consolidated financial statements were issued, the second closing has not
occurred.
The Convertible Commitment Debenture and the Convertible Bridge
Debenture accrue interest at a rate of 10% per annum. Each of the debentures are convertible at any time, in whole or in part,
at the option of the holders into shares of the Company’s common stock at a conversion price that is the lower of (a) $0.75,
or (b) a 40% discount to the lowest traded price of the Company’s common stock during the 30 trading days prior to the
conversion date.
The Company and the Investor also entered into an Equity Purchase
Agreement (the “Equity Purchase Agreement”, "EQP"), pursuant to which, following the filing and declaration
of effectiveness of a registration statement by the Company (the “Registration Statement”) and the availability of
authorized stock, the Company may “put” its shares of common stock to the Investor at a 20% discount to lowest traded
price over the prior 10 trading days for up to the higher of $50,000 or 300% of the average daily trading volume over the previous
10 trading days, for up to an aggregate of $5,000,000 in aggregates “puts”.
In connection with the Equity Purchase Agreement, the Company
entered into a registration rights agreement (the “Registration Rights Agreement”) with the Investors, pursuant to
which the Company agreed to file the Registration Statement for the resale of shares of common stock put to the Investor under
the Equity Purchase Agreement, within 30 days of the closing date of the Equity Purchase Agreement, and to have such registration
statements become effective within 60 days of the closing date of the Purchase Agreement.
The Investor shall have a right of first refusal to participate
in future equity financings of the Company on the same terms as any new investors for a period of twelve months from the closing
of the last Convertible Bridge Debenture. The Company also shall not enter into other variable rate transactions other than with
pre-existing investors, so long as the Investors hold more than $2,000,000 in debentures of the Company, including pre-existing
debentures. The Company also may not enter into any equity line of credit with any other investor during the term of the Equity
Purchase Agreement, which expires on December 22, 2017.
No amounts have been funded under the Equity Purchase Agreement
to date. The Company and the Investor have entered into a verbal agreement to terminate the EQP, and the parties are working on
finalized a formal termination agreement.
To induce the Investor to purchase the Equity Purchase Agreement
(described below), the Company issued an additional $100,000 convertible debenture, on the same terms of the Convertible Bridge
Debentures to the Investor (the “Convertible Commitment Debenture”). The Company will not receive any cash for the
Convertible Commitment Debentures.
The Company entered into a Convertible Debenture with the above
Investor for an additional $10,000 on June 14, 2016. The convertible debenture is due on June 14, 2017 and accrues interest at
a rate of 10% per annum. The debenture is convertible at any time, in whole or in part, at the option of the holder into shares
of the Company’s common stock at a conversion price that is the lower of (a) $0.75, or (b) a 40% discount to the
lowest traded price of the Company’s common stock during the 30 trading days prior to the conversion date.
June 30, 2016 Financing
On June 30, 2016, the Company entered into
a securities purchase agreement (the “Securities Purchase Agreement”) with an accredited investor
(the “Investor”) pursuant to which two wholly-owned subsidiaries of the Company, EWSD I, LLC (“EWSD
I”) and Pueblo Agriculture Supply and Equipment, LLC (“Pueblo”, and together with EWSD I,
the ‘Subsidiaries”) agreed to jointly sell, and the Investors agreed to purchase, convertible debentures
(the “Convertible Debentures”) in the aggregate principal amount of $1,500,000, in six tranches over the
following 90-day period. The Company guaranteed the issuance of the Convertible Debentures and, upon notice from the
Investor, the Convertible Debentures are convertible in to the Common Stock of the Company. The initial closing in the
aggregate principal amount of $125,000 occurred on June 30, 2016, with additional closings subsequent to June 30, 2016,
of approximately $1,266,000, net, received through the issuance of these condensed consolidated financial
statements. The Company agreed to pay an aggregate of the Investor’s legal fees of $40,000 ($10,000 per tranche) in
connection with the closing of each of tranches three through six. The June 30, 2016 financing was subsequently assigned to a
new investor (Note 12).
The Company and the Subsidiaries also entered into a Security
Agreement (the “Security Agreement”) and Parent Guarantee (the “Guarantee”), securing a lien for the Investor
on EWSD I’s assets on a secondary basis to the primary lien holder and securing a lien for the Investor on Pueblo’s
assets on a primary basis and with the Company guaranteeing all obligations of EWSD I and Pueblo to the Investor. Pursuant to the
Security Agreement, the Company agreed to, within 14 calendar days, negotiate and enter into an Intercreditor Agreement among the
other secured creditors of the Company and EWSD I. The Company subsequently entered into a Subordination Agreement, which replaced
the Intercreditor Agreement, on August 23, 2016.
The Convertible Debentures accrue interest at a rate of 10% per
annum. Each of the debentures are convertible at any time into shares of common stock of the Company, in whole or in part, at the
option of the holders into shares of the Company’s common stock at a conversion price that is the lower of (a) $0.75,
or (b) a 40% discount to the lowest traded price of the Company’s common stock during the 30 trading days prior to the
conversion date.
The Investor shall have a right of first refusal to participate
in future equity financings of the Company on the same terms as any new investors for a period of twelve months from the closing
of the last Convertible Debenture. The Company and the Subsidiaries also shall not enter into other variable rate transactions
other than with pre-existing investors, so long as the Investors hold more than $2,000,000 in debentures of the Company, including
pre-existing debentures.
The conversion feature of the Debentures meets the definition
of a derivative and due to the reset provision to occur upon subsequent sales of securities at a price lower than the fixed conversion
price, requires bifurcation and is accounted for as a derivative liability.
The derivatives related to the above convertible debentures
were initially recognized at their estimated fair values as described previously, which amounted to approximately $4,932,000 in
the six months ended June 30, 2016 and $1,885,000 for the same period of 2015. The resulting debt discount is amortized as
over the life of the convertible debenture, or until conversion if earlier, which resulted in amortization expense of $2,086,000
and $6,050,000, for the three months ended June 30, 2016 and 2015, respectively. Additionally, the current year closings to
convertible debentures resulted in the calculated fair value of the debt being greater than the face amounts of the debt by approximately
$2,627,000, with this excess amount being immediately expensed as financing costs. Financing costs for the six months ended
June 30, 2015, were approximately $3,061,000. The fair value of the embedded derivative consisting of all related convertible debentures is
measured and recognized at fair value each subsequent reporting period and the changes in fair value for all derivatives for six
months ended June 30, 2016 and 2015, resulted in a gain of approximately $9,320,000 and $3,053,000, respectively, which are recognized
in the condensed consolidated Statement of Comprehensive Income (Loss) as Change in fair value of derivative liability.
Related Party Financing
One of the directors on the Company’s Board entered into
three separate subordinated convertible promissory notes convertible at $0.01 with the Company on March 4, 2016, March 10,
2016 and March 15, 2016, respectively, each in the principal amount of $25,000, for a total of $75,000. Also on March 15,
2016, another of the Company’s directors entered into a subordinated convertible promissory note convertible at $0.01 with
the Company in the principal amount of $25,000, and two other of the Company’s directors each entered into a subordinated
convertible promissory note convertible at $0.01 with the Company in the principal amount of $2,500. All of the foregoing convertible
promissory notes have three year terms and an interest rate of 8% per annum. The debentures were evaluated to determine if
the conversion feature fell within the guidance for derivative accounting, and as the debentures are convertible at a fixed conversion
price, and do not include a the reset provision to occur upon subsequent sales of securities at a price lower than the fixed conversion
price, the Company concluded the conversion feature did not qualify as a derivative.
In connection with their funding of the Notes (collectively
the “Notes”), the directors each receive a warrant, exercisable for a period of three (3) years from the date
of Notes, to purchase an amount of Company Common Stock equal to 50% of the principal sum under each of the director notes, at
an exercise price equal to 200% of the applicable Conversion Price. The exercise price of the warrants is $0.02. The warrants were
determined to have a fair value of $42,000, calculated with the Black Sholes Merton model, with the following key valuation assumptions:
estimated term of three years, annual risk-free rate of .93%, and annualized expected volatility of 172%.
Conversions
During the six months ended June 30, 2016 and 2015, respectively,
approximately $1,904,000 and $4,000,000 of principal and approximately $14,000 and $27,000, of accrued interest were converted
into approximately 2,648,938,000 and 12,383,229 of the Company’s common shares at an average price of $0.0007 and $0.74,
based on 51% of the calculated VWAP. Upon conversion, the derivative fair value for the amounts converted were re-measured through
the date of conversion, with the conversion date fair value reclassified to equity, amounting to approximately $3,200,000 and $1,160,000
in the six months ended June 30, 2016 and 2015, respectively. As a result of the conversions, the resulting decrease of fair value
of approximately $1,885,000 of the related debt discount was recognized on the Condensed Consolidated Statement of Comprehensive
Income (Loss).
Warrants
The warrants issued under all debentures, and other agreements,
are summarized below:
Date issued
|
|
Number of
warrants
|
|
|
Exercise
price
|
|
|
December 18,
2015 re-price
|
|
|
Fair Value at issuance
|
|
July 2014 Modified Debentures
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
January 30, 2015
|
|
|
40,552
|
|
|
|
4.93
|
|
|
|
.06
|
|
|
$
|
159,601
|
|
February 26, 2015
|
|
|
45,537
|
|
|
|
2.20
|
|
|
|
.06
|
|
|
|
79,904
|
|
March 13, 2015
|
|
|
21,151
|
|
|
|
2.36
|
|
|
|
.06
|
|
|
|
39,965
|
|
March 16, 2015
|
|
|
10,575
|
|
|
|
2.36
|
|
|
|
.06
|
|
|
|
19,981
|
|
March 20, 2015
|
|
|
41,946
|
|
|
|
1.79
|
|
|
|
.06
|
|
|
|
59,942
|
|
March 27, 2015
|
|
|
75,758
|
|
|
|
1.98
|
|
|
|
.06
|
|
|
|
119,888
|
|
April 2, 2015
|
|
|
60,386
|
|
|
|
1.66
|
|
|
|
.06
|
|
|
|
74,025
|
|
April 2, 2015
|
|
|
30,193
|
|
|
|
1.66
|
|
|
|
.06
|
|
|
|
37,012
|
|
April 10, 2015
|
|
|
107,914
|
|
|
|
1.39
|
|
|
|
.06
|
|
|
|
112,460
|
|
April 17, 2015
|
|
|
41,667
|
|
|
|
1.20
|
|
|
|
.06
|
|
|
|
37,680
|
|
April 24, 2015
|
|
|
127,119
|
|
|
|
1.18
|
|
|
|
.06
|
|
|
|
112,635
|
|
April 24, 2015
|
|
|
21,186
|
|
|
|
1.18
|
|
|
|
.06
|
|
|
|
18,772
|
|
May 1, 2015
|
|
|
156,250
|
|
|
|
.96
|
|
|
|
.06
|
|
|
|
113,133
|
|
May 7, 2015
|
|
|
134,615
|
|
|
|
.78
|
|
|
|
.06
|
|
|
|
79,234
|
|
May 8, 2015
|
|
|
42,000
|
|
|
|
.75
|
|
|
|
.06
|
|
|
|
23,768
|
|
May 15, 2015
|
|
|
200,000
|
|
|
|
.75
|
|
|
|
.06
|
|
|
|
113,365
|
|
May 22, 2015
|
|
|
250,000
|
|
|
|
.60
|
|
|
|
.06
|
|
|
|
113,366
|
|
May 29, 2015
|
|
|
258,621
|
|
|
|
.58
|
|
|
|
.06
|
|
|
|
112,537
|
|
June 5, 2015
|
|
|
288,462
|
|
|
|
.52
|
|
|
|
.06
|
|
|
|
120,738
|
|
June 12, 2015
|
|
|
930,233
|
|
|
|
.43
|
|
|
|
.06
|
|
|
|
303,246
|
|
June 19, 2015
|
|
|
3,448,276
|
|
|
|
.29
|
|
|
|
.06
|
|
|
|
751,159
|
|
September 2014 Modified Debentures
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
January 28, 2015
|
|
|
18,038
|
|
|
|
5.54
|
|
|
|
.06
|
|
|
|
80,156
|
|
February 13, 2015
|
|
|
57,870
|
|
|
|
1.73
|
|
|
|
.06
|
|
|
|
96,689
|
|
April 2, 2015
|
|
|
181,159
|
|
|
|
1.66
|
|
|
|
.06
|
|
|
|
222,109
|
|
April 24, 2015
|
|
|
90,579
|
|
|
|
1.10
|
|
|
|
.06
|
|
|
|
80,548
|
|
May 15, 2015
|
|
|
200,000
|
|
|
|
.75
|
|
|
|
.06
|
|
|
|
113,365
|
|
Date issued
|
|
Number of
warrants
|
|
|
Exercise
price
|
|
|
December 18,
2015 re-price
|
|
|
Fair Value at issuance
|
|
June 12, 2015
|
|
|
1,744,186
|
|
|
|
.43
|
|
|
|
.06
|
|
|
|
570,248
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
August 2015 Debentures
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
August 24, 2015
|
|
|
6,666,667
|
|
|
|
.06
|
|
|
|
|
|
|
|
321,757
|
|
September 18, 2015
|
|
|
588,235
|
|
|
|
.17
|
|
|
|
|
|
|
|
82,804
|
|
October 28, 2015
|
|
|
4,166,667
|
|
|
|
.12
|
|
|
|
|
|
|
|
363,306
|
|
November 16, 2015
|
|
|
1,785,714
|
|
|
|
.07
|
|
|
|
|
|
|
|
92,798
|
|
November 23, 2015
|
|
|
2,083,333
|
|
|
|
.06
|
|
|
|
|
|
|
|
68,988
|
|
November 30,2015
|
|
|
2,500,000
|
|
|
|
.05
|
|
|
|
|
|
|
|
81,988
|
|
December 7, 2015
|
|
|
6,250,000
|
|
|
|
.02
|
|
|
|
|
|
|
|
163,382
|
|
December 17, 2015
|
|
|
10,000,000
|
|
|
|
.02
|
|
|
|
|
|
|
|
76,376
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Directors
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
January 5, 2015
|
|
|
129,305
|
|
|
|
.40
|
|
|
|
|
|
|
|
39,901
|
|
January 30, 2015
|
|
|
129,917
|
|
|
|
.40
|
|
|
|
|
|
|
|
39,916
|
|
February 2, 2015
|
|
|
237,778
|
|
|
|
.22
|
|
|
|
|
|
|
|
16,619
|
|
March 4, 2016
|
|
|
1,250,000
|
|
|
|
.02
|
|
|
|
|
|
|
|
10,000
|
|
March 10, 2016
|
|
|
1,250,000
|
|
|
|
.02
|
|
|
|
|
|
|
|
10,000
|
|
March 15, 2016
|
|
|
1,250,000
|
|
|
|
.02
|
|
|
|
|
|
|
|
10,000
|
|
March 15, 2016
|
|
|
1,250,000
|
|
|
|
.02
|
|
|
|
|
|
|
|
10,000
|
|
March 15, 2016
|
|
|
125,000
|
|
|
|
.02
|
|
|
|
|
|
|
|
1,000
|
|
March 15, 2016
|
|
|
125,000
|
|
|
|
.02
|
|
|
|
|
|
|
|
1,000
|
|
April 20, 2016
|
|
|
1,041,663
|
|
|
|
.02
|
|
|
|
|
|
|
|
4,000
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
June 8, 2016
|
|
|
5,000,000
|
|
|
|
.01
|
|
|
|
|
|
|
|
4,425
|
|
June 8, 2016
|
|
|
2,691,250
|
|
|
|
.01
|
|
|
|
|
|
|
|
2,381
|
|
June 8, 2016
|
|
|
1,500,000
|
|
|
|
.01
|
|
|
|
|
|
|
|
1,327
|
|
June 8, 2016
|
|
|
3,343,750
|
|
|
|
.01
|
|
|
|
|
|
|
|
2,959
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other Agreements
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 18, 2015
|
|
|
4,000,000
|
|
|
|
.50
|
|
|
|
|
|
|
|
76,000
|
|
April 13, 2016
|
|
|
500,000
|
|
|
|
.03
|
|
|
|
|
|
|
|
3,869
|
|
May 5, 2016
|
|
|
590,625
|
|
|
|
.01
|
|
|
|
|
|
|
|
3,477
|
|
June 8, 2016
|
|
|
2,678,571
|
|
|
|
.01
|
|
|
|
|
|
|
|
2,265
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
|
69,757,748
|
|
|
|
|
|
|
|
|
|
|
$
|
5,256,064
|
|
Effective September 18, 2015, the holder of the September 2014
Debentures and the Company agreed to amend its September 2014 Warrants, to reduce the exercise price of the warrants to purchase
an aggregate of 2,291,832 shares of the Company’s common stock to six cents per share. Additionally, the holder of the July
2014 Debentures and the Company agreed to amend its July 2014 Warrants, to reduce the exercise price of the warrants to purchase
an aggregate of 6,332,441 shares of Common Stock to six cents per share. As a result of the amendment, the fair value of the warrants
was remeasured as of September 18, 2015, for an additional fair value of approximately $38,000 recognized as a financing expense.
During the year ended December 31, 2015, approximately 2,292,000 warrants were exercised for cash proceeds of $137,510 at
an average exercise price of $0.06.
During the three and six months ended June 30, 2016 and 2015,
there were no warrants exercised.
The Company determined at issuance that the warrants were properly
classified in equity as there is no cash settlement provision and the warrants have a fixed exercise price and, therefore, result
in an obligation to deliver a known number of shares.
The Company adopted a sequencing policy that reclassifies contracts,
with the exception of stock options, from equity to assets or liabilities for those with the earliest inception date first. Any
future issuance of securities, as well as period-end reevaluations, will be evaluated as to reclassification as a liability under
our sequencing policy of earliest inception date first until all of the convertible debentures are either converted or settled.
The Company reevaluated the warrants as of June 30, 2016 and
determined that they did not have a sufficient number of authorized and unissued shares to settle all existing commitments, and
the fair value of the warrants for which there was insufficient authorized shares, were reclassified out of equity to a liability.
Under the sequencing policy, of the approximately 67,466,000 warrants outstanding at June 30, 2016, it was determined there was
not sufficient authorized shares for approximately 53,970,000 of the outstanding warrants. The fair value of these warrants was
re-measured on June 30, 2016 using the Black Scholes Merton Model, with key valuation assumptions used that consist of the price
of the Company’s stock on June 30, 2016, a risk free interest rate based on the average yield of a 2 or 3 year Treasury note
and expected volatility of the Company’s common stock, resulting in the fair value for the Warrant liability of approximately
$6,000. The resulting change in fair value of approximately $441,000 and $931,000 was recognized as a gain in the Condensed consolidated
statement of comprehensive income(loss).
NOTE 8 – NOTES PAYABLE
Notes payable consists of:
|
|
June 30,
2016
|
|
|
December 31,
2015
|
|
Southwest Farms (Note 3)
|
|
$
|
3,617,548
|
|
|
$
|
3,645,163
|
|
East West Secured Development (Note 3)
|
|
|
515,633
|
|
|
|
675,093
|
|
Washington Property (Note 6)
|
|
|
199,000
|
|
|
|
208,605
|
|
Investment funds (Note 8)
|
|
|
1,257,500
|
|
|
|
—
|
|
|
|
|
|
|
|
|
|
|
Financial Freedom, LLC
|
|
|
62,500
|
|
|
|
—
|
|
|
|
|
5,652,181
|
|
|
|
4,528,861
|
|
Less discounts
|
|
|
(323,924
|
)
|
|
|
—
|
|
Plus premium
|
|
|
10,000
|
|
|
|
16,667
|
|
|
|
|
|
|
|
|
|
|
|
|
|
5,338,257
|
|
|
|
4,545,528
|
|
Less current maturities
|
|
|
1,294,051
|
|
|
|
256,897
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
4,044,206
|
|
|
$
|
4,288,631
|
|
Maturities on Notes Payable are as follows:
Years ending:
|
|
|
|
December 31, 2016
|
|
$
|
1,045,988
|
|
December 31, 2017
|
|
|
287,643
|
|
December 31, 2018
|
|
|
4,004,626
|
|
|
|
$
|
5,338,257
|
|
The Company entered into a Securities Purchase Agreement dated
May 20, 2016 (the “SPA”) with an investor (the “Investor”) pursuant to which it issued to the Investor
a Convertible Promissory Note (the “Note”) in the principal amount of $1,242,500 that matures on July 20, 2017
and earns interest at the rate of 10% per annum. The Note carries an original issuance discount of $112,500 and the Company
agreed to pay $5,000 in legal fees for the Investor. In exchange for the Note, the Investor (1) paid to the Company $125,000
less $6,250 in broker fees paid by the Company, and (2) issued to the Company eight (8) secured promissory notes in the
principal amount of $125,000 each (each, a “Investor Note” and collectively the “Investor Notes”). This
amount is included with Investment funds in schedule above.
The Company must begin repaying principal and interest on funded
portions of the Note beginning 180 days after the date of the Note, and each month thereafter for a total period of 10 months,
in fixed amounts of $124,250 per month. The Company has a right to prepay the total outstanding balance of the Note at any time
(so long as it is not in default under the Note) in cash equal to 125% of the outstanding balance of the Note. Furthermore, for
a period of sixty days from the date of entry into the Note, a third party has the right to prepay the outstanding balance of the
Note in cash equal to 130% of the outstanding balance of the Note.
The notes become convertible into commons shares of the Company's
stock upon an Event of Default, as set forth in the terms of the SPA. The conversion price shall be 50% of the lowest closing bid
price during the twenty trading days immediately preceding the conversion. This conversion feature was considered to be a contingent
conversion feature, and therefore the conversion feature would not be bifurcated and accounted for as a derivative, until such
time as and if the Company is in an event of default.
In connection with any Event of Default by the Company, the
Investor may accelerate the Note with the outstanding balance becoming immediately due and payable in cash at 125% of the outstanding
balance. Furthermore, the Investor may elect to increase the outstanding balance by applying a 125% “default effect”
(up to two applications for two defaults) without accelerating the outstanding balance, in which event the outstanding balance
shall be increased as of the date of the occurrence of the applicable event of default. Furthermore, following the occurrence of
an event of default interest shall accrue on the outstanding balance beginning on the date the applicable event of default occurring
at an interest rate equal to the lesser of 22% per annum or the maximum rate permitted under applicable law.
In connection with entry into the SPA, the Company agreed to
reserve 300% of the shares into which the Note can be converted for the Investor.
The Investor may, with the Company’s consent, prepay,
without penalty, all or any portion of the outstanding balance of the Investor Notes at any time prior to the Investor Note Maturity
Date. Notwithstanding the foregoing, beginning on the date that is 90 days from the date of the issuance of the Note, and then
on the 6-month anniversary of the date of entry into the Note and monthly thereafter for a total of eight payments, the Investor
shall be obligated to prepay one of the eight Investor Notes at each such occurrence, if at the time of such occurrence: (a) no
event of default under the Note has occurred; (b) the average daily dollar volume of the Common Stock on its principal market
for the twenty (20) trading days is greater than $55,000.00; (c) the market capitalization of the Common Stock on the
date of the occurrence is greater than $3,000,000.00; and (d) the share reserve described below remains in place at the required
thresholds.
The Company also made extensive representations and warranties
relating to the transaction.
To date, no amounts have been received by the Company against
the eight Investor Notes.
On April 6, 2016, the Company entered into a Promissory note
for $85,000, which was issued with a $2,500 premium, and bears interest at 0.0%. The proceeds were to be used by the Farm, to pay
for water usage. Additionally, the Company issued 600,000 of the Company's restricted common stock to the holder. The shares were
valued at the market value of the common shares of the Company on the date of the issuance of the note. The payment terms called
for $40,000 to be paid on or before April 21, 2016, $20,000 to be paid on or before May 6, 2016, and the final $27,500 to also
be paid on or before May 6, 2016. The Note also allowed for the extension of the maturity date by 30 days, at the Company's request,
in exchange for an additional $2,500 payment. The note and the $2,500 extension payment were paid during July, 2016.
Notes payable, related parties, consists of:
|
|
June 30,
2016
|
|
|
December 31,
2015
|
|
Directors Notes
|
|
$
|
289,866
|
|
|
$
|
—
|
|
|
|
|
|
|
|
|
|
|
Less discounts
|
|
|
(12,000
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
277,866
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Less current maturities
|
|
|
(277,866
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
—
|
|
|
$
|
|
|
Maturities on Notes payable, related parties, are as follows:
Years ending:
|
|
|
|
December 31, 2016
|
|
$
|
39,166
|
|
December 31, 2017
|
|
|
250,700
|
|
|
|
$
|
289,866
|
|
On June 8, 2016, the Company issued Promissory Notes
(the "Directors Notes"), in the amount of $250,700, to all the directors in exchange for various amounts
outstanding for fees and reimbursements incurred during December 2015 and April 2016. The Notes have a term of six months and
bear interest at 8% until the note is paid in full. The Directors Notes were each issued with a warrant for fifty percent of
the face amount of the note, with an exercise price of $0.01 and exercisable for three years. The Company estimated the fair
value of the warrants based on a Black Scholes valuation model. The warrants were determined to have a fair value of
$12,000, calculated with the Black Sholes Merton model, with the following key valuation assumptions: estimated term of three
years, annual risk-free rate of .93%, and annualized expected volatility of 172%. The $12,000 fair value was recognized as a
debt discount and is being amortized over the six month term of the Directors Notes.
NOTE 9 – SHARE BASED AWARDS, RESTRICTED STOCK AND RESTRICTED
STOCK UNITS (“RSUs”)
The Board resolved that, beginning with the fourth calendar
quarter of 2015, the Company shall pay each member of the Company’s Board of Directors, who is not also an employee of the
Company, for each calendar quarter during which such member continues to serve on the Board compensation in the amount of $15,000
in cash and 325,000 shares of Company common stock. The 975,000 shares issued to all the directors for the three months ended
March 31, 2016 were valued at the market price of the Company’s common stock on March 31, 2016, for total compensation
expense of $9,750. On March 31, 2016, the Board awarded the Chairman a cash bonus of approximately $89,000 and, 2,230,000
shares of Company common stock for his service in the three months ended March 31, 2016,
The Board authorized grants of approximately 2,761,000 shares
of the Company common stock during the second quarter of 2016, which were valued at the market price of the Company's common stock
on date of grant, for total compensation expense of approximately $13,000. On June 8, 2016, the Board also awarded the Chairman
a cash bonus of approximately $89,200 and 6,027,000 shares of Company common stock, valued at approximately $8,000.
The Board also voted on June 8, 2016, to increase the shares
available for grant under the 2014 Equity Incentive Plan to 125,000,000. The Company intends to file a Form S-8 regarding
the increased shares available for grant now that the increase in authorized shares has been approved.
A summary of the activity related to RSUs for the three months
ended June 30, 2016 and 2015 is presented below:
Restricted stock units (RSU’s)
|
|
Total shares
|
|
|
Grant date fair
value
|
|
RSU’s non-vested at January 1, 2016
|
|
|
152,823
|
|
|
|
$0.51 - $1.88
|
|
RSU’s granted
|
|
|
14,285,714
|
|
|
|
$0.007
|
|
RSU’s vested
|
|
|
(125,431
|
)
|
|
|
$0.51- $1.88
|
|
RSU’s forfeited
|
|
|
—
|
|
|
|
$—
|
|
|
|
|
|
|
|
|
|
|
RSU’s non-vested June 30, 2016
|
|
|
14,313,106
|
|
|
|
$0.51 - $1.88
|
|
Restricted stock units (RSU’s)
|
|
Total shares
|
|
|
Grant date fair
value
|
|
RSU’s non-vested at January 1, 2015
|
|
|
199,584
|
|
|
|
$10.70
|
|
RSU’s granted
|
|
|
177,633
|
|
|
|
$1.88 - $6.70
|
|
RSU’s vested
|
|
|
(135,135
|
)
|
|
|
$1.88 - $6.70
|
|
RSU’s forfeited
|
|
|
—
|
|
|
|
$—
|
|
|
|
|
|
|
|
|
|
|
RSU’s non-vested June 30, 2015
|
|
|
242,082
|
|
|
|
$1.88 - $11.00
|
|
A summary of the expense related to restricted stock, RSUs and
stock option awards for the three and six months ended June 30, 2016 is presented below:
|
|
Three months ended
June 30, 2016
|
|
|
Six months ended
June 30, 2016
|
|
Restricted Stock
|
|
$
|
—
|
|
|
$
|
390,000
|
|
RSU’s
|
|
|
38,144
|
|
|
|
192,192
|
|
Stock options
|
|
|
—
|
|
|
|
—
|
|
Common stock
|
|
|
30,281
|
|
|
|
62,331
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
68,425
|
|
|
$
|
644,523
|
|
NOTE 10 – RELATED PARTY TRANSACTIONS
During the first quarter of 2015, the Company issued two convertible
notes to one of its directors in the aggregate principal amount of $100,000 and one convertible note to another of its director
in the aggregate principal amount of $50,000. These notes were all converted to common stock during the third quarter of 2015.
During the first quarter of 2016, the Company issued three convertible
notes to one of its directors in the aggregate principal amount of $75,000 and one convertible note to another of its director
in the aggregate principal amount of $25,000, plus a convertible note to each of its other two directors, in the amount of
$2,500 each. See Note 7 for a description of these notes.
In the second quarter of 2016, the Company issued promissory
notes to all of the directors, in exchange for past unpaid cash bonuses, board compensation and expenses. See Note 8 for a description
of these notes
NOTE 11 – COMMITMENTS AND CONTINGENCIES
The Company previously leased property for its day to day operations
and facilities for possible retail dispensary locations and cultivation locations as part of the process of applying for retail
dispensary and cultivation licenses.
Entry into Agreement to Acquire Real Property
On June 17, 2016, EWSD I, LLC, a wholly owned subsidiary of
the Company, entered into a Contract to Buy and Sell Real Estate (the “Acquisition Agreement”) with Tammy J. Sciumbato
and Donnie J. Sciumbato (collectively, the “Sellers”) to purchase certain real property comprised of 116-acres of agricultural
land, a barn and a farmhouse in Pueblo, Colorado (the “Property”). The closing of the Acquisition Agreement is scheduled
to occur on or about September 22, 2016 (the “Closing”), with possession of the land and barn occurring twelve (12)
days after the Closing and possession of the farm house occurring on or before January 1, 2017. The Sellers will were to rent back
the farm house from the Company until January 1, 2017. The purchase price to acquire the Property is $650,000, including $10,000
paid by the Company as a deposit into the escrow for the Property. The $10,000 is recognized as Deposits in Escrow on the accompanying
Condensed Consolidated Balance Sheet.
Office Leases
On August 1, 2011, the Company entered into a lease agreement
for office space located in West Hollywood, California through June 30, 2017 at a current monthly rate of $14,828 per month.
The Company moved to new offices in Los Angeles, CA in April 2015. The sublease on the new office has a term of 18 months
with monthly rent of $7,486.
The landlord for the West Hollywood space has filed a suit against
the Company and independent guarantors on the West Hollywood lease. The Company has expensed all lease payments due under the West
Hollywood lease. The Company’s liability for the West Hollywood lease will be adjusted, if required, upon settlement of the
suit with the landlord. On September 8, 2016, the court approved the landlord's application for writ of attachment in the State
of California in the amount of $374,402 against Prescription Vending Machines, Inc. (“PVM”). A trial date has been
set for May 2017 (Note 12).
Total rent expense under operating leases for the three months
ended June 30, 2016 and 2015 was $23,000 and $66,000, respectively. Rent expense for the six months ended June 30, 2016 and 2015
was approximately $376,000 and $110,000, respectively.
Retail/Cultivation facility leases
The Company’s business model of acquiring retail dispensary
and cultivation licenses often requires us to acquire real estate either through lease arrangements or through purchase agreements
in order to secure a possible license. Deposits in escrow consist of amounts paid to open escrow accounts for the purchase of multiple
properties to be used to develop retail dispensary or product cultivation facilities.
The following table is a summary of our material contractual
lease commitments as of June 30, 2016:
Year Ending
|
|
Office Rent
|
|
|
Retail/Cultivation
Facility Lease
|
|
2016
|
|
$
|
22,458
|
|
|
$
|
44,400
|
|
2017
|
|
|
—
|
|
|
|
88,800
|
|
2018
|
|
|
—
|
|
|
|
88,800
|
|
2019
|
|
|
—
|
|
|
|
29,600
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
22,458
|
|
|
$
|
251,600
|
|
Consulting Agreements
On December 7, 2015, the Company entered into a consulting agreement
for marketing and PR services, for a term of six months, which was subsequently extended through August 30, 2016. Compensation
under this agreement through May 30, 2016 was $25,000 per month, with twenty percent, or $5,000, of this amount to be paid in shares
of the Company's common stock. Per the terms of the agreement, the number of shares issued is determined at the end of each quarter.
Upon extension, the terms were adjusted to $15,000 per month for services, with $5,000 to be paid in shares of the Company's common
stock.
On March 1, 2016, the Company entered into a consulting agreement
for corporate financial advisory services, for a term of twelve months, which is cancellable anytime with thirty days written notice
after the first ninety days. Compensation under this agreement consists of a retainer of $3,500 per month, plus 1,500,000 shares
of common stock issuable in 375,000 share tranches on a quarterly basis.
Litigation
On May 22, 2013, Medbox
(now known as Notis Global, Inc.) initiated litigation in the United States District Court in the District of Arizona against three
shareholders of MedVend Holdings LLC (“Medvend”) in connection with a contemplated transaction that Medbox entered
into for the purchase of an approximate 50% ownership stake in Medvend for $4.1 million. The lawsuit alleges fraud and related
claims arising out of the contemplated transaction during the quarter ended June 30, 2013. The litigation is pending and Medbox
has sought cancellation due to a fraudulent sale of the stock because the selling shareholders lacked the power or authority to
sell their ownership stake in MedVend, and their actions were a breach of representations made by them in the agreement. On November
19, 2013 the litigation was transferred to United States District Court for the Eastern District of Michigan. MedVend recently
joined the suit pursuant to a consolidation order executed by a new judge assigned to the matter. In the litigation, the selling
shareholder defendants and Medvend seek to have the transaction performed, or alternatively be awarded damages for the alleged
breach of the agreement by Medbox. Medvend and the shareholder defendants seek $4.55 million in damages, plus costs and attorneys’
fees. Medbox has denied liability with respect to all such claims. On June 5, 2014, the Company entered into a purchase and sale
agreement (the “Medvend PSA”) with PVM International, Inc. (“PVMI”) concerning this matter. Pursuant to
the Medvend PSA, the Company sold to PVMI the Company’s rights and claims attributable to or controlled by the Company against
those three certain stockholders of Medvend, known as Kaplan, Tartaglia and Kovan (the “Medvend Rights and Claims”),
in exchange for the return by PVMI to the Company of 30,000 shares of the Company’s common stock. PVMI is owned by Vincent
Mehdizadeh, formerly the Company’s largest stockholder. On December 17, 2015, the Company entered into a revocation of the
Medvend PSA, which provided that from that date forward, Medbox would take over the litigation and be responsible for the costs
and attorneys’ fees associated with the Medvend Litigation from December 17, 2015 forward. All costs and attorneys’
fees through December 16, 2015 will be borne by PVMI. After the filing of a motion for substitution of Medbox n/k/a Notis Global,
Inc. for PVMI, Defendants’ agreed, via a stipulated order, to permit the substitution. The Court entered the order substituting
Notis Global, Inc. for PVMI on February 17, 2016. A new litigation schedule was recently issued which resulted in an adjournment
of the trial. A new trial date will be set by the court following its ruling on a motion for summary judgment filed by Defendants
and Medvend, which is set for hearing on November 16, 2016. At this time, the Company cannot determine whether the likelihood of
an unfavorable outcome of the dispute is probable or remote, nor can they reasonably estimate a range of potential loss, should
the outcome be unfavorable.
On February 20, 2015, Michael A. Glinter, derivatively and on
behalf of nominal defendants Medbox, Inc. the Board and certain executive officers (Pejman Medizadeh, Matthew Feinstein, Bruce
Bedrick, Thomas Iwanskai, Guy Marsala, J. Mitchell Lowe, Ned Siegel, Jennifer Love, and C. Douglas Mitchell) filed a suit in the
Superior Court of the State of California for the County of Los Angeles. The suit alleges breach of fiduciary duties and abuse
of control by the defendants. Relief is sought awarding damages resulting from breach of fiduciary duty and to direct the Company
and the defendants to take all necessary actions to reform and improve its corporate governance and internal procedures to comply
with applicable law. The Company has entered into a Stipulation and Agreement of Settlement on October 16, 2015. See more
detailed discussion below under
Derivative Settlement
s.
On January 21, 2015, Josh Crystal on behalf of himself and of
all others similarly situated filed a class action lawsuit in the U.S. District Court for Central District of California against
Medbox, Inc., and certain past and present members of the Board (Pejman Medizadeh, Bruce Bedrick, Thomas Iwanskai, Guy Marsala,
and C. Douglas Mitchell). The suit alleges that the Company issued materially false and misleading statements regarding its financial
results for the fiscal year ended December 31, 2013 and each of the interim financial periods that year. The plaintiff seeks relief
of compensatory damages and reasonable costs and expenses or all damages sustained as a result of the wrongdoing. On April 23,
2015, the Court issued an Order consolidating the three related cases in this matter: Crystal v. Medbox, Inc., Gutierrez v. Medbox,
Inc., and Donnino v. Medbox, Inc., and appointing a lead plaintiff. On July 27, 2015, Plaintiffs filed a Consolidated Amended Complaint.
The Company has entered into a Stipulation and Agreement of Settlement on October 16, 2015. See more detailed discussion below
under
Class Settlement
.
On January 18, 2015, Ervin Gutierrez filed a class action lawsuit
in the U.S. District Court for the Central District of California. The suit alleges violations of federal securities laws through
public announcements and filings that were materially false and misleading when made because they misrepresented and failed to
disclose that the Company was recognizing revenue in a manner that violated US GAAP. The plaintiff seeks relief for compensatory
damages and reasonable costs and expenses or all damages sustained as a result of the wrongdoing. On April 23, 2015, the Court
issued an Order consolidating the three related cases in this matter: Crystal v. Medbox, Inc., Gutierrez v. Medbox, Inc., and Donnino
v. Medbox, Inc., and appointing a lead plaintiff. On July 27, 2015, Plaintiffs filed a Consolidated Amended Complaint. The
Company has entered into a Stipulation and Agreement of Settlement on October 16, 2015. See more detailed discussion below
under
Class Settlement
.
On January 29, 2015, Matthew Donnino filed a class action lawsuit
in the U.S. District Court for Central District of California. The suit alleges that the Company issued materially false and misleading
statements regarding its financial results for the fiscal year ended December 31, 2013 and each of the interim financial periods
that year. The plaintiff seeks relief for compensatory damages and reasonable costs and expenses or all damages sustained as a
result of the wrongdoing. On April 23, 2015, the Court issued an Order consolidating the three related cases in this matter: Crystal
v. Medbox, Inc., Gutierrez v. Medbox, Inc., and Donnino v. Medbox, Inc., and appointing a lead plaintiff. On July 27, 2015 Plaintiffs
filed a Consolidated Amended Complaint. The Company has entered into a Stipulation and Agreement of Settlement on October 16, 2015. See
more detailed discussion below under
Class Settlement
.
On February 12, 2015, Jennifer Scheffer, derivatively on behalf
of Medbox, Guy Marsala, Ned Siegel, Mitchell Lowe and C. Douglas Mitchell filed a lawsuit in the Eighth Judicial District Court
of Nevada seeking damages for breaches of fiduciary duty regarding the issuance and dissemination of false and misleading statements
and regarding allegedly improper and unfair related party transactions, unjust enrichment and waste of corporate assets. On April
17, 2015, Ned Siegel and Mitchell Lowe filed a Motion to Dismiss. On April 20, 2015, the Company filed a Joinder in the Motion
to Dismiss. On July 27, 2015, the Court held a hearing on and granted the Motion to Dismiss without prejudice. The Company has
entered into a Stipulation and Agreement of Settlement on October 16, 2015. See more detailed discussion below under
Derivative
Settlements
.
On March 10, 2015, Robert J. Calabrese, derivatively and on
behalf of nominal defendant Medbox, Inc., filed a suit in the United States District Court for the District of Nevada against certain
Company officers and/or directors (Ned L. Siegel, Guy Marsala, J. Mitchell Lowe, Pejman Vincent Mehdizadeh, Bruce Bedrick, and
Jennifer S. Love). The suit alleges breach of fiduciary duties and gross mismanagement by issuing materially false and misleading
statements regarding the Company’s financial results for the fiscal year ended December 31, 2013 and each of the interim
financial periods. Specifically the suit alleges that defendants caused the Company to overstate the Company’s revenues by
recognizing revenue on customer contracts before it had been earned. The plaintiff seeks relief for compensatory damages and reasonable
costs and expenses for all damages sustained as a result of the alleged wrongdoing. The Company has entered into a Stipulation
and Agreement of Settlement on October 16, 2015. See more detailed discussion below under
Derivative Settlements
.
On March 27, 2015, Tyler Gray, derivatively and on behalf of
nominal defendant Medbox, Inc., filed a suit in the United States District Court for the District of Nevada against the Company’s
Board of Directors and certain executive officers (Pejman Vincent Mehdizadeh, Matthew Feinstein, Bruce Bedrick, Thomas Iwanski,
Guy Marsala, J. Mitchell Lowe, Ned Siegel, Jennifer S. Love, and C. Douglas Mitchell). The suit alleges breach of fiduciary duties
and abuse of control. The plaintiff seeks relief for compensatory damages and reasonable costs and expenses for all damages sustained
as a result of the alleged wrongdoing. Additionally the plaintiff seeks declaratory judgments that plaintiff may maintain the action
on behalf of the Company, that the plaintiff is an adequate representative of the Company, and that the defendants have breached
and/or aided and abetted the breach of their fiduciary duties to the Company. Lastly the plaintiff seeks that the Company be directed
to take all necessary actions to reform and improve its corporate governance and internal procedures to comply with applicable
law. The Company has entered into a Stipulation and Agreement of Settlement on October 16, 2015. See more detailed discussion
below under
Derivative Settlements
.
On May 20, 2015, Patricia des Groseilliers, derivatively and
on behalf of nominal defendant Medbox, Inc., filed a suit in the United States District Court for the District of Nevada against
the Company’s Board of Directors and certain executive officers (Pejman Vincent Mehdizadeh, Ned Siegel, Guy Marsala, J. Mitchell
Lowe, Bruce Bedrick, Jennifer S. Love, Matthew Feinstein, C. Douglas Mitchell, and Thomas Iwanski). The suit alleges breach of
fiduciary duties and unjust enrichment. The plaintiff seeks relief for compensatory damages and reasonable costs and expenses for
all damages sustained as a result of the alleged wrongdoing. Additionally the plaintiff seeks declaratory judgments that plaintiff
may maintain the action on behalf of the Company, that the plaintiff is an adequate representative of the Company, and that the
defendants have breached and/or aided and abetted the breach of their fiduciary duties to the Company. Lastly the plaintiff seeks
that the Company be directed to take all necessary actions to reform and improve its corporate governance and internal procedures
to comply with applicable law. The Company has entered into a Stipulation and Agreement of Settlement on October 16, 2015. See
more detailed discussion below under
Derivative Settlements
.
On June 3, 2015, Mike Jones, derivatively and on behalf of nominal
defendant Medbox, Inc., filed a suit in the U.S. District Court for Central District of California against the Company’s
Board of Directors and certain executive officers (Guy Marsala, J. Mitchell Lowe, Ned Siegel, Jennifer S. Love, C. Douglas Mitchell,
Pejman Vincent Mehdizadeh, Matthew Feinstein, Bruce Bedrick, and Thomas Iwanski). The suit alleges breach of fiduciary duties,
abuse of control, and breach of duty of honest services. The plaintiff seeks relief for compensatory damages and reasonable costs
and expenses for all damages sustained as a result of the alleged wrongdoing. Additionally the plaintiff seeks declaratory judgments
that plaintiff may maintain the action on behalf of the Company, that the plaintiff is an adequate representative of the Company,
and that the defendants have breached and/or aided and abetted the breach of their fiduciary duties to the Company. Lastly the
plaintiff seeks that the Company be directed to take all necessary actions to reform and improve its corporate governance and internal
procedures to comply with applicable law. On July 20, 2015, the Court issued an Order consolidating this litigation with those
previously consolidated in the Central District (Crystal, Gutierrez, and Donnino). On October 7, 2015, the Court issued an
Order modifying the July 20, 2015 Order consolidating the litigation so that the matters remain consolidated for the purposes of
pretrial only. The Company has entered into a Stipulation and Agreement of Settlement on October 16, 2015. See more detailed
discussion below under
Derivative Settlement
s.
On July 20, 2015, Kimberly Freeman, derivatively and on behalf
of nominal defendant Medbox, Inc., filed a suit in the Eighth Judicial District Court of Nevada against the Company’s Board
of Directors and certain executive officers (Pejman Vincent Mehdizadeh, Guy Marsala, Ned Siegel, J. Mitchell Lowe, Jennifer S.
Love, C. Douglas Mitchell, and Bruce Bedrick). The suit alleges breach of fiduciary duties and unjust enrichment. The plaintiff
seeks relief for compensatory damages and reasonable costs and expenses for all damages sustained as a result of the alleged wrongdoing.
Additionally the plaintiff seeks declaratory judgments that plaintiff may maintain the action on behalf of the Company, that the
plaintiff is an adequate representative of the Company, and that the defendants have breached and/or aided and abetted the breach
of their fiduciary duties to the Company. Lastly the plaintiff seeks that the Company be directed to take all necessary actions
to reform and improve its corporate governance and internal procedures to comply with applicable law. The Company has entered into
a Stipulation and Agreement of Settlement on October 16, 2015. See more detailed discussion below under
Derivative Settlement
s.
On October 16, 2015, solely to avoid the costs, risks, and uncertainties
inherent in litigation, the parties to the class actions and derivative lawsuits named above entered into settlements that collectively
effect a global settlement of all claims asserted in the class actions and the derivative actions. The global settlement provides,
among other things, for the release and dismissal of all asserted claims. The global settlement is contingent on final court approval,
respectively, of the settlements of the class actions and derivative actions. If the global settlement does not receive final court
approval, it could have a material adverse effect on the financial condition, results of operations and/or cash flows of the Company
and their ability to raise funds in the future.
On October 27, 2015, separate from the above lawsuits and settlement,
Richard Merritts, derivatively and on behalf of nominal defendant Medbox, Inc., filed a suit in the Superior Court of the State
of California for the County of Los Angeles against the Board and certain executive officers (Guy Marsala, J. Mitchell Lowe, Ned
Siegel, Jennifer S. Love, C. Douglas Mitchell, Pejman Vincent Mehdizadeh, Matthew Feinstein, Bruce Bedrick, Jeff Goh, and Thomas
Iwanski). The suit titled
Merritts v. Marsala, et al.
, Case No. BC599159 (the “Merritts Action”), alleges breach
of fiduciary duties by the defendants. Relief is sought awarding damages resulting from breach of fiduciary duty and to direct
the Company and the defendants to take all necessary actions to reform and improve its corporate governance and internal procedures
to comply with applicable law. On February 16, 2016, the court issued an order staying the litigation pending final court
approval of the settlement of the other pending derivative actions involving Medbox, Inc., as nominal defendant, and former and
current officers and directors. The settlement of the other derivative actions has been preliminarily approved by the court
in
Jones v. Marsala, et al
., Case No. 15-cv-4170 BRO (JEMx), in the U.S. District Court for the Central District of California.
On March 25, 2016, Merritts filed a Motion to Intervene in the case filed by Mike Jones in the U.S. District Court for the Central
District of California. By his Motion, Merritts seeks limited intervention in the Jones shareholder derivative action in order
to seek confirmatory information and discovery regarding the Stipulation and Agreement of Settlement preliminarily approved by
the Court on February 3, 2016. On April 4, 2016, Plaintiff Jones and the Company separately filed oppositions to the
Motion to Intervene. On April 22, 2016, the Court issued an Order granting, without a hearing, shareholder Richard Merritts’
Motion to Intervene in the lawsuit titled
Mike Jones v. Guy Marsala, et al.
, in order to conduct limited discovery. On
September 16, 2016, solely to avoid the costs, risks, and uncertainties inherent in litigation, the parties entered into a settlement
regarding Merritts’ claims. See more detailed discussion below under
Derivative Settlements
.
Class Settlement
On December 1, 2015, Medbox and the class plaintiffs in Josh
Crystal v. Medbox, Inc., et al., Case No. 2:15-CV-00426-BRO (JEMx), pending before the United States District Court for the Central
District of California (the “Court”) notified the Court of the settlement. The Court stayed the action pending the
Court’s review of the settlement and directed the parties to file a stipulation of settlement. On December 18, 2015, plaintiffs
filed the Motion for Preliminary Approval of Class Action Settlement that included the stipulation of settlement. On February 3,
2016, the Court issued an Order granting preliminary approval of the settlement. The settlement provides for notice to be given
to the class, a period for opt outs and a final approval hearing. The Court originally scheduled the Final Settlement Approval
Hearing to be held on May 16, 2016 at 1:30 p.m., but continued it to August 15, 2016 at 1:30 p.m. to be heard at the same time
as the Final Settlement Approval Hearing for the derivative actions, discussed below. The principal terms of the settlement are:
|
•
|
a cash payment to a settlement escrow account in the amount
of $1,850,000 of which $150,000 will be paid by the Company and $1,700,000 will be paid by the Company’s insurers;
|
|
•
|
a transfer of 2,300,000 shares of Medbox common stock to
the settlement escrow account, of which 2,000,000 shares would be contributed by Medbox and 300,000 shares by Bruce Bedrick;
|
|
•
|
the net proceeds of the settlement escrow, after deduction
of Court-approved administrative costs and any Court-approved attorneys’ fees and costs would be distributed to the Class;
and
|
|
•
|
releases of claims and dismissal of the action.
|
By entering into the settlement, the settling parties have resolved
the class claims to their mutual satisfaction. However, the final determination is subject to approval by the Federal Courts. Defendants
have not admitted the validity of any claims or allegations and the settling plaintiffs have not admitted that any claims or allegations
lack merit or foundation. If the global settlement does not receive final court approval, it could have a material adverse effect
on the financial condition, results of operations and/or cash flows of the Company and their ability to raise funds in the future.
Derivative Settlements
As previously announced on October 22, 2015, on October 16,
2015, the Company, in its capacity as a nominal defendant, entered into a memorandum of understanding of settlement (the “Settlement”)
in the following shareholder derivative actions: (1) Mike Jones v. Guy Marsala, et al., in the U.S. District Court for Central
District of California; (2) Jennifer Scheffer v. P. Vincent Mehdizadeh, et al., in the Eighth Judicial District Court of Nevada;
(3) Kimberly Y. Freeman v. Pejman Vincent Mehdizadeh, et al., in the Eighth Judicial District Court of Nevada; (4) Tyler Gray v.
Pejman Vincent Mehdizadeh, et al., in the U.S. District Court for the District of Nevada; (5) Robert J. Calabrese v. Ned L. Siegel,
et al., in the U.S. District Court for the District of Nevada; (6) Patricia des Groseilliers v. Pejman Vincent Mehdizadeh, et al.,
in the U.S. District Court for the District of Nevada; (7) Michael A. Glinter v. Pejman Vincent Mehdizadeh, et al., in the Superior
Court of the State of California for the County of Los Angeles (the “Shareholder Derivative Lawsuits”). In addition
to the Company, Pejman Vincent Mehdizadeh, Matthew Feinstein, Bruce Bedrick, Thomas Iwanski, Guy Marsala, J. Mitchell Lowe, Ned
Siegel, and C. Douglas Mitchell were named as defendants in all of the lawsuits, and Jennifer S. Love was named in all of the lawsuits
but the Scheffer action (the “Individual Defendants”).
On December 3, 2015, the parties in the Jones v. Marsala action
advised the Court of the settlements in the Shareholder Derivative Lawsuits and that the parties would be submitting the settlement
to the Court in the Jones action for approval. The Court thereafter issued an order vacating all pending dates in the action and
ordered Plaintiff to file the Stipulation and Agreement of Settlement for the Court’s approval. On December 18, 2015, plaintiffs
filed the Motion for Preliminary Approval of Derivative Settlement that included the Stipulation and Agreement of Settlement. On
February 3, 2016, the Court issued an Order granting preliminary approval of the settlement.
The Court originally scheduled a final Settlement Hearing to
be held on May 16, 2016, but subsequently continued that hearing to October 17, 2016. By the terms of
the settlement, a final Court approval would provide for a release of the claims in the Shareholder Derivative Actions and a bar
against continued prosecution of all claims covered by the release. By entering into the Settlement, the settling parties have
resolved the derivative claims to their mutual satisfaction. The Individual Defendants have not admitted the validity of any claims
or allegations and the settling plaintiffs have not admitted that any claims or allegations lack merit or foundation.
The final Settlement Hearing was held on October 17, 2016, and the Court has taken the settlement under
review.
Under the terms of the Settlement, the Company agrees to adopt
and adhere to certain corporate governance processes in the future. In addition to these corporate governance measures, the Company’s
insurers, on behalf of the Individual Defendants, will make a payment of $300,000 into the settlement escrow account and Messrs.
Mehdizadeh and Bedrick will deliver 2,000,000 and 300,000 shares, respectively, of their Medbox, Inc. common stock into the settlement
escrow account. Subject to Court approval, the funds and common stock in the settlement escrow account will be paid as attorneys’
fees and expenses, or as service awards to plaintiffs.
On September 16, 2016, solely to avoid the costs,
risks, and uncertainties inherent in litigation, the parties entered into a settlement regarding the Merritts Action. The
settlement provides, among other things, for the release and dismissal of all asserted claims. Under the terms of the
settlement, the Company agrees to adopt and to adhere to certain corporate governance processes in the future. In addition to
these corporate governance measures, the Company will make a payment of $135,000 in cash to be used to pay Merritts’
counsel for any attorneys’ fees and expenses, or as service awards to plaintiff Merritts, that are approved and awarded
by the Court. The settlement is contingent on final court approval. The final Settlement Hearing was held on October 17, 2016, at the same date and time as the final Settlement Hearing for the Shareholder Derivative Lawsuits. The Court has taken the settlement under review.
The Settlements remain subject to approval by the Court. The
Court must determine whether (1) the terms and conditions of the Settlements are fair, reasonable, and adequate in the best interest
of the Company and its stockholders, (2) if the judgment, as provided for in the Settlements, should be entered, and (3) if the
request of plaintiff’s counsel for an award of attorneys’ fees and reimbursement of expenses should be granted.
The Company’s responsibilities as to the proposed settlements
of the Class Action and the Shareholder Derivative Lawsuits have been accrued and included in Accrued settlement and severance
expenses on the accompanying consolidated balance sheet as of December 31, 2015. If the settlements of the Class Action, the Shareholder
Derivative Lawsuits, or the Merritts Action do not receive final court approval, it could have a material adverse effect on the
financial condition, results of operations and/or cash flows of the Company and their ability to raise funds in the future.
SEC Investigation
In October 2014, the Board of Directors of the Company appointed
a special board committee (the “Special Committee”) to investigate issues arising from a federal grand jury subpoena
pertaining to the Company’s financial reporting which was served upon the Company’s predecessor independent registered
public accounting firm as well as certain alleged wrongdoing raised by a former employee of the Company. The Company was subsequently
served with two SEC subpoenas in early November 2014. The Company is fully cooperating with the grand jury and SEC investigations.
In connection with its investigation of these matters, the Special Committee in conjunction with the Audit Committee initiated
an internal review by management and by an outside professional advisor of certain prior period financial reporting of the Company.
The outside professional advisor reviewed the Company’s revenue recognition methodology for certain contracts for the third
and fourth quarters of 2013. As a result of certain errors discovered in connection with the review by management and its professional
advisor, the Audit Committee, upon management’s recommendation, concluded on December 24, 2014 that the consolidated financial
statements for the year ended December 31, 2013 and for the third and fourth quarters therein, as well as for the quarters ended
March 31, 2014, June 30, 2014 and September 30, 2014, should no longer be relied upon and would be restated to correct the
errors. On March 6, 2015 the audit committee determined that the consolidated financial statements for the year ended December
31, 2012, together with all three, six and nine month financial information contained therein, and the quarterly information for
the first two quarters of the 2013 fiscal year should also be restated. On March 11, 2015, the Company filed its restated Form
10 Registration Statement with the SEC with restated financial information for the years ended December 31, 2012 and December 31,
2013, and on March 16, 2015, the Company filed amended and restated quarterly reports on Form 10-Q, with restated financial information
for the periods ended March 31, June 30 and September 30, 2014, respectively.
In March 2016, the staff of the Los Angeles Regional Office
of the U.S. Securities and Exchange Commission advised counsel for the Company in a telephone conversation, followed by a written
“Wells” notice, that it is has made a preliminary determination to recommend that the Commission file an enforcement
action against the Company in connection with misstatements by prior management in the Company’s financial statements for
2012, 2013 and the first three quarters of 2014. A Wells Notice is neither a formal allegation of wrongdoing nor a finding that
any violations of law have occurred. Rather, it provides the Company with an opportunity to respond to issues raised by the Staff
and offer its perspective prior to any SEC decision to institute proceedings. These proceedings could result in the Company being
subject to an injunction and cease and desist order from further violations of the securities laws as well as monetary penalties
of disgorgement, pre-judgment interest and a civil penalty. The Company has responded in writing to the “Wells” notice.
Under current management, the Company restated the relevant financial statements and took other remedial action, and has been cooperating
with the SEC’s investigation since November 2014, including the appointment of a Special Committee of the Board to investigate
the conduct of prior management and disclose this conduct to the SEC. The Company has also produced documents to the SEC and has
made witnesses available, both voluntarily and for sworn testimony pursuant to subpoena. The Company is unable to predict the outcome
of the investigation, any potential enforcement actions or any other impact on the Company that may arise as a result of such investigation.
The Company has not established a liability for this matter, because it believes that the probability of loss related to this matter
and an estimate of the amount of loss, if any, are not determinable at this time. An adverse judgment or action of the SEC could
have a material adverse effect on the financial condition, results of operations and/or cash flows of the Company and their ability
to raise funds in the future.
Other litigation
Whole Hemp complaint
A complaint was filed by Whole Hemp Company, LLC d/b/a Folium
Biosciences (“Whole Hemp”) on June 1, 2016, naming Notis Global, Inc. and EWSD I, LLC (collectively, “Notis”),
as defendants in Pueblo County, CO district court. The complaint alleges five causes of action against Notis: misappropriation
of trade secrets, civil theft, intentional interference with prospective business advantage, civil conspiracy, and breach of contract.
All claims concern contracts between Whole Hemp and Notis for the Farming Agreement and the Distributor Agreement.
The court entered an
ex parte
temporary restraining order
on June 2, 2016, and a modified temporary restraining order on July 14, 2016, enjoining Notis from disclosing, using, copying,
conveying, transferring, or transmitting Whole Hemp’s trade secrets, including Whole Hemp’s plants. On June 13,
2016, the court ordered that all claims be submitted to arbitration, except for the disposition of the temporary restraining order.
On August 12, 2016, the court ordered that all of Whole Hemp’s
plants in Notis’ possession be destroyed, which occurred by August 24, 2016,, at which time the temporary restraining order
was dissolved and the parties will soon file a motion to dismiss the district court action.
In light of the Whole Hemp plants all being destroyed per the
court order, the Company has immediately expensed all Capitalized agricultural costs as of June 30, 2016, as all costs as of that
date related to Whole Hemp plants.
Notis commenced arbitration in Denver, CO on August 2, 2016,
seeking injunctive relief and alleging breaches of the contracts between the parties. Whole Hemp filed is Answer and counterclaims
on September 6, 2016, asserting similar allegations that were asserted to the court. .
On September 30, 2016, the arbitrator held an initial status
conference and agreed to allow EWSD and Notis to file a motion to dismiss some or all of Whole Hemp’s claims by no later
than October 28, 2016. The parties were also ordered to make initial disclosures of relevant documents and persons with knowledge
of relevant information by October 21, 2016.
West Hollywood Lease
The lease for the former office at 8439 West Sunset Blvd. in
West Hollywood, CA has been partially subleased. The Company plans to sublease the remainder of the office in West Hollywood, CA
and continues to incur rent expense while the space is being marketed. The landlord for the prior lease filed a suit in Los Angeles
Superior Court in April 2015 against the Company for damages they allege have been incurred from unpaid rent and otherwise. In
January 2016, the landlord filed a first amended complaint adding the independent guarantors under the lease as co-defendants and
specifying damages claim of approximately $300,000. On September 8, 2016, the court approved the landlord's application for writ
of attachment in the State of California in the amount of $374,402 against Prescription Vending Machines, Inc. (“PVM”).
A trial date has been set in May 2017. The Company is presently unable to determine whether the likelihood of an unfavorable outcome
of the dispute is probable or remote, nor can it reasonably estimate a range of potential loss, should the outcome be unfavorable.
Los Angeles Lease
The Company’s former landlord, Bank Leumi, filed an action
against the Company in Los Angeles Superior Court for breach of lease on August 31, 2016, seeking $29,977 plus fees and interest,
in addition to rent payment for September 2016. The Company filed a response to the complaint on September 21, 2016, and a case
management conference is scheduled for December 9, 2016. The Company is presently trying settle the dispute with the landlord.
NOTE 12 – SUBSEQUENT EVENTS
Letter agreements
On August 3, 2016, Notis Global, Inc. executed letter agreements
with each of the Company’s two largest investors (the “First Investor” and the “Second Investor”,
respectively) (Note 7).
First Investor Letter Agreement
Pursuant to the letter agreement with the First Investor (the
“First Investor Letter Agreement”), the First Investor agreed to waive, until October 31, 2016, any defaults relating
to the requirement to reserve shares of common stock in excess of shares presently held in the First Investor’s reserve with
the Company’s transfer agent, as required pursuant to all securities purchase agreements between the Company and the First
Investor, debentures issued by the Company to the First Investor and promissory notes issued by the Company to the First Investor
(collectively, the “First Investor Credit Agreements”). The First Investor Letter Agreement also extended the
maturity dates of certain debentures issued to the First Investor dated July 10, 2015, August 24, 2015, August 28, 2015, May 13,
2016 and May 20, 2016 from their original maturity dates (occurring between July 10, 2016 and August 28, 2016) to October 31, 2016.
Additionally, the parties to the First Investor Letter Agreement
agreed that any payments made to the First Investor pursuant to Section 4.16 (Profit Sharing) of that certain Stock Purchase Agreement
among the First Investor, the Company, EWSD I LLC, a subsidiary of the Company (“EWSD”), and Pueblo Agriculture Supply
and Equipment, LLC, a subsidiary of the Company (“PASE”) dated as of June 30, 2016 (the “EWSD SPA”) (Note
7), shall be applied as repayments of any redemption premium, accrued and unpaid interest, and outstanding principal owed to the
First Investor under the First Investor Credit Agreements, and that the provisions of Section 4.16 of the EWSD SPA are only applicable
until the First Investor has been repaid required principal, interest, fees and premiums under the EWSD SPA and any related debentures
issued by the Company pursuant thereto.
Second Investor Letter Agreement
Pursuant to the letter agreement with the Second Investor (the
“Second Investor Letter Agreement”), the Second Investor (on behalf of itself and its affiliates) also agreed to waive,
until October 31, 2016, any defaults relating to the requirement to reserve shares of common stock in excess of shares presently
held in the Second Investor’s reserve with the Company’s transfer agent, as required pursuant to all securities purchase
agreements between the Company and the Second Investor, debentures issued by the Company to the Second Investor and promissory
notes issued by the Company to the Second Investor (collectively, the “Second Investor Credit Agreements”). The
Second Investor Letter Agreement also extended the maturity dates of certain debentures issued (or assigned) to the Second Investor
(or its affiliates) dated August 24, 2015, March 27, 2015, May 7, 2015, May 15, 2015, May 22, 2015 and August 14, 2015
from their original maturity dates (occurring between July 10, 2016 and August 24, 2016) to October 31, 2016.
Pursuant to the Second Investor Letter Agreement, the Company
agreed to pay the Second Investor within five (5) days of the end of each fiscal quarter, (i) 20% of all distributed cash
flow from PASE and EWSD to the Company after taking into account amounts owed to First Investor pursuant to Section 4.16 (Profit
Sharing) of the EWSD SPA, and (ii) 20% of any money raised at either EWSD or PASE that is distributable or paid to the Company.
Such payments will be credited as repayments of amounts owed to the Second Investor under all securities purchase agreements between
the Company and the Second Investor, debentures issued by the Company to the Second Investor and promissory notes issued by the
Company to the Second Investor (collectively, the “Second Investor Credit Agreements”) including towards any redemption,
premium accrued and unpaid interest, and outstanding principal thereunder, and such payments shall only occur until the Second
Investor has been repaid the sum of $500,000 of principal under the Second Investor Credit Agreements, plus a 30% premium on such
amount.
Subsequent funding
Subsequent to June 30, 2016, the Company has received approximately
$1,266,000, net of approximately $40,000 in withholdings, in additional closings under the June 30, 2016 funding (Note 7).
Additionally, the Company has received approximately $650,000 under the September 30, 2016 financing discussed below.
Event of Default
On September 22, 2016, Notis Global, Inc. received notice of
an Event of Default and Acceleration (the “
Notice Letter
”) in connection with the promissory note (the
"Note"), dated March 14, 2016, in the original principal amount of $140,000 (Note 8). Pursuant to the Notice Letter,
(1) beginning on September 14, 2016, the maturity date of the Note, the Note began to accrue interest at a default rate of 22%
per annum (the “
Default Rate Adjustment
”), (2) the noteholder declared all unpaid principal, accrued
interest and other amounts due and payable at 125% of the outstanding balance of the Note (the “
Mandatory Default Amount
”),
and (3) the noteholder declared the outstanding balance of the Note immediately due and payable (the “
Acceleration
Payment
”).
On September 23, 2016, the noteholder agreed to forebear the
Acceleration Payment for a period of 30 days, and is in the process with the Company of negotiating a forbearance agreement reflecting
the 30-day forbearance. Regardless of such forbearance, the Default Rate Adjustment and the application of the Mandatory Default
Amount formula shall remain in effect. As a result of the application of the Mandatory Default Amount formula, the outstanding
balance of the Note increased to $184,022 from $147,217.
As a result of the effect of the Notice Letter, other of the
Company’s lenders could issue similar notices of events of default or acceleration or penalties due to the Company’s
Event of Default set forth in the Notice Letter.
Entry into Note Purchase Agreement,
Exchange Agreement, and Security Agreement
On September 30, 2016, the Company entered
into a securities purchase agreement (the “Securities Purchase Agreement”) with a new investor (the “Investor”)
pursuant to which two wholly-owned subsidiaries of the Company, EWSD I, LLC (“EWSD I”) and Pueblo Agriculture Supply
and Equipment, LLC (“Pueblo”, and together with EWSD I, the “Subsidiaries”) agreed to jointly sell, and
the Investor agreed to purchase, an aggregate of up to $3,349,599 in subscription amount of convertible secured promissory notes
(plus the Investor Subscription Amount of $1,431,401, described below, which was tendered with the first tranche of the Securities
Purchase Agreement) (collectively, the “New Notes”) in seven tranches (each, a “Closing”).
The Investor’s commitment to purchase
the New Notes may, at the option of the Investor, be reduced by up to $700,000 for monies raised by the Company or the Subsidiaries.
The Investor Note Subscription Amount refers to $1,431,401 of 10% convertible notes of the Company previously issued to the Company's
major investor ("First Investor") pursuant to that certain Securities Purchase Agreement dated on or about June 30, 2016
(the “July SPA”) (Note 11). The debentures issued pursuant to the July SPA were subsequently assigned to the Investor
and were tendered for cancellation to the Company for the Investor Subscription Amount portion of the New Notes.
The New Notes accrue interest at a rate
of 5% per annum and are issued at a 40% discount to purchase price. Therefore, if each of the seven tranches described below are
fully funded, the Company would receive cash in the aggregate of $1,983,599 in exchange for the issuance of New Notes with a face
value of $3,349,599 in principal to be repaid to the Investor. The first New Note issued in the first tranche under the Securities
Purchase Agreement was for an original purchase price of $1,881,401 (representing the Investor Note Subscription Amount of $1,431,401
plus $450,000 funded purchase price) and an original principal amount of $2,633,961. The New Notes may be prepaid inclusive of
interest of the greater of one year or the current amount of time that the New Note has been outstanding.
The funding of New Notes under the Securities Purchase Agreement are as follows: The first tranche of up to $539,306 plus
the Investor Note Subscription Amount, the second tranche of up to $100,000 being closed upon on or about October 1, 2016,
the third tranche of up to $208,424 being closed upon on or about October 17, 2016, the fourth tranche of up to $100,000 being
closed upon on or about November 1, 2016, the fifth tranche of up to $188,818 being closed upon on or about November 15, 2016,
the sixth tranche of up to $182,051 being closed upon on or about December 15, 2016, and the seventh tranche of up to $665,000,
the closing of which is contingent upon, among other things, the purchase of that certain parcel of land located at 212 39th
Ln, Pueblo CO 81006 referred to as "Farm#2", upon terms and conditions that are satisfactory to the Investor and the assignment
of a 20% ownership interest in that certain 320-acres of agricultural land in Pueblo, Colorado (the "Farm") and Farm #2 to
the Investor. As of October 20, 2016 the new investor has funded $650,000 in cash for New Notes with the total face value
of $910,000, excluding the Investor Note Subscription Amount.
Upon retirement of the New Notes, the Company
or its Subsidiaries or affiliates as applicable, shall assign twenty percent (20%) of their respective ownership interest in the
Farm and Farm #2 to the Investor.
The Company and Ned Siegel, Jeffrey Goh,
and Clinton Pyatt, each an executive officer of the Company or member of the Company’s Board shall enter into management
contracts with the Company upon terms and subject to conditions that are reasonably acceptable to the Investor.
Furthermore, the Company shall pay to the
Investor as partial repayment of the New Notes or other indebtedness at the end of each calendar month:
(a) Out
of the first $1,000,000 in the aggregate of combined revenues received from all sources, including, without limitation, any revenue
from any legal settlement, judgment, or other legal proceeding (collectively, a “Legal Matter”), received of the Company
and all of its Subsidiaries net of any payments to an ‘outside farmer’ (collectively, the “Combined Revenues”),
80% of the Combined Revenues, except to the extent the Combined Revenues are from a Legal Matter, in which event, the percentage
shall be 50% (collectively, the “Combined Net Revenues”).
(b) Out
of the second $1,000,000 in the aggregate of Combined Revenues, 70% of the Combined Net Revenues, except to the extent the Combined
Revenues are from a Legal Matter, in which event, the percentage shall be 50%.
(c) Out
of any Combined Revenues in excess of $2,000,000, 60% of the Combined Net Revenues, except to the extent the Combined Revenues
are from a Legal Matter, in which event, the percentage shall be 50%.
(d) Upon
full satisfaction of the New Notes, 60% of the Combined Net Revenues shall be used to redeem any outstanding indebtedness owed
to the Investor.
(e) The
foregoing amounts may, at the Investor’s option, be reduced to allow EWSD to meet its overhead not to exceed $120,000 per
month plus a maximum of $100,000 per month to the Company beginning January 15, 2017.
(f) The
Company shall be permitted to enter into one or more agreements with third parties to allocate to such third parties up to no more
than 20% of the Combined Net Revenues. Any such agreements shall reduce the percentage of the Combined Net Revenues to be paid
by the Companies to the Investor.
The Company agreed to use commercially
reasonable efforts to amend the Subordination Agreement (referred to above) to reflect the issuance of New Notes to the Investor
within 14 days of the date of the Securities Purchase Agreement. The First Investor and the Investor are affiliates of one another.
The Company and the Subsidiaries also entered
into an Exchange Agreement with First Investor, pursuant to which the First Investor agreed to exchange each of the Company’s
outstanding debentures issued in their favor (in the principal outstanding balance amount of approximately $5,882,242 (plus accrued
interest) (the “Original Debentures”) for certain 10% Convertible Debentures issued by the Subsidiaries, due June 30,
2017, on substantially the same terms as the Original Debentures (the “Subsidiary Debentures”).
The Company and the Subsidiaries
also entered into a Security Agreement (the “Security Agreement”), securing a lien for the Investor on the Farm (subject
to the rights of the primary lien holder in the Farm pursuant to the Subordination Agreement (as defined above)) and securing
a lien for the Investor on Subsidiaries’ other assets on a primary basis. Pursuant to the Security Agreement, the Company
agreed to, within 14 calendar days, negotiate and enter into an amendment to the Subordination Agreement to reflect the rights
of the Investor set forth in the Security Agreement. The Company also intends to negotiate related waivers with its other creditors.
In the instance of an Event of Default,
as such term is defined in the New Note, the Investor has the right to convert all or any portion of principal and/or interest
of the New Notes into shares of Common Stock of the Company in accordance with the terms of the form of 10% Convertible Debenture
dated as of June 30, 2016 issued under the July SPA.
The Investor shall have a right of first
refusal to participate in future equity financings of the Company on the same terms as any new investors for a period of twelve
months from the closing of the last Convertible Debenture.
Grant of Second Deed of Trust and Assignment of Rents
On September 30, 2016, EWSD I, LLC (“
EWSD I
”),
a wholly-owned subsidiary of the Company granted a junior lender (the “
Junior Lender
”) a Second Deed of Trust,
Security Agreement and Financing Statement (the “
Second Trust Deed
”) and an Assignment of Rents and Leases (the
“
Assignment of Rents
”). The Second Trust Deed and the Assignment of Rents encumber the Farm, and the rents payable
by tenants under any current and future leases of and from the Farm. The Second Trust Deed and the Assignment of Rents secure the
payment of all obligations of EWSD I pursuant to any debentures issued to the Junior Lender in accordance with the Securities Purchase
Agreement dated June 30, 2016 by and among EWSD I, Junior Lender, and Company (the “
Securities Purchase Agreement
”).
The security granted to the Junior Lender pursuant to the Second
Trust Deed and the Assignment of Rents is subordinate to the rights of Southwest Farms, Inc. (the “
Senior Lender
”)
as set forth in the Deed of Trust, Security Agreement and Financing Statement dated as of August 7, 2015 granted by EWSD I in favor
of Senior Lender and the Assignment of Rents and Leases by and between EWSD I and Senior Lender dated as of August 7, 2015. Such
subordination is documented in a Subordination Agreement dated as of August 23, 2016 by and among Senior Lender, Junior Lender,
Company, EWSD I, and Pueblo Agriculture Supply and Equipment, LLC, another wholly-owned subsidiary of the Company, as amended by
a First Amendment to Subordination Agreement dated as of September 19, 2016 (collectively, the “
Subordination Agreement
”)
pursuant to which Senior Lender consented to the Second Trust Deed and the Assignment of Rents. The Subordination Agreement also
provides that the Junior Lender may not increase the principal amount of indebtedness pursuant to the Securities Purchase Agreement
beyond $1,500,000.
On September 9, 2016, the Company received notice from the
OTC Markets that OTC Markets would move the Company’s listing from the OTCQB market to OTC Pink Sheets market, if the
Company had not filed its Quarterly Report on Form 10-Q for the period ended June 30, 2016 by September 30, 2016. On or about
October 1, 2016, the Company moved to the OTC Pink Sheets market. This might also impact the Company's ability to
obtain funding.
Entry
into Note Purchase Agreement and Global Debenture Amendment
On
October 10, 2016, the Company entered into a Note Purchase Agreement (the “Purchase Agreement”) with an accredited
investor (the “Investor”), pursuant to which the Company agreed to sell, and the Investor agreed to purchase, a secured
convertible promissory note (the “Note”) in the aggregate principal amount of $53,000.
The
Investor deducted a commitment fee in the amount of $3,000 at the closing. The Note bears interest at the rate of 5% per annum
and matures on April 30, 2017. The Company may not prepay any part of the outstanding balance of the Note at any time prior to
maturity without the written consent of the Investor. At any time or from time to time, the Investor may convert the Note, in whole
or in part, into shares of the Company's common stock at a conversion price that is the lower of (a) $0.75, or (b) 51% of the lowest
volume weighted average price for the 30 consecutive trading days prior to the conversion date.
In
connection with entry into the Note Purchase Agreement, the parties also entered into a Global Debenture Amendment (the “Debenture
Amendment”), pursuant to which the Investor shall be entitled to the same “look-back” period on establishing
the conversion price of a Note as any other Investor is entitled to pursuant to notes or debentures held by such Investor. Based
on the terms of the Company's other convertible notes and debentures, other investors shall be entitled to the same rights established
in the Debenture Amendment. Therefore, each of the company's investors holding convertible debt shall be entitled to the same “look-back”
period when establishing the conversion price for their respective notes or debentures.