CONDENSED
CONSOLIDATED NOTES TO FINANCIAL STATEMENTS
(UNAUDITED)
SEPTEMBER
30, 2016
Unless
otherwise noted, (1) “Sunworks” refers to Sunworks, Inc., a Delaware corporation formerly known as Solar3D, Inc. (2)
the “Company,” “we,” “us,” and “our,” refer to the ongoing business operations
of Sunworks and its Subsidiaries, whether conducted through Sunworks or a subsidiary of Sunworks, (3) “Subsidiaries”
refers collectively to Sunworks United, Inc. (“Sunworks United”), MD Energy, Inc. (“MD Energy”) and Elite
Solar Acquisition Sub, Inc. (“Elite Solar”), (4) “Common Stock” refers to Sunworks’ Common Stock,
and (5) “Stockholder(s)” refers to the holders of Sunworks’ Common Stock.
1.
BASIS OF PRESENTATION
The
accompanying unaudited condensed consolidated financial statements have been prepared in accordance with generally accepted accounting
principles for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly,
they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial
statements. The financial statements and notes are representations of the Company’s management, which is responsible for
their integrity and objectivity. In the opinion of management, all normal recurring adjustments considered necessary for a fair
presentation have been included. Operating results for the three and nine months ended September 30, 2016 are not necessarily
indicative of the results that may be expected for the year ending December 31, 2016. For further information, refer to the consolidated
financial statements and footnotes thereto included in the Company’s Form 10-K for the year ended December 31, 2015.
2.
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles
of Consolidation
The
accompanying condensed consolidated financial statements include the accounts of Sunworks and its wholly owned operating Subsidiaries.
All material intercompany accounts and transactions are eliminated in consolidation.
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Use
of Estimates
The
preparation of financial statements in conformity with accounting principles generally accepted in the United States requires
management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent
assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting
period. In the opinion of management, all adjustments, consisting of normal recurring accruals, considered necessary for a fair
presentation have been included. Actual results could materially differ from those estimates. Significant estimates include estimates
used to review the Company’s goodwill, impairments and estimations of long-lived assets, revenue recognition on percentage
of completion type contracts, allowances for uncollectible accounts, inventory valuation, valuations of non-cash capital stock
issuances and the valuation allowance on deferred tax assets. Management bases its estimates on historical experience and on various
other assumptions that are believed to be reasonable in the circumstances, the results of which form the basis for making judgments
about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ
from these estimates under different assumptions or conditions.
Reclassifications
Certain
reclassifications have been made to prior period financial statements to conform to the current period presentation
Revenue
Recognition
Revenues
and related costs on construction contracts are recognized using the “percentage of completion method” of accounting
in accordance with Accounting for Performance of Construction-Type and Certain Production Type Contracts (“ASC 605-35”).
Under this method, contract revenues and related expenses are recognized over the performance period of the contract in direct
proportion to the costs incurred as a percentage of total estimated costs for the entirety of the contract. Costs include direct
material, direct labor, subcontract labor and any allocable indirect costs. All un-allocable indirect costs and corporate general
and administrative costs are charged to the periods as incurred. However, in the event a loss on a contract is foreseen, the Company
recognizes the loss, as it is determined.
The
Asset, “Costs in excess of billings”, represents revenues recognized in excess of amounts billed on contracts in progress.
The Liability, “Billings in excess of costs”, represents billings in excess of revenues recognized on contracts in
progress. At September 30, 2016 and December 31, 2015, the costs in excess of billings balance were $8,108,000 and $2,130,000
and the billings in excess of costs balance were $3,800,000 and $1,990,000 respectively.
Cash
and Cash Equivalent
The
Company considers all liquid investments with an original maturity of three months or less to be cash equivalents. The Company
had $37,000 of restricted cash at September 30, 2016.
Concentration
Risk
The
Company maintains several bank accounts at multiple financial institutions for its operations. These accounts are insured by the
Federal Deposit Insurance Corporation (FDIC) for up to $250,000 per institution. Management believes the Company is not exposed
to significant credit risk due to the financial position of the depository institutions in which these deposits are held. As of
September 30, 2016, the cash balance in excess of the FDIC limits was $6,258,000.
Contracts
Receivable
The
Company performs ongoing credit evaluation of its customers. Management closely monitors outstanding receivables based on factors
surrounding the credit risk of specific customers, historical trends, age of receivables and other information, and records bad
debts using the allowance method. Accounts receivable are presented net of an allowance for doubtful accounts of $50,000 at September
30, 2016, and $0 at December 31, 2015.
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Inventory
Inventory
is valued at the lower of cost or market and is determined by the first-in, first-out method. Inventory consists primarily of
solar panels and other materials.
Property
and Equipment
Property
and equipment is recorded at cost. Depreciation of property and equipment is recorded on the straight-line method over the respective
useful lives of the assets ranging from 3 to 7 years. Leasehold improvements are amortized over the initial term of the leases.
Machinery
& equipment
|
5
Years
|
Furniture
& fixtures
|
5-7
Years
|
Computer
equipment
|
3-5
Years
|
Vehicles
|
5-7
Years
|
Leasehold
improvements
|
3-5
Years
|
Depreciation
expense for the nine months ended September 30, 2016 and 2015 was $215,000 and $26,000 respectively.
Long-Lived
Assets
The
Company reviews its property and equipment and any identifiable intangibles for impairment whenever events or changes in circumstances
indicate that the carrying amount of an asset may not be recoverable. The test for impairment is required to be performed by management
at least annually. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset
to the future undiscounted operating cash flow expected to be generated by the asset. If such assets are considered to be impaired,
the impairment to be recognized is measured by the amount by which the carrying amount of the asset exceeds the fair value of
the asset. Long-lived assets to be disposed of are reported at the lower of carrying amount or fair value less costs to sell.
Indefinite
Lived Intangibles and Goodwill Assets
The
Company accounts for business combinations under the acquisition method of accounting in accordance with ASC 805, “Business
Combinations,” where the total purchase price is allocated to the tangible and identified intangible assets acquired and
liabilities assumed based on their estimated fair values. The purchase price is allocated using the information currently available,
and may be adjusted, up to one year from acquisition date, after obtaining more information regarding, among other things, asset
valuations, liabilities assumed and revisions to preliminary estimates. The purchase price in excess of the fair value of the
tangible and identified intangible assets acquired less liabilities assumed is recognized as goodwill.
The
Company tests for indefinite lived intangibles and goodwill impairment in the fourth quarter of each year and whenever events
or circumstances indicate that the carrying amount of the asset exceeds its fair value and may not be recoverable. In accordance
with its policies, the Company performed a qualitative assessment of indefinite lived intangibles and goodwill at December 31,
2015 and determined there was no impairment of indefinite lived intangibles and goodwill.
Fair
Value of Financial Instruments
Disclosures
about fair value of financial instruments, requires disclosure of the fair value information, whether or not recognized in the
balance sheet, where it is practicable to estimate that value. As of September 30, 2016, the amounts reported for cash, accrued
interest and other expenses, and notes payable approximate the fair value because of their short maturities.
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We
adopted ASC Topic 820 as of January 1, 2008 for financial instruments measured as fair value on a recurring basis. ASC Topic 820
defines fair value, established a framework for measuring fair value in accordance with accounting principles generally accepted
in the United States and expands disclosures about fair value measurements.
Fair
value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction
between market participants at the measurement date. ASC Topic 820 established a three-tier fair value hierarchy which prioritizes
the inputs used in measuring fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets
for identical assets or liabilities (level 1measurements) and the lowest priority to unobservable inputs (level 3 measurements).
These tiers include:
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Level
1, defined as observable inputs such as quoted prices for identical instruments in active markets;
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Level
2, defined as inputs other than quoted prices in active markets that are either directly or indirectly observable such as
quoted prices for similar instruments in active markets or quoted prices for identical or similar instruments in markets that
are not active; and
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●
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Level
3, defined as unobservable inputs in which little or no market data exists, therefore requiring an entity to develop its own
assumptions, such as valuations derived from valuation techniques in which one or more significant inputs or significant value
drivers are unobservable.
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Warranty
Liability
The
Company establishes warranty liability reserves to provide for estimated future expenses as a result of installation and product
defects, product recalls and litigation incidental to the Company’s business. Liability estimates are determined based on
management’s judgment, considering such factors as historical experience, the likely current cost of corrective action,
manufacturers’ and subcontractors’ participation in sharing the cost of corrective action, consultations with third
party experts such as engineers, and discussions with the Company’s general counsel and outside counsel retained to handle
specific product liability cases. Solar panel manufacturers currently provide substantial warranties between ten to twenty-five
years with full reimbursement to replace and install replacement panels while inverter manufacturers currently provide warranties
covering ten to fifteen-year replacement and installation. Warranty costs and associated liabilities for the three months ended
September 30, 2016 and 2015 were $0 and $0, respectively, and for the nine months ended September 30, 2016 and 2015 were $13,000
and $0, respectively.
Selling
and Marketing
The
Company expenses selling and marketing costs as incurred. Selling and marketing costs include printed material, direct mail, radio,
telemarketing, tradeshow costs, magazine and catalog advertisements. Selling and marketing costs for the three months ended September
30, 2016 and 2015 were $2,145,000 and $1,835,000 respectively, and for the nine months ended September 30, 2016 and 2015 were
$7,932,000 and $5,179,000 respectively.
Research
and Development Costs
Research
and development costs are expensed as incurred. These costs consist primarily of consulting fees, salaries and direct payroll
related costs. The costs for the three months ended September 30, 2016 and 2015 were $0 and $6,000 respectively, and for the nine
months ended September 30, 2016 and 2015 were $0 and $53,000 respectively.
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Stock-Based
Compensation
The
Company accounts for share-based compensation arrangements in accordance with FASB ASC 718, which requires the measurement and
recognition of compensation expense for all share-based payment awards to be based on estimated fair values. The Company uses
the Black-Scholes option valuation model to estimate the fair value of its stock options at the date of grant. The Black-Scholes
option valuation model requires the input of subjective assumptions to calculate the value of stock options. For restricted stock
units, the value of the award is based on the Company’s stock price at the grant date. For performance-based restricted
stock unit awards, the value of the award is based on the Company’s stock price at the grant date, with consideration given
to the probability of the performance condition being achieved. The Company uses historical data and other information to estimate
the expected price volatility for stock option awards and the expected forfeiture rate for all awards. Expense is recognized over
the vesting period for all awards, and commences at the grant date for time-based awards and upon the Company’s determination
that the achievement of such performance conditions is probable for performance-based awards. This determination requires significant
judgment by management.
Basic
and Diluted Net (Loss) Income per Share Calculations
(Loss)
Income per Share dictates the calculation of basic earnings per share and diluted earnings per share. Basic earnings per share
are computed by dividing income available to common shareholders by the weighted-average number of common shares available. Diluted
earnings per share is computed similar to basic earnings per share except that the denominator is increased to include the number
of additional common shares that would have been outstanding if the potential common shares had been issued and if the additional
common shares were dilutive. The shares for employee options, warrants and convertible notes were used in the calculation of the
income per share.
For
the period ended September 30, 2016, the Company has excluded 938,188 options and 2,997,000 warrants outstanding because they
are below the period ending stock price. The Company has also excluded Series B preferred stock convertible into 1,506,024 shares
of common stock due to trading restrictions. For the prior period ended September 30, 2015, the Company excluded 899,574 options,
2,997,000 warrants outstanding, and notes convertible into 5,168,639 shares of common stock because their impact on the loss per
share is anti-dilutive.
Segment
Reporting
Operating
segments are defined as components of an enterprise for which separate financial information is available and evaluated regularly
by the chief operating decision maker, or decision making group, in deciding the method to allocate resources and assess performance.
The Company currently has one reportable segment for financial reporting purposes, which represents the Company’s core business.
Recently
adopted pronouncements
In
January 2016, FASB issued ASU No. 2016-1 which amended the guidance for recognition and measurement of financial assets and
liabilities. These amendments address certain aspects of recognition, measurement, presentation, and disclosure of financial instruments.
The adoption of this guidance is effective for fiscal years beginning after December 15, 2017, including interim periods within
those years. Early adoption of certain provisions of this guidance is permitted as of the beginning of the fiscal year of adoption.
Entities should apply these amendments by means of a cumulative-effect adjustment to the balance sheet as of the beginning of
the fiscal year of adoption. The amendments related to equity securities without readily determinable fair value should be applied
prospectively to equity investments that exist as of the date of adoption. The Company does not expect this guidance to have a
significant impact on the results of operations, financial condition, or cash flows.
In
February 2016, the FASB issued ASU No. 2016-2, which creates ASC Topic 842, “Leases.” This update increases transparency
and comparability among organizations by recognizing lease assets and lease liabilities on the balance sheet and disclosing key
information about leasing arrangements. This guidance is effective for interim and annual reporting periods beginning after December
15, 2018. We are evaluating what impact, if any, the adoption of this guidance will have on our financial condition, results of
operations, cash flows or financial disclosures.
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In
March 2016, the FASB issued ASU No. 2016-9, which amends ASC Topic 718, “Compensation – Stock Compensation.”
This amendment 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. This guidance is effective
for interim and annual reporting periods beginning after December 15, 2016. We are evaluating what impact, if any, the adoption
of this guidance will have on our financial condition, results of operations, cash flows or financial disclosures.
In
August 2016, the FASB issued ASU No. 2016-15 which amends ASC Topic 230, “Classification of Certain Cash Receipts and Cash
Payments.” The amendments in this Update address eight specific cash flow issues with the objective of reducing the existing
diversity in practice. The update outlines the classification of specific transactions as either cash inflows or outflows from
financing activities, operating activities, investing activities or non-cash activities. This guidance is effective for interim
and annual reporting periods beginning after December 15, 2017. We are evaluating what impact, if any, the adoption of this guidance
will have on our financial condition, results of operations, cash flows or financial disclosures.
Management
reviewed currently issued pronouncements during the three months ended September 30, 2016, and does not believe that any other
recently issued, but not yet effective, accounting standards, if currently adopted, would have a material effect on the accompanying
condensed financial statements.
3.
BUSINESS ACQUISITION
MD
Energy, LLC (MD ENERGY)
On
March 2, 2015, the Company acquired 100% of the tangible and intangible assets of MD Energy, LLC (MD Energy), for cash in the
amount of $850,000 a convertible promissory note in the principal amount of $2,650,000 and payment of working capital surplus
in the amount of $437,000. The acquisition was accounted for under ASC 805. MD Energy designs, monitors and maintains solar systems,
but outsources the physical construction of the systems. MD Energy is now a wholly-owned subsidiary of the Company.
Under
the purchase method of accounting, the transactions were valued for accounting purposes at $3,937,000 which was the fair value
of MD Energy at the time of the acquisition. Since the Company determined there were no other separately identifiable intangible
assets, any difference between the cost of the acquired entity and the fair value of the assets acquired and liabilities assumed
is recorded as goodwill. The acquisition date estimated fair value of the consideration transferred consisted of the following:
Closing cash payment
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$
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850,
000
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Working capital surplus
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437,000
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Convertible promissory notes
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2,650,000
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Total purchase price
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$
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3,937,000
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Tangible assets acquired
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$
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1,442,000
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Liabilities assumed
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(799,000
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)
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Net tangible assets
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643,000
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Goodwill
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3,294,000
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Total purchase price
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$
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3,937,000
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Plan
B Enterprises, Inc. (Plan B)
On
December 1, 2015, the Company acquired 100% of the issued and outstanding stock of Plan B Enterprises, Inc., a California corporation
and d/b/a Elite Solar, Universal Racking Solutions (collectively, “Plan B”) whereby Plan B was merged with and into
Elite Solar Acquisition Sub, Inc., a wholly owned subsidiary of the Company (“Acquisition Sub”) for $2,500,000 cash,
net of recoverable of $137,000 and by issuance of 1,506,024 shares of convertible preferred stock in the principal amount of $4,500,000.
The acquisition was accounted for under ASC 805. Plan B provides solar photovoltaic installation and consulting services for residential,
commercial and agricultural properties.
Under
the purchase method of accounting, the transactions were valued for accounting purposes at $7,000,000 which was the fair value
of Plan B at the time of the acquisition. The assets and liabilities of Plan B were recorded at their respective fair values as
of the date of acquisition. Since the Company determined there were no other separately identifiable intangible assets, any difference
between the cost of the acquired entity and the fair value of the assets acquired and liabilities assumed is recorded as goodwill.
The acquisition date estimated fair value of the consideration transferred consisted of the following:
Closing cash payment, net of recoverable of $137,000.
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$
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2,363,
000
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Preferred share value / Series B
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4,500,000
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Total purchase price
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6,863,000
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Tangible assets acquired
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5,203,000
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Liabilities assumed
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(3,674,000
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)
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Net tangible assets
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1,529,000
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Goodwill
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4,834,000
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Other intangible assets
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500,000
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Total purchase price
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$
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6,863,000
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The
above estimated fair value of the intangible assets of MD Energy and Plan B is based on final and preliminary purchase price allocations
prepared by management, respectively. During the preliminary purchase price allocation period, which may be up to one year from
the business combination date, we may record adjustments to the assets acquired and liabilities assumed, with the corresponding
offset to goodwill. After the preliminary purchase price allocation period, we record adjustments to assets acquired or liabilities
assumed, subsequent to the purchase price allocation period, in our operating results in the period in which the adjustments were
determined.
Pro
forma results
The
following tables set forth the unaudited pro forma results of the Company as if the acquisition of MD Energy and Plan B had taken
place on the first day of the periods presented. These combined results are not necessarily indicative of the results that may
have been achieved had the companies been combined as of the first day of the periods presented.
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Nine months ended,
September 30, 2015
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Total revenues
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$
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46,245
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Net income
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|
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613
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Basic and diluted net loss per common share
|
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$
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0.04
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4.
LOANS PAYABLE
Plan
B, a subsidiary of the Company, prior to its acquisition by the Company, established a line of credit on March 10, 2014, with
Tri Counties Bank to borrow up to $200,000 maturing on March 10, 2015. The maturity date was subsequently extended to March 10,
2016. The minimum monthly payment was dependent upon the outstanding balance due. This was a variable rate revolving line of credit
with a minimum interest rate of 4.75%. The outstanding balance at December 31, 2015 was $137,000. The outstanding balance was
paid in full before the maturity date.
Plan
B, a subsidiary of the Company, entered into a business loan agreement prior to the acquisition with Tri Counties Bank dated March
14, 2014, in the original amount of $131,000 bearing interest at 4.95%. The loan agreement called for monthly payments of $2,500
and was scheduled to mature on March 14, 2019. Proceeds from the loan were used to purchase a pile driver and related equipment
and is secured by the equipment. The outstanding balance at September 30, 2016, is $69,000.
Plan
B, a subsidiary of the Company, entered into a business loan agreement prior to the acquisition with Tri Counties Bank dated April
9, 2014, in the original amount of $250,000 bearing interest at 4.95%. The loan agreement calls for monthly payments of $4,700
and is scheduled to mature on April 9, 2019. Proceeds from the loan were used to purchase racking inventory and related equipment.
The loan is secured by the inventory and equipment. The outstanding balance at September 30, 2016, is $136,700.
MD
Energy, a subsidiary of the Company, entered into notes payable in October 2014, secured by transportation equipment, requiring
combined monthly payments of $1,500 including principal and interest at various rates of interest per annum. Principal and any
accrued interest are payable until September 2019. One note was cancelled with the disposition of the vehicle and another note
was paid in full during the quarter ended June 30, 2016.
On
December 31, 2015, the Company entered into a $2.5 million Credit Facility or the Credit Agreement with JPMorgan Chase Bank, N.A.
Availability under the Credit Facility is a Line of Credit with a Letter of Credit Sublimit up to $2.5 million. Upon execution,
the Company accessed $1.8 million that was repaid in full on January 5, 2016. The Company had no borrowings under the Credit Agreement
during the quarter ended September 30, 2016. The Credit Agreement matures on November 30, 2017, but may be cancelled at any time
by the Company. Loans are secured by a security interest in the Company’s account held with the Lender. Interest on any
unpaid balance accrues at the Prime Rate, as defined in the Credit Agreement; provided that, on any given day, shall not be less
than the Adjusted One Month LIBOR rate. Until the maturity date, the Company shall pay monthly interest only on loans. The Credit
Facility provides for the payment of certain fees, including fees applicable to each standby letter of credit and standard transaction
fees with respect to any transactions occurring on account of any letter of credit. Subject to customary carve-outs, the Credit
Agreement contains customary negative covenants and restrictions for agreements of this type on actions by the Company including,
without limitation, restrictions on indebtedness, liens, investments, loans, consolidation, mergers, dissolution, asset dispositions
outside the ordinary course of business, change in business and restriction on use of proceeds. In addition, the Credit Agreement
requires compliance by the Company with covenants including, but not limited to, furnishing the lender with certain financial
reports. The Credit Agreement contains customary events of default, including, without limitation, non-payment of principal or
interest, violation of covenants, inaccuracy of representations in any material respect and cross defaults with certain other
indebtedness and agreements.
On
January 5, 2016, the Company entered into a loan agreement for the acquisition of a pile driver in the principle amount of $182,000
bearing interest at 5.5%. The loan agreement calls for monthly payments of $4,200 and is scheduled to mature on January 15, 2020.
The loan is secured by the equipment. The outstanding balance at September 30, 2016, is $157,600.
On
September 8, 2016, the Company entered into a loan agreement for the acquisition of a pile driver in the principle amount of $174,000
bearing interest at 5.5%. The loan agreement calls for monthly payments of $4,000 and is scheduled to mature on January 15, 2020.
The loan is secured by the equipment. The outstanding balance at September 30, 2016, is $174,000.
5.
ACQUISITION CONVERTIBLE PROMISSORY NOTES
On
January 31, 2014, the Company issued 4% convertible promissory notes in the aggregate principal amount of $1,750,000 as part of
the consideration paid to acquire 100% of the issued and outstanding stock of Sunworks United. The notes are convertible into
shares of fully paid and non-assessable shares of common stock. The conversion price was $0.52 per share until March 30, 2015,
which was amended to extend to March 31, 2016. The Notes were five (5) year notes and bore interest at the rate of 4% per annum.
In February and March 2014, $625,000 of the notes was converted into 1,201,923 shares of common stock, leaving a remaining note
balance of $1,125,000 as of December 31, 2014. During the twelve months ended December 31, 2015, the Company issued 721,154 shares
of common stock upon conversion of principal in the amount of $375,000. The principal note balance remaining as of December 31,
2015 was $750,000. On February 29, 2016, the $750,000 balance remaining was fully converted into 1,442,308 shares of common stock.
The Company recorded amortization of the beneficial conversion feature as interest expense in the amount of $0 and $234,000 during
the nine months ended September 30, 2016 and 2015, respectively.
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On
February 28, 2015, the Company issued a 4% convertible promissory note in the aggregate principal amount of $2,650,000 as part
of the consideration paid to acquire 100% of the total outstanding stock of MD Energy. The note is convertible into shares of
common stock on or after each of the following dates: November 30, 2015, November 30, 2016 and November 30, 2017. The conversion
price is $2.60 per share. A beneficial conversion feature of $3,261,500 was calculated but capped at the $2,650,000 value of the
note. The beneficial conversion feature was calculated by multiplying the difference between the fair value of stock at the date
of the note $5.80 less the conversion price of $2.60 multiplied by the maximum number of share subject to conversion, 1,019,231.
In November 2015, the Company issued 339,743 shares of common stock upon conversion of the principal amount of $883,000. Commencing
on March 31, 2015, and each quarter thereafter during the first two (2) years of the note, the Company will make quarterly interest
only payments to the shareholder for accrued interest on the Note during the quarter. Commencing with the quarter ending on June
30, 2017, the Company will make quarterly payments of interest accrued on the convertible note during the prior quarter plus $221,000
with the final payment of all outstanding principal and accrued but unpaid interest on the convertible note due and payable on
February 28, 2020 (the maturity date). The Company recorded amortization of the beneficial conversion feature as interest expense
in the amount of $210,000 and $240,000 during the three months ended September 30, 2016 and 2015, respectively, and $693,000 and
$565,000 during the nine months ended September 30, 2016 and 2015, respectively. The debt discount will be amortized over the
life of the convertible note, or until such time that the convertible note is converted, in full or in part, into shares of common
stock of the Company with any unamortized debt discount continuing to be amortized in the event of any partial conversion thereof
and any unamortized debt discount being expensed at such time of full conversion thereof.
We
evaluated the foregoing financing transactions in accordance with ASC Topic 470, Debt with Conversion and Other Options, and determined
that the conversion feature of the convertible promissory note was afforded the exemption for conventional convertible instruments
due to its fixed conversion rate. The convertible promissory notes have explicit limits on the number of shares issuable so they
did meet the conditions set forth in current accounting standards for equity classification. The convertible promissory notes
were issued with non-detachable conversion options that are beneficial to the investors at inception, because the conversion option
has an effective strike price that is less than the market price of the underlying stock at the commitment date. The accounting
for the beneficial conversion feature requires that the beneficial conversion feature be recognized by allocating the intrinsic
value of the conversion option to additional paid-in-capital, resulting in a discount on the convertible notes, which will be
amortized and recognized as interest expense.
6.
CONVERTIBLE PROMISSORY NOTES
On
March 1, 2013, the Company entered into a securities purchase agreement providing for the sale of a 5% convertible promissory
note in the aggregate principal amount of $8,000 for consideration of $8,000. The note was convertible into shares of common stock
of the Company at a price equal to a variable conversion price equal to the lesser of $0.52 per share or the lowest closing price
after the effective date. The note matured on March 31, 2015 and the Company issued 16,987 shares of common stock for principal
in the amount of $8,000 plus accrued interest of $800.
On
January 29, 2014, the Company entered into a securities purchase agreement providing for the sale of a 10% convertible promissory
note in the principal amount of up to $100,000. Upon execution of the note, the Company received an initial advance of $90,000.
On December 4, 2014, the Company issued 192,543 shares of common stock upon conversion of $60,000 in principal, plus interest
of $5,000. As of December 31, 2014, the remaining balance was $30,000. The note was convertible into shares of common stock of
the Company at a price equal to a variable conversion price equal to the lesser of $0.338 per share, or fifty percent (50%) of
the lowest trading price after the effective date. The Company issued 97,633 shares of common stock upon conversion of principal
in the amount of $30,000 plus accrued interest of $3,000 during the nine months ended September 30, 2015
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On
January 31, 2014, the Company entered into a securities purchase agreement providing for the sale of a 10% convertible promissory
note in the principal amount of up to $750,000 for consideration of $750,000. The proceeds were restricted and were used for the
purchase of Solar United Network, Inc. The note was convertible into shares of common stock of the Company at a price equal to
a variable conversion price equal to the lesser of $1.30 per share, or fifty percent (50%) of the lowest trading price after the
effective date. As of September 30, 2014, the note was exchanged for a new note with a fix price of $0.338, and convertible into
shares of common stock. Per ASC 815, the derivative liability on the note was extinguished and the new note was re-valued per
ASC 470 as a beneficial conversion feature, which was expensed in the statement of operations during the prior year. The note
originally matured on October 28, 2014, was extended three months to January 31, 2015, was extended to September 30, 2016, and
in March 2016 was subsequently extended to June 30, 2019 with zero interest. The Company recorded interest expense in the amount
of $11,000 and $60,000 during the nine months ended September 30, 2016 and 2015, respectively. During the nine months ended September
30, 2016, the noteholder made a partial conversion of principal and accrued interest in the amount of $196,000 and $45,000 respectively
with a remaining principal balance of $554,000.
On
February 11, 2014, the Company entered into a securities purchase agreement providing for the sale of a 10% convertible promissory
note in the principal amount of up to $100,000. Upon execution of the note, the Company received an initial advance of $20,000.
In February and March, the Company received additional advances in an aggregate amount of $80,000 for an aggregate total of $100,000.
The note was convertible into shares of common stock of the Company at a price equal to a variable conversion price equal to the
lesser of $1.30 per share, or fifty percent (50%) of the lowest trading price after the effective date. As of September 30, 2014,
the note was exchanged for a new note with a fixed price of $0.338, and convertible into shares of common stock. Per ASC 815,
the derivative liability on the note was extinguished and the new note was re-valued per ASC 470 as a beneficial conversion feature.
The note matured on various dates from the effective date of each advance with respect to each advance. At the sole discretion
of the lender, the lender was able to modify the maturity date to be twelve (12) months from the effective date of each advance.
The note matured on various dates in 2014, and was extended to September 30, 2016, and in March 2016 was subsequently extended
to June 30, 2019 with zero interest. The Company recorded interest expense in the amount of $0 and $8,000 during the nine months
ended September 30, 2016 and 2015, respectively.
At
the time of issuance, the Company evaluated the financing transactions in accordance with ASC Topic 815, Derivatives and Hedging,
and determined that the conversion feature of the convertible promissory note was not afforded the exemption for conventional
convertible instruments due to its variable conversion rate. The notes had no explicit limit on the number of shares issuable
so they did not meet the conditions set forth in current accounting standards for equity classification. The Company elected to
recognize the note under paragraph 815-15-25-4, whereby, there would be a separation into a host contract and derivative instrument.
The Company elected to initially and subsequently measure the note in its entirety at fair value, with changes in fair value recognized
in earnings. The derivative liability was adjusted periodically according to the stock price fluctuations.
7.
CAPITAL STOCK
Reverse
Stock Split
On
February 25, 2015, the Company effected a 26:1 reverse stock split on its issued and outstanding shares of common stock. All share
and per share dollar amounts have been retrospectively revised to reflect the twenty- six-for-one (26:1) reverse stock split.
Common
Stock
During
the nine months ended September 30, 2016, the Company issued 1,442,309 shares of common stock at a price of $0.52 per share for
conversion of principal for three convertible promissory notes in the aggregate amount of $750,000.
During
the nine months ended September 30, 2016, the Company issued 711,586 shares of common stock at a price of $0.338 per share for
partial conversion of principal and interest for a convertible promissory note in the aggregate amount of $241,000.
During
the nine months ended September 30, 2016, the Company issued 379,491 shares of restricted common stock per terms of the performance-based
RSGA awards and another 746,157 vested shares of restricted common stock that remain to be issued. The Company recorded stock
based compensation costs at fair value as of the date of grant of $5,541,000 related to the vesting of these awards.
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Preferred
Stock
On November 25, 2015, the Company
designated 1,700,000 shares, of its authorized preferred stock, as Series B Preferred Stock, $0.001 par value per share. The Certificate
of Designation was filed with the Secretary of State of the State of Delaware. Pursuant to the Certificate of Designation and
subject to the rights of any other series of preferred stock that may be established by the Board of Directors, holders of Series
B Preferred Stock (the “Holders”) will have liquidation preference over the holders of the Company’s Common
Stock in any distribution upon winding up, dissolution, or liquidation. Holders will also be entitled to receive dividends, if,
when and as declared by the Board of Directors, which dividends shall be payable in preference and priority to any payment of
any dividend to holders of Common Stock. Holders will be entitled to convert each share of Series B Preferred Stock into one (1)
share of Common Stock, and will also be entitled to vote together with the holders Common Stock on all matters submitted to shareholders
at a rate of one (1) vote for each share of Series B Preferred Stock. In addition, so long as at least 100,000 shares of Series
B Preferred Stock are outstanding, the Company may not, without the consent of the Holders of at least a majority of the shares
of Series B Preferred Stock then outstanding: (i) amend, alter or repeal any provision of the Certificate of Incorporation or
bylaws of the Company or the Certificate of Designation so as to adversely affect any of the rights, preferences, privileges,
limitations or restrictions provided for the benefit of the Holders or (ii) issue or sell, or obligate itself to issue or sell,
any additional shares of Series B Preferred Stock, or any securities that are convertible into or exchangeable for shares of Series
B Preferred Stock. 1,506,024 shares of Series B Preferred stock, at a fair value of $4,500,000 were issued in December 2015 in
connection with the acquisition of Plan B.
8.
STOCK OPTIONS, RESTRICTED STOCK AND WARRANTS
Options
As
of September 30, 2016, the Company has 1,534,574 non-qualified stock options outstanding to purchase 1,534,574 shares of common
stock, per the terms set forth in the option agreements. The stock options vest at various times, and are exercisable for a period
of seven years from the date of grant at exercise prices ranging from $0.26 to $4.42 per share, the market value of the Company’s
common stock on the date of each grant. The Company determined the fair market value of these options by using the Black Scholes
option valuation model.
|
|
September 30, 2016
|
|
|
|
|
|
|
Weighted
|
|
|
|
Number
|
|
|
average
|
|
|
|
of
|
|
|
exercise
|
|
|
|
Options
|
|
|
price
|
|
Outstanding, beginning January 1, 2016
|
|
|
899,574
|
|
|
$
|
1.30
|
|
Granted
|
|
|
635,000
|
|
|
|
2.69
|
|
Exercised
|
|
|
-
|
|
|
|
-
|
|
Expired
|
|
|
-
|
|
|
|
-
|
|
Outstanding, end of September 30, 2016
|
|
|
1,534,574
|
|
|
|
1.87
|
|
Exercisable at the end of September 30, 2016
|
|
|
938,188
|
|
|
|
1.30
|
|
During
the nine months ended September 30, 2016 and 2015, the Company charged a total of $222,000 and $75,000 respectively, to operations
related to recognized stock based compensation expense for stock options.
Restricted
Stock CEO
During
the year ended December 31, 2013, the Company entered into a restricted stock grant agreement or RSGA with its Chief Executive
Officer, James B. Nelson, intended to provide and incentivize Mr. Nelson to improve the economic performance of the Company and
to increase its value and stock price. All shares issuable under the RSGA are performance-based shares and are valued as of the
grant date at $0.47 per share. The RSGA provides for the issuance of up to 769,230 shares of the Company’s common stock
to Mr. Nelson provided certain milestones are met in certain stages. As of September 30, 2014, two of the milestones were met,
when the Company’s market capitalization exceeded $10 million and the consolidated gross revenue, calculated in accordance
with GAAP, equaled or exceeded $10 million for the trailing twelve-month period. The Company issued 384,615 shares of common stock
to Mr. Nelson at fair value of $786,000 during the year ended December 31, 2014. If the Company’s consolidated net profit,
calculated in accordance to GAAP, equals or exceeds $2 million for a trailing twelve-month period and the sooner of Mr. Nelson’s
retirement, change of control, or January 2019, the Company will issue an additional 384,615 shares of the Company’s common
stock to Mr. Nelson. We have not recognized any cost associated with the third milestone due to the inability to estimate the
probability of it being achieved. As the final performance goal is achieved, the shares shall become eligible for vesting and
issuance.
In
recognition of the efforts of James B. Nelson, the Company’s Chief Executive Officer, in leading the Company through the
uplisting and financing transaction consummated by the Company in 2015, on August 31, 2016, the Company granted Mr. Nelson a restricted
stock grant of 250,000 shares of the Company’s common stock pursuant to the terms of the Company’s 2016 Equity Incentive
Plan (the “2016 Plan”). All shares issuable under the RSGA are valued as of the grant date at $2.90 per share. The
restricted stock grant to Mr. Nelson will vest upon the earlier of (i) January 1, 2021, (ii) a Change of Control as defined in
the 2016 Plan (iii) upon Mr. Nelson’s retirement or (iv) upon Mr. Nelson’s death. “Change of Control”
as defined in the 2016 Plan means (i) a sale of all or substantially all of the Company’s assets or (ii) a merger with another
entity or an acquisition of the Company that results in the existing shareholders of the Company owning less than fifty percent
(50%) of the outstanding shares of capital stock of the surviving entity following such transaction.
In
the 3 months ended September 30, 2016, one month’s or $14,000 of stock based compensation expense was recognized for the
August 31, 2016 RSGA.
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Restricted
Shares to Shareholders
During
the year ended December 31, 2014, the Company entered into RSGAs with the three Shareholders of Sunworks United (Sunworks United
Shareholders), intended to provide incentive to the recipients to ensure economic performance of the Company. All shares issuable
under the RSGAs are performance based shares and are valued as of the grant date at $5.12 per share. Each of the RSGAs provide
for the issuance of up to 276,924 shares of the Company’s common stock in the aggregate to the Sunworks United Shareholders
provided certain milestones are met in certain stages as follows: a) If the Company’s aggregate net income from operations,
for any trailing four (4) quarters equals or exceeds $2 million, the Company will issue each Sunworks United Shareholder 92,308
shares of common stock and 276,924 shares in the aggregate; b) If the Company’s aggregate net income from operations, for
any trailing four (4) quarters exceeds $3 million, the Company will issue each Sunworks United Shareholder 92,308 shares and 276,924
shares of common stock in the aggregate; c) If the Company’s aggregate net income from operations, for any trailing four
(4) quarters exceeds $4 million, the Company will issue each Sunworks United Shareholder 92,307 and 276,924 shares in the aggregate.
Based on the probability that the first milestone would be achieved the Company recognized $100,000 in stock compensation expense
during the year 2015. As of September 30, 2016 the Company achieved each of the three milestones. During the quarter ended June
30, 2016 the Company issued 276,924 shares in aggregate associated with the first milestone. The issuance of the remaining 553,845
shares will be completed during the fourth quarter of 2016. The stock based compensation expense associated with the achievement
of the second and third milestones totaled $2,837,000 and was recognized in the quarter ended September 30, 2016. No additional
compensation expense will be required with the issuance of the 553,845 shares.
Restricted
Shares to Employees
During
the year ended December 31, 2014, the Company entered into RSGAs with certain employees of Sunworks United, intended to provide
incentive to the recipients to ensure certain economic performance of the Company. All shares issuable under the RSGA are performance
based shares and are valued as of the grant date at $5.12 per share. Each of the RSGAs provides for the issuance of up to 38,462
shares of the Company’s common stock to each employee provided certain milestones are met in certain stages as follows:
a) If the Company’s aggregate net income from operations, for any trailing four (4) quarters equals or exceeds $2 million,
the Company will issue to each employee 12,821 shares of common stock and 64,105 shares in the aggregate; b) If the Company’s
aggregate net income from operations, for any trailing four (4) quarters exceeds $3 million, the Company will issue each employee
12,821 shares of common stock and 64,105 shares in the aggregate; c) If the Company’s aggregate net income from operations,
for any trailing four (4) quarters exceeds $4 million, the Company will issue each employee 12,820 and 51,280 shares in the aggregate.
Based on the probability that the first milestone would be achieved the Company recognized $33,000 in stock compensation expense
during the year 2015. As of September 30, 2016 the Company achieved each of the three milestones. During the quarter ended June
30, 2016 the Company issued 64,105 shares in aggregate associated with the first milestone. The issuance of the remaining 115,385
shares will be completed during the fourth quarter of 2016. The stock based compensation expense associated with the achievement
of the second and third milestones totaled $591,000 and was recognized in the quarter ended September 30, 2016. No additional
compensation expense will be required with the issuance of the 115,385 shares.
Restricted
Shares to Former CFO
On
February 1, 2015, the Company entered into a RSGA with its former Chief Financial Officer, intended to provide incentive to the
former CFO to ensure certain economic performance of the Company. All shares issuable under the RSGA are performance-based shares
and are valued as of the grant date at $4.21 per share. The RSGA provides for the issuance of up to 115,385 shares of the Company’s
common stock provided certain milestones are met in certain stages as follows: a) If the Company’s aggregate net income
from operations, for any trailing four (4) quarters equals or exceeds $2 million, the Company will issue 38,462 shares of common
stock; b) If the Company’s aggregate net income from operations, for any trailing four (4) quarters exceeds $3 million,
the Company will issued 38,462 shares of common stock; c) If the Company’s aggregate net income from operations, for any
trailing four (4) quarters exceeds $4 million, the Company will issue 38,461. As of September 30, 2016 the Company achieved each
of the three milestones. During the quarter ended June 30, 2016 the Company issued 38,462 shares associated with the first milestone.
The issuance of the remaining 76,723 shares will be completed during the fourth quarter of 2016. The stock based compensation
expense associated with the achievement of the second and third milestones totaled $324,000 and was recognized in the quarter
ended September 30, 2016. No additional compensation expense will be required with the issuance of the 76,723 shares.
Under
the terms of the RSGA, the Company issued 379,491 shares of restricted common stock in the nine months ended September 30, 2016.
Another 746,157 shares of restricted common stock vested and remain to be issued. The total combined option and restricted stock
compensation expense recognized, in the statement of operations, during the nine months ended September 30, 2016 and 2015 was
$5,764,000 and $107,000 respectively.
Warrants
As
of September 30, 2016, the Company had 2,997,000 common stock purchase warrants outstanding with an exercise price of $4.15 per
share.
9.
SUBSEQUENT EVENTS
None.
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