UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549
______________________

 

FORM 10-K
______________________

 

þ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the fiscal year ended: December 31, 2016

 

or

 

o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from: _____________ to _____________

 

HEALTHIER CHOICES MANAGEMENT CORP.

(Exact name of registrant as specified in its charter)

 

Delaware
(State or Other Jurisdiction
of Incorporation or Organization) 		001-36469
(Commission
File Number) 		84-1070932
(I.R.S. Employer
Identification No.)

 

Address of Principal Executive Office: 3800 North 28 th Way Hollywood, FL 33020

 

Registrant’s telephone number, including area code: (888) 766-5351

 

Securities registered pursuant to Section 12(b) of the Act: Common Stock, par value $0.0001

 

Securities registered pursuant to Section 12(g) of the Act :

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. ¨  Yes   þ  No

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.   ¨  Yes   þ  No

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. þ  Yes   ¨  No

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). þ Yes   ¨  No

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ¨

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.

 

Large accelerated filer      ¨ Accelerated filer      ¨ Non-accelerated filer      ¨ Smaller reporting company        þ

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes ¨   þ  No

 

The aggregate market value of the voting and non-voting common equity held by non-affiliates computed by reference to the price at which the common equity was last sold as of the last business day of the registrant’s most recently completed second fiscal quarter was approximately $953,896.44 million based on the June 30, 2016 closing price of $0.0002 per share.

 

Indicate the number of shares outstanding of each of the registrant’s classes of common stock, as of the latest practicable date. 19,643,675,411 shares outstanding as of March 20, 2017.

 

 

 

 

 

 

INDEX

 

  Page
   
PART I
   
Item 1. Business. 3
   
Item 1A. Risk Factors. 14
   
Item 1B. Unresolved Staff Comments. 15
   
Item 2. Properties. 15
   
Item 3. Legal Proceedings. 15
   
Item 4. Mine Safety Disclosures. 15
   
PART II
   
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities. 15
   
Item 6. Selected Financial Data. 17
   
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations. 17
   
Item 7A. Quantitative and Qualitative Disclosures About Market Risk. 41
   
Item 8. Financial Statements and Supplementary Data. 41
   
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure. 41
   
Item 9A. Controls and Procedures. 42
   
Item 9B. Other Information. 42
   
PART III
   
Item 10. Directors, Executive Officers and Corporate Governance 42
   
Item 11. Executive Compensation. 45
   
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholders Matters. 49
   
Item 13. Certain Relationships and Related Transactions, and Director Independence. 49
   
Item 14. Principal Accounting Fees and Services. 50
   
PART IV
   
Item 15.  Exhibits, Financial Statement Schedules. 51
   
SIGNATURES 52
   
Exhibit Index 53

 

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PART I

 

Item 1. Business.

 

Healthier Choices Management Corp. (the “Company”) is a holding company focused on providing consumers with healthier daily choices with respect to nutrition and other lifestyle alternatives. The Company currently operates thirteen retail vape stores in the Southeast region of the United States. The Company offers e-liquids, vaporizers and related products through our retail vape stores.

 

On June 1, 2016, the Company acquired Ada’s Natural Market, a natural and organic grocery store, through its wholly owned subsidiary Healthy Choice Markets, Inc. The grocery store has been a leader in the natural grocery vertical for the past forty years. The Fort Myers store offers fresh produce, bulk foods, vitamins and supplements, packaged groceries, meat and seafood, deli, baked goods, dairy products, frozen foods, health & beauty products and natural household items. The core mission of the store is to specialize in facilitating a healthy and positive lifestyle.

 

VAPORIZER AND E-LIQUID BUSINESS

 

Retail Stores

 

While evaluating retail store operations in 2016, management decided to close three of its Atlanta area vape stores on February 15, 2016, and December 31, 2016. Additionally, six of its Florida vape stores were closed between May 31, 2016 and December 31, 2016.

 

Vaporizers

 

“Vaporizers” are battery-powered products that enable users to inhale nicotine vapor without smoke, tar, ash, or carbon monoxide. Regardless of their construction, they are comprised of three functional components:

 

· a mouthpiece, which is a small plastic cartridge that contain a liquid nicotine solution;

 

· the heating element that vaporizes the liquid nicotine so that it can be inhaled; and

 

· the electronic devices which include: a lithium-ion battery, an airflow sensor, a microchip controller and an LED, which illuminates to indicate use.

 

When a user draws air through the vaporizer, the air flow is detected by a sensor, which activates a heating element that vaporizes the solution stored in the mouthpiece/cartridge, the solution is then vaporized and it is this vapor that is inhaled by the user. The cartridge contains either a nicotine solution or a nicotine free solution, either of which may be flavored.

 

Vaporizers feature a tank or chamber, a heating element and a battery. The vaporizer user fills the tank with e-liquid or the chamber with dry herb or leaf. The vaporizer battery can be recharged and the tank and chamber can be refilled.

 

Our Brands

 

We sell a wide variety of our e-liquid under the Vape Store brand. Our in-house engineering and graphic design teams work to provide aesthetically pleasing, technologically advanced and affordable vaporizer and e-liquid flavor options. We are in the process of preparing to commercialize additional brands which we intend to market to new customers and demographics .

 

Our Improvements and Product Development

 

We have developed and trademarked or are preparing to commercialize additional products. We include product development expenses as part of our operating expenses. While we currently own no patents which are material to our business, we were recently issued a utility patent covering a vaporizer or electronic cigarette device.  This patented improvement is intended to prevent the release and ingestion of metal particles from the heating element from entering the lungs of the user of the vaporizer or electronic cigarette.  Additionally, we have five patent applications pending in the United States. There is no assurance that we will be awarded patents for of any of these pending patent applications.

 

Flavor Profiles

 

We are developing new flavor profiles that are distinct to our brands. We believe that as the vaporizer industry matures, users of vaporizers and e-liquids will continue to develop preferences for the product based not only on their quality, ability to successfully

 

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deliver nicotine, battery capacity, and vapor volume they generate, but on taste and flavor, like smokers do with their preferred brand of conventional tobacco cigarettes.

 

Vaporizer Biometric Fingerprint Lock Sensor Patent

 

We have a patent pending for a biometric fingerprint lock sensor that can be used in vaporizers. The biometric fingerprint lock sensor will allow the owner of the vaporizer to keep the device locked and turned off unless the authorized user unlocks the device via fingerprint scan, protecting the device from use by another individual. This technology may be used to protect against minors being able to turn on the device and will also deem the devices unusable in the event the device is lost or stolen. There is no assurance that we will be awarded a patent for this technology.

 

Our Kits and Accessories

 

Our vaporizers are available in kits that contain everything a user needs to begin enjoying their “vaping” experience. In addition to kits we sell replacement parts including batteries, coils, refill cartridges or cartomizers that contain the liquid solution, atomizers, tanks and e-liquids. Our refill cartridges and e-liquids are available in various assorted flavors and nicotine levels (including 0.0% nicotine). In addition to our vaporizer products we sell an assortment of accessories, including various types of chargers (including USB chargers), carrying cases and lanyards.

 

The Market for Vaporizers

 

We market our vaporizers as an alternative to traditional tobacco cigarettes and cigars. We offer our products in multiple nicotine strengths and flavors. Because vaporizers and electronic cigarettes offer a “smoking” experience without the burning of tobacco leaf, vaporizers and electronic cigarettes offer users the ability to satisfy their nicotine cravings without smoke, tar, ash or carbon monoxide. In many cases vaporizers may be used where tobacco-burning cigarettes may not. Vaporizers may be used in some instances where for regulatory or safety reasons tobacco burning cigarettes may not be used. However, certain states, cities, businesses, providers of transportation and public venues in the U.S. have banned the use of vaporizers, where traditional cigarettes may not be smoked, while others are considering banning the use of vaporizers. We cannot provide any assurances that the use of vaporizers will be permitted in places where traditional tobacco burning cigarette use is banned. See the “Risk Factors” on page 23.

 

Advertising

 

Currently, we advertise our products primarily through point of sale materials and displays at retail locations. We also attempt to build brand awareness through social media marketing activities, price promotions, in-store and on premise promotions, public relations and radio advertising. We intend to continue to strategically manage our advertising activities in 2017 to gain editorial coverage for our brands. Some of our competitors promote their brands through print media and television commercials, and through celebrity endorsements, and have substantial resources to devote to such efforts. We believe that our and our competitors’ efforts have helped increase our sales, our product acceptance and general industry awareness.

 

Distribution and Sales

 

The Company sells directly to consumers through thirteen company owned retail vape stores. Our management believes that consumers are shifting towards vape stores for an enhanced experience. This enhanced experienced is derived from the greater variety of products at the stores, the knowledgeable staff and the social atmosphere. The Company anticipates a significant portion of future revenue will come from its retail stores.

 

Business Strategy

 

We believe and are seeing in our current stores that there is a large consumer demand centered on the vaporizer products and the “atmosphere” created by the vape stores. We believe that our reputation and our experience in the vaporizer industry, from a development, customer service and production perspective, give us an advantage in attracting customers.

 

Moreover, we believe that our history with our suppliers, including the volume of products we source, gives us an advantage over other market participants as it relates to favorable pricing, priority as to inventory supply and delivery and first access to new products, including first access to next generation products and technology.

 

Our goal is to achieve a position of sustainable leadership in the vaporizer industry. Our strategy consists of the following key elements:

 

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· develop new product offerings with new technology and performance advancements;
· continue our product focus on vaporizers and e-liquids;
· invest in and leverage our existing brand through marketing and advertising;
· expanding into new potential markets;
· align our product offerings and cost with market demand; and
· consider diversifying our line of business

 

Competition

 

Competition in the vaporizer and e-liquid industry is intense. We compete with other sellers of vaporizes, most notably Altria Group, Inc., JT International, Imperial Tobacco, and Reynolds American, Inc., which are big tobacco companies that have vaporizer and electronic cigarette business segments. The nature of our competitors is varied as the market is highly fragmented and the barriers to entry into the business are low. Our direct competitors sell products that are substantially similar to ours. As a general matter, we have access to market and sell the similar vaporizers as our competitors and we sell our products at substantially similar prices as our competitors; accordingly, the key competitive factors for our success is the quality of service we offer our customers, the scope and effectiveness of our marketing efforts, including media advertising campaigns and, increasingly, the ability to identify and develop new sources of customers.

 

As discussed above, we compete against “big tobacco”, U.S. cigarette manufacturers of both conventional tobacco cigarettes and electronic cigarettes like Altria Group, Inc., JT International, Imperial Tobacco, and Reynolds American, Inc. We compete against “big tobacco” who offers not only conventional tobacco cigarettes and electronic cigarettes and vaporizers, but also smokeless tobacco products such as “snus” (a form of moist ground smokeless tobacco that is usually sold in sachet form that resembles small tea bags), chewing tobacco and snuff. “Big tobacco” has nearly limitless resources, global distribution networks in place and a customer base that is fiercely loyal to their brands. Furthermore, we believe that “big tobacco” is devoting more attention and resources to developing, acquiring technology patents, and offering electronic cigarettes, vaporizers and e-liquids as these markets grow. Because of their well-established sales and distribution channels, marketing expertise and significant resources, “big tobacco” is better positioned than small competitors like us to capture a larger share of the electronic cigarette market.

 

Manufacturing

 

We have no manufacturing capabilities and do not intend to develop any manufacturing capabilities. Third party manufacturers make our products to meet our design specifications. We depend on third party manufacturers for our vaporizer e-liquid and accessories. Our customers associate certain characteristics of our products including the weight, feel, draw, unique flavor, packaging and other attributes of our products to the brands we market, distribute and sell. Any interruption in supply and or consistency of our products may harm our relationships and reputation with customers, and have a material adverse effect on our business, results of operations and financial condition. In order to minimize the risk of supply interruption, we currently utilize several third-party manufacturers to manufacture our products to our specifications.

 

We currently utilize several manufacturers both domestically and internationally. We contract with our manufacturers on a purchase order basis. We do not have any output or requirements contracts with any of our manufacturers. Our manufacturers provide us with finished products, which we hold in inventory for distribution, sale and use. Certain Chinese factories and the products they export have recently been the source of safety concerns and recalls, which is generally attributed to lax regulatory, quality control and safety standards. Should Chinese factories continue to draw public criticism for exporting unsafe products, whether those products relate to our products or not, we may be adversely affected by the stigma associated with Chinese production, which could have a material adverse effect on our business, results of operations and financial position.

 

Although we believe that several alternative sources for our products are available, any failure to obtain the components, chemical constituents and manufacturing services necessary for the production of our products would have a material adverse effect on our business, results of operations and financial condition.

 

Source and Availability of Raw Materials

 

We believe that an adequate supply of product and raw materials will be available to us as needed and from multiple sources and suppliers.

 

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Intellectual Property

 

We have developed and trademarked or are preparing to commercialize additional products. We include product development expenses as part of our operating expenses. While we currently own no patents which are material to our business, we were recently issued a utility patent covering a vaporizer or electronic cigarette device.  This patented improvement is intended to prevent the release and ingestion of metal particles from the heating element from entering the lungs of the user of the vaporizer or electronic cigarette.  Additionally, we have five patent applications pending in the United States. There is no assurance that we will be awarded patents for any of these pending patent applications.

 

Patent Litigation

 

Third party patent lawsuits alleging our infringement of patents, trade secrets or other intellectual property rights have and could force us to do one or more of the following:

 

· stop selling products or using technology that contains the allegedly infringing intellectual property;
· incur significant legal expenses;
· pay substantial damages to the party whose intellectual property rights we may be found to be infringing;
· redesign those products that contain the allegedly infringing intellectual property; or
· attempt to obtain a license to the relevant intellectual property from third parties, which may not be available to us on reasonable terms or at all.

 

Future third party lawsuits alleging our infringement of patents, trade secrets or other intellectual property rights could have a material adverse effect on our business, results of operations and financial condition. 

 

We are required to obtain licenses to patents or proprietary rights of others and may be required to obtain more in the future and as the product continues to evolve. We cannot assure you that any future licenses required under any such patents or proprietary rights would be made available on terms acceptable to us or at all. If we do not obtain such licenses, we could encounter delays in product market introductions while we attempt to design around such patents, or could find that the development, manufacture, or sale of products requiring such licenses could be foreclosed. Litigation may be necessary to defend against claims of infringement asserted against us by others, or assert claims of infringement to enforce patents issued to us or exclusively licensed to us, to protect trade secrets or know-how possessed by us, or to determine the scope and validity of the proprietary rights of others. In addition, we may become involved in oppositions in foreign jurisdictions, reexaminations declared by the United States Patent and Trademark Office, or interference proceedings declared by the United States Patent and Trademark Office to determine the priority of inventions with respect to our patent applications or those of our licensors. Litigation, opposition, reexamination or interference proceedings could result in substantial costs to and diversion of effort by us, and may have a material adverse impact on us. In addition, we cannot assure you that our efforts to maintain or defend our patents will be successful .

 

Regulations

 

Since a 2010 U.S. Court of Appeals decision, the Food and Drug Administration (“FDA”) is permitted to regulate electronic cigarettes as “tobacco products” under the Family Smoking Prevention and the Tobacco Control Act. Under this decision, the FDA is not permitted to regulate electronic cigarettes as “drugs” or “devices” or a “combination product” under the Federal Food, Drug and Cosmetic Act unless they are marketed for therapeutic purposes. This is contrary to anti-smoking devices like nicotine patches, which undergo more extensive FDA regulation. Because the Company does not market its electronic cigarettes for therapeutic purposes, the Company’s electronic cigarettes are subject to being classified as “tobacco products” under the Tobacco Control Act. The Tobacco Control Act grants the FDA broad authority over the manufacture, sale, marketing and packaging of tobacco products, although the FDA is prohibited from issuing regulations banning all cigarettes or all smokeless tobacco products, or requiring the reduction of nicotine yields of a tobacco product to zero.

 

On April 24, 2014, the FDA released proposed rules that would extend its regulatory authority to electronic cigarettes and certain other tobacco products under the Tobacco Control Act. The proposed rules would require that electronic cigarette manufacturers (i) register with the FDA and report electronic cigarette product and ingredient listings; (ii) market new electronic cigarette products only after FDA review; (iii) only make direct and implied claims of reduced risk if the FDA confirms that scientific evidence supports the claim and that marketing the electronic cigarette product will benefit public health as a whole; (iv) not distribute free samples; (v) implement minimum age and identification restrictions to prevent sales to individuals under age 18; (vi) include a health warning; and (vii) not sell electronic cigarettes in vending machines, unless in a facility that never admits youth. It is not known how long this regulatory process to finalize and implement the rules may take. Accordingly, the Company cannot predict the content of any final rules from the proposed rules or the impact they may have. See the “Risk Factor” on page 24 which also discusses possible additional FDA rulemaking.

 

In this regard, total compliance and related costs are not possible to predict and depend substantially on the future requirements imposed by the FDA under the Tobacco Control Act. Costs, however, could be substantial and could have a material adverse effect on the Company’s business, results of operations and financial condition. In addition, failure to comply with the Tobacco Control Act and with FDA regulatory requirements could result in significant financial penalties and could have a material adverse effect on the Company’s business, financial condition and results of operations and ability to market and sell the Company’s products. At present, it is difficult to predict whether the Tobacco Control Act will impact the Company to a greater degree than competitors in the industry, thus affecting the Company’s competitive position.

 

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State and local governments currently legislate and regulate tobacco products, including what is considered a tobacco product, how tobacco taxes are calculated and collected, to whom and by whom tobacco products can be sold and where tobacco products may or may not be smoked. State and local regulation of the e-cigarette market and the usage of e-cigarettes is beginning to accelerate.

 

As local regulations expand, vaporizers and electronic cigarettes may lose their appeal as an alternative to cigarettes, which may have the effect of reducing the demand for the Company’s products and as a result have a material adverse effect on the Company’s business, results of operations and financial condition.

 

At present, neither the Prevent All Cigarette Trafficking Act (which prohibits the use of the U.S. Postal Service to mail most tobacco products, which would require individuals and businesses that make interstate sales of cigarettes or smokeless tobacco to comply with state tax laws) nor the Federal Cigarette Labeling and Advertising Act (which governs how cigarettes can be advertised and marketed) apply to electronic cigarettes. The application of either or both of these federal laws to vaporizers and electronic cigarettes would have a material adverse effect on the Company’s business, results of operations and financial condition.

 

On July 1, 2015, the FDA published a document entitled “Advanced notice of proposed rulemaking” or the Advance. Through the Advance, the FDA solicited public comments on whether it should issue rules with respect to nicotine exposure warning and child-resistant packaging for e-liquids containing nicotine. Following public comment, the FDA may issue proposed rules in furtherance of the purposes outlined in the Advance and ultimately pass the rules as proposed or in modified form. We cannot predict whether if rules are passed it will have a material adverse effect on our future results of operations and financial conditions.

 

The Company expects that the tobacco industry will experience significant regulatory developments over the next few years, driven principally by the World Health Organization’s FCTC. The FCTC is the first international public health treaty on tobacco, and its objective is to establish a global agenda for tobacco regulation with the purpose of reducing initiation of tobacco use and encouraging cessation. Regulatory initiatives that have been proposed, introduced or enacted include:

 

· the levying of substantial and increasing tax and duty charges;
· restrictions or bans on advertising, marketing and sponsorship;
· the display of larger health warnings, graphic health warnings and other labelling requirements;
· restrictions on packaging design, including the use of colors and generic packaging;
· restrictions or bans on the display of tobacco product packaging at the point of sale, and restrictions or bans on cigarette vending machines;
· requirements regarding testing, disclosure and performance standards for tar, nicotine, carbon monoxide and other smoke constituents’ levels;
· requirements regarding testing, disclosure and use of tobacco product ingredients;
· increased restrictions on smoking in public and work places and, in some instances, in private places and outdoors;
· elimination of duty free allowances for travelers; and
· encouraging litigation against tobacco companies.

 

If Vaporizers, electronic cigarettes, or e-liquids, are subject to one or more significant regulatory initiates enacted under the FCTC, the Company’s business, results of operations and financial condition could be materially and adversely affected.

 

Sale of Wholesale Business and Discontinued Operations

 

On July 29, 2016, the Company, entered into an Asset Purchase Agreement (the “Wholesale Business Purchase Agreement”) with VPR Brands, L.P. (the “Purchaser”) and the Purchaser’s Chief Executive Officer, Kevin Frija (the former Chief Executive Officer of the Company) pursuant to which the Company sold its wholesale inventory and the related business operations (collectively, “Wholesale Business Assets”), which previously operated at 3001 Griffin Road, Dania Beach, Florida 33312. The sale transaction was approved by the Company’s Board of Director’s on July 26, 2016 and completed on July 31, 2016. The consideration for the Wholesale Business Assets is (i) a secured, one-year promissory note in the principal amount of $370,000 (the “Acquisition Note”) bearing an interest rate of 4.5%, which payments thereunder are $10,000 monthly, with such payments commencing on October 28, 2016, with a balloon payment of the remainder of principal and interest on July 29, 2017; (ii) A secured, 36-month promissory note in the principal amount of $500,000 bearing an interest rate of prime plus 2%, resetting annually on July 29th, which payments thereunder are $14,000 per

 

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month, with such payments deferred and commencing on January 26, 2017, with subsequent installments payable on the same day of each month thereafter and in the 37th month, a balloon payment for all remaining accrued interest and principal; (iii) the assumption by the Purchaser of certain liabilities related to the Company’s wholesale operations, including but not limited to the month-to-month lease for the premises. Pursuant to the Wholesale Business Purchase Agreement, the Company shall continue to own its accounts receivable from its wholesale operations as of July 29, 2016. The Company records all proceeds related to both notes as income from discontinued operations as proceeds are received. The Company agreed to use its commercially reasonable efforts, consistent with standard industry practice, to collect such accounts receivable, and any and all amounts so collected (i) up to $150,000 (net of any refunds) in the aggregate shall be credited against payment of the Acquisition Note; and (ii) in excess of $150,000 (up to $95,800) will be transferred to the Purchaser’s Chief Executive Officer as additional consideration for the transfer to the Company by Mr. Frija of 1,405,910,203 shares of the Company’s common stock (the “Retired Shares”) that he had acquired on the open market.

 

Healthy Choice Markets

 

Healthy Choice is a specialty retailer of natural and organic groceries and dietary supplements. We focus on providing high-quality products at affordable prices, exceptional customer service, nutrition education and community outreach. We strive to generate long-term relationships with our customers based on quality and service by:

 

· selling only natural and organic groceries

 

· offering affordable prices and a shopper-friendly retail environment; and

 

· dine-in options at our Natural Organic Juice Bar and Green Leaf Café.

 

Our History and Founding Principles

 

We are committed to maintaining the following founding principles, which have helped foster our growth:

 

· Quality. Every product on our shelves must go through a rigorous screening and approval process. Our mission includes providing the highest quality groceries and supplements, Natural Grocers branded products, European and United States Department of Agriculture (USDA) certified organic and fresh produce at the best prices in the industry.

 

· Community. Ada’s Market has been serving the Ft. Myers community for 40 years.

 

· Employees. Our employees make our company great. We work hard to ensure that our employees are able to live a healthy, balanced lifestyle. We support them with free nutrition education programs, good pay and excellent benefits.

 

Our Market

 

We operate within the natural products retail industry, which is a subset of the United States grocery industry and the dietary supplement business. This industry includes conventional supermarkets, natural, gourmet and specialty food markets, mass and discount retailers, warehouse clubs, independent health food stores, dietary supplement retailers, drug stores, farmers’ markets, food co-ops, mail order and online retailers and multi-level marketers. Industry-wide sales of natural and organic foods and dietary supplements have experienced meaningful growth over the past several years, and we believe that growth will continue for the foreseeable future.

 

We believe the growth in sales of natural and organic foods and dietary supplements continues to be driven by numerous factors, including:

 

· greater consumer focus on high-quality nutritional products;

 

· an increased awareness of the importance of good nutrition to long-term wellness;

 

· an aging Ft. Myer’s community that is seeking healthy lifestyle alternatives;

 

· heightened consumer awareness about the importance of food quality and a desire to avoid pesticide residues, growth hormones, artificial ingredients and genetically engineered ingredients in foods;

 

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· growing consumer concerns over the use of harmful chemical additives in body care and household cleaning supplies;

 

· well-established natural and organic brands, which generate additional industry awareness and credibility with consumers; and

 

· the growth in the number of consumers with special dietary requirements as a result of allergies, chemical sensitivities, auto-immune disorders and other conditions.

 

Our Competitive Strengths

 

We believe we are well-positioned to capitalize on favorable natural and organic grocery and dietary supplement industry dynamics as a result of the following competitive strengths:

 

Strict focus on high-quality natural and organic grocery products. We offer high-quality products and brands, including an extensive selection of widely-recognized natural and organic food, dietary supplements, body care products, pet care products and books. We offer our customers approximately 10,000 Stock Keeping Units (SKUs) of natural and organic products. We believe our broad product offering enables our customers to shop our stores for substantially all of their grocery and dietary supplement purchases. In our grocery departments, we primarily sell USDA certified organic produce and do not approve for sale grocery products that are known to contain artificial colors, flavors, preservatives or sweeteners or partially hydrogenated or hydrogenated oils. In addition, we only sell pasture-raised, humanely-raised dairy products. Consistent with this strategy, our product selection does not include items that do not meet our strict quality guidelines. Our store managers enhance our robust product offering by customizing their stores’ selections to address the preferences of local customers.

 

Engaging customer service experience based on education and empowerment. We strive to offer consistently exceptional customer service in a shopper-friendly environment, which we believe creates a differentiated shopping experience, enhances customer loyalty and generates repeat visits from our clientele. A key aspect of our customer service model is to provide free nutrition education to our customers. We believe this focus provides an engaging retail experience while also empowering our customers to make informed decisions about their health. We offer our science-based nutrition education through our trained employees, our newsletter and sales flyer, community out-reach programs, one-on-one nutrition health coaching, nutrition classes and cooking demonstrations.

 

Our Growth Strategies

 

We expect to pursue several strategies to continue our profitable growth, including:

 

Expand our store base. We intend to expand our store base through the acquisition of new stores.

 

Increase sales from existing customers. In order to increase our average ticket and the number of customer transactions, we plan to continue offering an engaging customer experience by providing science-based nutrition education and a differentiated merchandising strategy that delivers affordable, high-quality natural and organic grocery products and dietary supplements. We also plan to continue to utilize targeted marketing efforts to reach our existing customers, which we anticipate will drive customer transactions and convert occasional, single-category customers into core, multi-category customers.

 

Grow our customer base. We plan to implement several measures aimed at building our brand awareness and growing our customer base, including: (i) redesigning our website ( www.adasmarket.com ) to enhance functionality, create a more engaging user experience and increase its reach and effectiveness; (ii) introducing customer appreciation program at all our stores; and (iii) developing new collateral marketing materials. We believe offering nutrition education has historically been one of our most effective marketing strategies for reaching new customers and increasing the demand for natural and organic groceries and dietary supplements in our markets.

 

Improve operating margins. We expect to continue to improve our operating margins as we benefit from investments we have made or are making in fixed overhead and information technology. As we add additional stores, we expect to achieve greater economies of scale through sourcing and distribution as we add more stores. In addition, to achieve additional operating margin expansion, we intend to further optimize performance, maintain appropriate store labor levels and effectively manage product selection and pricing.

 

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Ada’s Natural Market

 

Ada’s offers a comprehensive selection of natural and organic groceries and dietary supplements in a smaller-store format that aims to provide a convenient, easily shopped and relaxed environment for our customers. Our store design emphasizes a clutter-free, organized feel, a quiet ambience accented with warm lighting. We believe our core customers consider us a destination stop for their nutritional education and information, natural and organic products and dietary supplements.

 

Our Store Format. Ada’s has 16,000 selling square feet. Approximately 1000 of our stores’ selling square footage is dedicated to dietary supplements. Ada’s sells approximately 10,000 SKUs of natural and organic products per store.

 

Our Products

 

Product Selection Guidelines. We have a set of strict quality guidelines covering all products we sell. For example:

 

· we do not approve for sale food known to contain artificial colors, flavors, preservatives or sweeteners or partially hydrogenated or hydrogenated oils or phthalates or parabens, regardless of the proportion of its natural or organic ingredients;

 

· we sell USDA certified organic produce;

 

· we sell meats naturally raised without hormones, antibiotics or treatments and that were not fed animal by-products; and

 

· we do not sell any tobacco or tobacco-related products

 

Our product review team analyzes all new products and approves them for sale based on ingredients, price and uniqueness within the current product set. We actively research new products in the marketplace through our product vendors, private label manufacturers, scientific findings, customer requests and general trends in popular media. Our stores are able to fully merchandise all departments by providing an extensive assortment of natural and organic products. We do not believe we need to sell conventional products to fill our selection, increase our margins or attract more customers.

 

What We Sell. We operate both a full-service natural and organic grocery store and a dietary supplement store within a single retail location. The following is a breakdown of our sales mix for the fiscal year ended December 31, 2016:

 

The products in our stores include:

 

· Grocery. We offer a broad selection of natural and organic grocery products with an emphasis on minimally processed and single ingredient products that are not known to contain artificial colors, flavors, preservatives or sweeteners or partially hydrogenated or hydrogenated oils. Additionally, we carry a wide variety of products associated with special diets such as gluten free, vegetarian and non-dairy. Our grocery products include:

 

· Produce. We sell USDA-certified organic produce and source from local, organic producers whenever feasible. Our selection varies based on seasonal availability, and we offer a variety of organic produce offerings that are not typically found at conventional food retailers.

 

· Bulk Food and Private Label Products. We sell a wide selection of private label repackaged bulk and other products, including nuts, water, pasta, canned seafood, dried fruits, grains, granolas, honey, eggs, herbs, spices and teas.

 

· Dry, Frozen and Canned Groceries. We offer a wide variety of natural and organic dry, frozen and canned groceries, including cereals, soups, baby foods, frozen entrees and snack items. We offer a broad selection of natural chocolate bars, and energy, protein and food bars.

 

· Meats and Seafood. We offer naturally-raised or organic meat products. The meat products we offer come from animals that have never been treated with antibiotics or hormones or fed animal by-products. Additionally, we only buy from companies we believe employ humane animal-raising practices. Our seafood items are generally frozen at the time of processing and sold from our freezer section, thereby ensuring freshness and reducing food spoilage and safety issues.

 

  10

 

· Dairy Products and Dairy Substitutes. We offer a broad selection of natural and organic dairy products such as milk, eggs, cheeses, yogurts and beverages, as well as non-dairy substitutes made from almonds, coconuts, rice and soy.

 

· Prepared Foods. Our stores have a convenient selection of refrigerated prepared fresh food items, including salads, sandwiches, salsa, humus and wraps. The size of this offering varies by location.

 

· Bread and Baked Goods. We receive regular deliveries of a wide selection of bakery products for our bakery section, which includes an extensive selection of gluten-free items.

 

· Beverages. We offer a wide variety of non-alcoholic and alcoholic beverages containing natural and organic ingredients.

 

· Dietary Supplements. We offer a wide selection of vitamins, supplements and natural remedies. Our staff is well educated and trained on multiple aspects of natural medicine.

 

· Body Care . We offer a full range of cosmetics, skin care, hair care, fragrance and personal care products containing natural and organic ingredients. Our body care offerings range from bargain-priced basics to high-end formulations.

 

· Household and General Merchandise . Our offerings include sustainable, hypo-allergenic and fragrance-free household products, including cleaning supplies, paper products, dish and laundry soap and other common household products, including diapers.

 

Quality Assurance. We endeavor to ensure the quality of the products we sell. We work with reputable suppliers we believe are compliant with established regulatory and industry guidelines. Our purchasing department requires a complete supplier and product profile as part of the approval process. Our dietary supplement suppliers must follow Food and Drug Administration (FDA) current good manufacturing practices supported by quality assurance testing for both the base ingredients and the finished product. We expect our suppliers to comply with industry best practices for food safety.

 

Many of our suppliers are inspected and certified under the USDA National Organic Program, voluntary industry associations, and other third party auditing programs with regard to additional ingredients, manufacturing and handling standards. We operate all our stores in compliance with the National Organic Program standards, which restricts the use of certain substances for cleaning and pest control and requires rigorous recordkeeping, among other requirements.

 

Our Pricing Strategy

 

We believe our pricing strategy allows our customers to shop our stores on a regular basis for their groceries and dietary supplements.

 

The key elements of our pricing strategy include:

 

· heavily advertised deals supported by manufacturer participation;

 

· in-store specials generally lasting for 30 days and not advertised outside the store;

 

· managers’ specials, such as clearance, overstock, short-dated or promotional incentives; and

 

· specials on seasonally harvested produce.

 

As we expand our store base, we believe there are opportunities for increased leverage in fixed costs, such as administrative expenses, as well as increased economies of scale in sourcing products. We strive to keep our product, operating and general and administrative costs low, which allows us to continue to offer attractive pricing for our customers.

 

Our Store Operations

 

Store Hours. Our stores are open from 8:00 a.m. to 8:30 p.m., Monday through Saturday, and from 9:00 a.m. to 8:00 p.m. on Sunday.

 

  11

 

Store Management and Staffing. Our store staffing includes a manager and assistant manager, with department managers in each of the dietary supplement, grocery, dairy and frozen, produce, body care and receiving departments, as well as several non-management employees. The store manager is responsible for monthly store profit and loss, including labor, merchandising and inventory costs.

 

To ensure a high level of service, all employees receive training and guidance on customer service skills, product attributes and nutrition education. Employees are carefully trained and evaluated based on a requirement that they present nutrition information in an appropriate and legally compliant educational context while interacting with customers. Additionally, store employees are cross-trained in various functions, including cashier duties, stocking and receiving product.

 

Inventory. We use a robust merchandise management and perpetual inventory system that values goods at average cost. We manage shelf stock based on weeks-on-hand relative to sales, resupply time and minimum economic order quantity.

 

Sourcing and Vendors. We source from approximately 250 suppliers, and offer over 4000 brands. These suppliers range from small independent businesses to multi-national conglomerates. As of December 31, 2016, we purchased approximately 75% of the goods we sell from our top 20 suppliers. For the fiscal year ended December 31, 2016, approximately 40% of our total purchases were from one vendor. We maintain good relations with all our suppliers and believe we have adequate alternative supply methods, including self-distribution.

 

We have longstanding relationships with our suppliers, and we require disclosure from them regarding quality, freshness, potency and safety data information. Our bulk food private label products are packaged by us in pre-packed sealed bags to help prevent contamination while in transit and in our stores. Unlike most of our competitors, most of our private label nuts, trail mix and flours are refrigerated in our warehouse and stores to maintain freshness.

 

Our Employees

 

Commitment to our employees is one of our five founding principles. Employees are eligible for health, long-term disability, vision and dental insurance coverage, as well as Company paid short-term disability and life insurance benefits, after they meet eligibility requirements. Additionally, our employees are offered a 401(k) retirement savings plan with discretionary contribution matching opportunities. This further offers our employees the opportunity to become more familiar with our products, which we believe improves the customer service our employees are able to provide. We believe these and other factors result in higher retention rates and encourage our employees to appreciate our culture, which helps them better promote our brand.

 

Our Customers

 

The growth in the natural and organic grocery and dietary supplement industries and growing consumer interest in health and nutrition have led to an increase in our core customer base. We believe the demands for affordable, nutritious food and dietary supplements are shared attributes of our core customers, regardless of their socio-economic status. Additionally, we believe our core customers prefer a retail store environment that offers carefully selected natural and organic products and dietary supplements. Our customers tend to be interested in health and nutrition, and expect our store employees to be highly knowledgeable about these topics and related products.

 

Competition

 

The grocery and dietary supplement retail business is a large, fragmented and highly competitive industry, with few barriers to entry. Our competition varies by market and includes conventional supermarkets such as Publix and Winn-Dixie, mass or discount retailers such as Wal-Mart and Target, natural and gourmet markets such as Whole Foods and The Fresh Market, specialty food retailers such as Trader Joe’s, independent health food stores, dietary supplement retailers, drug stores, farmers’ markets, food co-ops, mail order and online retailers and multi-level marketers. These businesses compete with us for customers on the basis of price, selection, quality, customer service, shopping experience or any combination of these or other factors. They also compete with us for products and locations. In addition, some of our competitors are expanding to offer a greater range of natural and organic foods. We believe our commitment to carrying only carefully vetted, affordably priced and high-quality natural and organic products and dietary supplements, as well as our focus on providing nutritional education, differentiate us in the industry and provide a competitive advantage.

 

  12

 

Seasonality

 

Our business is active throughout the calendar year and does not experience significant fluctuation caused by seasonal changes in consumer purchasing.

 

Insurance and Risk Management

 

We use a combination of insurance and self-insurance to cover workers’ compensation, general liability, product liability, director and officers’ liability, employment practices liability, associate healthcare benefits and other casualty and property risks. Changes in legal trends and interpretations, variability in inflation rates, changes in the nature and method of claims settlement, benefit level changes due to changes in applicable laws, insolvency of insurance carriers and changes in discount rates could all affect ultimate settlements of claims. We evaluate our insurance requirements and providers on an ongoing basis.

 

Information Technology Systems

 

We have made significant investments in overhead and information technology infrastructure, including purchasing, receiving, inventory, point of sale, warehousing, distribution, accounting, reporting and financial systems.

 

Segment Information

 

We have two reporting segments, natural and organic retail stores and vapor products, through which we conduct all of our business.

 

Potential Medical Marijuana Business

 

As a result of the recent legalization of medical marijuana in Florida, the Company is taking steps to explore the possibility of obtaining licensure for dispensaries in Florida. In furtherance of this goal, the Company has retained a national law firm, a local law firm and an M&A consulting firm. Through these professionals, the Company is also seeking investment opportunities in the medical marijuana business in several states. The Company hopes to enter into this new line of business through strategic partnerships and/or mergers, acquisitions and investments in the medical marijuana field. Ultimately, the Company hopes to obtain licensure for medical marijuana in Florida to complement and grow its existing retail operations. With nine retail vape stores in Florida, the Company is well-positioned to leverage a portion of its existing customer base who we believe will be consumers when the sale of medical marijuana commences available in Florida. No Company operations or assets are currently dedicated to the medical marijuana dispensary business, other than the fees for the engagement of advisory professionals.

 

Growth Strategy

 

The Company is in the process of establishing a well-defined strategy for entering and maintaining a strong presence in the legal marijuana sector. The cornerstones of this strategy include:  

 

•   All operations are to be conducted in accordance with state and local laws and regulations and guidance outlined in the U.S. Department of Justice “Cole Memo” dated August 29, 2013.
     
•   The Company will seek to grow organically, as well as through a mergers, acquisitions and/or investment strategy.
     
•   The Company will seek to engage, sponsor or lead local advocacy and lobbying groups that have a significant impact on the evolution and character of laws and the regulations under which legal marijuana operations are implemented in select markets.
     
•   The Company shall work with law enforcement and government officials to insure compliance with all regulations.
     

The core strategic marketing objectives include:

 

•   Establish or Acquire a Brand – positioning the Company’s brand to have positive and value related associations with all prospective and existing customers.
   
•   Operate Cooperatively - cooperation, as a strategy, helps develop a network of suppliers and marketing channels able to promote our brand.
     
•   Deliver Value - customer value is achieved when the perceived value of what we sell along with the value of the experience we deliver exceeds the price we charge.
     
•   Drive Customer Traffic - the only two ways to increase store income is to sell more to our existing customers and attract new customers.  With respect to increasing income, we believe that a portion of our existing customer base will likewise purchase medical marijuana from our stores when available.  With respect to increasing sales, we currently have advertising programs in place which will be easily modified to accomplish this task.  

 

  13

Government Regulation

 

General

 

Any medical marijuana business we develop would be subject to general business regulations and laws, as well as regulations and laws directly applicable to these operations. As we continue to expand the scope of our operations, the application of existing laws and regulations could include matters such as pricing, advertising, consumer protection, quality of products, and intellectual property ownership. In addition, the medical marijuana business will also be subject to new laws and regulations directly applicable to its activities.

 

Any existing or new legislation applicable to us could expose us to substantial liability, including significant expenses necessary to comply with such laws and regulations, which could hinder or prevent the growth of our business.

 

Federal, state and local laws and regulations governing legal recreational and medical marijuana use are broad in scope and are subject to evolving interpretations, which could require us to incur substantial costs associated with compliance. Violations of these laws or allegations of such violations could disrupt our planned business and adversely affect our financial condition and results of operations. In addition, it is possible that additional or revised federal, state and local laws and regulations may be enacted in the future governing the legal marijuana industry. There can be no assurance that we will be able to comply with any such laws and regulations and its failure to do so could significantly harm our business, financial condition and results of operations.  

 

Competition

 

The legal marijuana sector is rapidly growing and the Company could face significant competition in the operation of medical marijuana dispensaries. Many of these competitors will have far greater experience, more extensive industry contacts and greater financial resources than the Company. There can be no assurance that we can adequately compete to succeed in our business plan.

 

Employees

 

As of March 20, 2017, we had 105 full-time employees and 38 part-time employees, none of which are represented by a collective bargaining agreement. We believe that our employee relations are good.

 

Going Concern and Liquidity

 

The accompanying consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America (“GAAP”), which contemplate the continuation of the Company as a going concern and realization of assets and satisfaction of liabilities in the normal course of business and do not include any adjustments that might result from the outcome of any uncertainties related to our going concern assessment. The carrying amounts of assets and liabilities presented in the consolidated financial statements do not necessarily purport to represent realizable or settlement values.

 

We had a large number of warrants outstanding with features that made the warrants more debt like and possibly result in cash outflows and were thus classified as derivative liabilities. As a result, for 2015, the Company reflected a loss from operations and had an accumulated deficit. These factors raised substantial doubt about our ability to continue as a going concern.

 

During 2016 and early 2017, we took steps to mitigate these factors by:

 

1) increasing the number of authorized shares to 750,000,000,000 shares so that there would be sufficient shares available for issuance should all the warrant holders exercise;

 

2) entering into a Fifth Amended and Restated Series A Warrant Standstill Agreement (the “Fifth Amendment”) with warrant holders effectively eliminating the possibility that warrant holders will exercise for anything other than shares, and

 

3) completing a tender offer to repurchase its Series A Warrants which resulted in 10,073,884 of the warrants being repurchased for $0.22 per warrant.

 

The steps above substantially lowered our outstanding liabilities and resulted in the Company having positive equity. As a result, as of the date of the issuance of these financial statements, we believe our plans have alleviated substantial doubt about the Company’s ability to sustain operations for the foreseeable future through a year and a day from the issuance of these consolidated financial statements.

 

Item 1A. Risk Factors.

 

Not applicable to smaller reporting companies. Please see the Company’s risk factors contained under Item 7.

 

  14

 

Item 1B. Unresolved Staff Comments.

 

None

 

Item 2. Properties.

 

The Company currently has lease agreements for 13 retail vape store locations and an administrative office. Under these leases, the initial lease terms range from one to five years. The Company also has a lease agreement for its grocery sales operations. Refer to Note 10 for the overall lease liability commitment.

 

Item 3. Legal Proceedings.

 

California Center for Environment Health Matters

 

On June 22, 2015, the Center for Environment Health, as plaintiff, filed suit against a number of defendants including the Company, its wholly-owned subsidiary, the Vape Store, Inc., Vaporin and another wholly-owned subsidiary, Vaporin Florida, Inc. The lawsuit was filed in the Superior Court of the State of California, County of Alameda. The suit seeks relief under California Proposition 65 which makes it unlawful for businesses to knowingly and intentionally expose individuals in California to chemicals known to cause birth defects or other harm without providing clear and reasonable warnings. All of the defendants are alleged to have sold products containing significant quantities of nicotine without warnings in violation of Proposition 65. The plaintiff sought a civil penalty against these defendants in the amount of $2,500 per day for each violation of Proposition 65, together with attorneys’ fees and costs. Discovery commenced in November 2015. On April 6, 2016, the Company and the plaintiff entered into a settlement agreement, which required the Company to (1) make a payment of $45,000 and (2) comply with enhanced product labeling requirements within a set implementation period as defined in the consent judgment.

 

On March 2, 2016, Hudson Bay Master Fund Ltd. (“HB”), filed an action against the Company in the Supreme Court of the State of New York, County of New York, captioned Hudson Bay Master Fund Ltd. versus Vapor Corp. (the Company’s former name), Index No. 651094/2016. This action alleged that the Company failed to timely effect exercises of its Series A Warrants delivered by the plaintiff and sought damages of $339,810. On May 10, 2016, solely to avoid the costs, risks and uncertainties inherent in litigation, the Company entered into a settlement agreement with respect to all claims included in the action by HB (the “HB Settlement”). The HB Settlement provided, among other things, that the parties entered into and filed a stipulation of discontinuance that provided for the dismissal of the action against the Company (the “HB Stipulation”). This action was dismissed with prejudice.

 

On June 2, 2016, four Series A Warrant holders, filed an action against the Company in the Supreme Court of the State of New York, County of New York, captioned Empery Asset Master, LTD, Empery Tax Efficient, LP, Empery Tax Efficient II, LP and Intracoastal Capital, LLC versus Vapor Corp. (the Company’s former name), Index No. 652950/2016. This action alleged that the Company failed to timely effect exercises of its Series A Warrants delivered by the plaintiffs and sought aggregate damages of approximately $603,000. Between June 17, 2016 and June 22, 2016, solely to avoid the costs, risks and uncertainties inherent in litigation, the Company entered into settlement agreements with respect to all claims included in the Complaints (the “Settlements”). The Settlements provide, among other things, that the parties would enter into and file a stipulation of discontinuance that provides for the dismissal of the Complaint (the “Stipulation”), and the holders would surrender the balance of their Series A Warrant upon receipt of settlement payments. These actions were dismissed with prejudice.

 

Item 4. Mine Safety Disclosures.

 

None.

 

PART II

 

Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.

 

Our common stock is currently listed on the OTC Pink marketplace under the symbol “HCMC” On January 25, 2016, the Units separated into Series A Convertible Preferred Stock and Series A Warrants and public trading of the Units ceased.

 

Change from NASDAQ to OTCQB to OTC Pink Sheets Stock Listing

 

On January 22, 2016, the Company received a letter from the Listing Qualifications Staff (the “Staff”) of The NASDAQ Stock Market LLC (“Nasdaq”) indicating that the Staff had determined to delist the Company’s securities based upon its concerns that the Company’s

 

  15

 

continued listing on Nasdaq, particularly pursuant to a grace period within which to regain compliance with the $1.00 bid price requirement set forth in Nasdaq Listing Rule 5450, is no longer in the public interest as that concept is described in Nasdaq Listing Rule 5110. Specifically, the Staff indicated that, given the potential for dilution of the Company’s stockholders that may be caused by the cashless exercise provision of the Company’s Series A warrants, the Staff believes that the grace period provided to the Company to regain compliance with the $1.00 bid price requirement is no longer warranted. Previously on September 14, 2015, the Staff had notified the Company that, based upon its non-compliance with the minimum $1.00 bid price requirement for the prior 30 consecutive business days, the Company – in accordance with the Nasdaq Listing Rules – had been provided a grace period, through March 14, 2016, to regain compliance with the minimum bid price requirement. On the afternoon of February 11, 2016, the Company was notified by Nasdaq that trading of the Company’s common stock would be halted.

 

On February 16, 2016, the Company notified the Staff of Nasdaq that it was withdrawing its request to the Nasdaq Listing Qualifications Panel (the “Panel”) for an appeal of the delisting determination made by the Staff on January 22, 2016. As a result, the Company’s shares of common stock were suspended from The Nasdaq Capital Market at the opening of business on Wednesday, February 17, 2016. Nasdaq filed a Form 25 Notification of Delisting with the Securities and Exchange Commission relating to the delisting of the Company’s common stock. The official delisting of the Company’s common stock became effective ten days thereafter. Upon the delisting from Nasdaq, the Company no longer met the “Equity Conditions” required to issue the Company’s common stock to fulfill a cashless exercise pursuant to Section 1(d) of its Series A Warrants. The Company began trading on the OTCQB Market at the opening of the markets on March 16, 2016 under its temporary symbol, VPCOD and thereby met the “Equity Conditions” required to issue the Company’s common stock to fulfill a cashless exercise pursuant to Section 1(d) of its Series A Warrants.

 

On October 31, 2016, the Company received notice from OTC Markets Group that the Company’s common stock would be moved from the OTCQB to the OTC Pink Sheets on November 1, 2016, as a result of the Company’s failure to cure its bid price deficiency. On November 1, 2016, the date of the delisting from OTCQB, the Company no longer meets the “Equity Conditions” required to allow the Company to elect to issue common stock to fulfill a cashless exercise pursuant to Section 1(d) of its Series A Warrants. Holders of the Series A Warrants may still undertake a cashless exercise of their warrants and agree to permit the Company to issue common stock to fulfill such exercise.

 

On July 7, 2015, the Company filed an amendment to its Certificate of Incorporation to effectuate a one-for-five reverse stock split to its Common Stock. On February 1, 2016, the Company’s stockholders approved an amendment to the Company’s Amended and Restated Certificate of Incorporation to (i) effect a reverse stock split of the Common Stock at a ratio between 1-for-10 and 1-for-70, such ratio to be determined by the Board, (ii) reduce the par value of the Common Stock from $0.001 to $0.0001 and (iii) increase the number of authorized shares of the Common Stock from 500,000,000 shares to 5,000,000,000 shares. Each share entitles the holder to one vote. On March 8, 2016, the Board effected a reverse stock split of the Common Stock at a ratio of 1-for-70. On March 21, 2016, the Company’s stockholders approved an amendment to the Company’s Amended and Restated Certificate of Incorporation to effect a reverse stock split of the Common Stock at a ratio between 1-for-10,000 and 1-for-20,000, such ratio to be determined by the Board. On June 1, 2016, the Board effected a reverse stock split of the Common Stock at a ratio of 1-for-20,000.

 

The following table contains, for the periods indicated, the intraday high and low sale prices per share of our common stock and Units. 1

 

    Common Stock 1     Units  
    High     Low     High     Low  
    $     $     $     $  
Fiscal 2015     0.02       0.0005       11.25       4.25  
First Quarter     0.02       0.0175       N/A       N/A  
Second Quarter     0.02       0.0056       N/A       N/A  
Third Quarter     0.01       0.0015       11.25       4.25  
Fourth Quarter     0.00       0.0005       10.48       7.25  
Fiscal 2016     1.00       .00005       N/A       N/A  
First Quarter     0.25       0.0071       N/A       N/A  
Second Quarter     1.00       0.00001       N/A       N/A  
Third Quarter     .00002       0.00001       N/A       N/A  
Fourth Quarter     .00001       0.00005       N/A       N/A  

 

1 The Company effected a 1-for-5 reverse stock split on December 27, 2013, a 1-for-5 reverse stock split on July 9, 2015, 1-for-70 reverse stock split on March 9, 2016 and a 1-for-20,000 reverse stock split on May 27, 2016. Common stock per share information gives effect to the aforementioned reverse splits of the Company’s common stock.

 

 

  16

 

As of March 20, 2017, there were approximately 1,496 stockholders of record for our common stock. A substantially greater number of stockholders may be “street name” or beneficial holders, whose shares are held of record by banks, brokers and other financial institutions.

 

As of March 20, 2017, the last reported sale price of our common stock on OTC Pink Marketplace was $0.0001 per share.

 

We have never declared or paid, and do not anticipate declaring or paying, any cash dividends on any of our capital stock. We currently intend to retain all available funds and any future earnings for use in the operation of our business and do not anticipate paying any dividends in the foreseeable future. Future determination as to the declaration and payment of dividends, if any, will be at the discretion of our Board and will depend on then existing conditions, including our operating results, financial conditions, contractual restrictions, capital requirements, business prospects and other factors our Board may deem relevant.

 

Tender Offer for the Repurchase of Outstanding Series A Warrants

 

On December 7, 2016, the Company commenced a tender offer to repurchase its outstanding Series A Warrants, which offer expired on January 17, 2017 with a total of 10,073,884 Series A Warrants being tendered at a cost of $2,216,255 to the Company.

 

Other Repurchases of Outstanding Series A Warrants

 

Other repurchases of Series A Warrants during 2016 are set forth in the table below.

 

Period   Total Number of
Series A Warrants
Purchased 		    Average Price Paid
per Series A
Warrant 		    Total Number of
Series A Warrants
Purchased as Part
of Publicly
Announced Plans or
Programs 		    Maximum Number
(or Approximate
Dollar Value) of
Series A Warrants
that May Yet Be
Purchased Under
the Plans or
Programs 		 
April 1, 2016 – June 30, 2016     3,706,793.000       0.39       0       -  
July 1, 2016 – September 30, 2016     1,817,501.000       0.25       0       -  

 

Item 6. Selected Financial Data.

 

Not required for smaller reporting companies.

 

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

 

You should read the following discussion in conjunction with our audited historical consolidated financial statements, which are included elsewhere in this report. Management’s Discussion and Analysis of Financial Condition and Results of Operations contains forward-looking statements that reflect our plans, estimates, and beliefs. Our actual results could differ materially from those discussed in the forward-looking statements.

 

Cautionary Note Regarding Forward Looking Statements

 

This report includes forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. All statements other than statements of historical facts contained in this report, including statements regarding our future financial position, liquidity, business strategy, plans and objectives of management for future operations, are forward-looking statements.

 

Forward-looking statements contained in this report include:

 

● Our liquidity;

 

● Increase demand for vaporizers and related products;

 

  17

 

● Opportunities for our business; and

 

● Growth of our business.

 

The words “believe,” “may,” “estimate,” “continue,” “anticipate,” “intend,” “should,” “plan,” “could,” “target,” “potential,” “is likely,” “expect,” and similar expressions, as they relate to us, are intended to identify forward-looking statements.  We have based these forward-looking statements largely on our current expectations and projections about future events and financial trends that we believe may affect our financial condition, results of operations, business strategy and financial needs.  

 

The results anticipated by any or all of these forward-looking statements might not occur.  Important factors, uncertainties and risks that may cause actual results to differ materially from these forward-looking statements are contained in the Risk Factors contained herein.  We undertake no obligation to publicly update any forward-looking statement, whether as a result of new information, future developments or otherwise.  For more information regarding some of the ongoing risks and uncertainties of our business, see the Risk Factors below.

 

Company Overview

 

Healthier Choices Management Corp. (the “Company”) is a holding company focused on providing consumers with healthier daily choices with respect to nutrition and other lifestyle alternatives. The Company operates thirteen vape retail stores in the Southeast region of the United States of America. The Company offers e-liquids vaporizers and related products through its vape retail stores. The Company sold its wholesale business on July 31, 2016. The sale of the wholesale business was not contemplated prior to July 1, 2016. The sale of the wholesale business qualifies as a discontinued operation and accordingly the Company has excluded results for the wholesale business operations from the Company’s continuing operations in the audited consolidating Statements of Operations for all periods presented.

 

On June 1, 2016, the Company acquired the business assets of Ada’s Whole Food Market LLC, a natural and organic grocery store, through its wholly owned subsidiary Healthy Choice Markets, Inc. The grocery store has been a leader in the natural grocery market in the Fort Myers, Florida for the past 40 years, offering fresh, natural and organic products and specializing in facilitating a healthy, well balanced lifestyle. In addition to a comprehensive selection of vitamins and health & beauty products, the grocery store provides a fresh café and an organic juice bar.

 

Factors Affecting Our Performance

 

We believe the following factors affect our performance:

 

Retail : We believe the operating performance of our retail stores will affect our revenue and financial performance. The Company has a total of thirteen retail vape stores which are located in Florida, Georgia and Alabama. The Company has ceased plans to increase the number of retail vape stores due to adverse industry trends and increasing federal and state regulations that, if implemented, may negatively impact future retail revenues.

 

Inventory Management : Our revenue trends are affected by an evolving product acceptance and consumer demand. We are creating and offering new products to our retail customers. Evolving product development and technology impacts our licensing and intellectual properties spending. We expect the transition to vaporizer and advanced technology and enhanced performance products to continue and will impact our operating results in the future.

 

Increased Competition : The Launch by national competitors of branded vaporizer and e-cigarette products have made it more difficult to compete on prices and to secure business. We expect increased vaporizer product supply and downward pressure on prices to continue and impact our operating results in the future. We market and sell the similar vaporizers and e-liquids as our competitors and we sell our products at substantially similar prices as our competitors; accordingly, the key competitive factors for our success is maintain the quality of service we offer our customers and effective marketing efforts.

 

  18

 

Results of Operations

 

The following table sets forth our Consolidated Statements of Operations for the years ended December 31, 2016 and 2015 that is used in the following discussions of our results of operations:

 

    For the Year Ended
December 31, 		       
    2016     2015     2016 to 2015
Change $ 		 
SALES:                        
Vapor sales, net   $ 6,722,052     $ 5,252,611     $ 1,469,441  
Grocery sales, net     3,843,111       -       3,843,111  
Total Sales     10,565,163       5,252,611       5,312,552  
Cost of sales vapor     2,979,609       2,172,447       807,162  
Cost of sales grocery     2,352,201       -       2,352,201  
GROSS PROFIT     5,233,353       3,080,164       2,153,189  
                         
EXPENSES:                        
Advertising     92,124       120,831       (28,707 )
Selling, general and administrative     9,700,479       9,374,349       326,130  
Impairment of goodwill and intangible assets     3,955,362       15,403,833       (11,448,471 )
Retail store and kiosk closing costs     347,656       729,468       (381,812 )
Total operating expenses     14,095,621       25,628,481       (11,532,860 )
Operating loss     (8,862,268 )     (22,548,317 )     13,686,049  
                         
OTHER INCOME (EXPENSES):                        
Amortization of debt discounts     21,599       (833,035 )     854,634  
Amortization of deferred financing costs     -       (144,903 )     144,903  
Gain on warrant repurchases     5,189,484       -       5,189,484  
Loss on debt extinguishment     -       (1,497,169 )     1,497,169  
Cost associated with underwriting offering     -       (5,279,003 )     5,279,003  
Non-cash change in fair value of derivative liabilities     15,255,143     42,221,418       (26,966,275 )
Stock-based expense in connection with waiver agreements     -       (3,748,062 )     3,748,062  
Other Income     640,000       -       640,000  
Interest income     45,723       19,323       26,400  
Interest expense     (15,386 )     (108,356 )     92,970  
Interest expense-related party     -       (80,545 )     80,545  
Total other income (expense)     21,136,563     30,549,668       (9,413,105 )
Net income (loss) from continuing operations     12,274,295     8,001,351       4,272,944
Net income (loss) from discontinued operations     (1,589,803 )     (6,200,598 )     4,610,795  
NET INCOME (LOSS)     10,684,492     1,800,753       8,883,739
                         
Deemed dividend     -       (38,068,021 )     38,068,021  
                         
NET INCOME (LOSS) ALLOCABLE TO COMMON SHAREHOLDERS   $ 10,684,492   $ (36,267,268 )   $ 46,951,760  

 

Net vapor sales increased $1,469,441 to $6,722,052 for the twelve months ended December 31, 2016 as compared to $5,252,611 for the same period in 2015. The increase in sales is primarily due to the increased number of stores open during 2016 of twenty, compared to eight retail stores acquired by us in connection with our acquisition of Vaporin in March of 2015. Sales for five Florida and two Georgia retail stores were not sufficient to recover operating costs and the decision was made to close these seven stores by December 31, 2016.

 

Net grocery store sales were $3,843,111 with the June 1, 2016 acquisition of Ada’s Natural Market and represents seven months of sales.

 

Vapor cost of goods sold for the twelve months ended December 31, 2016 and 2015 were $2,979,609 and $2,172,447, respectively an increase of $807,162. The increase is due to increased sales from our retail stores and an increase in write down of slow moving and obsolete inventory for the twelve months ended December 31, 2016 and 2015. Charges to cost of goods sold were recorded for approximately $301,898 and $0, respectively, for obsolete and slow moving wholesale inventories for the twelve months ended

 

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December 31, 2016 and 2015. Gross profit from retail stores increased by $662,279 to $3,742,443 for the twelve months ended December 31, 2016 as compared to $3,080,164 for the twelve months ended December 31, 2015.

 

Grocery store cost of goods sold increased $2,352,201 with the June 1, 2016 acquisition of Ada’s Natural Market and represents seven months cost of goods sold. Gross profit from the grocery store was $1,490,910 for the seven months ended December 31, 2016.

 

Total operating expenses decreased $11,532,860 to $14,095,621 for the twelve months ended December 31, 2016 compared to $25,628,481 for the same period in 2015. The decrease is primarily attributable to a decrease of approximately $11,448,471 for impairment of goodwill in 2015, a decrease in professional fees of $682,760, a decrease in postage and delivery of $93,727 and depreciation expense of $87,714. These decreases were offset by increases in payroll and employee related cost of $1,665,588. Payroll and employee related costs were approximately $4,697,463 and $3,031,875 respectively, for the twelve months ended December 31, 2016 and 2015. The increase is due to the addition of headcount for the retail store and Ada’s Natural Market employees, offset by reductions in headcount of management employees. Advertising expense decreased $28,707 to approximately $92,124 for the twelve months ended December 31, 2016 compared to $120,831 for the twelve months ended December 31, 2015. The decrease was due to our reduction in internet advertising, television direct marketing campaigns and participation in trade shows, offset by advertising expense of $67,823 for the grocery store.

 

During the twelve months ended December 31, 2016, the Company closed seven retail vape stores. In connection with the retail store closings, the Company incurred approximately $103,312 of losses on disposal of computer equipment, fixtures, and furniture, and $181,153 of exit costs for non-cancellable leases and $58,227 of other exit costs for the twelve months ended December 31, 2016. During the twelve months ended December 31, 2015, the Company closed seven retail vape kiosks located in malls. In connection with the retail kiosk closings, the Company incurred approximately $463,840 of losses on disposal of computer equipment, fixtures, and furniture, and $265,627 of exit costs for non-cancellable leases for the twelve months ended December 31, 2015.

 

The Company concluded that goodwill was impaired and recorded an impairment charges of $3,955,362 for the twelve months ended December 31, 2016. The Company determined its intangible assets in connection with the merger with Vaporin that its carrying value exceeded the potential cash flow from their disposition. The Company recorded an impairment charge of $15,403,833 for the twelve months ended December 31, 2015.

 

Net other income (expense) of $21,136,563 for the twelve months ended December 31, 2016 included a $15,255,143 non-cash net income from the change in the fair value of the derivatives and $5,189,484 gain on debt extinguishment recorded in connection with the repurchase of Series A Warrants. Net other income of $30,549,668 for the twelve months ended December 31, 2015 includes a $42,221,418 non-cash gain from the change in the fair value of derivatives, $5,279,003 of costs associated with the underwriting of our July 29, 2015 public offering, stock-based expense of $3,748,062 incurred in connection with the Waiver agreement, $977,938 of amortization of deferred debt discounts and financing costs, and $1,497,169 of loss on debt extinguishment, interest expense of $188,901 offset by $19,323 of interest income.

 

A non-cash deemed dividend of $38,068,021 was recognized in connection with the public offering of the Units in July 2015.

 

Liquidity and Capital Resources

 

    For the year ended
December 31, 		 
    2016     2015  
             
Net cash used in operating activities   $ (7,315,987 )   $ (9,506,567 )
Net cash used in investing activities     (3,187,516 )     (790,473 )
Net cash provided by (used in) financing activities     (3,345,216 )     37,040,837  
    $ (13,848,719 )   $ 26,743,797  

 

Our net cash used in continuing operating activities of $3,576,816 for the twelve months ended December 31, 2016 resulted from our net income from continuing operations of $12,274,295, a net cash usage of $846,858 from changes in operating assets and liabilities offset by non-cash adjustments of $15,004,253. Our net cash used in discontinued operations of $3,739,171 for the twelve months ended December 31, 2016 resulted from our net loss from discontinued operations of $1,589,803 a net cash usage of $2,466,269 from changes in assets and liabilities from discontinued operations offset by non-cash adjustments of $316,901. 

 

  20

 

The net cash used in investing activities of $3,187,516 for the twelve months ended December 31, 2016 resulted from the acquisition of grocery store business assets for $2,910,612 and purchases of $25,299 of property and equipment, proceeds of $100,000 from the sale of tradename, offset by a $500,000 issuance of a note receivable less $173,395 of collection. The net cash used in investing activities of $790,473 for the year ended December 31, 2015 is due to the acquisition of our retail stores of $1,179,270, purchases of property and equipment of $194,766 and $20,000 of tradenames, offset by the collection of a $467,095 loan receivable and $136,468 of cash received in connection with the Merger with Vaporin. The net cash provided by financing activities of $37,040,837 for the year ended December 31, 2015 is due to proceeds of $41,378,227 from the July 29, 2015 public offering of Units net of $3,726,585 of associated cost, net proceeds of $2,941,960 from a private place of common stock and warrants less $196,250 of offering costs, net proceeds of $1,662,500 from the issuance of convertible debenture, and $350,000 of loan proceeds from Vaporin offset by the debt repayments of $1,750,000 of convertible debentures, and $1,250,000 of senior notes payables to related parties. $1,000,000 of notes payable to related party, $567,000 of convertible notes payable, $750,000 of a term loan payable, and $52,015 of a capital lease obligation.

 

The net cash used in financing activities of $3,345,216 for the twelve months ended December 31, 2016 is due to repurchases of Series A warrants totaling $3,278,827 and payment of $66,389 of capital lease obligation.

 

At December 31, 2016 and December 31, 2015, we do not have any material financial guarantees or other contractual commitments with these vendors that are reasonably likely to have an adverse effect on liquidity.

 

Our cash balances are kept liquid to support our growing acquisition and infrastructure needs for operational expansion. The majority of our cash and cash equivalents are concentrated in one large financial institution. The following table presents the Company's cash position as of December 31, 2016 and December 31, 2015.

 

    December 31, 2016     December 31, 2015  
             
Cash   $ 13,366,272     $ 27,214,991  
Total assets   $ 17,234,751     $ 34,247,862  
Percentage of total assets     77.6 %     79.5 %

  

The Company reported net income allocable to common stockholders of approximately $10.7 million for the year ended December 31, 2016. The Company had a deficit in working capital of approximately $0.5 million as of December 31, 2016, As of March 20, 2017, the Company had approximately $10 million of cash. The decrease in cash from December 31, 2016 is primarily attributable to payment of settlements and related legal fees.

 

Critical Accounting Policies and Estimates

 

Use of Estimates in the Preparation of Financial Statements

 

To understand our financial statements, it is important to understand our critical accounting estimates. The preparation of our financial statements in conformity with generally accepted accounting principles in the United States (“GAAP”) requires us 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. These estimates and assumptions include allowances, reserves and write-downs of receivables and inventory, valuing equity securities and hybrid instruments, share-based payment arrangements, deferred taxes and related valuation allowances, and the valuation of the net assets acquired in the Merger and retail store acquisitions. Some of these judgments can be subjective and complex, and, consequently, actual results may differ from these estimates. Actual results may differ significantly from our estimates. Our estimates often are based on complex judgments, probabilities and assumptions that we believe to be reasonable but that are inherently uncertain and unpredictable. For any given individual estimate or assumption made by us, there may also be other estimates or assumptions that are reasonable.

 

We consider an accounting estimate to be critical if: (1) the accounting estimate requires us to make assumptions about matters that were highly uncertain at the time the accounting estimate was made, and (2) changes in the estimate that are reasonably likely to occur from period to period, or use of different estimates that we reasonably could have used in the current period, would have a material impact on our financial condition results of operations or cash flows.

 

Revenue Recognition

 

The Company recognizes revenue from product sales or services rendered when the following four revenue recognition criteria are met: persuasive evidence of an arrangement exists, delivery has occurred or services have been rendered, the selling price is fixed or determinable, and collectability is reasonably assured.

 

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Product sales and shipping revenues, net of promotional discounts, rebates, and return allowances, are recorded when the products are shipped, title passes to customers and collection is reasonably assured. Retail sales to customers are made pursuant to a sales contract that provides for transfer of both title and risk of loss upon the Company’s delivery to the carrier. Return allowances, which reduce product revenue, are estimated using historical experience. Revenue from product sales and services rendered is recorded net of sales and consumption taxes.

 

The Company periodically provides incentive offers to its customers to encourage purchases. Such offers include current discount offers, such as percentage discounts off current purchases, inducement offers, such as offers for future discounts subject to a minimum current purchase, and other similar offers. Current discount offers, when accepted by the Company’s customers, are treated as a reduction to the purchase price of the related transaction, while inducement offers, when accepted by its customers, are treated as a reduction to the purchase price of the related transaction based on estimated future redemption rates. Redemption rates are estimated using the Company’s historical experience for similar inducement offers. The Company reports sales, net of current discount offers and inducement offers on its consolidated statements of operations.

 

Identifiable Intangible Assets and Goodwill

 

Identifiable intangible assets are recorded at cost, or when acquired as part of a business acquisition, at estimated fair value. Certain identifiable intangible assets are amortized over 5 and 10 years. Similar to tangible personal property and equipment, the Company periodically evaluates identifiable intangible assets for impairment whenever events or changes in circumstances indicate that the carrying amount may not be recoverable.

 

Indefinite-lived intangible assets, such as goodwill are not amortized. The Company assesses the carrying amounts of goodwill for recoverability on at least an annual basis or when events or changes in circumstances indicate evidence of potential impairment exists, using a fair value based test. Application of the goodwill impairment test requires significant judgments including estimation of future cash flows, which is dependent on internal forecasts, estimation of the long-term rate of growth for the businesses, and the useful life over which cash flows will occur. Changes in these estimates and assumptions could materially affect the determination of fair value and/or conclusions on goodwill impairment for the Company.

 

Impairment of Long-Lived Assets

 

The Company reviews long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying value of the asset may not be recoverable. In connection with this review, the Company also reevaluates the depreciable lives for these assets. The Company assesses recoverability by determining whether the net book value of the related asset will be recovered through the projected undiscounted future cash flows of the asset. If the Company determines that the carrying value of the asset may not be recoverable, it measures any impairment based on the projected future discounted cash flows as compared to the asset’s carrying value.

 

Derivative Instruments

 

The Company accounts for free-standing derivative instruments and hybrid instruments that contain embedded derivative features in accordance with Accounting Standards Codification (“ASC”) ASC Topic No. 815, “Derivative Instruments and Hedging Activities,” (“ASC 815”) as well as related interpretations of this topic. In accordance with this topic, derivative instruments and hybrid instruments are recognized as either assets or liabilities in the balance sheet and are measured at fair values with gains or losses recognized in earnings. Embedded derivatives that are not clearly and closely related to the host contract are bifurcated and are recognized at fair value with changes in fair value recognized as either a gain or loss in earnings. The Company determines the fair value of derivative instruments and hybrid instruments based on available market data using appropriate valuation models, giving consideration to all of the rights and obligations of each instrument.

 

The Company estimates the fair values of derivative instruments and hybrid instruments using various techniques (and combinations thereof) that are considered to be consistent with the objective of measuring fair values. In selecting the appropriate technique, the Company considers, among other factors, the nature of the instrument, the market risks that it embodies and the expected means of settlement. For complex instruments, we utilize custom Monte Carlo simulation models. For less complex instruments, such as free-standing warrants, the Company generally uses the Binomial Lattice model, adjusted for the effect of dilution, because it embodies all of the requisite assumptions (including trading volatility, estimated terms, dilution and risk free rates) necessary to fair value these instruments. Estimating fair values of derivative financial instruments requires the development of significant and subjective estimates that may, and are likely to, change over the duration of the instrument with related changes in internal and external market factors. In addition, option-based techniques (such as the Binomial Lattice model or the Black-Scholes-Merton valuation model) are highly volatile and sensitive to changes in the trading market price of the Company’s common stock. Since derivative financial instruments are initially and subsequently carried at fair values, the Company’s net income (loss) going forward will reflect the volatility in these estimates and assumption changes. Under ASC 815, increases in the trading price of the Company’s common stock and increases in fair value during

 

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a given financial quarter result in the application of non-cash derivative expense. Conversely, decreases in the trading price of the Company’s common stock and decreases in trading fair value during a given financial quarter result in the application of non-cash derivative income.

 

Convertible Debt Instruments

 

The Company accounts for convertible debt instruments when the Company has determined that the embedded conversion options should be bifurcated from their host instruments in accordance with ASC 815. The Company records discounts to convertible notes for the fair value of bifurcated embedded conversion options embedded in debt instruments and the relative fair value of freestanding warrants issued in connection with convertible debt instruments. The Company amortizes the respective debt discount over the term of the notes, using the straight-line method, which approximates the effective interest method over a short-term period.

 

Stock-Based Compensation

 

The Company accounts for stock-based compensation for employees and directors under ASC Topic No. 718, “Compensation-Stock Compensation” (“ASC 718”). These standards define a fair value based method of accounting for stock-based compensation. In accordance with ASC 718, the cost of stock-based compensation is measured at the grant date based on the value of the award and is recognized over the vesting period. The value of the stock-based award is determined using an appropriate valuation model, whereby compensation cost is the fair value of the award as determined by the valuation model at the grant date. The resulting amount is charged to expenses on the straight-line basis over the period in which the Company expects to receive the benefit, which is generally the vesting period. The Company considers many factors when estimating expected forfeitures, including types of awards, employee class, and historical experience. Stock-based compensation for non-employees is measured at the grant date, is re-measured at subsequent vesting dates and reporting dates, and is amortized over the service period.

 

Preferred Stock

 

The Company applies the accounting standards for distinguishing liabilities from equity when determining the classification and measurement of its preferred stock. Shares that are subject to mandatory redemption (if any) are classified as liability instruments and are measured at fair value. The Company classifies conditionally redeemable preferred shares, which include preferred shares that feature redemption rights that are either within the control of the holder or subject to redemption upon the occurrence of uncertain events not solely within the Company’s control, as temporary equity. At all other times, preferred shares are classified as stockholders’ equity.

 

Impact of Recent Accounting Pronouncements

 

Please refer to Note 2 to the Company’s consolidated financial statements for a discussion of recently issued accounting pronouncements.

 

Off-Balance Sheet Arrangements

 

We do not have any off-balance sheet arrangements.

 

Seasonality

 

We do not consider our business to be seasonal.

 

Non-GAAP – Financial Measure

 

The following discussion and analysis includes both financial measures in accordance with GAAP, as well as a non-GAAP financial measure. Generally, a non-GAAP financial measure is a numerical measure of a company’s performance, financial position or cash flows that either excludes or includes amounts that are not normally included or excluded in the most directly comparable measure calculated and presented in accordance with GAAP. Non-GAAP financial measures should be viewed as supplemental to, and should not be considered as alternative to, net income, operating income, and cash flow from operating activities, liquidity or any other financial measures. Non-GAAP financial measures may not be indicative of the historical operating results of the Company nor are they intended to be predictive of potential future financial results. Investors should not consider non-GAAP financial measures in isolation or as substitutes for performance measures calculated in accordance with GAAP.

 

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We believe that the Company’s management and stockholders benefit from referring to the Adjusted EBITDA in planning, forecasting, and analyzing future periods. Our management uses this non-GAAP financial measure in evaluating its financial and operational decision making and as a means of evaluating period to period comparison.

 

We define Adjusted EBITDA as net loss allocable to common stockholders before interest expense, income taxes, depreciation and amortization, stock-based compensation, non-cash change in fair value of derivatives, non-recurring acquisition costs, offering restructuring, or other non-recurring settlements or expenses, loss on debt extinguishment, loss on sale or abandonment of assets, and impairment charges against goodwill, intangible and long lived assets, if any. The Company’s management believes Adjusted EBITDA is an important measure of our operating performance because it allows management, investor and analysts to evaluate and assess our core operating results from period to period after removing the impact of acquisition and offering related costs, debt extinguishment, and other items of a non-operating nature that effect comparability. Our management recognizes that Adjusted EBITDA has inherent limitations because of the excluded items.

 

We have included a reconciliation of our non-GAAP financial measure to the most comparable financial measure calculated in accordance with GAAP. We believe that providing the non-GAAP financial measure, together with the reconciliation to GAAP, helps investors make comparisons between the Company and other companies. In making any comparisons to other companies, investors need to be aware that companies use different non-GAAP measures to evaluate their financial performance. Investors should pay close attention to specific definition being used and to the reconciliation between such measures and the corresponding GAAP measure provided by each company under applicable rules of the Securities Exchange Commission (“SEC”). The following table presents a reconciliation of Adjusted EBITDA to loss from operations allocable to common stockholders, a GAAP financial measure:

 

    2016     2015  
             
Reconciliation of Adjusted EBITDA to net loss allocable to common stockholders:                
NET INCOME (LOSS) ALLOCABLE TO COMMON STOCKHOLDERS   $ 10,684,492   $ (36,267,268 )
Interest     15,386       188,901  
Income tax expense     -       -  
Acquisition holdback     (640,000 )     -  
Depreciation and amortization     374,388       462,102  
Costs associated with underwritten offering     -       5,279,003  
Deemed dividend     -       38,068,021  
Non-cash change in fair value of derivatives     (15,255,143 )     (42,221,418 )
Stock-based expense in connection with waiver agreements     -       3,748,062  
Loss on debt extinguishment     -       1,497,169  
Amortization of debt discounts and deferred financing costs     (21,599 )     977,938  
Gain on warrant repurchases     (5,189,484 )     0  
Stock-based compensation expense     75,430       582,356  
Impairment of goodwill and intangible assets     3,955,362       15,403,833  
Non-recurring legal settlements     -       1,700,000  
Retail kiosk closing costs     347,656       729,467  
Adjusted EBITDA   $ (5,653,512 )   $ (9,851,834 )

 

RISK FACTORS

 

Investing in our common stock involves a high degree of risk.  You should carefully consider the following Risk Factors before deciding whether to invest in the Company.  Additional risks and uncertainties not presently known to us, or that we currently deem immaterial, may also impair our business operations or our financial condition.  If any of the events discussed in the Risk Factors below occur, our business, consolidated financial condition, results of operations or prospects could be materially and adversely affected.  In such case, the value and marketability of the common stock could decline.

 

Risks Relating to Our Vaporizer Business

 

We have incurred significant operating losses in the past and cannot assure you that we will achieve and/or maintain profitable operations or liquidity.

 

The Company reported net income allocable to common stockholders of approximately $10.7 million and net loss of $36.3 million for the years ended December 31, 2016 and 2015. The Company had working capital of approximately of $11.2 million as of December 31, 2016.

 

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Our operating losses are primarily due to, among other reasons, consumer shift from e-cigarettes to vaporizers which caused a significant decline in our business, increasing competition, and the establishment of our business infrastructure and operations.

 

The Company could be adversely affected if consumers lose confidence in the safety and quality of the food supply chain.  Adverse publicity about these types of concerns, whether or not valid, could discourage consumers from buying our products.  The real or perceived sale of contaminated food products by us could result in a loss of consumer confidence and product liability claims, which could have a material adverse effect on our sales and operations

 

Inflation and deflation in the prices of food and other products we sell may affect our sales, gross profit and gross margin. The short-term impact of inflation and deflation is largely dependent on whether or not the effects are passed through to our customers, which is subject to competitive market conditions. Food inflation and deflation is affected by a variety of factors and our determination of whether to pass on the effects of inflation or deflation to our customers is made in conjunction with our overall pricing and marketing strategies. Although we may experience periodic effects on sales, gross profit and gross margins as a result of changing prices, the effect of inflation could have an adverse impact on our future revenues.

 

The Company’s liquidity and capital resources have decreased significantly as a result of the net operating losses. We cannot assure you that we will be able to generate operating profits in the future on a sustainable basis or at all as we continue to expand our infrastructure, further develop our marketing efforts and otherwise implement our growth initiatives. Future working capital limitations could impinge on our day-to-day operations, thus contributing to continued operating losses.

 

If the FDA passed regulations to extend its authority to e-vapor products, including e-cigarettes, vaporizers and e-liquids, necessitating stringent and costly product review requirements, such regulations could curtail or prevent our ability to sell e-vapor products and significantly reduce the number of e-vapor products available for sale to the public.

 

It is anticipated that the FDA’s prospective regulation of e-vapor products, including requiring costly formal product approvals, limiting the manufacture and distribution of e-vapor products will impact availability. Any such regulations and approval process would make product development and manufacture cost prohibitive for the Company.  A reduction in available e-vapor products would diminish the need for our dedicated retail stores.

 

The recent development of electronic cigarettes has not allowed the medical profession to study the long-term health effects of electronic cigarette use.

 

Because electronic cigarettes were recently developed the medical profession has not had a sufficient period of time to study the long-term health effects of electronic cigarette use. Currently, therefore, there is no way of knowing whether or not electronic cigarettes are safe for their intended use. If the medical profession were to determine conclusively that electronic cigarette usage poses long-term health risks, electronic cigarette usage could decline, which could have a material adverse effect on our business, results of operations and financial condition.

 

Our business, results of operations and financial condition could be adversely affected if our products are taxed like other tobacco products.

 

Presently the sale of electronic cigarettes is not subject to federal, state and local excise taxes like the sale of conventional cigarettes or other tobacco products, all of which have faced significant increases in the amount of taxes collected on their sales. Should federal, state and local governments and or other taxing authorities impose excise taxes similar to those levied against conventional cigarettes and tobacco products on our products, it may have a material adverse effect on the demand for our products, as consumers may be unwilling to pay the increased costs for our products.

 

The market for vaporizers is a niche market, subject to a great deal of uncertainty and is still evolving.

 

Vaporizers and electronic cigarettes, having recently been introduced to market, are at an early stage of development, represent a niche market and are evolving rapidly and are characterized by an increasing number of market entrants. Our future sales and any future profits are substantially dependent upon the widespread acceptance and use of electronic cigarettes. Rapid growth in the use of, and interest in, electronic cigarettes is recent, and may not continue on a lasting basis. The demand and market acceptance for these products is subject to a high level of uncertainty. Therefore, we are subject to all of the business risks associated with a new enterprise in a niche market, including risks of unforeseen capital requirements, failure of widespread market acceptance of electronic cigarettes, in general or, specifically our products, failure to establish business relationships and competitive disadvantages as against larger and more established competitors.

 

  25

 

Because we face intense competition from big tobacco companies and other competitors, our failure to compete effectively could have a material adverse effect on our business, results of operations and financial condition.

 

Competition in the electronic cigarette industry is intense. The nature of our competitors is varied as the market is highly fragmented and the barriers to entry into the business are low.

 

We compete primarily on the basis of product quality, brand recognition, brand loyalty, service, marketing, advertising and price. We are subject to highly competitive conditions in all aspects of our business. The competitive environment and our competitive position can be significantly influenced by weak economic conditions, erosion of consumer confidence, competitors’ introduction of low-priced products or innovative products, cigarette excise taxes, higher absolute prices and larger gaps between price categories, and product regulation that diminishes the ability to differentiate tobacco products.

 

Our principal competitors are “big tobacco”, U.S. cigarette manufacturers of both conventional tobacco cigarettes and electronic cigarettes like Altria Group, Inc., Lorillard, Inc. and Reynolds American Inc. We compete against “big tobacco” which offers not only conventional tobacco cigarettes and electronic cigarettes but also smokeless tobacco products such as “snus” (a form of moist ground smokeless tobacco that is usually sold in sachet form that resembles small tea bags), chewing tobacco and snuff. Furthermore, we believe that “big tobacco” will devote more attention and resources to developing and offering electronic cigarettes (including vaporizers) as the market grows. Because of their well-established sales and distribution channels, marketing expertise and significant financial and marketing resources, “big tobacco” is better positioned than small competitors like us to capture a larger share of the electronic cigarette market. We also compete against numerous other smaller manufacturers or importers of cigarettes. There can be no assurance that we will be able to compete successfully against any of our competitors, some of whom have far greater resources, capital, experience, market penetration, sales and distribution channels than us. If our major competitors were, for example, to significantly increase the level of price discounts offered to consumers, we could respond by offering price discounts, which could have a materially adverse effect on our business, results of operations and financial condition.

 

Sales of conventional tobacco cigarettes have been declining, which could have a material adverse effect on our business.

 

The overall U.S. market for conventional tobacco cigarettes has generally been declining in terms of volume of sales, as a result of restrictions on advertising and promotions, funding of smoking prevention campaigns, increases in regulation and excise taxes, a decline in the social acceptability of smoking, and other factors, and such sales are expected to continue to decline. In September 2014, CVS, a leading national drug store chain ceased selling tobacco products. If other national drug store chains also decide to cease selling tobacco products, cigarette sales could decline further. While the sales of vaporizers have been increasing over the last several years, the vaporizer and electronic cigarettes market is only developing and is a fraction of the size of the conventional tobacco cigarette market. A continual decline in cigarette sales may adversely affect the growth of the vaporizer and electronic cigarette market, which could have a material adverse effect on our business, results of operations and financial condition.

 

If we are subject to intellectual property litigation, we may incur substantial additional costs which will adversely affect our results of operations.

 

The cost to prosecute infringements of our intellectual property or the cost to defend our products against patent infringement or other intellectual property litigation by others could be substantial. We cannot assure you that:

 

· pending and future patent applications will result in issued patents;

 

· patents we own or which are licensed by us will not be challenged by competitors;

 

· the patents will be found to be valid or sufficiently broad to protect our technology or provide us with a competitive advantage; and

 

· we will be successful in defending against patent infringement claims asserted against our products.

 

Both the patent application process and the process of managing patent disputes can be time consuming and expensive. In addition, changes in the U.S. patent laws could prevent or limit us from filing patent applications or patent claims to protect our products and/or technologies or limit the exclusivity periods that are available to patent holders. In September 2011, the Leahy-Smith America Invents Act, or the Leahy-Smith Act, was signed into law and includes a number of significant changes to U.S. patent law, including the transition from a “first-to-invent” system to a “first-to-file” system and changes to the way issued patents are challenged. These changes may favor larger and more established companies that have more resources than we do to devote to patent application filing and prosecution. The U.S. Patent and Trademark Office issued new regulations effective March 16, 2013 to administer the Leahy-Smith Act. Accordingly, it

 

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is not clear what, if any, impact the Leahy-Smith Act will ultimately have on the cost of prosecuting our patent applications, our ability to obtain patents based on our discoveries and our ability to enforce or defend our issued patents. However, it is possible that in order to adequately protect our patents under the “first-to-file” system, we will have to allocate significant additional resources to the establishment and maintenance of a new patent application process designed to be more streamlined and competitive in the context of the new “first-to-file” system, which would divert valuable resources from other areas of our business. In addition to pursuing patents on our technology, we have taken steps to protect our intellectual property and proprietary technology by entering into confidentiality agreements and intellectual property assignment agreements with our employees, consultants, and corporate partners. Such agreements may not be enforceable or may not provide meaningful protection for our trade secrets or other proprietary information in the event of unauthorized use or disclosure or other breaches of the agreements, and we may not be able to prevent such unauthorized disclosure. Monitoring unauthorized disclosure is difficult, and we do not know whether the steps we have taken to prevent such disclosure are, or will be, adequate.

 

If a third-party asserts that we are infringing on its intellectual property, whether successful or not, it could subject us to costly and time-consuming litigation or require us to obtain expensive licenses, and our business may be adversely affected.

 

The vaporizer and electronic cigarette industry is nascent and third parties may claim patent rights over one or more types of vaporizers and electronic cigarettes. For example, Fontem Ventures B.V. (“Fontem”), previously made certain public claims as to their ownership of patents relating to our products and has filed a number of separate lawsuits against us. In December 2015, the Company entered into a confidential Settlement Agreement and a non-exclusive royalty-bearing Global License Agreement with Fontem Ventures B.V. (“Fontem”) resulting in the dismissal of all of the patent infringement cases by Fontem against the Company. On January 15, 2016, the Company made a payment of $1.7 million under the terms of the Settlement and License Agreement. In connection with the License Agreement, Fontem granted the Company a non-exclusive license to certain of its products. As consideration, the Company will make quarterly license and royalty payments to Fontem based on the sale of qualifying products as defined in the confidential License Agreement. The term of the License Agreement will continue until all of the patents on the products subject to the agreement are no longer enforceable.  For a description of these lawsuits against us, please see the section titled “ Legal Proceedings ” contained herein. Third party lawsuits alleging our infringement of patents, trade secrets or other intellectual property rights could cause us to do one or more of the following:

 

· stop selling products or using technology that contains the allegedly infringing intellectual property;

 

· incur significant legal expenses;

 

· cause our management to divert substantial time to our defenses;

 

· pay substantial damages to the party whose intellectual property rights we may be found to be infringing;

 

· indemnify distributors and customers;

 

· redesign those products that contain the allegedly infringing intellectual property; or

 

· attempt to obtain a license to the relevant intellectual property from third parties, which may not be available to us on reasonable terms or at all.

 

Third party lawsuits alleging our infringement of patents, trade secrets or other intellectual property rights could have a material adverse effect on our business, results of operations and financial condition.

 

If we cannot protect our intellectual property rights, we may be unable to compete with competitors developing similar technologies.

 

We believe that patents, trademarks, trade secrets and other intellectual property we use and are developing are important to sustaining and growing our business. We utilize third party manufacturers to manufacture our products in China, where the validity, enforceability and scope of protection available under intellectual property laws are uncertain and still evolving. Implementation and enforcement of Chinese intellectual property-related laws have historically been deficient, ineffective and hampered by corruption and local protectionism. Accordingly, we may not be able to adequately protect our intellectual property in China, which could have a material adverse effect on our business, results of operations and financial condition. Furthermore, policing unauthorized use of our intellectual property in China and elsewhere is difficult and expensive, and we may need to resort to litigation to enforce or defend our intellectual property or to determine the enforceability, scope and validity of our proprietary rights or those of others. Such litigation and an adverse

 

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determination in any such litigation, if any, could result in substantial costs and diversion of resources and management attention, which could harm our business and competitive position.

 

If vaporizers continue to face intense media attention and public pressure, our operations may be adversely affected.

 

Since the introduction of electronic cigarettes and vaporizers, certain members of the media, politicians, government regulators and advocate groups, including independent medical physicians, have called for an outright ban of all electronic cigarettes and vaporizers, pending regulatory review and a demonstration of safety. A partial or outright ban would have a material adverse effect on our business, results of operations and financial condition and we may have to shut down our operations in the locations implemented any such ban.

 

If we fail to retain our key personnel, we may not be able to achieve our anticipated level of growth and our business could suffer.

 

Our future depends, in part, on our ability to attract and retain key personnel and the continued contributions of our executive officers, each of whom may be difficult to replace. In particular, Jeffrey Holman, our Chief Executive Officer, is important to the management of our business and operations and the development of our strategic direction. The loss of the services of this officer, and the process to replace him would involve significant time and expense and may significantly delay or prevent the achievement of our business objectives.

 

We may experience product liability claims in our business, which could adversely affect our business.

 

The tobacco industry in general has historically been subject to frequent product liability claims. As a result, we may experience product liability claims from the marketing and sale of electronic cigarettes. Any product liability claim brought against us, with or without merit, could result in:

 

· liabilities that substantially exceed our product liability insurance, which we would then be required to pay from other sources, if available;

 

· an increase of our product liability insurance rates or the inability to maintain insurance coverage in the future on acceptable terms, or at all;

 

· damage to our reputation and the reputation of our products, resulting in lower sales;

 

· regulatory investigations that could require costly recalls or product modifications;

 

· litigation costs; and

 

· the diversion of management’s attention from managing our business.

 

Any one or more of the foregoing could have a material adverse effect on our business, results of operations and financial condition.

 

If we experience product recalls, we may incur significant and unexpected costs and our business reputation could be adversely affected.

 

We may be exposed to product recalls and adverse public relations if our products are alleged to cause illness or injury, or if we are alleged to have violated governmental regulations. A product recall could result in substantial and unexpected expenditures and could harm our reputation, which could have a material adverse effect on our business, results of operations and financial condition. In addition, a product recall may require significant management time and attention and may adversely impact on the value of our brands. Product recalls may lead to greater scrutiny by federal or state regulatory agencies and increased litigation, which could have a material adverse effect on our business, results of operations and financial condition.

 

If we experience a high amount of product exchanges, returns and warranty claims, our business will be adversely affected.

 

If we are unable to maintain an acceptable degree of quality control of our products, we will incur costs associated with the exchange and return of our products as well as servicing our customers for warranty claims. In addition, customers may require us to take back unsold products which we may be unable to resell. Any of the foregoing on a significant scale may have a material adverse effect on our business, results of operations and financial condition.

 

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If the economy declines, such decline may adversely affect the demand for our products.

 

Vaporizers and electronic cigarettes may be regarded by users as a novelty item and expendable as such demand for our products may be extra sensitive to economic conditions. When economic conditions are prosperous, discretionary spending typically increases; conversely, when economic conditions are unfavorable, discretionary spending often declines. Any significant decline in economic conditions that affects consumer spending could have a material adverse effect on our business, results of operations and financial condition.

 

Our future growth and profitability will depend in large part upon the effectiveness of our marketing and advertising expenditures.

 

Our future growth and profitability will depend in large part upon our media performance, including our ability to:

 

· create greater awareness of our products and stores;

 

· identify the most effective and efficient level of spending in each market and specific media vehicle;

 

· determine the appropriate creative message and media mix for advertising, marketing, and promotional expenditures; and

 

· effectively manage marketing costs (including creative and media).

 

Our planned marketing expenditures may not result in increased revenue. If our media performance is not effective, our future results of operations and financial condition will be adversely affected.

 

If we are unable to promote and maintain our brands, our results of operations will be adversely affected.

 

We believe that establishing and maintaining the brand identities of our products is a critical aspect of attracting and expanding a large customer base. Promotion and enhancement of our brands will depend largely on our success in continuing to provide high quality products. If our customers and end users do not perceive our products to be of high quality, or if we introduce new products or enter into new business ventures that are not favorably received by our customers and end users, we will risk diluting our brand identities and decreasing their attractiveness to existing and potential customers.

 

Moreover, in order to attract and retain customers and to promote and maintain our brand equity in response to competitive pressures, we may have to increase substantially our financial commitment to creating and maintaining a distinct brand loyalty among our customers. If we incur significant expenses in an attempt to promote and maintain our brands, our business, results of operations and financial condition could be adversely affected.

 

If we are unable to adapt to trends in our industry, our results of operations will be adversely affected.

 

We may not be able to adapt as the vaporizer and electronic cigarette industry and customer demand evolve, whether attributable to regulatory constraints or requirements, a lack of financial resources or our failure to respond in a timely and/or effective manner to new technologies, customer preferences, changing market conditions or new developments in our industry. Any of the failures to adapt for the reasons cited herein or otherwise could make our products obsolete and would have a material adverse effect on our business, financial condition and results of operations.

 

If our third-party manufacturers produce unacceptable or defective products or do not provide products in a timely manner, our business will be adversely affected.

 

We depend on third party manufacturers for our electronic cigarettes, vaporizers and accessories. Our customers associate certain characteristics of our products including the weight, feel, draw, unique flavor, packaging and other attributes of our products to the brands we market, distribute and sell. Any interruption in supply, consistency of our products may adversely impact our ability to deliver our products to our wholesalers, distributors and customers and otherwise harm our relationships and reputation with customers, and have a materially adverse effect on our business, results of operations and financial condition.

 

Although we believe that several alternative sources for the components, chemical constituents and manufacturing services necessary for the production of our products are available, any failure to obtain any of the foregoing would have a material adverse effect on our business, results of operations and financial condition.

 

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Because we rely on Chinese manufacturers to produce our products, we are subject to potential adverse safety and other issues.

 

The majority of our manufacturers are based in China. Certain Chinese factories and the products they export have recently been the source of safety concerns and recalls, which is generally attributed to lax regulatory, quality control and safety standards. Should Chinese factories continue to draw public criticism for exporting unsafe products, whether those products relate to our products or not we may be adversely affected by the stigma associated with Chinese production, which could have a material adverse effect on our business, results of operations and financial condition.

 

We expect that new products and/or brands we develop will expose us to risks that may be difficult to identify until such products and/or brands are commercially available.

 

We are currently developing, and in the future, will continue to develop, new products and brands, the risks of which will be difficult to ascertain until these products and/or brands are commercially available. For example, we are developing new formulations, packaging and distribution channels. Any negative events or results that may arise as we develop new products or brands may adversely affect our business, financial condition and results of operations.

 

If we are unable to manage our anticipated future growth, our business and results of operations could suffer materially.

 

Our business has grown rapidly during our limited operating history. Our future operating results depend to a large extent on our ability to successfully manage our anticipated growth. To manage our anticipated growth, we believe we must effectively, among other things:

 

· hire, train, and manage additional employees;

 

· expand our marketing and distribution capabilities;

 

· increase our product development activities;

 

· add additional qualified finance and accounting personnel; and

 

· implement and improve our administrative, financial and operational systems, procedures and controls.

 

We are increasing our investment in marketing and distribution channels and other functions to grow our business. We are likely to incur the costs associated with these increased investments earlier than some of the anticipated benefits and the return on these investments, if any, may be lower, may develop more slowly than we expect or may not materialize.

 

If we are unable to manage our growth effectively, we may not be able to take advantage of market opportunities or develop new products, and we may fail to satisfy product requirements, maintain product quality, execute our business plan or respond to competitive pressures, any of which could have a material adverse effect on our business, results of operations and financial condition.

 

We face competition from foreign importers who do not comply with government regulation which may result in the loss of customers and result in adverse effects to our results of operations.

 

We face competition from foreign sellers of electronic cigarettes and vaporizers that may illegally ship their products into the United States for direct delivery to customers. These market participants will not have the added cost and expense of complying with U.S. regulations and taxes and as a result will be able to offer their product at a more competitive price than us and potentially capture market share. Moreover, should we be unable to sell certain of our products during any regulatory approval process we have no assurances that we will be able to recapture those customers that we lost to our foreign domiciled competitors during any “blackout” periods, during which we are not permitted to sell our products. This competitive disadvantage may have a material adverse effect on our business, results of operations and our financial condition.

 

Our results of operations could be adversely affected by currency exchange rates and currency devaluations.

 

Our functional currency is the U.S. dollar; substantially all of our purchases and sales are currently generated in U.S. dollars. However, our manufacturers and suppliers are located in China. The Chinese currency, the renminbi, has appreciated significantly against the U.S. dollar in recent years. Fluctuations in exchange rates between our respective currencies could result in higher production and supply costs to us which would have a material adverse effect on our results of operations if we are not willing or able to pass those costs on to our customers.

 

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Risks Related to Government Regulation

 

Changes in laws, regulations and other requirements could adversely affect our business, results of operations or financial condition.

 

In addition to the anticipated regulation of our business by the FDA, our business, results of operations or financial condition could be adversely affected by new or future legal requirements imposed by legislative or regulatory initiatives, including, but not limited to, those relating to health care, public health and welfare and environmental matters. For example, in recent years, states and many local and municipal governments and agencies, as well as private businesses, have adopted legislation, regulations or policies which prohibit, restrict, or discourage smoking; smoking in public buildings and facilities, stores, restaurants and bars; and smoking on airline flights and in the workplace. At present, it is not clear if electronic cigarettes, which emit no smoke or noxious odors, are subject to such restrictions. Furthermore, some states and localities prohibit and others are prohibiting the sales of electronic cigarettes and vaporizers to minors. Other similar laws and regulations are currently under consideration and may be enacted by state and local governments in the future. If electronic cigarettes and vaporizers are subject to restrictions on smoking in public and other places, our business, operating results and financial condition could be materially and adversely affected. New legislation or regulations may result in increased costs directly for our compliance or indirectly to the extent such requirements increase the prices of goods and services because of increased costs or reduced availability. We cannot predict whether such legislative or regulatory initiatives will result in significant changes to existing laws and regulations and/or whether any changes in such laws or regulations will have a material adverse effect on our business, results of operations or financial condition.

 

Restrictions on the public use of vaporizers and electronic cigarettes may reduce the attractiveness and demand for our products.

 

Certain states, cities, businesses, providers of transportation and public venues in the U.S. have already banned the use of vaporizers and electronic cigarettes, while others are considering banning their use. If the use of vaporizers and electronic cigarettes are banned anywhere the use of traditional tobacco burning cigarettes is banned, our products may lose their appeal as an alternative to traditional tobacco burning cigarettes, which may reduce the demand for our products and, thus, have a material adverse effect on our business, results of operations and financial condition.

 

Limitation by states on sales of vaporizers and electronic cigarettes may have a material adverse effect on our ability to sell our products.

 

On February 15, 2010, in response to a civil investigative demand from the Office of the Attorney General of the State of Maine, we voluntarily executed an assurance of discontinuance with the State of Maine, which prohibits us from selling electronic cigarettes in the State of Maine until such time as we obtain a retail tobacco license in the state. While suspending sales to residents of Maine is not material to our operations, other electronic cigarette companies have entered into similar agreements with other states, such as the State of Oregon. If one or more states from which we generate or anticipate generating significant sales bring actions to prevent us from selling our products unless we obtain certain licenses, approvals or permits and if we are not able to obtain the necessary licenses, approvals or permits for financial reasons or otherwise and/or any such license, approval or permit is determined to be overly burdensome to us then we may be required to cease sales and distribution of our products to those states, which would have a material adverse effect on our business, results of operations and financial condition.

 

The FDA has issued an import alert which has limited our ability to import certain of our products.

 

As a result of FDA import alert 66-41 (which allows the detention of unapproved drugs promoted in the U.S.), the U.S. Customs has from time to time temporarily and in some instances indefinitely detained products sent to us by our Chinese suppliers. If the FDA modifies the import alert from its current form which allows U.S. Customs discretion to release our products to us, to a mandatory and definitive hold we will no longer be able to ensure a supply of saleable product, which will have a material adverse effect on our business, results of operations and financial condition. We believe that FDA import alert will become less relevant to us as and when the FDA regulates electronic cigarettes and vaporizers under the Tobacco Control Act.

 

The application of the Prevent All Cigarette Trafficking Act and/or the Federal Cigarette Labeling and Advertising Act to vaporizers and/or electronic cigarettes would have a material adverse effect on our business.

 

At present, neither the Prevent All Cigarette Trafficking Act (which prohibits the use of the U.S. Postal Service to mail most tobacco products and which amends the Jenkins Act, which would require individuals and businesses that make interstate sales of cigarettes or smokeless tobacco to comply with state tax laws) nor the Federal Cigarette Labeling and Advertising Act (which governs how cigarettes can be advertised and marketed) apply to vaporizers and/or electronic cigarettes. The application of either or both of these federal laws to either vaporizers and/or electronic cigarettes could result in additional expenses, could prohibit us from selling products through the

 

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Internet and require us to change our advertising and labeling and method of marketing our products, any of which would have a material adverse effect on our business, results of operations and financial condition.

 

We may face the same governmental actions aimed at conventional cigarettes and other tobacco products.

 

The tobacco industry expects significant regulatory developments to take place over the next few years, driven principally by the World Health Organization’s Framework Convention on Tobacco Control, or the FCTC. The FCTC is the first international public health treaty on tobacco, and its objective is to establish a global agenda for tobacco regulation with the purpose of reducing initiation of tobacco use and encouraging cessation. Regulatory initiatives that have been proposed, introduced or enacted include:

 

· the levying of substantial and increasing tax and duty charges;

 

· restrictions or bans on advertising, marketing and sponsorship;

 

· the display of larger health warnings, graphic health warnings and other labeling requirements;

 

· restrictions on packaging design, including the use of colors and generic packaging;

 

· restrictions or bans on the display of tobacco product packaging at the point of sale, and restrictions or bans on cigarette vending machines;

 

· requirements regarding testing, disclosure and performance standards for tar, nicotine, carbon monoxide and other smoke constituent’s levels;

 

· requirements regarding testing, disclosure and use of tobacco product ingredients;

 

· increased restrictions on smoking in public and work places and, in some instances, in private places and outdoors;

 

· elimination of duty free allowances for travelers; and

 

· encouraging litigation against tobacco companies.

 

· If vaporizers and/or electronic cigarettes are subject to one or more significant regulatory initiatives enacted under the FCTC, our business, results of operations and financial condition could be materially and adversely affected.

 

Risks Related To Our Natural Grocery Business

 

We may not be successful in our efforts to grow.

 

Our growth largely depends on our ability to increase sales in our existing Ada’s store and successfully open and operate new stores on a profitable basis. Our comparable store sales growth could be lower than our historical average for various reasons, including the opening of new stores that cannibalize sales in existing stores, increased competition, general economic conditions, regulatory changes, price changes as a result of competitive factors and product pricing and availability.

 

Delays or failures in opening new stores, or achieving lower than expected sales in new stores, could materially and adversely affect our growth. Our plans for expansion could place increased demands on our financial, managerial, operational and administrative resources. For example, our planned expansion will require us to increase the number of people we employ and may require us to upgrade our management information system and our distribution infrastructure. These increased demands and operating complexities could cause us to operate our business less efficiently, which could materially and adversely affect our operations, financial performance and future growth.

 

We may not be able to open new stores on schedule or operate them successfully. Our ability to successfully open new stores depends upon a number of factors, including our ability to select suitable sites for our new store locations, to negotiate and execute leases, to coordinate the contracting work on our new stores, to identify and recruit store managers, and other staff, to secure and manage the inventory necessary for the launch and successful operation of our new stores and to effectively promote and market our new stores. If we are ineffective in performing these activities, our efforts to open and operate new stores may be unsuccessful or unprofitable, which could materially and adversely affect our operations, financial performance and future growth.

 

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Ada’s and any newly opened stores may negatively impact our financial results in the short-term, and may not achieve expected sales and operating levels on a timely basis or at all.

 

We will actively pursue new store growth. Our new store openings may not be successful or reach the sales and profitability levels of our existing stores. Although we target particular levels of cash-on-cash returns and capital investment for each of our new stores, new stores may not meet these targets. Any store we open may not be profitable or achieve operating results similar to those of our existing store. New store openings may negatively impact our financial results in the short-term due to the effect of store opening costs and lower sales and contribution to overall profitability during the initial period following opening. New stores build their sales volume and their customer base over time and, as a result, generally have lower margins and higher operating expenses, as a percentage of net sales, than our existing store. New stores may not achieve sustained sales and operating levels consistent with our existing store base on a timely basis or at all. This may have an adverse effect on our financial condition and operating results. In addition, we may not be able to successfully integrate new stores into Ada’s and those new stores may not be as profitable as Ada’s.

 

If we are unable to successfully identify market trends and react to changing consumer preferences in a timely manner, our sales may decrease.

 

We believe our success depends, in substantial part, on our ability to:

 

o anticipate, identify and react to natural and organic grocery and dietary supplement trends and changing consumer preferences in a timely manner;
o translate market trends into appropriate, saleable product and service offerings in our stores before our competitors; and
o develop and maintain vendor relationships that provide us access to the newest merchandise, and dairy products that satisfy upgraded standards, on reasonable terms.

 

Consumer preferences often change rapidly and without warning, moving from one trend to another among many product or retail concepts. Our performance is impacted by trends regarding natural and organic products, dietary supplements and at-home meal preparation. Consumer preferences towards dietary supplements or natural and organic food products might shift as a result of, among other things, economic conditions, food safety perceptions, reduced or changed consumer choices and the cost of these products. Our store offerings are comprised of natural and organic products and dietary supplements. A change in consumer preferences away from our offerings, including as a result of, among other things, reductions or changes in our offerings, would have a material adverse effect on our business. Additionally, negative publicity regarding the safety of natural and organic products or dietary supplements, or new or upgraded regulatory standards may adversely affect demand for our products and could result in lower customer traffic, sales and results of operations. In addition, reduced or changed consumer choices may result from, among other things, the implementation of our requirements for dairy products that satisfy our pasture-based, non-confinement standards.

 

If we are unable to anticipate and satisfy consumer merchandise preferences in the regions where we operate, our net sales may decrease, and we may be forced to increase markdowns of slow-moving merchandise, either of which could have a material adverse effect on our business, financial condition and results of operations.

 

Our comparable store sales and quarterly financial performance may fluctuate for a variety of reasons.

 

Our comparable store sales and quarterly results of operations have fluctuated in the past, and we expect them to continue to fluctuate in the future. A variety of other factors affect our comparable store sales and quarterly financial performance, including:

 

o changes in our merchandising strategy or product mix;
o performance of our newer and remodeled stores;
o the effectiveness of our inventory management;
o the timing and concentration of new store openings, and the related additional human resource requirements and pre-opening and other start-up costs;
o the cannibalization of existing store sales by new store openings;
o levels of pre-opening expenses associated with new stores;
o timing and effectiveness of our marketing activities;

 

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o seasonal fluctuations due to weather conditions and extreme weather-related disruptions;
o actions by our existing or new competitors, including pricing changes;
o regulatory changes affecting availability and marketability of products;
o supply shortages; and
o general United States economic conditions and, in particular, the retail sales environment.

 

Accordingly, our results for any one fiscal year or quarter are not necessarily indicative of the results to be expected for any other year or quarter, and comparable store sales of any particular future period may decrease. In the event of such a decrease, the price of our common stock would likely decline.

 

We may be unable to compete effectively in our markets, which are highly competitive.

 

The markets for natural and organic groceries and dietary supplements are large, fragmented and highly competitive, with few barriers to entry. Our competition varies by market and includes conventional supermarkets, natural, gourmet and specialty food markets, mass and discount retailers, warehouse clubs, independent health food stores, dietary supplement retailers, drug stores, farmers’ markets, food co-ops, mail order and online retailers and multi-level marketers. These businesses compete with us for customers on the basis of price, selection, quality, customer service, shopping experience or any combination of these or other factors. They also compete with us for products and locations. In addition, some of our competitors are expanding to offer a greater range of natural and organic foods. Many of our competitors are larger, more established and have greater financial, marketing and other resources than us, and may be able to adapt to changes in consumer preferences more quickly, devote greater resources to the marketing and sale of their products, or generate greater brand recognition. An inability to compete effectively may cause us to lose market share to our competitors and could have a material adverse effect on our business, financial condition and results of operations.

 

If we or our third-party suppliers fail to comply with regulatory requirements, or are unable to provide products that meet our specifications, our business and our reputation could suffer.

 

If we or our third-party suppliers, including suppliers of our private label products, fail to comply with applicable regulatory requirements or to meet our quality specifications, we could be required to take costly corrective action and our reputation could suffer. We do not own or operate any manufacturing facilities, except for our bulk food repackaging facility and distribution center discussed below, and therefore depend upon independent third-party vendors to produce our private label branded products, such as vitamins, minerals, dietary supplements, body care products, food products and bottled water. Third-party suppliers of our private label products may not maintain adequate controls with respect to product specifications and quality. Such suppliers may be unable to produce products on a timely basis or in a manner consistent with regulatory requirements. We depend upon our bulk food repackaging facility and distribution center for the majority of our private label bulk food products. We may also be unable to maintain adequate product specification and quality controls at our bulk food repackaging facility and distribution center, or produce products on a timely basis and in a manner consistent with regulatory requirements. In addition, we may be required to find new third-party suppliers of our private label products or to find third-party suppliers to source our bulk foods. There can be no assurance that we would be successful in finding such third-party suppliers that meet our quality guidelines.

 

Disruptions affecting our significant suppliers, or our relationships with such suppliers, could negatively affect our business.

 

Due to this concentration of purchases from third-party suppliers, the cancellation or non-renewal of our distribution agreement or the disruption, delay or inability of these third party suppliers to deliver product to our stores may materially and adversely affect our operating results and we may be unable to establish alternative distribution channels on reasonable terms or at all.

 

Certain of our vendors use overseas sourcing to varying degrees to manufacture some or all of their products. Any event causing a sudden disruption of manufacturing or imports from such foreign countries, including the imposition of additional import restrictions, unanticipated political changes, increased customs duties, labor disputes, health epidemics, adverse weather conditions, crop failure, acts of war or terrorism, legal or economic restrictions on overseas suppliers’ ability to produce and deliver products, and natural disasters, could increase our costs and materially harm our business and financial condition and results of operations. Our business is also subject to a variety of other risks generally associated with indirectly sourcing goods from abroad, such as political instability, disruption of imports by labor disputes and local business practices. In addition, requirements imposed by the FSMA compel importers to verify that food products and ingredients produced by a foreign supplier comply with all applicable legal and regulatory requirements enforced by the FDA, which could result in certain products being deemed inadequate for import.

 

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The current geographic concentration of our store creates exposure to local economies, regional downturns or severe weather or catastrophic occurrences.

 

Ada’s is located in Ft. Myers, Florida and we expect new stores to be located in Southern and Central Florida. As a result, our business is currently more susceptible to regional conditions than the operations of more geographically diversified competitors, and we are vulnerable to economic downturns in those regions. Any unforeseen events or circumstances that negatively affect these areas could materially adversely affect our revenues and profitability. These factors include, among other things, changes in demographics, population, competition, consumer preferences, new or revised laws or regulations, fires, floods or other natural disasters in these regions.

 

Consumers or regulatory agencies may challenge certain claims made regarding our products.

 

Our reputation could also suffer from real or perceived issues involving the labeling or marketing of our products. Products that we sell may carry claims as to their origin, ingredients or health benefits, including, by way of example, the use of the term “natural.” Although the FDA and USDA each has issued statements regarding the appropriate use of the word “natural,” there is no single, United States government regulated definition of the term “natural” for use in the food industry. The resulting uncertainty has led to consumer confusion, distrust and legal challenges. Plaintiffs have commenced legal actions against a number of food companies that market “natural” products, asserting false, misleading and deceptive advertising and labeling claims, including claims related to genetically modified ingredients. In limited circumstances, the FDA has taken regulatory action against products labeled “natural” but that nonetheless contain synthetic ingredients or components. Should we become subject to similar claims, consumers may avoid purchasing products from us or seek alternatives, even if the basis for the claim is unfounded. Adverse publicity about these matters may discourage consumers from buying our products. The cost of defending against any such claims could be significant. Any loss of confidence on the part of consumers in the truthfulness of our labeling or ingredient claims would be difficult and costly to overcome and may significantly reduce our brand value. Any of these events could adversely affect our reputation and brand and decrease our sales, which would have a material adverse effect on our business, financial condition and results of operations.

 

Perishable food product losses could materially impact our results of operations.

 

Our stores offer a significant number of perishable products. Our offering of perishable products may result in significant product inventory losses in the event of extended power or other utility outages, natural disasters or other catastrophic occurrences.

 

The decision by certain of our suppliers to distribute their specialty products through other retail distribution channels could negatively impact our revenue from the sale of such products.

 

Some of the specialty retail products that we sell in our stores are not generally available through other retail distribution channels such as drug stores, conventional grocery stores or mass merchandisers. In the future, our suppliers could decide to distribute such products through other retail distribution channels, allowing more of our competitors to offer these products, and adversely affecting the desirability of these products to our core customers, which could negatively impact our revenues.

 

A widespread health epidemic could materially impact our business.

 

Our business could be severely impacted by a widespread regional, national or global health epidemic. A widespread health epidemic may cause customers to avoid public gathering places such as our stores or otherwise change their shopping behaviors. Additionally, a widespread health epidemic could adversely impact our business by disrupting production and delivery of products to our stores and by impacting our ability to appropriately staff our stores.

 

Union activity at third-party transportation companies or labor organizing activities among our employees could disrupt our operations and harm our business.

 

Independent third-party transportation companies deliver the majority of our merchandise to our stores and to our customers. Some of these third parties employ personnel represented by labor unions. Disruptions in the delivery of merchandise or work stoppages by employees of these third parties could delay the timely receipt of merchandise, which could result in cancelled sales, a loss of loyalty to our stores and excess inventory.

 

While all of our employees are currently non-union, our employees may attempt to organize and join a union. That effort was unsuccessful. We could face union organizing activities at other locations. The unionization of all or a portion of our workforce could result in work slowdowns, could increase our overall costs and reduce the efficiency of our operations at the affected locations, could adversely affect our flexibility to run our business competitively, and could otherwise have a material adverse effect on our business, financial condition and results of operations.

 

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Our products could suffer from real or perceived quality or food safety concerns and may cause unexpected side effects, illness, injury or death that could result in their discontinuance or expose us to lawsuits, any of which could result in unexpected costs and damage to our reputation.

 

We could be materially, adversely affected if consumers lose confidence in the safety and quality of products we sell. There is substantial governmental scrutiny of and public awareness regarding food safety. We believe that many customers hold us to a higher quality standard than other retailers. Many of our products are vitamins, herbs and other ingredients that are classified as foods or dietary supplements and are not subject to pre-market regulatory approval in the United States. Our products could contain contaminated substances, and some of our products contain ingredients that do not have long histories of human consumption. Previously unknown adverse reactions resulting from human consumption of these ingredients could occur. Unexpected side effects, illness, injury or death caused by our products could result in the discontinuance of sales of our products or prevent us from achieving market acceptance of the affected products. Such side effects, illnesses, injuries and death could also expose us to product liability or negligence lawsuits. Any claims brought against us may exceed our existing or future insurance policy coverage or limits. Any judgment against us that is in excess of our policy limits would have to be paid from our cash reserves, which would reduce our capital resources. Further, we may not have sufficient capital resources to pay a judgment in which case our creditors could levy against our assets. The real or perceived sale of contaminated or harmful products would cause negative publicity regarding our company, brand or products, including negative publicity in social media, which could in turn harm our reputation and net sales and could have a material adverse effect on our business, financial condition and results of operations, or result in our insolvency.

 

Increases in the cost of raw materials could hurt our sales and profitability.

 

Costs of the raw agricultural commodities used in our private label products, including our bulk repackaged products, could increase. Such commodities are generally subject to availability constraints and price volatility caused by weather, supply conditions, government regulations, energy prices, price inflation and general economic conditions and other unpredictable factors. An increase in the demand for or a reduced supply of raw agricultural commodities could cause our vendors to seek price increases from us, which could cause the retail price we charge for certain products to increase, in turn decreasing our sales of such products. Supply shortages may cause certain items to be unavailable, which could negatively affect our sales. Our profitability may be adversely impacted as a result of such developments through reduced gross margins or a decline in the number and average size of customer transactions. The cost of construction materials we use to build and remodel our stores is also subject to significant price volatility based on market and economic conditions. Higher construction material prices would increase the capital expenditures needed to construct a new store or remodel an existing store and, as a result, could increase the rent payable by the Company under its leases.

 

Increases in certain costs affecting our marketing, advertising and promotions may adversely impact our ability to advertise effectively and reduce our profitability.

 

Postal rate increases, and increasing paper and printing costs affect the cost of our promotional mailings. Previous changes in postal rates increased the cost of our Health Hotline mailings and previous increases in paper and printing costs increased the cost of producing our Health Hotline newspaper inserts. In response to any future increase in mailing costs, we may consider reducing the number and size of certain promotional pieces. In addition, we rely on discounts from the basic postal rate structure, such as discounts for bulk mailings and sorting by zip code and carrier routes. We are not party to any long-term contracts for the supply of paper. We are also affected by increases in billboard costs and the cost of producing and broadcasting our television, radio and internet advertising pieces. Previous changes in broadcast rates resulted in an increase in the cost of our television commercials. In response to any future increase in broadcast costs, we may consider reducing the frequency, placement and length of certain promotional pieces. We are not party to any long-term contracts for broadcast time. Future increases in costs affecting our marketing, advertising and promotions could adversely impact our ability to advertise effectively and our profitability.

 

Legal proceedings could adversely affect our business, financial condition and results of operations.

 

Our operations, which are characterized by transactions involving a high volume of customer traffic and a wide variety of product selections, carry a higher exposure to consumer litigation risk when compared to the operations of companies operating in certain other industries. Consequently, we have been, are, and may in the future become a party to individual personal injury, product liability and other legal actions in the ordinary course of our business. While these actions are generally routine in nature, incidental to the operation of our business and immaterial in scope, the outcome of litigation is difficult to assess or quantify. Additionally, we could be exposed to industry-wide or class-action claims arising from the products we carry or industry-specific business practices. Further, we have been, are and may in the future become subject to claims for discrimination, harassment, wages and hours and other federal or state employment matters. While we maintain insurance, such coverage may not be adequate or may not cover a specific legal claim. Moreover, the cost to defend against litigation may be significant. As a result, litigation could have a material adverse effect on our business, financial position and results of operations.

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Risks Related to Participation in the Marijuana Industry

 

Federal regulation and enforcement may adversely affect the implementation of medical marijuana laws and regulations may negatively impact our revenues and profits.

 

Currently, there are 23 states plus the District of Columbia that have laws and/or regulations that recognize, in one form or another, legitimate medical uses for cannabis and consumer use of cannabis in connection with medical treatment. Many other states are considering similar legislation. Conversely, under the Controlled Substance Act (the “CSA”), the policies and regulations of the Federal government and its agencies are that cannabis has no medical benefit and a range of activities including cultivation and the personal use of cannabis is prohibited. Unless and until Congress amends the CSA with respect to medical marijuana, as to the timing or scope of any such potential amendments there can be no assurance, there is a risk that federal authorities may enforce current federal law, and we may be deemed to be producing, cultivating, or dispensing marijuana in violation of federal law with respect to the Company’s proposed business operations or we may be deemed to be facilitating the sale or distribution of drug paraphernalia in violation of federal law. Active enforcement of the current federal regulatory position on cannabis may thus indirectly and adversely affect our revenues and profits. The risk of strict enforcement of the CSA in light of Congressional activity, judicial holdings, and stated federal policy remains uncertain.

 

The U.S. Supreme Court declined to hear a case brought by San Diego County, California that sought to establish federal preemption over state medical marijuana laws. The preemption claim was rejected by every court that reviewed the case. The California 4th District Court of Appeals wrote in its unanimous ruling, “Congress does not have the authority to compel the states to direct their law enforcement personnel to enforce federal laws.” However, in another case, the U.S. Supreme Court held that, as long as the CSA contains prohibitions against marijuana, under the Commerce Clause of the United States Constitution, the United States may criminalize the production and use of homegrown cannabis even where states approve its use for medical purposes.

 

In an effort to provide guidance to federal law enforcement, the DOJ has issued Guidance Regarding Marijuana Enforcement to all United States Attorneys in a memorandum from Deputy Attorney General David Ogden on October 19, 2009, in a memorandum from Deputy Attorney General James Cole on June 29, 2011 and in a memorandum from Deputy Attorney General James Cole on August 29, 2013. Each memorandum provides that the DOJ is committed to the enforcement of the CSA, but, the DOJ is also committed to using its limited investigative and prosecutorial resources to address the most significant threats in the most effective, consistent, and rational way.

 

The August 29, 2013 memorandum provides updated guidance to federal prosecutors concerning marijuana enforcement in light of state laws legalizing medical and recreational marijuana possession in small amounts.

 

The memorandum sets forth certain enforcement priorities that are important to the federal government:

 

· Distribution of marijuana to children;
 
· Revenue from the sale of marijuana going to criminals;
 
· Diversion of medical marijuana from states where it is legal to states where it is not;
 
· Using state authorized marijuana activity as a pretext of other illegal drug activity;
 
  · Preventing violence in the cultivation and distribution of marijuana;
 
· Preventing drugged driving;
 
· Growing marijuana on federal property; and
 
· Preventing possession or use of marijuana on federal property.

 

The DOJ has not historically devoted resources to prosecuting individuals whose conduct is limited to possession of small amounts of marijuana for use on private property but has relied on state and local law enforcement to address marijuana activity. In the event the DOJ reverses its stated policy and begins strict enforcement of the CSA in states that have laws legalizing medical marijuana and recreational marijuana in small amounts, there may be a direct and adverse impact to our business and our revenue and profits. Furthermore, H.R. 83, enacted by Congress on December 16, 2014, provides that none of the funds made available to the DOJ pursuant to the 2015 Consolidated and Further Continuing Appropriations Act may be used to prevent certain states, including Nevada and California, from implementing their own laws that authorized the use, distribution, possession, or cultivation of medical marijuana.

 

We could be found to be violating laws related to medical cannabis.

 

Currently, there are 23 states plus the District of Columbia that have laws and/or regulations that recognize, in one form or another, legitimate medical uses for cannabis and consumer use of cannabis in connection with medical treatment. Many other states are considering similar legislation. Conversely, under the CSA, the policies and regulations of the federal government and its agencies are that cannabis has no medical benefit and a range of activities including cultivation and the personal use of cannabis is prohibited. Unless and until Congress amends the CSA with respect to medical marijuana, as to the timing or scope of any such amendments there can be no assurance, there is a risk that federal authorities may enforce current federal law. The risk of strict enforcement of the CSA in light of Congressional activity, judicial holdings, and stated federal policy remains uncertain. If we obtain the necessary government approvals and permits in Florida and obtain the necessary funding to commence the operation of dispensary facilities, there can be no assurance, we could be found in violation of the CSA.

 

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Variations in state and local regulation and enforcement in states that have legalized medical cannabis that may restrict marijuana-related activities, including activities related to medical cannabis may negatively impact our revenues and profits.

 

Individual state laws do not always conform to the federal standard or to other states laws. A number of states have decriminalized marijuana to varying degrees, other states have created exemptions specifically for medical cannabis, and several have both decriminalization and medical laws. Four states, Colorado, Washington, Oregon, and Alaska, have legalized the recreational use of cannabis. Variations exist among states that have legalized, decriminalized, or created medical marijuana exemptions. For example, Alaska and Colorado have limits on the number of marijuana plants that can be homegrown. In most states, the cultivation of marijuana for personal use continues to be prohibited except for those states that allow small-scale cultivation by the individual in possession of medical marijuana needing care or that person’s caregiver. Active enforcement of state laws that prohibit personal cultivation of marijuana may indirectly and adversely affect our business and our revenue and profits.

 

Prospective customers may be deterred from doing business with a company with a significant nationwide online presence because of fears of federal or state enforcement of laws prohibiting possession and sale of medical or recreational marijuana.

 

Our website is visible in jurisdictions where medicinal and/or recreational use of marijuana is not permitted and, as a result, we may be found to be violating the laws of those jurisdictions. These violations may affect other segments of the Company’s business.

  

Marijuana remains illegal under Federal law.

 

Marijuana is a Schedule-I controlled substance and is illegal under federal law. Even in those states in which the use of marijuana has been legalized, its use remains a violation of federal law. Since federal law criminalizing the use of marijuana preempts state laws that legalize its use, strict enforcement of federal law regarding marijuana would likely result in our inability to proceed with our business plans.

 

Laws and regulations affecting the medical marijuana industry are constantly changing, which could detrimentally affect the proposed operations of the Company.

 

Local, state, and federal medical marijuana laws and regulations are broad in scope and subject to evolving interpretations, which could require us to incur substantial costs associated with compliance or alter certain aspects of our business plan. In addition, violations of these laws, or allegations of such violations, could disrupt certain aspects of our business plan and result in a material adverse effect on certain aspects of our planned operations. In addition, it is possible that regulations may be enacted in the future that will be directly applicable to certain aspects of our proposed business of selling cannabis products. We cannot predict the nature of any future laws, regulations, interpretations, or applications, nor can we determine what effect additional governmental regulations or administrative policies and procedures, when and if promulgated, could have on our business.

 

We may not obtain the necessary permits and authorizations to operate the medical marijuana business.

 

The Company may not be able to obtain or maintain the necessary licenses, permits, authorizations, or accreditations, or may only be able to do so at great cost, to operate its medical marijuana business. In addition, we may not be able to comply fully with the wide variety of laws and regulations applicable to the medical marijuana industry. Failure to comply with or to obtain the necessary licenses, permits, authorizations, or accreditations could result in restrictions on our ability to operate the medical marijuana business, which could have a material adverse effect on our business.

 

If we incur substantial liability from litigation, complaints, or enforcement actions, our financial condition could suffer.

 

The Company’s participation in the medical marijuana industry may lead to litigation, formal or informal complaints, enforcement actions, and inquiries by various federal, state, or local governmental authorities against the Company. Litigation, complaints, and enforcement actions involving the Company could consume considerable amounts of financial and other corporate resources, which could have a negative impact on our sales, revenue, profitability, and growth prospects.

 

We may have difficulty accessing the service of banks, which may make it difficult for us to operate.

 

Since the use of marijuana is illegal under federal law, there is a strong argument that banks cannot accept for deposit funds from businesses involved in the marijuana industry. Consequently, businesses involved in the marijuana industry often have difficulty finding a bank willing to accept their business. The inability to open bank accounts may make it difficult for us to operate our contemplated medical marijuana businesses.

 

We will likely face significant competition.

 

The legal marijuana industry is in its early stages and is attracting significant attention from both small and large entrants into the industry. The Company expects to encounter significant competition as it implements its business strategy. The ability of the Company to effectively compete could be hindered by a lack of funds, poor positioning, management error, and other factors. The inability to effectively compete could adversely affect our business, financial condition and results of operations.

 

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The successful operation of the Company’s business will depend in part upon the supply of marijuana and marijuana infused products from third party, non-affiliated suppliers and any interruption in that supply could significantly harm our business, financial condition and results of operations.

 

In certain states within which the Company expects to operate, the supply of marijuana and marijuana infused products must by law be provided by third-party, non- affiliated suppliers. The failure of these suppliers to provide us with sufficient quantities or the proper quality of marijuana and marijuana infused products could damage the Company’s reputation and significantly harm our business, financial condition and results of operations.

 

Risks Related to Our Securities

 

The Series A Warrants contain a cashless exercise feature with the potential for a highly dilutive issuance of common stock, which could adversely affect the value of the common stock.

 

The Series A Warrants, became exercisable commencing January 23, 2016. The Series A warrants contain a cashless exercise feature that provides for the issuance of a number of shares of our common stock that increases as the trading market price of our common stock decreases. Series A warrants are exercised pursuant to a cashless exercise and the closing bid price of our common stock as of the two trading days prior to the time of such exercise and the Black Scholes Value The potential for such highly dilutive exercise of the Series A Warrants may depress the price of our common stock regardless of the Company’s business performance, and could encourage short selling by market participants, especially if the trading price of our common stock begins to decrease. In any such event, your investment will be adversely affected

 

The market price of our common stock has been and may continue to be volatile.

 

The market price of our common stock has been volatile, and fluctuates widely in price in response to various factors, which are beyond our control. The price of our common stock is not necessarily indicative of our operating performance or long-term business prospects. In addition, the securities markets have from time to time experienced significant price and volume fluctuations that are unrelated to the operating performance of particular companies. These market fluctuations may also materially and adversely affect the market price of our common stock. Factors such as the following could cause the market price of our common stock to fluctuate substantially:

 

· our quarterly operating and financial results;

 

· government regulation of our industry;

 

· the introduction of new products by our competitors;

 

· changing conditions in the electronic cigarette and tobacco industries; as well as the grocery business

 

· developments concerning proprietary rights; or

 

· litigation or public concern about the safety of our products.

 

The stock market in general experiences from time to time extreme price and volume fluctuations. Periodic and/or continuous market fluctuations could result in extreme volatility in the price of our common stock, which could cause a decline in the value of our common stock. Price volatility may be worse if the trading volume of our common stock is low.

 

The volatility in our common stock price may subject us to securities litigation.

 

The market for our common stock is characterized by significant price volatility, especially since the Series A Units separation in January 2016, when compared to seasoned issuers, and we expect that our share price will continue to be more volatile than a seasoned issuer for the indefinite future. In the past, plaintiffs have often initiated securities class action litigation against a company following periods of volatility in the market price of its securities. We may, in the future, be the target of similar litigation. Securities litigation could result in substantial costs and liabilities to us and could divert our management’s attention and resources from managing our operations and business.

 

Future sales of our common stock may depress our stock price.

 

As of March 20, 2017, we had approximately 19,643,675,411 shares of our common stock outstanding. If any significant number of these shares are sold, such sales could have a depressive effect on the market price of our stock. A significant number of shares of common stock are issuable pursuant to the Series A warrants and options, and any such sale of these shares may have a depressive effect as well. We are unable to predict the effect, if any, that the sale of shares, or the availability of shares for future sale, will have on the market price of the shares prevailing from time to time. Sales of substantial amounts of shares in the public market, or the perception that such sales could occur, could depress prevailing market prices for the shares. Such sales may also make it more difficult for us to sell equity securities or equity-related securities in the future at a time and price, which we deem appropriate.

 

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Costs incurred because we are a public company may affect our profitability.

 

As a public company, we incur significant legal, accounting, and other expenses, and we are subject to the SEC’s rules and regulations relating to public disclosure that generally involve a substantial expenditure of financial resources.  In addition, the Sarbanes-Oxley Act of 2002, as well as rules subsequently implemented by the SEC, requires changes in corporate governance practices of public companies.  We expect that full compliance with such rules and regulations will significantly increase our legal and financial compliance costs and make some activities more time-consuming and costly, which may negatively impact our financial results.  To the extent our earnings suffer as a result of the financial impact of our SEC reporting or compliance costs, our ability to develop an active trading market for our securities could be harmed.

 

There is currently a limited public trading market for our common stock and we cannot assure you that a more active public trading market for our common stock will develop or be sustained. Even if a market further develops, you may be unable to sell at or near ask prices or at all if you need to sell your shares to raise money or otherwise desire to liquidate your shares.

 

There is currently a limited public trading market for our common stock. The numbers of institutions or persons interested in purchasing our common stock at or near ask prices at any given time may be relatively small or nonexistent. This situation may be attributable to a number of factors, including the fact that we are a small company that is relatively unknown to stock analysts, stock brokers, institutional investors and others in the investment community that generate or influence sales volume. Even if we came to the attention of such persons, they tend to be risk averse and may be reluctant to follow a relatively unproven company such as ours or purchase or recommend the purchase of our shares until such time as we become more seasoned and viable. As a consequence, there may be periods of several days or more when trading activity in our shares is minimal or non-existent, as compared to a seasoned issuer which has a large and steady volume of trading activity that will generally support continuous sales without an adverse effect on share price. We cannot assure you that an active public trading market for our common stock will develop or be sustained.

 

We do not expect to pay dividends for the foreseeable future, and we may never pay dividends.

 

We currently intend to retain any future earnings to support the development and expansion of our business and do not anticipate paying cash dividends in the foreseeable future. Our payment of any future dividends will be at the discretion of our Board of Directors after taking into account various factors, including but not limited to, our financial condition, operating results, cash needs, growth plans and the terms of any credit agreements that we may be a party to at the time. In addition, our ability to pay dividends on our common stock may be limited by state law. Accordingly, investors must rely on sales of their common stock after price appreciation, which may never occur, as the only way to realize certain returns on their investment.

 

Our common stock may be considered a “penny stock,” and thereby be subject to additional sale and trading regulations that may make it more difficult to sell.

 

Our common stock is considered to be a “penny stock.” It does not qualify for one of the exemptions from the definition of “penny stock” under Section 3a51-1 of the Exchange Act. The principal result or effect of being designated a “penny stock” is that securities broker-dealers participating in sales of our common stock are subject to the “penny stock” regulations set forth in Rules 15-2 through 15g-9 promulgated under the Securities Exchange Act. For example, Rule 15g-2 requires broker-dealers dealing in penny stocks to provide potential investors with a document disclosing the risks of penny stocks and to obtain a manually signed and dated written receipt of the document at least two business days before effecting any transaction in a penny stock for the investor’s account. Moreover, Rule 15g-9 requires broker-dealers in penny stocks to approve the account of any investor for transactions in such stocks before selling any penny stock to that investor. This procedure requires the broker-dealer to (i) obtain from the investor information concerning his or her financial situation, investment experience and investment objectives; (ii) reasonably determine, based on that information, that transactions in penny stocks are suitable for the investor and that the investor has sufficient knowledge and experience as to be reasonably capable of evaluating the risks of penny stock transactions; (iii) provide the investor with a written statement setting forth the basis on which the broker-dealer made the determination in (ii) above; and (iv) receive a signed and dated copy of such statement from the investor, confirming that it accurately reflects the investor’s financial situation, investment experience and investment objectives. Compliance with these requirements may make it more difficult and time consuming for holders of our common stock to resell their shares to third parties or to otherwise dispose of them in the market or otherwise.

 

FINRA sales practice requirements may limit a stockholder’s ability to buy and sell our common shares.

 

In addition to the “penny stock” rules described above, FINRA has adopted rules that require that in recommending an investment to a customer, a broker-dealer must have reasonable grounds for believing that the investment is suitable for that customer. Prior to recommending speculative low priced securities to their non-institutional customers, broker-dealers must make reasonable efforts to obtain information about the customer’s financial status, tax status, investment objectives and other information. Under interpretations of these rules, FINRA believes that there is a high probability that speculative low priced securities will not be suitable for at least some

 

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customers. FINRA requirements make it more difficult for broker-dealers to recommend that their customers buy our common shares, which may limit your ability to buy and sell our stock and have an adverse effect on the market for our shares.

 

Our Board of Directors’ ability to issue undesignated preferred stock and the existence of anti-takeover provisions may depress the value of our common stock.

 

Our authorized capital includes 1,000,000 shares of preferred stock. Of this amount, all of such shares have been designated as Series A Convertible Preferred Stock and less than one share is issued and outstanding. Our Board of Directors has the power to issue any or all of the shares of undesignated preferred stock, including the authority to establish one or more series and to fix the powers, preferences, rights and limitations of such class or series, without seeking stockholder approval. Further, as a Delaware corporation, we are subject to provisions of the Delaware General Corporation Law regarding “business combinations.” We may, in the future, consider adopting additional anti-takeover measures. The authority of our Board of Directors to issue undesignated stock and the anti-takeover provisions of Delaware law, as well as any future anti-takeover measures adopted by us, may, in certain circumstances, delay, deter or prevent takeover attempts and other changes in control of the company not approved by our Board of Directors. As a result, our stockholders may lose opportunities to dispose of their shares at favorable prices generally available in takeover attempts or that may be available under a merger proposal and the market price, voting and other rights of the holders of common stock may also be affected.

 

Future sales and issuances of our common stock or rights to purchase common stock could result in additional dilution of the percentage ownership of our stockholders and could cause our share price to fall.

 

We also expect that additional capital will be needed in the future to continue our planned operations. To the extent that we raise additional capital by issuing equity securities, our stockholders may experience substantial dilution. We may sell common stock, convertible securities, or other equity securities in one or more transactions at prices and in a manner, we determine from time to time. If we sell common stock, convertible securities or other equity securities in more than one transaction, investors may be materially diluted by subsequent sales. Such sales may also result in material dilution to our existing stockholders, and new investors could gain rights superior to our existing stockholders. In addition, in the past, we have issued warrants to acquire shares of common stock. To the extent these warrants are ultimately exercised, further dilution will be sustained.

 

If we fail to maintain an effective system of internal control over financial reporting, we may not be able to accurately report our financial results. As a result, we could become subject to sanctions or investigations by regulatory authorities and/or stockholder litigation, which could harm our business and have an adverse effect on our stock price.

 

As a public reporting company, we are required to comply with the Sarbanes-Oxley Act of 2002 and the related rules and regulations of the SEC, including periodic reports, disclosures and more complex accounting rules. As directed by Section 404 of Sarbanes-Oxley, the SEC adopted rules requiring public companies to include a report of management on a company’s internal control over financial reporting in their Annual Report on Form 10-K. Based on current rules, we are required to report under Section 404(a) of Sarbanes-Oxley regarding the effectiveness of our internal control over financial reporting. If we were to determine that we have material weaknesses, it may be necessary to make restatements of our consolidated financial statements and investors will not be able to rely on the completeness and accuracy of the financial information contained in our filings with the SEC and this could potentially subject us to sanctions or investigations by the SEC or other regulatory authorities or stockholder litigation.

 

Item 7A. Quantitative and Qualitative Disclosures About Market Risk.

 

Not applicable to smaller reporting companies.

 

Item 8. Financial Statements and Supplementary Data.

 

See pages F-1 through F-36.

 

Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.

 

The Audit Committee of the Company recently completed a competitive process to determine what firm would serve as the Company’s independent registered public accounting firm for the year ended December 31, 2016. On December 29, 2016, the Audit Committee determined to dismiss Marcum LLP (“Marcum”) as the Company’s independent registered public accounting firm effective immediately.

 

During the year ended December 31, 2015, and through December 29, 2016, there were no (a) disagreements with Marcum on any matter of accounting principles or practices, financial statement disclosure, or auditing scope or procedure, which disagreements,

 

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if not resolved to Marcum’s satisfaction, would have caused Marcum to make reference to the subject matter thereof in connection with its reports for such years; or (b) reportable events, as described under Item 304(a)(1)(v) of Regulation S-K.

 

Item 9A. Controls and Procedures.

 

Evaluation of Disclosure Controls and Procedures . Our management carried out an evaluation, with the participation of our Principal Executive Officer and Principal Financial Officer, of the effectiveness of our disclosure controls and procedures as defined in Rule 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, or the Exchange Act. Based on their evaluation, our Principal Executive Officer and Principal Financial Officer concluded that our disclosure controls and procedures were effective as of the end of the period covered by this report.

 

Management’s Annual Report on Internal Control over Financial Reporting . Our management is responsible for establishing and maintaining adequate internal control over financial reporting (as defined in Rule 13a-15(f) and 15d-15(f) under the Exchange Act). Our management, under the supervision and with the participation of our Principal Executive Officer and Principal Financial Officer, evaluated the effectiveness of our internal control over financial reporting as of the end of the period covered by this report. In making this assessment, our management used the criteria set forth by the Committee of Sponsor Organizations of the Treadway Commission (COSO) in  Internal Control-Integrated Framework  (2013 framework) .  Based on that evaluation, our management concluded that our internal control over financial reporting was effective as of the end of the period covered by this report based on that criteria.

 

Our internal control over financial reporting is a process designed under the supervision of our Principal Executive Officer and Principal Financial Officer to provide reasonable assurance regarding the reliability of financial reporting and the preparation of our financial statements for external purposes in accordance with generally accepted accounting principles, or GAAP. Internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of our assets; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with GAAP, and that receipts and expenditures are being made only in accordance with authorizations of our management and directors; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of our assets that could have a material effect on the financial statements.

 

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with policies or procedures may deteriorate.

 

Changes in Internal Control over Financial Reporting . There were no changes in our internal control over financial reporting during the period covered by this report that have materially affected, or are reasonably likely to materially affect our internal control over financial reporting.

 

No Attestation Report of Registered Public Accounting Firm

 

This Annual Report does not contain an attestation report of our independent registered public accounting firm regarding internal control over financial reporting since the rules for smaller reporting companies provide for this exemption.

 

Item 9B. Other Information.

 

None.

 

PART III

 

Item 10. Directors, Executive Officers and Corporate Governance

 

Directors and Executive Officers

 

The following table sets forth information regarding our executive officers and directors as of March 20, 2017:

 

Name   Age   Position
Executive Officers:        
Jeffrey Holman   50   Chief Executive Officer, Chairman and Director
John A. Ollet   54   Chief Financial Officer
Christopher Santi   46   President and Chief Operating Officer

 

  42

 

 

Non-Employee Directors:        
Clifford J. Friedman   55   Director
Dr. Anthony Panariello   57   Director

 

Executive Officers

 

Jeffrey Holman has been our Chairman of the Board and Chief Executive Officer since April 2014. From February 2013 until March 4, 2015, Mr. Holman serviced as our President. Mr. Holman has been a member of our Board since May 2013 and has served as a member of the Board of Directors of our subsidiary Smoke Anywhere, USA since its inception on March 24, 2008. Since 1998, Mr. Holman has been the President of Jeffrey E. Holman & Associates, P.A., a South Florida based law firm. He has also been a Partner in the law firm of Holman, Cohen & Valencia since 2000. Mr. Holman was selected as a director for his business and legal experience. In addition, as one of the founders of Smoke Anywhere, Mr. Holman possesses an in-depth understanding of the challenges, risks and characteristics unique to our industry.

 

Christopher Santi has been our Chief Operating Officer since December 12, 2012 and has served as the President and Chief Operating Officer since April 11, 2016. Prior to that Mr. Santi served as Director of Operations of the Company beginning in October 2011. Mr. Santi served as the National Sales Manager of Collages.net from November 2007 to October 2011.

 

John A. Ollet has been our Chief Financial Officer since December 12, 2016. Mr. Ollet previously served as Executive Vice President-Finance for Systemax, Inc. (NYSE:SYX) from 2006 to 2016. His prior chief financial officer experience also includes serving as Vice President and Chief Financial Officer of Arrow Cargo Holdings, Inc., an airline logistics company, and VP Finance /CFO - The Americas - Cargo Division, KLM Royal Dutch Airlines, an airline company. He also previously served as Vice President Finance/Administration at Sterling-Starr Maritime Group, Inc. and served on the audit staff of Arthur Andersen & Co. Mr. Ollet received a bachelor’s degree in Finance/Economics and a master’s degree in business administration from Florida International University. Mr. Ollet is a Certified Public Accountant.

 

Non-Employee Directors

 

Anthony Panariello, M.D .  has been a director since April 15, 2016. Dr. Panariello is Board Certifed in Pulmonology and Internal Medicine in Florida and has been in private practice since 1996, serving as an attending physician at a number of hospitals.  Dr. Panariello is a member of the College of Physicians and the American College of Chest Physicians.  Additionally, Dr. Panariello currently serves as a Lieutenant Commander in the Medical Corps of the United States Navy Reserve.  Dr. Panariello received his Bachelor of Science from the State University of New York at Stony Brook and his medical degree from the Autonomous University of Guadalajara.

   

Clifford J. Friedman has been a director since April 15, 2016. Mr. Friedman is a certified public accountant in Coral Springs, Florida and managed his own public accounting, tax and consulting practice since 2001. From 1992 to 2000, Mr. Friedman was Vice President-Finance of Administration of the Box Worldwide, Inc., a Viacom company. He received an M.B.A. from Nova Southeastern University and his B.B.A. from Pace University.

 

Corporate Governance

 

Board Responsibilities

 

The Board oversees, counsels, and directs management in the long-term interest of the Company and its stockholders. The Board’s responsibilities include establishing broad corporate policies and reviewing the overall performance of the Company. The Board is not, however, involved in the operating details on a day-to-day basis.

 

Board Committees and Charters

 

The Board and its Committees meet throughout the year and act by written consent from time-to-time as appropriate. The Board delegates various responsibilities and authority to different Board Committees. Committees regularly report on their activities and actions to the Board.

 

The Board currently has and appoints the members of: The Audit Committee, the Compensation Committee and the Nominating and Corporate Governance Committee. Each of these committees have a written charter which can be found on our corporate website at www.healthiercmc.com/committee-charters/ .

 

The following table identifies the independent and non-independent current Board and committee members:

 

  43

 

Name   Independent   Audit   Compensation   Nominating
And Corporate
Governance
Jeffrey Holman                
Dr. Anthony Panariello   X   X   X   X
Clifford J. Friedman   X   X   X   X

 

Director Independence

 

Our Board has determined that Clifford J. Friedman and Dr. Anthony Panariello are independent in accordance with standards under the OTC Pink Marketplace. Our Board determined that as a result of being executive officer, Messrs. Jeffrey Holman is not independent under the OTC Pink Marketplace Bulletin Boards. Our Board has also determined that Clifford J. Friedman and Dr. Anthony Panariello are independent under the OTC Pink Marketplace independence standards for Audit and Compensation Committee members.

 

Committees of the Board

 

Audit Committee

 

The Audit Committee, which currently consists of Clifford J. Friedman (chair) and Dr. Anthony Panariello, reviews the Company’s financial reporting process on behalf of the Board and administers our engagement of the independent registered public accounting firm. The Audit Committee approves all audit and non-audit services, and reviews the independence of our independent registered public accounting firm.

 

Audit Committee Financial Expert

 

Our Board has determined that Clifford J. Friedman is qualified as an Audit Committee Financial Expert, as that term is defined by the rules of the SEC and in compliance with the Sarbanes-Oxley Act of 2002.

 

Compensation Committee

 

The function of the Compensation Committee is to determine the compensation of our executive officers. The Compensation Committee has the power to set performance targets for determining periodic bonuses payable to executive officers and may review and make recommendations with respect to stockholder proposals related to compensation matters. Additionally, the Compensation Committee is responsible for administering the Company’s equity compensation plans including the Plan.

 

The members of the Compensation Committee are all independent directors within the meaning of applicable Nasdaq Listing Rules and all of the members are “non-employee directors” within the meaning of Rule 16b-3 under the Exchange Act.

 

Nominating and Corporate Governance Committee

 

The responsibilities of the Nominating and Corporate Governance Committee include the identification of individuals qualified to become Board members, the selection of nominees to stand for election as directors, the oversight of the selection and composition of committees of the Board, establish procedures for the nomination process including procedures and the oversight of the evaluations of the Board and management. The Nominating and Corporate Governance Committee has not established a policy with regard to the consideration of any candidates recommended by stockholders since no stockholders have made any recommendations. If we receive any stockholder recommended nominations, the Nominating Committee will carefully review the recommendation(s) and consider such recommendation(s) in good faith.

 

Compensation Committee Interlocks and Insider Participation

 

None of the members of our compensation committee has ever been an officer or employee of the Company. None of our executive officers serve, or have served during the last fiscal year, as a member of our compensation committee or other Board committee performing equivalent functions of any entity that has one or more executive officers serving on our Board or on our compensation committee.

 

  44

 

Board Assessment of Risk

 

The Board is actively involved in the oversight of risks that could affect the Company. This oversight is conducted primarily through the Audit Committee, but the full Board has retained responsibility for general oversight of risks. The Audit Committee considers and reviews with our independent public accounting firm and management the adequacy of our internal controls, including the processes for identifying significant risks and exposures, and elicits recommendations for the improvements of such procedures where desirable. In addition to the Audit Committee’s role, the full Board is involved in oversight and administration of risk and risk management practices. Members of our senior management have day-to-day responsibility for risk management and establishing risk management practices, and members of management are expected to report matters relating specifically to the Audit Committee directly thereto, and to report all other matters directly to the Board as a whole. Members of our senior management have an open line of communication to the Board and have the discretion to raise issues from time-to-time in any manner they deem appropriate, and management’s reporting on issues relating to risk management typically occurs through direct communication with directors or committee members as matters requiring attention arise. Members of our senior management regularly attend portions of the Board’s meetings, and often discuss the risks related to our business.

 

Presently, the largest risks affecting the Company are the Company’s ability to manage and satisfy the Series A Warrant obligations and evaluation of potential adverse impact of the FDA’s final regulations on vaporizers and e-liquids on the retail business operations. The Board actively interfaces with management on seeking solutions.

 

Code of Ethics

 

The Company has a code of ethics, “Business Conduct: “Code of Conduct and Policy,” that applies to all of the Company’s employees, including its principal executive officer, principal financial officer and principal accounting officer, and the Board. A copy of this code is available on the Company’s website at www.vapor-corp.com. The Company intends to disclose any changes in or waivers from its code of ethics by posting such information on its website or by filing a Current Report on Form 8-K.

 

Stockholder Communications

 

Although we do not have a formal policy regarding communications with our Board, stockholders may communicate with the Board by writing to us at Healthier Choices Management Corp., 3800 N 28th Way, Hollywood, FL 33020, Attention: Corporate Secretary, or by facsimile (954) 367-6306.  Stockholders who would like their submission directed to a member of the Board may so specify, and the communication will be forwarded, as appropriate.

 

Section 16(a) Beneficial Ownership Reporting Compliance

 

Section 16(a) of the Exchange Act requires our officers and directors, and persons who own more than 10% of a registered class of our equity securities, to file with the SEC initial reports of ownership and reports of changes in ownership of common stock and the other equity securities. Officers, directors and greater than ten percent stockholders are required by SEC rules to furnish us with copies of all Section 16(a) reports they file.

 

Based solely on a review of the reports furnished to us, or written representations from reporting persons that all reportable transactions were reported and that no Form 5s were required, we believe that during 2016 our officers, directors and greater than 10% owners timely filed all reports they were required to file under Section 16(a).

 

ITEM 11. Executive Compensation

 

The following information is related to the compensation paid, distributed or accrued by us for fiscal 2016 and 2015 to all Chief Executive Officers (principal executive officers) serving during the last fiscal year and the two other most highly compensated executive officers serving at the end of the last fiscal year whose compensation exceeded $100,000. We refer to these individuals as our “named executive officers.”

 

  45

 

Summary Compensation Table

 

Name and
Principal Position 		  Year   Salary
($) 		    Bonus
($) 		    Stock
Awards
($)(1) 		    Option
Awards 		    All
Other
Compensation
($) 		    Total  
                                         
Jeffrey Holman   2016     312,346       100,000       -       -       -       412,346  
Chief Executive Officer   2015     226,624       100,000       -       -       -       326,624  
                                                     
Christopher Santi   2016     209,117       50,000       -       -       -       259,119  
President & Chief Operating Officer   2015     179,505       10,000       104,000       -       -       293,505  
                                                     
Gina Hicks   2016     197,117       -       -       -       45,133       242,250  
Former Chief Financial Officer   2015     -       -       -       -       -       -  

 

(1)   Amounts reflect the aggregate grant date fair value, without regard to forfeitures, computed in accordance with ASC 718. These amounts represent awards of the Company’s common stock and do not reflect the actual amounts that may be realized by the Named Executive Officers. Our assumptions with respect to the calculation of the stock award value are set forth in Note 2 to the consolidated financial statements contained herein.

 

Named Executive Officer Employment Agreements

 

On August 10, 2015, the Company entered into three-year Employment Agreements with Jeffrey Holman, the Company’s Chief Executive Officer, and Gregory Brauser, the Company’s President. Each of the Employment Agreements provide for an annual base salary of $300,000 and a target bonus in an amount ranging from 20% to 200% of their base salaries subject to the Company meeting certain adjusted earnings before interest, taxes depreciation and amortization (“Adjusted EBITDA”) performance milestones. Adjusted EBITDA is defined in the Employment Agreements as earnings (loss) from continuing operations before interest expense, income taxes, collateral valuation adjustment, bad debt expense, one-time expenses, depreciation and amortization and amortization of stock compensation or Adjusted EBITDA defined in any filing of the Company with the SEC subsequent to the date of the Employment Agreements. Additionally, the Company approved and paid a bonus of $100,000 to each of Mr. Holman and Mr. Brauser in August 2015. Messrs. Holman and Brauser are also entitled to receive severance payments, including two years of their then base salary and other benefits in the event of a change of control, termination by the Company without cause, termination for good reason by the executive or non-renewal by the Company.

 

Effective December 12, 2012, the Company entered into a three-year employment agreement with Christopher Santi, the Company’s President and Chief Operating Officer. The employment agreement paid a beginning base salary of $156,000 which increased to $170,000 beginning in December 2016. In accordance with this employment agreement, Mr. Santi received a 10-year option to purchase up to 57 shares of the Company’s common stock at an exercise price of $437.50, vesting monthly at the rate of approximately 2 shares per month. As of the date of this report, the options are fully vested. On January 30, 2017, the Company entered into a new employment agreement with Mr. Santi for a three-year term beginning January 30, 2017. Pursuant to the new employment agreement, Mr. Santi will receive a base salary of $225,000, increasing to $250,000 and $275,000, respectively, for the second and third years of the employment agreement. Mr. Santi is also eligible to earn an annual bonus at the discretion of the Company’s Board of Directors.

 

Termination Provisions

 

The table below describes the severance payments that our Named Executive Officers are entitled to in connection with a termination of their employment upon death, disability, dismissal without cause, Change of Control or for Good Reason. All of the termination provisions are intended to comply with Section 409A of the Internal Revenue Code of 1986 and the Regulations thereunder.

 

   

Holman

 

Santi

Death or Total Disability   Any amounts due at time of termination plus full vesting of equity awards   Any amounts due at time of termination
         
Dismissal Without Cause or Termination by Executive for Good Reason or upon a Change of Control (1)   Two years of Base Salary, full vesting of equity awards, benefit continuation for eighteen months plus pro-rated bonus if, any, that would have been earned for the fiscal year in which the termination occurs   Fifteen months of Base Salary plus one additional month for every additional four months of service, up to eighteen months’ maximum

  

  46

 

Termination upon a Change of Control (2)   Two years of Base Salary, full vesting of equity awards, benefit continuation for eighteen months plus pro-rated bonus if, any, that would have been earned for the fiscal year in which the termination occurs   Eighteen months of Base Salary

 

(1) Good reason is generally (with certain exceptions) defined, in the case of Holman, as (i) a material diminution in their authority, duties or responsibilities, (y) the Company failing to maintain an office in the stated area or (ii) any other action or inaction that constitutes a material breach by the Company of the Employment Agreement. Mr. Santi’s employment agreement does not include the concept of good reason.

 

(2) Change of Control is generally defined (i) in the case of Holman, as any Change of Control Event as defined in Treasury Regulation Section 1.409A-3(i)(5); and (ii) in the case of Santi, as (w) a sale of substantially all of the Company, (x) any “person” (as such term is defined under the Exchange Act) becomes the beneficial owners of over 50% of the Company’s voting power, (y) a change in the majority of the composition of the Board or (z) a transaction that results in over 50% of the Company’s voting power ceasing to hold a majority of the voting power post-transaction.

 

Risk Assessment Regarding Compensation Policies and Practices as they Relate to Risk Management

 

Our compensation program for employees does not create incentives for excessive risk taking by our employees or involve risks that are reasonably likely to have a material adverse effect on us. Our compensation has the following risk-limiting characteristics:

 

· Our base pay programs consist of competitive salary rates that represent a reasonable portion of total compensation and provide a reliable level of income on a regular basis, which decreases incentive on the part of our executives to take unnecessary or imprudent risks; and

 

· Cash bonus awards are not tied to formulas that could focus executives on specific short-term outcomes;

 

Outstanding Awards at Fiscal Year End

 

Listed below is information with respect to unexercised options that have not vested, and equity incentive plan awards for each named executive officer outstanding as of December 31, 2016:

 

Outstanding Equity Awards at 2016 Fiscal Year-End

 

Name   Number of
Securities
Underlying
Unexercised
Options (#)
Exercisable 		    Number of
Securities
Underlying
Unexercised
Options
(#)
Exercisable 		    Equity
Incentive
Plan
Awards:
Number of
Securities
Underlying
Unexercised
Unearned
Options
(#) 		    Option
Exercise
Price
($) 		    Option
Expiration
Date 		    Number
of
Shares
or
Units of
Stock
That
Have
Not
Vested
(#) 		    Market
Value
of
Shares
or
Units
of
Stock
That
Have
Not
Vested
($) 		   

Equity

Incentive
Plan
Awards:
Number
of
Unearned
Shares,
Units or
Other
Rights
That
Have
Not
Vested
(#)

   

Equity
Incentive
Plan
Awards:
Market
or
Payout
Value of
Unearned
Shares,
Units or
Other
Rights
That
Have
Not

Vested
(#)

 
Christopher Santi     1       -       -       0.02       3/29/22       -       -       -       -  

 

  47

 

Director Compensation

 

Non-employee directors are paid a monthly fee of $1,000 per month and $1,000 for each meeting attended. Because we do not pay any compensation to employee directors, Messrs. Holman and Brauser are omitted from the following table. Non-employee members of our Board of Directors were compensated for as follows:

 

Fiscal 2016 Director Compensation

 

Name   Fees
Earned or
Paid in Cash
($) 		    Total
($) 		 
             
William Conway III (1)     9,500       9,500  
Daniel MacLauchlan (1)     9,500       9,500  
Nikhil Raman (1)     6,500       6,500  
Dr. Anthony Panariello     13,000       13,000  
Clifford J. Friedman     17,000       17,000  

 

(1) Resigned as a director in 2016.

 

Equity Compensation Plan Information

 

The 2015 Equity Incentive Plan (the “Plan”) was approved by the Company’s stockholders at the June 26, 2015 stockholders meeting. On November 21, 2016, the Company’s Board of Directors increased the number of shares of common stock available for issuance pursuant to the Plan to 100,000,000,000. The Plan is a broad-based plan in which all employees, consultants, officers, and directors of the Company are eligible to participate. The purpose of the Plan is to further the growth and development of the Company by providing, through ownership of stock of the Company and other equity-based awards, an incentive to its officers and other key employees and consultants who are in a position to contribute materially to the prosperity of the Company, to increase such persons’ interests in the Company’s welfare, by encouraging them to continue their services to the Company, and by enabling the Company to attract individuals of outstanding ability to become employees, consultants, officers and directors of the Company.

 

The following chart reflects the number of awards granted under equity compensation plans approved and not approved by stockholders and the weighted average exercise price for such plans as of December 31, 2016.

 

Name of Plan   Number of
securities
to be issued
upon
exercise of
outstanding
options,
warrants and
rights
(a) 		    Weighted
average
exercise price
of outstanding
options,
warrants and
rights
(b) 		    Number of
securities
remaining
available for
future issuance
under equity
compensation
plans
(excluding
securities
reflected in
column (a))
(c) 		 
Equity compensation plans approved by security holders                        
2009 Equity Incentive Plan     0.011     $ 20,506,610       0  
2015 Equity Incentive Plan    

5,001,000,004

      0.0001      

94,998,999,996

 
Total     5,001,000,004               94,998,999,996  

 

  48

 

Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholders Matters.

 

The following table sets forth the number of shares of our common stock beneficially owned as of March 20, 2017, by (i) those persons known by us to be owners of more than 5% of our common stock, (ii) each director, (iii) our Named Executive Officers and (iv) all of our executive officers and directors of as a group. Unless otherwise specified in the notes to this table, the address for each person is: c/o Healthier Choices Management Corp., 3800 North 28th Way, Hollywood, Florida 33020.

 

Title of Class   Beneficial Owner  

Amount and
Nature of Beneficial
Owner (1)

   

Percent of
Class (1)

 
Directors and Executive Officers:                    
Common Stock   Jeffrey E. Holman (2)     4,711,732,180       19.99 %
Common Stock   Christopher Santi (3)     4,711,732,180       19.99 %
Common Stock   Gina Hicks (4)     2,969       *
Common Stock   Dr. Anthony Panariello (5)     500,000,000       2.62 %
Common Stock   Clifford J. Friedman (6)     500,000,000       2.62 %
    All directors and officers as a group (6 persons) (7)     10,423,467,329       55.13 %  
                     
5% Stockholders:                    
None         0       0 %
Total:         10,423,467,329       53.06 %

 

* Less than 1%.

 

(1) Beneficial Ownership. Applicable percentages are based on 19,643,675,411 shares of common stock outstanding as of March 20, 2017, Beneficial ownership is determined under the rules of the SEC and generally includes voting or investment power with respect to securities. Shares of common stock subject to options, warrants, convertible notes and preferred stock currently exercisable or convertible or exercisable or convertible within 60 days are deemed outstanding for computing the percentage of the person holding such securities but are not deemed outstanding for computing the percentage of any other person. The table includes shares of common stock, options, warrants, and preferred stock exercisable or convertible into common stock and vested or vesting within 60 days. Unless otherwise indicated in the footnotes to this table, we believe that each of the stockholders named in the table has sole voting and investment power with respect to the shares of common stock indicated as beneficially owned by them. The table does not include: (i) restricted stock units that do not have the right to vote until they vest and the shares are delivered or (ii) unvested options that do not vest within 60 days of the date listed above in this footnote.

 

(2) Holman. Chairman and Chief Executive Officer. The option agreement includes a provision that prevents Mr. Holman from exercising the option into common stock to the extent (but only to the extent) that such conversion would result in the holder, or any of its affiliates, beneficially owning (as determined in accordance with Section 13(d) of the Securities Exchange Act of 1934, as amended, and the rules and regulations promulgated thereunder) more than 19.9% of the Company’s outstanding Common Stock (the “Exercise Blocker”). Without the Exercise Blocker, Mr. Holman would be deemed to beneficially own 25,000,000,000 shares of Common Stock pursuant to vested options.

 

(3) Santi. Santi and Chief Operation Officer. The option agreement of Mr. Santiu includes the Exercise Blocker. Without the Exercise Blocker, Mr. Santi would be deemed to beneficially own 12,500,000,000 shares of Common Stock pursuant to vested options.

 

(4) Hicks. A former officer.

 

(5) Panariello. A director. Includes 500,000,000 vested options.

 

(6) Friedman. A director. Includes 500,000,000 vested options.

 

(7) Directors and Executive Officers. Includes executive officers who are not Named Executive Officers under the SEC’s rules and regulations.

 

Item 13. Certain Relationships and Related Transactions, and Director Independence.

 

During 2015, the Company purchases, at rates comparable to market rates, e-liquids sold in its retail stores and wholesale operations, respectively from Liquid Science, Inc., a company in which Jeffrey Holman (the Company’s Chief Executive Officer), Gregory Brauser

 

  49

 

(the Company’s former President) and Michael Brauser each had a 15% beneficial ownership interest. During 2016, the Company made approximately 23% of its purchases of e-liquid from Liquid Science, which purchases equaled $356,000 in the aggregate. In 2016, the Company received approximately $94,000 in royalty income from Liquid Science related to the use of the Company trademark. In April 2016, Mr. Holman sold all of his interest in Liquid Science.

 

Policies and Procedures for Related Party Transactions

 

We have adopted a policy that our executive officers, directors, nominees for election as a director, beneficial owners of more than 5% of any class of our common stock and any members of the immediate family of any of the foregoing persons are not permitted to enter into a related person transaction with us without the prior consent of our audit committee. Our audit committee will review and oversee all transactions with an executive officer, director, nominee for election as a director, beneficial owner of more than 5% of any class of our common stock or any member of the immediate family of any of the foregoing persons and such person would have a direct or indirect interest. In approving or rejecting any such transactions, our audit committee is to consider the material facts of the transaction, including, but not limited to, whether the transaction is on terms no less favorable than terms generally available to an unaffiliated third party under the same or similar circumstances and the extent of the related person’s interest in the transaction.

 

Item 14. Principal Accounting Fees and Services.

 

Our Audit Committee pre-approves audit and permissible non-audit services performed by its independent registered public accounting firm, as well as the fees charged for such services.   All of the services related to audit fees and audit-related fees charged by Marcum LLP, if any, were pre-approved by the Audit Committee.  The following table shows the fees for the years ended December 31, 2016 and 2015.

 

    2016
($) 		    2015
($) 		 
Audit Fees (1)   $ 364,929     $ 330,590  
Audit Related Fees     15,126       16,000  
All Other Fees                 
Total   $ 380,055     $ 346,590  

 

(1) Audit fees — these fees relate to the audit of our annual financial statements and the review of our interim quarterly financial statements and our registration statements.

 

  50

 

PART IV

 

Item 15. Exhibits, Financial Statement Schedules.

 

(a) Documents filed as part of the report.

 

(1) Financial Statements.  See Index to Consolidated Financial Statements, which appears on page F-1 hereof.  The financial statements listed in the accompanying Index to Consolidated Financial Statements are filed herewith in response to this Item.

 

(2) Financial Statements Schedules.  All schedules are omitted because they are not applicable or because the required information is contained in the consolidated financial statements or notes included in this report.

 

(3) Exhibits. The exhibits listed in the accompanying Exhibit Index are filed or incorporated by reference as part of this report.

 

  51

 

FINANCIAL STATEMENT INDEX

 

Report of Morrison, Brown, Argiz & Farra, LLC

F-2
   
Report of Marcum LLP, Independent Registered Public Accounting Firm F-3
   
Financial Statements F-4
   
Consolidated Balance Sheets as of December 31, 2016, and 2015 F-4
   
Consolidated Statements of Operations for the Years Ended December 31, 2016 and 2015 F-5
   
Consolidated Statements of Changes in Stockholders’ Equity (Deficit) for the Years Ended December 31, 2016 and 2015 F-6
   
Consolidated Statements of Cash Flows for the Years Ended December 31, 2016 and 2015 F-7
   
Notes to Consolidated Financial Statements F-9

 

  F- 1  
 

 

 

  

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

 

To the Audit Committee of the
Board of Directors and Stockholders
of Healthier Choices Management Corp. (f/k/a Vapor Corp.)

 

We have audited the accompanying consolidated balance sheet of Healthier Choice Management Corp. (formerly known as Vapor Corp.) (the “Company”)  as of December 31, 2016, and the related consolidated statements of operations, changes in stockholders’ (deficit) equity, and cash flows for the year then ended. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audit.

 

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.

 

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Healthier Choice Management Corp. as of December 31, 2016, and the results of its operations and its cash flows for the year then ended in conformity with accounting principles generally accepted in the United States of America.

 

The Company has adjusted its 2015 consolidated financial statements to retrospectively apply the change in accounting related to the one-for-twenty thousand reverse split described in Note 11 and the presentation of discontinued operations as described in Note 3 to the consolidated financial statements. Other auditors reported on the consolidated financial statements before the retrospective adjustment. We also audited the adjustments to the 2015 consolidated financial statements to retrospectively apply the change in accounting as described in Notes 11 and 3. In our opinion, such adjustments are appropriate and have been properly applied. We were not engaged to audit, review, or apply any procedures to the Company's 2015 consolidated financial statements other than with respect to the adjustments and, accordingly, we do not express an opinion or any other form of assurance on the 2015 consolidated financial statements as a whole.

 

Morrison, Brown, Argiz & Farra, LLC
Miami, FL
March 23, 2017

 

 

  F- 2  
 

 

 

  

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

 

To the Audit Committee of the

Board of Directors and Stockholders

of Healthier Choices Management Corp. (f/k/a Vapor Corp.)

 

We have audited the accompanying consolidated balance sheet of Healthier Choices Management Corp. (f/k/a Vapor Corp.) (the “Company”) as of December 31, 2015, and the related consolidated statements of operations, changes in stockholders’ deficit and cash flows for the year then ended before the effects of the adjustments to retrospectively apply the effects of the one-for-twenty thousand reverse stock split described in Note 11 and the presentation of discontinued operations as described in Note 3. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audit.

 

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provide a reasonable basis for our opinion.

 

In our opinion, before the effects of the adjustments to retrospectively apply the effects of the one-for-twenty thousand reverse stock split described in Note 11 and the presentation of discontinued operations as described in Note 3, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Healthier Choices Management Corp. (f/k/a Vapor Corp.) as of December 31, 2015, and the consolidated results of its operations and its cash flows for the year then ended in conformity with accounting principles generally accepted in the United States of America.

 

The accompanying financial statements have been prepared assuming that the Company will continue as a going concern. As more fully discussed in Note 1 to the financial statements, the Company has incurred net losses and needs to raise additional funds to meet its obligations and sustain its operations. In addition, the Company currently does not have enough authorized common shares to settle all of its outstanding warrants if such warrants were exercised pursuant to their cashless exercise provisions. As a result, the Company could be required to settle a portion of these warrants with cash. These conditions raise substantial doubt about the Company’s ability to continue as a going concern. Management’s plans in regard to these matters are also described in Note 1. The financial statements do not include any adjustments that might result from the outcome of this uncertainty.

 

We were not engaged to audit, review or apply any procedures to the adjustments to retrospectively apply the change in accounting related to the one-for-twenty thousand reverse stock split described in Note 11 and the presentation of discontinued operations as described in Note 3, accordingly, we do not express an opinion or any other form of assurance about whether such adjustments are appropriate and have been properly applied. Those adjustments were audited by Morrison, Brown, Argiz, & Farra, LLC.

 

/s/ Marcum LLP

 

Marcum LLP
New York, NY
April 8, 2016

 

 

 

  F- 3  
 

  

HEALTHIER CHOICES MANAGEMENT CORP.
CONSOLIDATED BALANCE SHEETS

  

    December 31, 2016     December 31, 2015  
             
ASSETS                
CURRENT ASSETS                
Cash and cash equivalents   $ 13,366,272     $ 27,214,991  
Due from merchant credit card processor, net of reserves     30,272       9,475  
Accounts receivable, net of allowance $ 33,367 and $76,694     25,798       105,992  
Inventories     748,551       946,799  
Prepaid expenses and vendor deposits     93,229       255,599  
Current assets from discontinued operations     52,903       1,033,514  
TOTAL CURRENT ASSETS     14,317,025       29,566,370  
                 
Property and equipment, net of accumulated depreciation of $293,398 and $211,824 respectively     638,926       410,277  
Intangible assets, net of accumulated amortization of $130,171 and $126,000, respectively     1,669,329       929,000  
Goodwill     481,314       3,177,017  
Other assets     128,157       165,198  
                 
TOTAL ASSETS   $ 17,234,751     $ 34,247,862  
                 
LIABILITIES AND STOCKHOLDERS’ EQUITY (DEFICIT)                
                 
CURRENT LIABILITIES:                
Accounts payable   $ 520,586     $ 394,723  
Accrued expenses     779,676       1,225,632  
Current portion of capital lease     53,054       60,871  
Derivative liabilities - non consenting warrants     955,173       41,089,580  
Derivative liabilities - consenting warrants     11,912,906       -  
Current liabilities from discontinued operations     555,810       4,002,691  
TOTAL CURRENT LIABILITIES     14,777,205       46,773,497  
                 
Capital lease, net of current portion     -       58,572  
TOTAL LIABILITIES     14,777,205       46,832,069  
                 
COMMITMENTS AND CONTINGENCIES (SEE NOTE 10)                
                 
STOCKHOLDERS’ EQUITY (DEFICIT)                
Series A convertible preferred stock, $.001 par value, 1,000,000 shares authorized and designated, 0 and 1 share issued and outstanding, respectively, no liquidation value     -       -  
Common stock, $.0001 par value, 750,000,000,000 shares authorized, 14,213,861,174 issued and outstanding as of December 31, 2016 and 6 issued and outstanding as of December 31, 2015     1,421,386       -  
Additional paid-in capital     3,782,818       846,943  
Accumulated deficit     (2,746,658 )     (13,431,150 )
TOTAL STOCKHOLDERS’ EQUITY (DEFICIT)     2,457,546     (12,584,207 )
                 
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY (DEFICIT)   $ 17,234,751     $ 34,247,862  

 

See notes to consolidated financial statements

  F- 4  
 

  

HEALTHIER CHOICES MANAGEMENT CORP. 

CONSOLIDATED STATEMENTS OF OPERATIONS

 

    For the Year Ended
December 31, 		 
    2016     2015  
SALES:                
Vapor sales, net   $ 6,722,052     $ 5,252,611  
Grocery sales, net     3,843,111       -  
Total Sales     10,565,163       5,252,611  
Cost of sales vapor     2,979,609       2,172,447  
Cost of sales grocery     2,352,201       -  
GROSS PROFIT     5,233,353       3,080,164  
                 
EXPENSES:                
Advertising     92,124       120,831  
Selling, general and administrative     9,700,479       9,374,349  
Impairment of goodwill and intangible assets     3,955,362       15,403,833  
Retail store and kiosk closing costs     347,656       729,468  
Total operating expenses     14,095,621       25,628,481  
Operating loss     (8,862,268 )     (22,548,317 )
                 
OTHER INCOME (EXPENSES):                
Amortization of debt discounts     21,599       (833,035 )
Amortization of deferred financing costs     -       (144,903 )
Gain on warrant repurchases     5,189,484       -  
Loss on debt extinguishment     -       (1,497,169 )
Cost associated with underwriting offering     -       (5,279,003 )
Non-cash change in fair value of derivative liabilities     15,255,143     42,221,418  
Stock-based expense in connection with waiver agreements     -       (3,748,062 )
Other income     640,000       -  
Interest income     45,723       19,323  
Interest expense     (15,386 )     (108,356 )
Interest expense-related party     -       (80,545 )
Total other income (expense)     21,136,563     30,549,668  
Net income (loss) from continuing operations     12,274,295     8,001,351  
Net income (loss) from discontinued operations     (1,589,803 )     (6,200,598 )
NET INCOME     10,684,492     1,800,753  
                 
Deemed dividend     -       (38,068,021 )
NET INCOME (LOSS) ALLOCABLE TO COMMON SHAREHOLDERS   $ 10,684,492   $ (36,267,268 )
                 
NET INCOME (LOSS) PER SHARE-BASIC AND DILUTED:                
Continuing operations     0.00     (5,011,111.67 )
Discontinued operations     0.00     (1,033,433.00 )
NET INCOME (LOSS) PER SHARE BASIC AND DILUTED   $ 0.00   $ (6,044,544.67 )
                 
WEIGHTED AVERAGE NUMBER OF COMMON SHARES OUTSTANDING-                
BASIC     4,102,959,032       6  
DILUTED     640,656,219,521       6  

 

See notes to consolidated financial statements

 

  F- 5  
 

  

HEALTHIER CHOICES MANAGEMENT CORP.

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY (DEFICIT)

 

FOR THE YEARS ENDED DECEMBER 31, 2015 AND 2016

 

    Series A
Convertible
Preferred
Stock 		    Treasury Stock     Common Stock     Additional
Paid-In 		    Accumulated        
    Shares     Amount     Shares     Amount     Shares     Amount     Capital     Deficit     Total  
Balance – December 31, 2014     -     $   -       -      $ -       2      $ -      $ 16,043,713     $   (15,231,903 )   $   811,810  
                                                                         
Issuance of common stock in connection with the Merger (See Note 3)     -       -       -       -       2       -       17,028,399       -       17,028,399  
Issuance of common stock and warrants in connection with private placement, net of offering costs     -       -       -       -       -       -       447,321       -       447,321  
Reclassification of conversion option from liability to equity     -       -       -       -       -       -       13,300       -       13,300  
Contribution of note and interest payable to Vaporin to capital in connection with the Merger     -       -       -       -       -       -       354,029       -       354,029  
Issuance of common stock in connection with consulting services     -       -       -       -       -       -       143,000       -       143,000  
Issuance of common stock in connection with delivery of restricted stock units     -       -       -       -       -       -       -       -       -  
Issuance of common stock in connection with waiver deferral agreements     -       -       -       -       -       -       1,328,196       -       1,328,196  
Warrants issued or modified in connection with convertible note payable     -       -       -       -       -       -       124,211       -       124,211  
Issuance of common stock in connection with waiver agreement     -       -       -       -       2       -       1,297,081       -       1,297,081  
Issuance of Series A Units, Series A preferred stock and warrants in connection with underwritten offering     1       -       -       -       -       -       940       -       940  
Issuance of unit purchase option to underwriter in connection with Series A Units, Series A preferred stock and warrants     -       -       -       -       -       -       1,552,418       -       1,552,418  
Stock-based compensation expense     -       -       -       -       -       -       582,356       -       582,356  
Deemed dividend on issuance of Series A Units, Series A preferred stock and warrants     -       -       -       -       -       -       (38,068,021 )     -       (38,068,021 )
Net income (loss)     -       -       -       -       -       -       -       1,800,753       1,800,753  
Balance – December 31, 2015     1     $ -       -      $ -       6     $ -     $ 846,943     $ (13,431,150 )   $ (12,584,207 )
                                                                         
Issuance of common stock in connection with cashless exercise of Series A warrants     -       -       -       -       15,619,771,345       1,561,977             -       1,561,977  
Warrants exercised     -       -       -       -       -       -       2,936,071     -       2,936,071
Purchase of treasury stock made in conjunction with the sale of the wholesale business     -       -       (1,405,910,203 )     (140,591 )     -       -       (75,626 )     -       (216,217 )
Treasury stock cancellation                     1,405,910,203       140,591       (1,405,910,203 )     (140,591 )     -       -       -  
Issuance of common stock in connection with conversion of Series A convertible preferred stock     (1 )     -       -       -       26       -       -       -       -  
Stock-based compensation expense                                                     75,430               75,430  
Net income (loss)     -       -       -       -       -       -       -       10,684,492     10,684,492
Balance – December 31, 2016     -     $   -       -      $ -       14,213,861,174     $   1,421,386      $ 3,782,818     $   (2,746,658 )   $ 2,457,546  

 

See notes to consolidated financial statements

 

  F- 6  
 

  

HEALTHIER CHOICES MANAGEMENT CORP.
CONSOLIDATED STATEMENTS OF CASH FLOWS

 

    For the year ended
December 31, 		 
    2016     2015  
OPERATING ACTIVITIES:                
                 
Net income (loss)   $ 10,684,492   $ 1,800,753  
                 
Adjustments to reconcile net income (loss) to net cash used in operating activities:                
Loss from discontinued operations     1,589,803     6,200,598  
Change in allowances for bad debt     663,218       303,509  
Depreciation and amortization     374,388       462,103  
Loss on disposal of assets     103,312       463,840  
Loss on debt extinguishment     -       1,497,169  
Gain on warrant repurchases     (5,189,484 )     -  
Accretion of discounts on note receivable from related party     (21,600 )     -  
Accrued interest on notes receivable from related party     (11,634 )        
Amortization of debt discounts     -       833,034  
Amortization of deferred financing cost     -       144,903  
Cost associated with Series A Units Offering     -       3,726,585  
Write-down of obsolete and slow moving inventory     301,898       192,318  
Stock-based compensation expense     75,430       725,356  
Stock-based expense in connection with waiver agreements     -       3,748,062  
Impairment of goodwill and intangible assets     3,955,362       15,403,833  
Non-cash change in fair value of derivative liabilities     (15,255,143 )     (42,221,418 )
Unit purchase option granted for underwriters’ expense     -       1,552,419  
Net cash used in discontinued operating activities     (3,739,171 )     (2,094,399 )
Changes in operating assets and liabilities:                
Due from merchant credit card processors     (20,797 )     191,522  
Accounts receivable     (197,908 )     (328,245 )
Inventories     (350,148 )     17,217  
Prepaid expenses and vendor deposits     121,421       (64,499 )
Other assets     37,040       (56,101 )
Accounts payable     332,012       (1,192,155 )
Accrued expenses     (786,328 )     (812,971 )
Customer deposits     17,850       -  
NET CASH USED IN OPERATING ACTIVITIES     (7,315,987 )     (9,506,567 )
                 
INVESTING ACTIVITIES:                
Acquisition of grocery store business     (2,910,612 )     -  
Acquisition of vapor store businesses     -       (1,179,270 )
Cash received in connection with Merger     -       136,468  
Proceeds from sale of tradename     100,000       -  
Issuance of note receivable to related party in conjunction with sale of wholesale business     (500,000 )     -  
Collection of note receivable     173,395       -  
Collection of loan receivable     -       467,095  
Purchases of tradename     (25,000 )     (20,000 )
Purchases of property and equipment     (25,299 )     (194,766 )
NET CASH USED IN INVESTING ACTIVITIES:     (3,187,516 )     (790,473 )
                 
FINANCING ACTIVITIES:                
                 
Proceeds from private placement of common stock and warrants, net of offering costs     -       2,941,960  
Cost associated with Series A Units Offering     -       (3,726,585 )
Proceeds from Series A Units issuance     -       41,378,227  
Payments for repurchase of Series A warrants     (3,278,827 )     -  
Payment of offering costs in connection with convertible notes payable     -       (196,250 )
Proceeds from issuance of senior convertible notes payable     -       1,662,500  
Principal payments on convertible debentures     -       (1,750,000 )
Principal payments on senior convertible notes payable to related parties     -       (1,250,000 )
Principal payments on notes payable to related party     -       (1,000,000 )
Principal payments on convertible notes payable             (567,000 )
Principal payments on term loan payable     -       (750,000 )
Principal payments of capital lease obligations     (66,389 )     (52,015 )
Proceeds from loan payable from Vaporin, Inc.     -       350,000  
NET CASH (USED IN) PROVIDED BY FINANCING ACTIVITIES     (3,345,216 )     37,040,837  
                 
(DECREASE) INCREASE IN CASH     (13,848,719 )     26,743,797  
CASH — BEGINNING OF YEAR     27,214,991       471,194  
CASH — END OF YEAR   $ 13,366,272     $ 27,214,991  
                 
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:            
Cash paid for interest   $ 15,386     $ 251,920  
Cash paid for income taxes   $ -     $ 2,791  
NON-CASH INVESTING AND FINANCING ACTIVITIES:                
Deemed dividend   $ -     $ 38,068,021  
Embedded conversion feature recorded as debt discount and derivative liability   $ -     $ 248,359  
Warrants exercised   $ 2,936,071     $ -  
Recognition of debt discount in connection with convertible note issuance   $ -     $ 100,800  
Warrants issued as an offering costs   $ -     $ 87,779  
Contribution of note and interest payable to Vaporin to capital in connection with the Merger   $ -     $ 354,029  

 

  F- 7  
 

  

    FOR THE YEAR ENDED
DECEMBER 31, 		 
    2016     2015  
Purchase Price Allocation in connection with the Vaporin Inc. Merger:                
Cash       $ 136,468  
Accounts receivable             81,256  
Merchant credit card processor receivable             201,141  
Prepaid expense and other current assets             28,021  
Inventory             981,558  
Property and equipment             206,668  
Accounts payable and accrued expenses             (779,782 )
Derivative liabilities             (49,638 )
Notes payable, net of debt discount of $54,623             (512,377 )
Notes payable – related party             (1,000,000 )
Net liabilities assumed           $ (706,685 )
                 
Consideration:                
Value of common stock issued           $ 17,028,399  
Excess of liabilities over assets assumed             706,685  
Total consideration             17,735,084  
Amount allocated to goodwill             (15,654,484 )
Amount allocated to identifiable intangible assets             (2,080,600 )
Remaining unallocated consideration           $ -  
                 
Preliminary Purchase Price Allocation in connection with the grocery store acquisition:                
                 
Amount allocated to goodwill           $ 1,977,533  
Amount allocated to other assets             17,736  
Amount allocated to Inventory             263,810  
Purchase Price             2,259,079  
Hold Back obligation             (860,000 )
Cash used in retail store acquisitions           $ 1,399,079  
                 
Purchase Price Allocation in connection with the grocery store acquisition:                
                 
Amount allocated to goodwill   $ 481,314          
Property and equipment     500,225          
Intangible assets – favorable lease     890,000          
Intangible assets – customer relations     60,000          
Intangible assets – tradenames and technology     824,500          
Inventory     253,524          
Accrued expenses     (98,951 )        
Cash used in the grocery store acquisition   $ 2,910,612          
                 
Sale of Vapor Wholesale Inventory and Business                
Consideration received:                
Note receivable from related party, net of discount   $ 356,895          
Note receivable from related party, net of discount     470,485          
Treasury stock     140,591          
Total consideration     967,971          
Assets and liabilities transferred:                
Inventory     (258,743 )        
Accounts receivable, net     (244,735 )        
Vendor deposits     (40,949 )        
Accrued expenses     (35,273 )        
Customer deposits     17,850          
Loss on repurchase of treasury stock     61,850          
Cash used in the sale of wholesale business   $ 500,000          

 

See notes to consolidated financial statements

  F- 8  
 

  

HEALTHIER CHOICES MANAGEMENT CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Note 1. ORGANIZATION, GOING CONCERN, BASIS OF PRESENTATION, AND RECENT DEVELOPMENTS

 

Organization

 

Healthier Choices Management Corp. (the “Company” or “we”) is a holding company focused on providing consumers with healthier daily choices with respect to nutrition and other lifestyle alternatives. The Company operates thirteen vape retail stores in the Southeast of the United States of America. The Company offers e-liquids, vaporizers, e-cigarettes and related products through its vape retail stores and online. The Company sold its wholesale business on July 31, 2016. The sale of the wholesale business was not contemplated prior to July 1, 2016. The sale of the wholesale business qualifies as a discontinued operations and accordingly the Company has excluded results for the wholesale business operations from the Company’s continuing operations in the consolidating Statements of Operations for all periods.

 

On June 1, 2016, the Company acquired the business assets of Ada’s Whole Food Market LLC, a natural and organic grocery store, through its wholly owned subsidiary Healthy Choice Markets, Inc. The grocery store has been a leader in the natural grocery market in Fort Myers, Florida for the past 40 years, offering fresh, natural and organic products and specializing in facilitating a healthy, well balanced lifestyle. In addition to a comprehensive selection of vitamins and health & beauty products, the grocery store provides a fresh café and an organic juice bar.

 

Going Concern and Liquidity

 

The accompanying consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America (“GAAP”), which contemplate the continuation of the Company as a going concern and realization of assets and satisfaction of liabilities in the normal course of business and do not include any adjustments that might result from the outcome of any uncertainties related to our going concern assessment. The carrying amounts of assets and liabilities presented in the consolidated financial statements do not necessarily purport to represent realizable or settlement values.

 

We had a large number of warrants outstanding with features that made the warrants more debt like and possibly result in cash outflows and were thus classified as derivative liabilities. Additionally, for the year ended December 31, 2015, the Company reported a net loss allocable to common stockholders of approximately $36.3 million and had negative working capital of approximately $17.2 million. These factors raised substantial doubt about our ability to continue as a going concern.

 

During 2016 and early 2017, we took steps to mitigate these factors by:

 

· increasing the number of authorized shares to 750,000,000,000 shares so that there would be sufficient shares available for issuance should all the warrant holders exercise;

 

· entering into a Fifth Amended and Restated Series A Warrant Standstill Agreement (the “Fifth Amendment”) with warrant holders working to effectively eliminate the possibility that warrant holders will exercise for anything other than shares, and

 

· extending a tender offer to repurchase its Series A warrants which resulted in 10,073,884 (on a pre-split basis) of the warrants to be repurchased for $0.22 per warrant.

 

The steps above substantially lowered our potential cash exposure. As a result, as of the date of the issuance of these financial statements, we believe our plans have alleviated substantial doubt about the Company’s ability to sustain operations for the foreseeable future through a year and a day from the issuance of these consolidated financial statements.

 

Sourcing and Vendors.

 

We source from multiple suppliers. These suppliers range from small independent businesses to multinational conglomerates. As of December 31, 2016, we purchased approximately 75% of the goods we sell from our top 20 suppliers. For the fiscal year ended December 31, 2016, approximately 40% of our total purchases were from one vendor.

 

Basis of Presentation and Principles of Consolidation

 

The Company’s consolidated financial statements are prepared in accordance with GAAP. The consolidated financial statements include the accounts of all subsidiaries in which the Company holds a controlling financial interest as of the financial statement date.

 

The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries, Healthy Choice Markets, Inc. The Vape Store, Inc. (“Vape Store”), Vaporin, Inc. (“Vaporin”), Smoke Anywhere U.S.A., Inc. (“Smoke”), Emagine the Vape Store, LLC (“Emagine”), IVGI Acquisition, Inc., Vapormax Franchising LLC, Vaporin LLC, Vaporin Florida, Inc., All intercompany accounts and transactions have been eliminated in consolidation.

 

  F- 9  
 

  

Note 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

 

Reclassifications

 

Certain prior period amounts in the consolidated financial statements related to stock splits and the sale of discontinued operations have been reclassified to conform to the current period’s presentation. No changes to the Company’s net loss were made as a result of such reclassifications.

 

Segment Reporting

 

Operating segments are identified as components of an enterprise about which separate discrete financial information is available for evaluation by the operating decision makers, or decision-making group, in making decisions on how to allocate resources and assess performance. The Company’s decision making group are the senior executive management team. The Company and the decision-making group view the Company’s operations and manage its business as two operating segments. All long-lived assets of the Company reside in the U.S.

 

Use of Estimates in the Preparation of the Financial Statements

 

The preparation of consolidated financial statements in conformity with GAAP 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 consolidated financial statements, and the reported amounts of net revenue and expenses during the reporting periods. Actual results could differ from those estimates. These estimates and assumptions include allowances, reserves and write-downs of receivables and inventory, valuing equity securities and hybrid instruments, share-based payment arrangements, deferred taxes and related valuation allowances, and the valuation of the net assets acquired in acquisitions. Certain of our estimates could be affected by external conditions, including those unique to our industry, and general economic conditions. It is possible that these external factors could have an effect on our estimates that could cause actual results to differ from our estimates. The Company re-evaluates all of its accounting estimates at least quarterly based on these conditions and records adjustments when necessary.

 

Revenue Recognition

 

The Company recognizes revenue from product sales or services rendered when the following four revenue recognition criteria are met: persuasive evidence of an arrangement exists, delivery has occurred or services have been rendered, the selling price is fixed or determinable, and collectability is reasonably assured.

 

Product sales revenues, net of promotional discounts, rebates, and return allowances, are recorded when the products are shipped, title passes to customers and collection is reasonably assured. Retail sales revenues are recorded at the point of sale when both title and risk of loss is transferred to the customer. Return allowances, which reduce product revenue, are estimated using historical experience. Revenue from product sales and services rendered is recorded net of sales and consumption taxes.

 

The Company periodically provides incentive offers to its customers to encourage purchases. Such offers include current discount offers, such as percentage discounts off current purchases, inducement offers, such as offers for future discounts subject to a minimum current purchase, and other similar offers. Current discount offers, when accepted by the Company’s customers, are treated as a reduction to the purchase price of the related transaction, while inducement offers, when accepted by its customers, are treated as a reduction to the purchase price of the related transaction based on estimated future redemption rates. Redemption rates are estimated using the Company’s historical experience for similar inducement offers. The Company reports sales, net of current discount offers and inducement offers on its consolidated statements of operations.

 

Shipping and Handling

 

Shipping charges billed to customers are included in net sales and the related shipping and handling costs are included in cost of sales. For the years ended December 31, 2016 and 2015 shipping and handling costs of $105,486 and $132,331, were included in cost of sales, respectively.

 

Cash and Cash Equivalents

 

The Company considers all highly liquid instruments with an original maturity of three months or less, when purchased, to be cash and cash equivalents. The majority of the Company’s cash and cash equivalents are concentrated in one large financial institution. The Company continually monitors its positions with, and the credit quality of, the financial institutions with which it invests, as deposits are held in excess of federally insured limits. The Company’s cash equivalent at December 31, 2016 and 2015 was a money market account. The Company has not experienced any losses in such accounts.

 

  F- 10  
 

  

Accounts Receivable and Concentration of Risk

 

Accounts receivable, net is stated at the amount the Company expects to collect, or the net realizable value. The Company provides a provision for allowances that includes returns, allowances and doubtful accounts equal to the estimated uncollectible amounts. The Company estimates its provision for allowances based on historical collection experience and a review of the current status of trade accounts receivable. It is reasonably possible that the Company’s estimate of the provision for allowances will change.

 

At December 31, 2016, accounts receivable balances included a concentration from three customers with receivable balances ranging from approximately $9,000 to $24,000, all of which are greater than 10% of the total net accounts receivable balance. At December 31, 2015, accounts receivable balances included concentrations from four customers that had balances of an amount greater than 10%. The amounts ranged from $33,000 to $84,000.

 

For the years ended December 31, 2016 and 2015, the Company had no customers with sales in excess of 10%.

 

Due from Merchant Credit Card Processor

 

Due from merchant credit card processor represents monies held by the Company’s credit card processors. The funds are being held by the merchant credit card processors pending satisfaction of their hold requirements and expiration of charge backs/refunds from customers.

 

Inventories

 

Inventories are stated at average cost. If the cost of the inventories exceeds their net realizable value, provisions are recorded to write down excess inventory to its net realizable value. The Company’s inventories consist primarily of merchandise available for resale. The Company’s inventory consists of fresh produce, perishable grocery items and non-perishable consumable goods that are immediately available for sale.

 

Property and Equipment

 

Property and equipment is stated at cost less accumulated depreciation. Depreciation is calculated using the straight-line method over the expected useful life of the respective asset, after the asset is placed in service. The Company generally uses the following depreciable lives for its major classifications of property and equipment:

 

Description   Useful Lives
Warehouse fixtures   2 years
Signage   5 years
Furniture and fixtures   5 years
Computer hardware   3 years
Appliance   3-5 years
Cooler   5 years
Machinery   5-7 years
Displays   5-7 years
Leasehold improvements   Life of lease

 

Identifiable Intangible Assets and Goodwill

 

Identifiable intangible assets are recorded at cost, or when acquired as part of a business acquisition, at estimated fair value. Certain identifiable intangible assets are amortized over 5 and 10 years. Similar to tangible personal property and equipment, the Company periodically evaluates identifiable intangible assets for impairment whenever events or changes in circumstances indicate that the carrying amount may not be recoverable.

 

Indefinite-lived intangible assets, such as goodwill are not amortized. The Company assesses the carrying amounts of goodwill for recoverability on at least an annual basis or when events or changes in circumstances indicate evidence of potential impairment exists, using a fair value based test. Application of the goodwill impairment test requires significant judgments including estimation of future cash flows, which is dependent on internal forecasts, estimation of the long-term rate of growth for the businesses, and the useful life over which cash flows will occur. Changes in these estimates and assumptions could materially affect the determination of fair value and/or conclusions on goodwill impairment for the Company.

 

  F- 11  
 

  

Impairment of Long-Lived Assets

 

The Company reviews long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying value of the asset may not be recoverable. In connection with this review, the Company also reevaluates the depreciable lives for these assets. The Company assesses recoverability by determining whether the net book value of the related asset will be recovered through the projected undiscounted future cash flows of the asset. If the Company determines that the carrying value of the asset may not be recoverable, it measures any impairment based on the projected future discounted cash flows as compared to the asset’s carrying value.

 

Advertising

 

The Company expenses advertising costs as incurred.

 

Warranty Liability

 

The Company’s limited lifetime warranty policy generally allows its end users of vape products and retailers to return defective purchased rechargeable products in exchange for new products. The Company estimates a reserve for warranty liability and records that reserve amount as a reduction of revenues and as an accrued expense on the accompanying consolidated balance sheets. The warranty claims and expenses were not deemed material for the years ended December 31, 2016 and 2015.

 

Income Taxes

 

The Company uses the asset and liability method of accounting for income taxes in accordance with ASC 740, “Income Taxes” (“ASC 740”). Under this method, income tax expense is recognized as the amount of: (i) taxes payable or refundable for the current year and (ii) future tax consequences attributable to differences between financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in the results of operations in the period that includes the enactment date. A valuation allowance is provided to reduce the deferred tax assets reported if based on the weight of available evidence it is more likely than not that some portion or all of the deferred tax assets will not be realized.

 

Fair Value Measurements

 

The Company applies the provisions of ASC 820, “Fair Value Measurements and Disclosures,” (“ASC 820”). The Company’s short term financial instruments include cash, due from merchant credit card processors, accounts receivable, accounts payable and accrued expenses, each of which approximate their fair values based upon their short-term nature. The Company’s other financial instruments include notes payable obligations and derivative liabilities. The carrying value of these instruments approximate fair value, as they bear terms and conditions comparable to market, for obligations with similar terms and maturities.

 

ASC 820 defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. ASC 820 also establishes a fair value hierarchy, which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. ASC 820 describes three levels of inputs that may be used to measure fair value: Level 1 – quoted prices in active markets for identical assets or liabilities; Level 2 – quoted prices for similar assets and liabilities in active market or inputs that are observable; and Level 3 – inputs that are unobservable.

 

Stock-Based Compensation

 

The Company accounts for stock-based compensation for employees and directors under ASC Topic No. 718, “Compensation-Stock Compensation” (“ASC 718”). These standards define a fair value based method of accounting for stock-based compensation. In accordance with ASC 718, the cost of stock-based compensation is measured at the grant date based on the value of the award and is recognized over the vesting period. The value of the stock-based award is determined using an appropriate valuation model, whereby compensation cost is the fair value of the award as determined by the valuation model at the grant date. The resulting amount is charged to expense on the straight-line basis over the period in which the Company expects to receive the benefit, which is generally the vesting period. The Company considers many factors when estimating expected forfeitures, including types of awards, employee class, and historical experience. Stock-based compensation for non-employees is measured at the grant date, is re-measured at subsequent vesting dates and reporting dates, and is amortized over the service period.

 

Derivative Instruments

 

The Company accounts for free-standing derivative instruments and hybrid instruments that contain embedded derivative features in accordance with ASC Topic No. 815, “Derivative Instruments and Hedging Activities,” (“ASC 815”) as well as related interpretations

 

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of this topic. In accordance with this topic, derivative instruments and hybrid instruments are recognized as either assets or liabilities in the balance sheet and are measured at fair values with gains or losses recognized in earnings. Embedded derivatives that are not clearly and closely related to the host contract are bifurcated and are recognized at fair value with changes in fair value recognized as either a gain or loss in earnings. The Company determines the fair value of derivative instruments and hybrid instruments based on available market data using appropriate valuation models, giving consideration to all of the rights and obligations of each instrument.

 

The Company estimates fair values of derivative instruments and hybrid instruments using various techniques (and combinations thereof) that are considered to be consistent with the objective of measuring fair values. In selecting the appropriate technique, the Company considers, among other factors, the nature of the instrument, the market risks that it embodies and the expected means of settlement. For complex instruments, the Company utilizes custom Monte Carlo simulation models. For less complex instruments, such as free-standing warrants, the Company generally uses the Binomial Lattice model, adjusted for the effect of dilution, because it embodies all of the requisite assumptions (including trading volatility, estimated terms, dilution and risk free rates) necessary to fair value these instruments. Estimating fair values of derivative financial instruments requires the development of significant and subjective estimates that may, and are likely to, change over the duration of the instrument with related changes in internal and external market factors. In addition, option-based techniques (such as the Binomial Lattice model or the Black-Scholes-Merton valuation model) are highly volatile and sensitive to changes in the trading market price of the Company’s common stock. Since derivative financial instruments are initially and subsequently carried at fair values, the Company’s net income (loss) going forward will reflect the volatility in these estimates and assumption changes. Under ASC 815, increases in the trading price of the Company’s common stock and increases in fair value during a given financial quarter result in the application of non-cash derivative losses. Conversely, decreases in the trading price of the Company’s common stock and decreases in trading fair value during a given financial quarter result in the application of non-cash derivative gains.

 

Convertible Debt Instruments

 

The Company accounts for convertible debt instruments when the Company has determined that the embedded conversion options should be bifurcated from their host instruments in accordance with ASC 815. The Company records discounts to convertible notes for the fair value of bifurcated embedded conversion options embedded in debt instruments and the relative fair value of freestanding warrants issued in connection with convertible debt instruments. The Company amortizes the respective debt discount over the term of the notes, using the straight-line method, which approximates the effective interest method over a short-term period.

 

Sequencing Policy  

 

Under ASC 815-40-35, the Company has adopted a sequencing policy whereby, in the event that reclassification of contracts from equity to assets or liabilities is necessary pursuant to ASC 815 due to the Company's inability to demonstrate it has sufficient authorized shares, shares will be allocated on the basis of the earliest issuance date of potentially dilutive instruments, with the earliest grants receiving the first allocation of shares.

 

Preferred Stock

 

The Company applies the accounting standards for distinguishing liabilities from equity when determining the classification and measurement of its preferred stock. Shares that are subject to mandatory redemption (if any) are classified as liability instruments and are measured at fair value. The Company classifies conditionally redeemable preferred shares, which include preferred shares that feature redemption rights that are either within the control of the holder or subject to redemption upon the occurrence of uncertain events not solely within the Company’s control, as temporary equity. At all other times, preferred shares are classified as stockholders’ equity.

 

Treasury Stock

 

When the Company acquires its own common stock (“treasury stock”), the consideration paid, including any directly attributable incremental costs (net of tax), is deducted from equity. No gain is recognized on the purchase, sale, or cancellation of the treasury stock. When a loss results from the purchase of treasury stock at a premium, the related costs are expensed in the period incurred. The difference between the carrying amount and the consideration on sale is recognized as capital surplus.

 

 

Discontinued Operations  

 

On July 31, 2016, the Company sold its wholesale inventory and related operations. The sale of the wholesale business qualifies as discontinued operations and accordingly the Company has excluded results for the wholesale business operations from the Company’s continuing operations in the consolidating Statements of Operations for all periods presented.

 

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Adopted Accounting Pronouncements

 

In August 2014, FASB issued ASU No. 2014-15, “Presentation of Financial Statements – Going Concern (Subtopic 205-40): Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern” (“ASU 2014-15”). ASU 2014-15 explicitly requires management to evaluate, at each annual or interim reporting period, whether there are conditions or events that exist which raise substantial doubt about an entity’s ability to continue as a going concern and to provide related disclosures. ASU 2014-15 is effective for annual periods ending after December 15, 2016, and annual and interim periods thereafter, with early adoption permitted. The implementation of this update did not have a material effect on the Company’s consolidated financial statements.

 

In July 2015, the FASB issued ASU No. 2015-11, “Simplifying the Measurement of Inventory” (“ASU 2015-11”). ASU 2015-11 requires an entity to measure inventory at the lower of cost and net realizable value. Net realizable value is the estimated selling prices in the ordinary course of business, less reasonably predictable costs of completion, disposal, and transportation. Subsequent measurement is unchanged for inventory measured using last-in, first-out (“LIFO”) or the retail inventory method. It is effective for annual reporting periods beginning after December 15, 2016 (see Note 4). The amendments should be applied prospectively with earlier application permitted as of the beginning of an interim or annual reporting period. The implementation of this update did not have a material effect on the Company’s consolidated financial statements.

 

In November 2015, the FASB issued ASU No. 2015-17, “Income Taxes (Topic 740): Balance Sheet Classification of Deferred Taxes” (“ASU 2015-17”). The FASB issued this ASU as part of its ongoing Simplification Initiative, with the objective of reducing complexity in accounting standards. The amendments in ASU 2015-17 require entities that present a classified balance sheet to classify all deferred tax liabilities and assets as a noncurrent amount. This guidance does not change the offsetting requirements for deferred tax liabilities and assets, which results in the presentation of one amount on the balance sheet. Additionally, the amendments in this ASU align the deferred income tax presentation with the requirements in International Accounting Standards (IAS) 1, Presentation of Financial Statements.  The amendments in ASU 2015-17 are effective for financial statements issued for annual periods beginning after December 15, 2016, and interim periods within those annual periods. The implementation of this update did not have a material effect on the Company’s consolidated financial statements.

 

Recently Issued Accounting Pronouncements

 

In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2014-09, “Revenue from Contracts with Customers,” (“ASU 2014-09”). ASU 2014-09 supersedes the revenue recognition requirements in ASC 605 - Revenue Recognition and most industry-specific guidance throughout the ASC. The standard requires that an entity recognizes revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the company expects to be entitled in exchange for those goods or services. ASU 2014-09 should be applied retrospectively to each prior reporting period presented or retrospectively with the cumulative effect of initially applying ASU 2014-09 recognized at the date of initial application. To allow entities additional time to implement systems, gather data and resolve implementation questions, the FASB issued ASU No. 2015-14, Revenue from Contracts with Customers (Topic 606): Deferral of the Effective Date, in August 2015, to defer the effective date of ASU No. 2014-09 for one year, which is fiscal years beginning after December 15, 2017. Early adoption is permitted commencing January 1, 2017. The Company is currently evaluating the impact of the adoption of ASU 2014-09 on its consolidated financial statements or disclosures.

 

In February 2016, the FASB issued ASU No. 2016-02, “Leases (Topic 842)” (“ASU 2016-02”). ASU 2016-02 establishes a right-of-use (“ROU”) model that requires a lessee to record a ROU asset and a lease liability on the balance sheet for all leases with terms longer than 12 months. Leases will be classified as either finance or operating, with classification affecting the pattern of expense recognition in the income statement. ASU 2016-02 is effective for annual periods beginning after December 15, 2018, and annual and interim periods thereafter, with early adoption permitted. A modified retrospective transition approach is required for lessees for capital and operating leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements, with certain practical expedients available. The Company is currently evaluating the impact that the adoption of this new standard will have on its consolidated financial statements.

 

In March 2016, the FASB issued ASU No. 2016-08, Revenue from Contracts with Customers (Topic 606): Principal versus Agent Considerations (Reporting Revenue Gross versus Net). This ASU amends the principal versus agent guidance in ASU No. 2014-09, Revenue from Contracts with Customers (Topic 606), which was issued in May 2014 (“ASU 2014-09”). The effective date and transition requirements for the amendment to ASU 2014-09 are the same as those of ASU 2014-09, which was deferred for one year by ASU No. 2015-14, Revenue from Contracts with Customers (Topic 606): Deferral of the Effective Date. That is, the guidance under these standards is to be applied using a full retrospective method or a modified retrospective method, as outlined in the guidance, and is effective for annual periods, and interim periods within those annual periods, beginning after December 15, 2017. Early adoption is permitted only for annual periods, and interim periods within those annual periods, beginning after December 15, 2016. The Company is currently evaluating the provisions of each of these standards and assessing their impact on the Company’s consolidated financial statements and disclosures.

 

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In March 2016, the FASB issued ASU 2016-09, “Compensation – Stock Compensation (Topic 718)” (“ASU 2016-09”). ASU 2016-09 requires an entity to simplify 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, with early adoption permitted. The Company is currently evaluating ASU 2016-09 and its impact on its consolidated financial statements or disclosures.

 

In April 2016, the FASB issued ASU 2016-10 (Topic 606) “Revenue from Contracts with Customers: Identifying Performance Obligations and Licensing” (“ASU2-16-10”). ASU 2016-10 clarifies the principle for determining whether a good or service is “separately identifiable” from other promises in the contract and, therefore, should be accounted for as a separate performance obligation. In that regard, ASU 2016-10 requires that an entity determine whether its promise is to transfer individual goods or services to the customer, or a combined item (or items) to which the individual goods and services are inputs. In addition, ASU 2016-10 categorizes intellectual property, or IP, into two categories: “functional” and “symbolic.” Functional IP has significant standalone functionality. All other IP is considered symbolic IP. Revenue from licenses of functional IP is generally recognized at a point in time, while revenue from licenses of symbolic IP is recognized over time. ASU 2016-10 has the same effective date and transition requirements as ASU 2014-09, as amended by ASU 2015-14. The Company is currently evaluating the effect that adoption of ASU 2016-10 will have on its consolidated financial statements or disclosures.

 

In August 2016, the FASB issued ASU 2016-15 (Topic 230), “Statement of Cash Flows Classification of Certain Cash Receipts and Cash Payments”. The new standard will make eight targeted changes to how cash receipts and cash payments are presented and classified in the statement of cash flows. The new standard is effective for fiscal years beginning after December 15, 2017. The Company will require adoption on a retrospective basis unless it is impracticable to apply, in which case the Company would be required to apply the amendments prospectively as of the earliest date practicable. The Company is currently evaluating the effect that adopting this new accounting guidance will have on its consolidated cash flows and related disclosures.

 

In January 2017, the FASB issued ASU 2017-01, “Business Combinations (Topic 805) Clarifying the Definition of a Business” (“ASU 2017-01”). The amendments in ASU 2017-01 is to clarify the definition of a business with the objective of adding guidance to assist entities with evaluating whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses. The definition of a business affects many areas of accounting including acquisitions, disposals, goodwill, and consolidation. The guidance is effective for annual periods beginning after December 15, 2017, including interim periods within those periods. The Company is currently evaluating the impact of adopting this guidance.

 

In January 2017, the FASB issued ASU 2017-04, “Intangibles - Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment” (“ASU 2017-04”). ASU 2017-04 eliminates Step 2 along with amending other parts of the goodwill impairment test. Under ASU 2017-04, an entity should perform its annual or interim goodwill impairment test by comparing the fair value of the reporting unit with its carrying amount, and should recognize an impairment charge for the amount by which the carrying amount exceeds the reporting unit’s fair value with the loss not exceeding the total amount of goodwill allocated to that reporting unit. ASU 2017-04 is effective for annual periods beginning after December 15, 2019, and interim periods therein with early adoption permitted for interim or annual goodwill impairment tests performed after January 1, 2017. At adoption, this update will require a prospective approach. The Company is currently evaluating the impact of adopting this guidance.

 

Note 3. ACQUISITION AND DISPOSAL

 

MERGER WITH VAPORIN, INC.

 

On December 17, 2014, the Company entered into the Merger Agreement with Vaporin pursuant to which Vaporin was to merge with and into the Company with the Company being the surviving and controlling entity (as a result of the stockholders of the Company maintaining more than 50% ownership in the Company’s outstanding shares of common stock and the Company’s directors comprising the majority of the board at the date of the Merger). The Merger closed on March 4, 2015 and the purchase price consideration paid by the Company consisted of the following:

 

1. 100% of the issued and outstanding shares of Vaporin common stock (including shares of common stock issued upon conversion of Vaporin preferred stock immediately prior to the consummation of the merger in accordance with the Merger Agreement) were converted into, and became 1.94 shares of the Company’s common stock such that the former Vaporin stockholders collectively hold approximately 45% of the then issued and outstanding shares of the Company’s common stock following consummation of the Merger. The aggregate value of these shares issued was $14,949,328, or approximately $7,700,000 per share, and was based on the closing price of the Company’s common stock on March 4, 2015.

 

2. 100% of the issued shares of Vaporin restricted stock units were converted into the right to receive 0.27 shares of the Company’s common stock. The restricted stock units became fully-vested in connection with the Merger and as a result, were included as a part of the Company’s purchase price as no further services from the holders were

 

  F- 15  
 

  

required to be provided to the Company. The aggregate value of these shares issued was $2,079,071, or approximately $7,700,000 per share, and was based on the closing price of the Company’s common stock on March 4, 2015. Based on the terms of the Merger Agreement, the Company agreed to issue these in twelve equal monthly instalments, with the first delivery date being the date of the closing of the Merger, however, all shares of common stock were delivered by February 4, 2016.

 

The Merger Agreement contained customary conditions that were satisfied prior to the closing of the Merger, including the requirement for the Company to receive gross proceeds from a $3.5 million equity offering. The Company incurred approximately $559,000 of acquisition costs in connection with the Merger that were recorded to selling, general and administrative expenses.

 

The Merger was accounted for as a business combination. Accordingly, the fair value of the purchase consideration issued to the sellers of Vaporin was allocated to fair value of the net tangible assets acquired, with the resulting excess allocated to separately identifiable intangibles, and the remainder recorded as goodwill. Goodwill recognized from the transactions mainly represented the expected operational synergies upon acquisition of the combined entity and intangibles not qualifying for separate recognition. Goodwill is not expected to be deductible for income tax purposes in the tax jurisdiction of the acquired business. The purchase price allocation was based, in part, on management’s knowledge of Vaporin’s business and the results of a third-party appraisal commissioned by management.

 

Purchase Consideration      
Value of consideration paid:   $ 17,735,084  
         
Tangible assets acquired and liabilities assumed at fair value        
Cash   $ 136,468  
Accounts receivable     81,256  
Merchant credit card processor receivable     201,141  
Prepaid expense and other current assets     28,021  
Inventory     981,558  
Property and equipment     206,668  
Accounts payable and accrued expenses     (779,782 )
Derivative Liabilities     (49,638 )
Notes payable, net of debt discount of $54,623     (512,377 )
Notes payable – related party     (1,000,000 )
Net liabilities assumed   $ (706,685 )
         
Consideration:        
Value of common stock issued   $ 17,028,399  
Excess of liabilities over assets assumed     706,685  
Total consideration   $ 17,735,084  
         
Identifiable intangible assets        
Trade names and technology   $ 1,500,000  
Customer relationships     488,274  
Assembled workforce     92,326  
Total Identifiable Intangible Assets     2,080,600  
Goodwill     15,654,484  
Total allocation to identifiable intangible assets and goodwill   $ 17,735,084  

 

In addition, in connection with the Merger, an aggregate $354,029 of a note and interest payable by the Company to Vaporin was forgiven.

 

In connection with the Merger Agreement, the Company also issued 0.0354 warrants to purchase the Company’s common stock to certain warrant holders of Vaporin as replacement for warrants issued in connection with previous Vaporin note payable issuances. In addition, the Company also issued 0.0028 options to purchase common stock to certain holders of Vaporin as replacement for options issued for services. The Company determined that based on the remaining term of the warrants and options as well as the nature of the remaining services to be provided by the holders that the value of the warrants and options at the date of the Merger was not material.

 

The accounting and reporting operations of Vaporin were fully integrated into the Company on the date of the Merger and it is impracticable to separate.

 

  F- 16  
 

  

In connection with the acquisition of Vaporin, the Company acquired net deferred tax assets consisting of net operating loss carryforwards offset by the difference between the book and tax basis of intangible assets acquired. At the acquisition date this net deferred tax asset was completely offset by a valuation allowance as it was more likely than not that the Company’s would not have ability to use the deferred tax asset.

 

The following presents the unaudited pro-forma combined results of operations of the Company with Vaporin as if the Merger occurred on January 1, 2015.

  

    For the Year Ended
December 31, 		 
    2015  
       
Vapor Sales   $ 6,368,874  
Net Loss from Continuing operations   $ (31,464,401 )
Net loss from discontinued operations   $ (6,200,598 )
Net loss allocable to common shareholders     (37,664,999 )
Net loss per share- basic and diluted     (6,292,880 )
     Continuing operations     (1,240,119 )
     Discontinued operations     (7,532,999 )
Weighted average number of shares outstanding     5  

 

The unaudited pro-forma results of operations are presented for information purposes only. The unaudited pro-forma results of operations are not intended to present actual results that would have been attained had the acquisition been completed as of January 1, 2015 or to project potential operating results as of any future date or for any future periods.

 

The Joint Venture

 

On December 17, 2014, the Company and Vaporin agreed to enter into the Joint Venture through Emagine, a Delaware limited liability company of which the Company and Vaporin are 50% members. The Operating Agreement provides that Vaporin will serve as the initial manager of Emagine and will manage the day-to-day operations of Emagine, subject to certain customary limitations on managerial actions that require the unanimous consent of the Company and Vaporin, including but not limited to making or guaranteeing loans, distributing cash or other property to the members of Emagine, entering into affiliate transactions, amending or modifying limited liability company organizational documents, and redeeming or repurchasing membership interests from any of the members. The results of operations of Emagine from January 1, 2015 through the date of the Merger were not material. In connection with the completion of the Merger on March 4, 2015, Emagine became a wholly-owned subsidiary of the Company.

 

Retail Stores and Kiosks

 

Retail Stores

 

During 2015, the Company acquired the assets and business operations of established retail vapor stores. The purchase prices were generally allocated to inventory, leasehold improvements, fixtures, security deposits, intangible assets, and goodwill. No liabilities were assumed from the sellers and the Company has no obligation to retain existing employees.

 

The Company incurred aggregate cost of $2,259,079 for the acquisitions after the Merger. Leasehold improvements and fixtures acquired were not considered material to these purchases. The Company holds back a portion of the seller’s purchase price for three to six months during the operational transition period (the “hold back period”). If the stores’ gross minimum revenues during the hold back period do not reach an amount agreed upon by the buyer and seller at closing, then the hold back amount due to the seller is reduced in the final settlement. The hold back amount due to sellers of $860,000 was recorded in accrued liabilities at December 31, 2015 as the achievement of the minimum revenue milestones are considered probable. The hold back liability is considered contingent consideration recorded at fair value at each respective acquisition and is re-measured with each reporting period. During the year ended December 31, 2016, the Company made $220,000 of aggregate holdback payments. The remaining $640,000 balance was eliminated as the business did not achieve the targeted net sales figure and the seller was therefore not entitled to the holdback payment. Commissions and ancillary store closing costs totaling approximately $62,271 are expensed as incurred and reflected in selling general and administrative expenses for the year ended December 31, 2015.

 

During 2016, after evaluating retail store operations, management decided to close two of its Atlanta area vape retail stores on February 15, 2016, and September 30, 2016, respectively, and five of its Florida retail vapor stores were closed between May 31 and September 30, 2016. An additional Georgia retail location was closed during the fourth quarter of 2016 .

 

  F- 17  
 

  

 

The accounting and reporting of the acquired retail store operations were fully integrated into the Company at dates of the individual acquisitions and it is impracticable to separate. Unaudited pro-forma combined results of operations of the Company is not presented, as it is unfeasible to obtain complete, reliable and financial information prepared in accordance with GAAP. The prior owners of the retail store businesses were individuals without reporting requirement and accordingly the financial data available is incomplete, inconsistent, and the presentation would not add value to pro-forma financial disclosure.

 

The Company entered into retail leases for purchased retail locations and the resulting lease obligation are included in the Company’s commitments. The purchase price allocations were based, on management’s knowledge of the retail businesses acquired.

 

Purchase Consideration        
         
Goodwill   $ 1,977,533  
Other assets     17,736  
Inventory     263,810  
Total allocation to tangible assets and goodwill     2,259,079  
Holdback obligation     (860,000 )
Cash used in retail store business acquisitions   $ 1,399,079  

 

Retail Kiosks

 

The Company opened eight mall retail kiosks for its vaping products in October and November 2014. The Company’s management decided to close the kiosks after evaluating the short-term performance of the locations and to focus expansion efforts on retail stores. During 2015 the Company closed all of its mall kiosks. In connection with the kiosk closings, for the year ended December 31, 2015, the Company incurred $463,840 of loss on disposal of computer equipment, fixtures, and furniture and $265,627 of exit costs for settlement of non-cancellable leases and license obligations. The loss on disposal and exit costs are included in selling, general and administrative expenses.

 

ADA’S Whole Food Market

 

On June 1, 2016, the Company’s wholly owned subsidiary Healthy Choice Markets Inc., entered into a Business Sale Agreement with Ada’s Whole Food Market LLC (the “Seller”) to purchase the certain operating assets and assumed certain payables and a store lease obligation related to that constituted the business of Ada’s Natural Market grocery store (the “Grocery Acquisition”). The Company operates the grocery store under the same name, location, and management. The Company also entered into an employment agreement with the store manager.

 

The Grocery Acquisition was accounted for under the acquisition method of accounting. Accordingly, the acquired assets and assumed liabilities were recorded at their estimated fair values, and operating results for Ada’s Whole Food Market are included in the consolidated financial statements from the effective date of acquisition of June 1, 2016. The allocation of the purchase price is summarized as follows:

 

Purchase Consideration      
Cash paid:   $ 2,910,612  
         
Identifiable assets acquired and liabilities assumed at fair value        
Property and equipment     500,225  
Intangible assets - favorable lease     890,000  
Intangible assets - tradenames and technology     820,000  
Intangible assets - customer relationships     60,000  
Intangible assets - website     4,500  
Inventory     253,524  
Accrued expenses     (98,951 )
Net indentifiable assets acquired   $ 2,429,298  
         
Total allocated to goodwill   $ 481,314  

 

  F- 18  
 

  

Goodwill arising from the transaction mainly consists of the expected operational synergies upon acquisition of the combined entity and intangibles not qualifying for separate recognition. Goodwill is not expected to be deductible for income tax purposes in the tax jurisdiction of the acquired business. The favorable lease will be amortized on a straight-line basis over its expected useful life of 15.25 years, which represents the remaining lease term. The tradename will be amortized on a straight-line basis over its expected useful life of ten years. Customer relationships will be amortized on a straight-line basis over their expected useful lives of five years. The website will be amortized on a straight-line basis over its expected useful life of three years.

 

The following presents the unaudited pro-forma combined results of operations of the Company with Ada’s Whole Food Market and Vaporin as if both Acquisitions occurred on January 1, 2015.

   

    Year Ended
December 31, 		 
    2016     2015  
             
Retail sales, net   $ 6,722,052     $ 6,368,874  
Grocery sales, net   $ 7,149,223     $ 7,601,653  
Net income (loss) from continuing operations   $ 12,274,295   $ (30,608,739 )
Net income (loss) from discontinued operations   $ (1,589,803 )   $ (6,200,598 )
Net income (loss) allocable to common shareholders   $ 10,684,492   $ (36,809,337 )
Net loss per share:                
Continuing operations   $ (0.01 )   $ (6,121,748 )
Discontinued operations   $ (0.00 )   $ (1,240,119 )
Net loss allocable to common shareholders   $ (0.01 )   $ (7,361,867 )
Weighted average number of shares outstanding     2,506,158,054       5  

 

The unaudited pro-forma results of operations are presented for information purposes only and are based on estimated financial operations. The unaudited pro-forma results of operations are not intended to present actual results that would have been attained had the acquisition been completed as of January 1, 2015 or to project potential operating results as of any future date or for any future periods.

 

Sale of Wholesale Business

 

On July 29, 2016, the Company, entered into an Asset Purchase Agreement (the “Wholesale Business Purchase Agreement”) with VPR Brands, L.P. (the “Purchaser”) and the Purchaser’s Chief Executive Officer, Kevin Frija (the former Chief Executive Officer of the Company) pursuant to which the Company sold its wholesale inventory and the related business operations (collectively, “Wholesale Business Assets”), which previously operated at 3001 Griffin Road, Dania Beach, Florida 33312. The sale transaction was approved by the Company’s Board of Director’s on July 26, 2016 and completed on July 31, 2016. The consideration for the Wholesale Business Assets is (i) a secured, one-year promissory note in the principal amount of $370,000 (the “Acquisition Note”) bearing an interest rate of 4.5%, which payments thereunder are $10,000 monthly, with such payments commencing on October 28, 2016, with a balloon payment of the remainder of principal and interest on July 29, 2017; (ii) A secured, 36-month promissory note in the principal amount of $500,000 bearing an interest rate of prime plus 2%, resetting annually on July 29 th ,which payments thereunder are $14,000 per month, with such payments deferred and commencing on January 26, 2017, with subsequent installments payable on the same day of each month thereafter and in the 37 th month, a balloon payment for all remaining accrued interest and principal; (iii) the assumption by the Purchaser of certain liabilities related to the Company’s wholesale operations, including but not limited to the month-to-month lease for the premises. Pursuant to the Wholesale Business Purchase Agreement, the Company shall continue to own its accounts receivable from its wholesale operations as of July 29, 2016. The Company agreed to use its commercially reasonable efforts, consistent with standard industry practice, to collect such accounts receivable, and any and all amounts so collected (i) up to $150,000 (net of any refunds) in the aggregate shall be credited against payment of the Acquisition Note; and (ii) in excess of $150,000 (up to $95,800) will be transferred to the Purchaser’s Chief Executive Officer as additional consideration for the transfer to the Company by Mr. Frija of 1,405,910,203 shares of the Company’s common stock (the “Retired Shares”) that he had acquired on the open market.

 

The sale of the wholesale business qualifies as discontinued operations and, accordingly, the Company has excluded results for the wholesale business operations from the Company’s continuing operations in the consolidated statements of operations for all periods presented. The following table shows the results of the Company’s wholesale operations included in the loss from discontinued operations.

  F- 19  
 

  

    Year Ended
December 31, 		 
    2016     2015  
             
Wholesale vapor sales, net   $ 3,135,158     $ 5,497,422  
                 
Cost of sales – vapor wholesale     2,832,564       5,842,196  
Expenses – selling general and administrative     1,262,547       3,955,824  
Other Expense     629,850       1,900,000  
Total     4,724,961       11,698,020  
Loss from discontinued operations attributable to the wholesale business   $ (1,589,803 )   $ (6,200,598 )

 

The major classes of assets and liabilities of discontinued operations on the balance sheet are as follow:

 

    December 31, 2016     December 31, 2015  
Assets:                
Accounts receivable   $ 39,493     $ 184,104  
Due from merchant credit card processor, net     13,410       83,077  
Inventories     -       583,007  
Prepaid expenses and other     -       183,326  
Current assets of discontinued operations   $ 52,903     $ 1,033,514  
Liabilities:                
Accounts payable   $ -     $ 1,186,622  
Accrued expenses     555,810       2,723,571  
Customer deposits     -       92,498  
Total current liabilities of discontinued operations   $ 555,810     $ 4,002,691  

 

Note 4. INVENTORIES

 

Inventories are stated at average cost. If the cost of the inventories exceeds their market value, provisions are recorded to write down excess inventory to its net realizable value. The Company’s inventories consist primarily of merchandise available for resale.

 

    December 31, 2016     December 31, 2015  
Inventories:                
Vapor Business   $ 399,702     $ 946,799  
Grocery Business     348,849       -  
Total   $ 748,551     $ 946,799  

 

 

Note 5. NOTES RECEIVABLE

 

On January 12, 2015, the Company entered into an agreement with International Vapor Group, Inc. (“IVG”) whereby the Company agreed to reduce the $500,000 principal amount of the loan receivable by $50,000 if IVG were to remit payment of all principal and interest accrued on the loan receivable within one day. The Company included the write-down of the loan receivable in selling, general and administrative expenses on the consolidated statement of operations for the year ended December 31, 2014. On January 13, 2015, IVG repaid the Company in full.

 

On July 29, 2016, the Company, entered into an Asset Purchase Agreement (the “Wholesale Business Purchase Agreement”) with VPR Brands, L.P. (the “Purchaser”) and the Purchaser’s Chief Executive Officer, Kevin Frija (the former Chief Executive Officer of the Company) pursuant to which the Company sold its wholesale vapor inventory and the related business operations (collectively, “Wholesale Business Assets”), which previously operated at 3800 North 28th Way, Hollywood, Florida 33020 and to purchase 1,405,910,203 shares of the Company’s Common Stock held by Mr. Frija. The sale transaction was approved by the Company’s Board of Director’s on July 26, 2016 and completed on July 31, 2016. The consideration for the Wholesale Business Assets is (i) the transfer

 

  F- 20  
 

  

to the Company by Mr. Frija of 1,405,910,203 shares of the Company’s common stock that he had acquired on the open market; (ii) a secured, one-year promissory note in the principal amount of $370,000 (the “Acquisition Note”) bearing an interest rate of 4.5%, which payments thereunder are $10,000 monthly, with such payments commencing on October 28, 2016, with a balloon payment of the remainder of principal and interest on July 29, 2017; (iii) A secured, 36-month promissory note in the principal amount of $500,000 bearing an interest rate of prime plus 2%, resetting annually on July 29th,which payments thereunder are $14,000 per month, with such payments deferred and commencing on January 26, 2017, with subsequent installments payable on the same day of each month thereafter and in the 37th month, a balloon payment for all remaining accrued interest and principal; and (iv) the assumption by the Purchaser of certain liabilities related to the Company’s wholesale operations, including but not limited to the month-to-month lease for the premises. Pursuant to the Wholesale Business Purchase Agreement, the Company shall continue to collect the accounts receivable from its wholesale operations as of July 29, 2016, The Company agreed to use its commercially reasonable efforts, consistent with standard industry practice, to collect such accounts receivable, and any and all amounts so collected (i) up to $150,000 (net of any refunds) in the aggregate shall be credited against payment of the Acquisition Note; and (ii) in excess of $150,000 (up to $95,800) will be transferred to the Purchaser’s Chief Executive Officer. The Company records all proceeds related to both notes as income from discontinued operations as proceeds are received. The Company incurred costs to buy back it shares of its Common Stock in conjunction with the sale of its wholesale vapor business. The costs include approximately $43,000 of discounts on the notes receivable to related party, that were issued at below market rates, and $35,000 of professional fees. These costs were recorded as incurred as selling general and administrative expense, a component of the loss from discontinued operations.

 

Note 6. PROPERTY & EQUIPMENT and CAPITAL LEASE OBLIGATIONS

 

Property and equipment consists of the following:

 

    Year Ended
December 31, 		 
    2016     2015  
             
Appliances   $ 41,771     $ -  
Computer hardware & equipment     139,312       160,278  
Furniture and fixtures     242,005       243,380  
Machinery     92,825       -  
Displays     302,700       -  
Warehouse equipment     20,872       20,872  
Leasehold improvements     20,647       111,502  
Signage     72,192       86,069  
      932,324       622,101  
Less: accumulated depreciation and amortization     (293,398 )     (211,824 )
Total property and equipment   $ 638,926     $ 410,277  

 

During the years ended December 31, 2016 and 2015, the Company incurred $193,562 and $239,335, respectively, of depreciation expense.

 

As a result of the Company’s wholly owned subsidiary Healthy Choice Markets Inc., entering into a Business Sale Agreement with Ada’s Whole Food Market LLC (the “Seller”), the Company recorded favorable operating lease intangible asset of $890,000. The remaining life of said asset is 15 years and is being amortized on a straight line basis. Total accumulated amortization for the year ended December 31, 2016 was $33,859. Favorable lease terms, net of accumulated amortization, is reflected in other long-term assets on the consolidated balance sheet.

 

Capital Lease Obligations

 

On October 1, 2014, the Company entered into a capital lease obligation in connection with the acquisition of equipment software and licenses for its retail kiosk locations in the principal amount of $179,359. Annual interest on the capital lease obligation is 15.8% and borrowings are to be repaid over 36 months maturing on October 17, 2017. During the year ended December 31, 2016, the Company incurred interest expense associated with the capital lease obligation of $14,614. A portion of the retail kiosk equipment was returned to the vendor, the capital lease obligation was adjusted, and the net book value of the equipment and software licenses was written off at a loss of $124,555 for the year ended December 31, 2015. Depreciation expense of $44,840 was incurred during the year ended December 31, 2015 for equipment held under capital lease obligations.

 

  F- 21  
 

  

Future minimum lease payments under non-cancelable capital leases that have initial or remaining term in excess of one year as of December 31, 2016, are $60,010 which consist of $53,054 in principle, $3,560 in interest and $3,396 in taxes

 

Note 7. GOODWILL AND INTANGIBLE ASSETS

 

Goodwill represents the premium paid over the fair value of the intangible and net tangible assets acquired in the Merger and other retail business acquisitions. The Company assesses the carrying value of its goodwill on at least an annual basis. At December 31, 2016, management assessed relevant events and circumstances in evaluating whether it was more likely than not that its fair values were less than the respective carrying amounts of the acquired subsidiaries pursuant to ASC 350, “Intangibles, Goodwill and Other”. The Company then evaluated the carrying value of its goodwill by estimating the fair value of its consolidated business operations through the use of discounted cash flow models, which required management to make significant judgments as to the estimated future cash flows. The ceased retail store expansion plan and potential reduction in revenue resulting from pending regulations adversely impacted the Company’s projected cash flows and profits. Accordingly, the Company’s goodwill was evaluated for impairment. As a result of such analysis, the Company concluded that goodwill related to the retail business was impaired for the years ended December 31, 2016 and 2015.

 

The changes in the carrying amount of goodwill for the years ended December 31, 2016 and 2015 are as follows:

 

    December 31,
2016 		    December 31,
2015 		 
Beginning balance   $ 3,177,017     $ -  
Goodwill from Merger     -       15,654,484  
Goodwill from acquired retail businesses     -       1,977,533  
Goodwill from acquired grocery business     481,314       -  
Impairment of goodwill-retail business     (3,177,017 )     (14,455,000 )
Ending balance   $ 481,314     $ 3,177,017  

 

The Company’s amortizable intangible assets consist of the trade names and technology, customer relationships, and website that were capitalized in connection with the completion of the Merger and retail store business acquisitions; it also includes a favorable lease acquired with the Ada’s Whole Foods acquisition. Trade names and technology are amortized on a straight-line basis over their useful life of ten years. Customer relationships are amortized on a straight-line basis over their useful lives of five years, the website is amortized on a straight-line basis over its estimated useful life of three years and the favorable lease is amortized on a straight-line basis based on the lease terms. 

 

The Company records an impairment charge on its intangible assets if it determines that their carrying value may not be recoverable. The carrying value is not recoverable if it exceeds the undiscounted cash flows resulting from the use of the asset and its eventual disposition. When the Company determines that the carrying value of its intangible assets may not be recoverable, the Company measures the potential impairment based on a projected discounted cash flow method using a discount rate determined by its management to be commensurate with the risk inherent in its current business model. An impairment loss is recognized only if the carrying amount of the intangible assets exceeds its estimated fair value. An impairment charge is recorded to reduce the pre-impairment carrying amount of the intangible assets to their estimated fair value. Determining the fair value is highly judgmental in nature and requires the use of significant estimates and assumptions considered to be Level 3 fair value inputs, including anticipated future revenue opportunities, operating margins, and discount rates, among others. The estimated fair value of the intangible assets was determined based on the income approach, as it was deemed to be most indicative of the Company’s fair value in an orderly transaction between market participants. Upon completion of the analysis as of December 31, 2016 and 2015, the Company determined that certain intangible assets were impaired. Accordingly, the Company recorded an impairment charge of $778,345 and $948,833 during the years ended December 31, 2016 and 2015, respectively. The changes in the carrying amount of intangible assets for the years ended December 31, 2016 and 2015 are as follows:

 

Favorable

Lease

Trade Names
and Technology 		Customer
Relationships 		Assembled
Workforce 		Website Total
Beginning balance, January 1, 2015 $ - $ - $ - $ - $ - $ -
Additions from Merger - 1,500,000 488,274 92,326 - 2,080,600
Additions from acquisitions - 20,000 - - - 20,000
Impairment - (465,000 ) (406,895 ) (76,938 ) - (948,833 )
- 1,055,000 81,379 15,388 - 1,151,767
Accumulated amortization - (126,000 ) (81,379 ) (15,388 ) - (222,767 )
Ending balance, December 31, 2015 $ - $ 929,000 $ - $ - $ - $ 929,000
Additions from acquired grocery business 890,000 845,000 60,000 - 4,500 1,799,500
Sale of tradename - (100,000 ) - - - (100,000 )
Impairment - (778,345) - - - (778,345)
Accumulated amortization (33,859) (139,092) (7,000) - (875) (180,826)
Ending balance, December 31, 2016 $ 856,141 $ 756,563 $ 53,000 $ - $ 3,625 $ 1,669,329

 

The weighted-average remaining amortization period of the Company’s amortizable intangible assets is approximately 30.44 years as of December 31, 2016. The estimated future amortization of the intangible assets is as follows:

 

For the years ending December 31,
$
2017 222,793
2018 222,793
2019 221,918
2020 221,293
2021 196,794
Thereafter 583,738
Total $ 1,669,329

 

  F- 22  
 

 

 

Note 8. ACCRUED EXPENSES

 

Accrued expenses are comprised of the following:

 

    For the Year Ended
December 31, 		 
    2016     2015  
 Accrued Board of Directors   $ 29,000     $ -  
Accrued Loyalty and Gift Cards     85,274       -  
Accrued severance     37,440       51,145  
Accrued payroll and related employee expenses     229,768       124,186  
Accrued Delaware Franchise Tax     121,617       -  
Accrued Litigation and Settlements     70,872       -  
Accrued legal and professional fees     131,833       -  
Accrued retail store hold back payments from acquisitions     -       860,000  
Other accrued liabilities     73,872       190,301  
Total   $ 779,676     $ 1,225,632  

 

Note 9. NOTES PAYABLE

 

$567,000 Convertible Notes Payable

 

In 2015, Vaporin entered into a Securities Purchase Agreement with certain accredited investors providing for the sale of $567,000 of Vaporin’s Convertible Notes (the “Vaporin Notes”). The Vaporin Notes accrued interest on the outstanding principal at an annual rate of 10%. The principal and accrued interest on the Notes were due and payable between January 20, 2016 and January 23, 2016. The Vaporin Notes were assumed by the Company upon the closing of the Merger on March 4, 2015, at which time a debt discount of $54,623 was calculated. During the year ended December 31, 2015, the Company recorded contractual interest expense of $29,853. The Company amortized $28,859 of deferred debt discount, during year ended December 31, 2015 which is included in amortization of deferred debt discount on the consolidated statements of operations. As of December 31, 2015, the Vaporin Notes were repaid in full, including $567,000 in principal and $29,853 interest, and the Company recorded $25,764 of extinguishment loss.

 

$350,000 Convertible Notes Payable

 

On January 29, 2015, the Company issued a $350,000 convertible promissory note (the “Note”) to Vaporin in consideration of a loan of $350,000 made by Vaporin to the Company. The Note accrued interest on the outstanding principal at an annual rate of 12%. In connection with the completion of the Merger on March 4, 2015, the $350,000 Note along with accrued interest of $4,029 was forgiven.

 

$1,000,000 Note Payable to a Related Party

 

On December 8, 2014, Emagine entered into a Secured Line of Credit Agreement (the “Agreement”), effective as of December 1, 2014, with one affiliated stockholder of the Company and two unaffiliated investors (the “Lenders”). The funds were used to purchase and/or open Vape Stores similar to those operated by the Company. In connection with the completion of the Merger on March 4, 2015, Emagine became a wholly-owned subsidiary of the Company, and the debt was assumed by the Company. For the year ended December 31, 2015, the company recorded $60,285 of interest expense. On August 3, 2015, the Secured Line of Credit Agreement was repaid in full, including $1,000,000 in principal and $80,548 interest.

 

$1,250,000 Senior Convertible Notes Payable to Related Parties

 

On November 14, 2014, the Company entered into securities purchase agreements with certain accredited investors who are also stockholders of Vaporin providing for the sale of $1,250,000 in aggregate principal amount of the Company’s senior convertible notes

 

  F- 23  
 

  

(the “$1,250,000 Senior Convertible Notes”) and common stock purchase warrants to purchase up to an aggregate of 0.1624 shares of the Company’s common stock with an exercise price of $14,000,000 per share. The $1,250,000 Senior Convertible Notes accrued interest on the outstanding principal at an annual rate of 7% per annum. The principal and accrued interest on the Notes were due and payable on November 14, 2015, the maturity date of the Notes.

 

The Notes were convertible into shares of the Company’s common stock at any time, in whole or in part, at the option of the holder thereof at a conversion price of $7,700,000 per share (the “Conversion Price”).

 

In connection with the sale and issuance of the $1,250,000 Senior Convertible Notes, the Company also issued warrants to acquire an aggregate of 0.1624 shares of the Company’s common stock. The Warrants are exercisable after 180 days from the date of issuance, or May 14, 2015, until the fifth anniversary of such date of issuance at an exercise price of $14,000,000 per share (subject to certain customary adjustments upon the occurrence of certain events, including but not limited to stock dividends, stock splits, subsequent rights offerings of the Company, pro rata distributions of the Company, and in connection with a Fundamental Transaction. Palladium Capital Advisors, LLC acted as the exclusive placement agent for the $1,250,000 Senior Convertible Notes and, as compensation therefor, the Company paid Palladium Capital Advisors, LLC a placement agent fee of $62,500, included as part of financing fees described above, and issued to them a common stock warrant to purchase up to 0.008 shares of our common stock at an initial exercise price of $14,000,000 per share. The warrant is immediately exercisable and expires on November 14, 2019. The exercise price and number of shares of common stock issuable under the warrant are subject to customary anti-dilutive adjustments for stock splits, stock dividends, recapitalizations and similar transactions. At any time, the warrant may be exercised by means of a “cashless exercise” and the Company will not receive any proceeds at such time.

 

On the date of the issuance of the $1,250,000 Senior Convertible Notes, the Company recorded a debt discount of $1,250,000, of which $701,250 was allocated on a relative fair value basis to the warrants issued and the remaining $548,750 was allocated on a relative fair value basis to the conversion feature embedded within the $1,250,000 Senior Convertible Notes. The debt discount was to be amortized using the effective interest method over the life of the $1,250,000 Senior Convertible Note, as applicable, or until such time that the $1,250,000 Senior Convertible Notes are 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.

 

As of December 31, 2015, the $1,250,000 Senior Convertible Notes were repaid in full, including $1,250,000 in principal and $62,549 of interest, and the Company recorded an extinguishment loss of $548,130. During the year ended December 31, 2015, the Company amortized $81,473 of deferred financing costs associated with the $1,250,000 Senior Convertible Notes. For the year ended December 31, 2015, the Company recorded $230,891 of interest expense and amortization expense of $729,167.

 

$1,750,000 Convertible Debenture

 

On June 25, 2015, the Company received gross proceeds of $1,662,500 in connection with entering into a Securities Purchase Agreement, dated as of June 22, 2015, with certain purchasers in exchange for the issuance of convertible notes with a face value of $1,750,000 (the “Debentures”), interest accrued at 10% per annum and a final maturity date of December 22, 2015 (see Note 14- Certain Relationships and Related Party Transactions – for details on related party purchasers). The $87,500 (or 5%) original issue discount was recorded as a debt discount by the Company on the date the Debentures were issued and $19,542 was amortized using the effective interest method over the life of the Debentures during the year ended December 31, 2015, which is included in amortization of debt discounts on the consolidated statements of operations. Amounts of principal and accrued interest under the Debentures were convertible into common stock of the Company at a price per share of $3,500,000. The conversion feature embedded within the Debentures was determined to be a derivative instrument as the exercise price may be lowered if the Company issues securities at a lower price in the future (see Note 11). The aggregate fair value of the embedded conversion feature was $248,359, which was recorded as a derivative liability and a debt discount on the consolidated balance sheet on the date the Debentures were issued. The Company amortized the debt discount using the effective interest method over the life of the Debentures. During the year ended December 31, 2015, the Company recorded $459,144 of interest expense (inclusive of prepayment premiums) and amortized $55,467 of the deferred debt discount.

 

The Company incurred aggregate cash offering costs associated with the issuance of the Debentures of $196,250. Net proceeds to the Company from sale of the Debentures, after payment of commissions and legal fees of the lead investor, were $1,466,250. For acting as placement agent in the offering of the Debentures, the Company paid Chardan Capital Management, LLC (the “Placement Agent”) a fee equal to 10% of the gross proceeds from the sale of the Debentures, and issued the Placement Agent 1,000 five-year warrants exercisable at $3,500,000 per share. The value of the warrants granted to the placement agent of $87,779 was recorded as deferred financing costs on the Company’s consolidated balance sheet that was amortized over the term of the Debentures. During the year ended December 31, 2015, the Company amortized $63,430 of deferred financing costs associated with the Debentures.

 

As of December 31, 2015, the Debentures were paid in full, including $1,750,000 in principal and $459,144 of interest and prepayment premiums, and the Company recorded a $923,275 loss on debt extinguishment.

 

  F- 24  
 

  

$1,000,000 Term Loan

 

On September 23, 2014, the Company entered into a $1,000,000 term loan (the “Term Loan”) with Entrepreneur Growth Capital, LLC (the “Lender”) secured by a promissory note (the “Secured Note”) and a security interest in substantially all of the Company’s assets. Under the Secured Note, the principal amount of the Term Loan was payable in twelve successive monthly installments of $83,333. The Term Loan bore interest at 14% per year, payable in arrears. The Company used the proceeds of the Term Loan for general working capital purposes. The Company’s Chief Executive Officer and former executive officers personally guaranteed performance of certain of the Company’s obligations under the Term Agreement. During the year ended December 31, 2015, the Company incurred $45,092 of interest expense. The Term Loan was repaid in full on September 1, 2015.

 

Note 10. COMMITMENTS AND CONTINGENCIES

 

Lease Commitments

 

The Company leases its Florida office and warehouse facilities under a three-year lease. The lease provides for annual rental payments including taxes of $95,000 per year.

 

During the year ended December 31, 2015, the Company closed eight kiosks. The Company settled the lease commitment with the landlords on all leases with payments totaling $229,536. The landlords also kept the deposits on these leases in the amount of $23,500. These amounts were recorded in selling, general and administrative expenses for a total amount of $265,627 during the year ended December 31, 2015.

 

During the year ended December 31, 2015, the Company settled the lease commitment with the landlord of the retail store located in Ft. Lauderdale, FL. with a single payment of $45,000. The landlord also kept the deposit on these leases in the amount of $8,309. Therefore, the Company incurred lease costs in the total amount of $53,309 included in selling, general and administrative expenses, during the year ended December 31, 2015.

  

During the year ending 2016, the Company closed seven of its retail Vape Stores. The majority of the Vape stores closed were in the Orlando, Florida area and the others were in Georgia. The cost incurred with the closing of these stores amounted to $308.965. The landlords kept the deposits and the store closure cost was recorded in selling, general and administrative expenses during the year ended December 31, 2016

 

Future minimum lease payments under non-cancelable operating leases that have initial or remaining terms in excess of one year at December 31, 2016 are due as follows:

 

2017   $ 702,791  
2018     574,794  
2019     410,880  
2020     307,472  
2021     128,113  
Thereafter     -  
Total   $ 2,124,050  

 

Rent expense for the year ended December 31, 2016 and 2015 was $777,310 and $807,857, respectively, is included in selling, general and administrative expenses in the accompanying consolidated statement of operations. 

 

Employment Agreements 

 

In December 2016, Gina Hicks resigned from her position as the Chief Financial Officer of the Company and in December 2016, the Company appointed John A. Ollet to serve as the Company’s new Chief Financial Officer.

 

  F- 25  
 

  

On December 12, 2016, the Company entered into a three-year employment agreement with John Ollet. Mr. Ollet’s initial base salary shall be $180,000, $190,000 and $200,000 in years one, two and three, respectively. Mr. Ollet shall be eligible to receive a one-time sign-on bonus of $5,500. Mr. Ollet shall also be entitled to bonuses and other incentives at the discretion of the Company, based in part on Mr. Ollet’s performance.

 

Gina Hicks received severance compensation and accrued vacation in the total amount of $46,154, which is divided into equal weekly payments that ends on March 7, 2017. As of December 31, 2016, $37,440 of accrued severance was included in accrued expenses on the consolidated balance sheet.

 

On September 10, 2015, the Board of Directors approved the decision to replace Mr. James Martin, the Company’s former Chief Financial Officer, with Ms. Gina Hicks. Mr. Martin received severance compensation and accrued vacation in the total amount of $87,500, which is divided into equal weekly payments that end on March 11, 2016. As of December 31, 2015, $33,642 of accrued severance was included in accrued expenses on the consolidated balance sheet. The final payments for Jim Martin’s severance pay was paid in the first quarter of 2016.

 

On August 10, 2015, the Company entered into three-year Employment Agreements with Jeffrey Holman, the Company’s Chief Executive Officer, and Gregory Brauser, the Company’s President. Each of the Employment Agreements provide for an annual base salary of $300,000 and a target bonus in an amount ranging from 20% to 200% of their base salaries subject to the Company meeting certain adjusted earnings before interest, taxes depreciation and amortization (“Adjusted EBITDA”) performance milestones. Adjusted EBITDA is defined in the Employment Agreements as earnings (loss) from continuing operations before interest expense, income taxes, collateral valuation adjustment, bad debt expense, one-time expenses, depreciation and amortization and amortization of stock compensation or Adjusted EBITDA defined in any filing of the Company with the SEC subsequent to the date of the Employment Agreements. Additionally, the Company approved an immediate bonus of $100,000 to each of Mr. Holman and Mr. Brauser. Messrs. Holman and Brauser are also entitled to receive severance payments, including 2 years of their then base salary and other benefits in the event of a change of control, termination by the Company without cause, termination for good reason by the executive or non-renewal by the Company.

 

Effective April 25, 2014, Kevin Frija resigned as the Company’s Chief Executive Officer and the Company’s Board of Directors appointed the Company’s President and incumbent member of the Board, Jeffrey Holman, as the Company’s new Chief Executive Officer. In connection with Mr. Frija’ s resignation as Chief Executive Officer, the Board approved severance payments to Mr. Frija in an aggregate amount equal to one year of base salary at the rate of $159,000 per annum payable in installments in accordance with the Company’s normal payroll schedule conditioned upon his execution and delivery of a general release to the Company, and his compliance with the non-solicitation, confidentiality and non-competition covenants of his Employment Agreement dated February 27, 2012 with the Company until April 24, 2015 in certain respects and indefinitely in other respects. During the year ended December 31, 2014 the Company accrued severance expense in the amount of $167,003, which is included as part of the selling, general and administrative expenses in accompanying consolidated statements of operations in connection with Mr. Frija’ s resignation. During the year ended December 31, 2015 $77,028 was paid to Mr. Frija.   The last payment to Mr. Frija was in April 2015.

 

Legal Proceedings 

 

From time to time the Company may be involved in various claims and legal actions arising in the ordinary course of our business. With respect to legal costs, we record such costs as incurred.

 

Fontem Matters  

 

On June 22, 2012, Ruyan Investment (Holding) Limited (“Ruyan”) filed a lawsuit against the Company alleging infringement of U.S. Patent No. 8,156,944 (the “944 Patent”). Ruyan also filed separate cases for patent infringement against nine other defendants asserting infringement of the 944 Patent. Ruyan’s second lawsuit against the Company known as Ruyan Investment (Holdings) Limited vs. Vapor Corp. CV-12-5466 is pending in the United States District Court for the Central District of California. All of these lawsuits were consolidated for discovery and pre-trial purposes.

 

On February 25, 2013, Ruyan’s second patent infringement lawsuit against the Company as well as all of the other consolidated lawsuits were stayed as a result of the Court granting a stay in one of the consolidated lawsuits. The Court granted the motion to stay Ruyan’s separate lawsuits against the Company and the other defendants based on the filing of a request for inter partes reexamination of the 944 Patent at the United States Patent and Trademark Office.  

 

All reexamination proceedings of the 944 Patent had stayed by the United States Patent and Trademark Office Patent Trial and Appeal Board pending its approval of one or more of them. On March 5, 2014, Fontem Ventures, B.V. and Fontem Holdings 1 B.V. (the successors to Ruyan) filed a complaint against the Company alleging infringement of U.S. Patent No. 8,365,742, entitled “Aerosol Electronic Cigarette”, U.S. Patent No. 8,375,957, entitled “Electronic Cigarette”, U.S. Patent No. 8,393,331, entitled “Aerosol Electronic

 

  F- 26  
 

  

Cigarette” and U.S. Patent No. 8,490,628, entitled “Electronic Atomization Cigarette. On April 8, 2014, plaintiffs amended their complaint to add U.S. Patent No. 8,689,805, entitled “Electronic Cigarette.” The products accused of infringement by the plaintiff are various Krave, Fifty-one and Hookah Stix products and parts. Eight other companies were also sued in separate lawsuits alleging infringement of one or more of the patents listed above. The Company filed its Answer and Counterclaims on May 1, 2014.

 

On October 21, 2014, Fontem Ventures B.V. and Fontem Holdings 1 B.V. filed a complaint against the Company in the U.S. District Court for the Central District of California, captioned Fontem Ventures B.V., et al. v. Vapor Corp., No. 14-cv-8155. The complaint alleges infringement of United States Patent No. 8,863,752, entitled “Electronic Cigarette”. The products accused of infringement by plaintiffs are various Krave and Fifty-One products and parts On January 15, 2015, the Company filed its Answer and Counterclaims.

 

On December 2, 2014, Fontem Ventures B.V. and Fontem Holdings 1 B.V. filed a complaint against the Company in the U.S. District Court for the Central District of California, captioned Fontem Ventures B.V., et al. v. Vapor Corp., No. 14-cv-09267. The Complaint alleges infringement by the plaintiffs against the Company relating to various Krave, Vapor X and Fifty-One products and parts. Fontem amended its complaint on December 16, 2014, to allege infringement of United States Patent No. 8,910,641, entitled “Electronic Cigarette” against the same products. On January 15, 2015, the Company filed its Answer and Counterclaims. Fontem, by way of its expert, sought $1,982,504 in monetary damages for alleged past infringement. All of the above referenced cases filed by Fontem were consolidated.  

 

Effective December 16, 2015, the Company entered into a confidential Settlement Agreement and a non-exclusive royalty-bearing confidential Global License Agreement (“License Agreement”) with Fontem Ventures B.V. (“Fontem”) resulting in the dismissal of all of the aforementioned patent infringement cases by Fontem against the Company. The estimated settlement fee of approximately $1.7 million was included in selling, general and administrative expenses and in accrued expense at December 31, 2015. On January 15, 2016, the Company made a payment of $1.7 million under the terms of the Settlement and License Agreements. In connection with the License Agreement, Fontem granted the Company a non-exclusive license to certain of its products. As consideration, the Company will make quarterly license and royalty payments to Fontem based on the sale of qualifying products as defined in the License Agreement. The term of the License Agreement will continue until all of the patents on the products subject to the agreement are no longer enforceable.   During the year ended December 31, 2016 and 2015, the Company recorded $117,525 and $1,225,632 of accrued expense, respectively. As of December 31, 2016, the Company has made royalty payments in the amount of $1,829,242.

 

California Center for Environment Health Matters

 

On June 22, 2015, the Center for Environment Health, as plaintiff, filed suit against a number of defendants including the Company, its wholly-owned subsidiary, the Vape Store, Inc., Vaporin and another wholly-owned subsidiary, Vaporin Florida, Inc. The lawsuit was filed in the Superior Court of the State of California, County of Alameda. The suit seeks relief under California Proposition 65 which makes it unlawful for businesses to knowingly and intentionally expose individuals in California to chemicals known to cause birth defects or other harm without providing clear and reasonable warnings. All of the defendants are alleged to have sold products containing significant quantities of nicotine without warnings in violation of Proposition 65. On April 6, 2016, the Company and the plaintiff entered into a settlement agreement, which required the Company to (1) make a payment of $45,000 and (2) comply with enhanced product labeling requirements within a set implementation period as defined in the consent judgment. The settlement cost was included in selling, general and administrative expenses and accrued expenses at December 31, 2015.

 

  Future events or circumstances, currently unknown to management, will determine whether the resolution of pending or threatened litigation or claims will ultimately have a material effect on the Company’s consolidated financial position, liquidity or results of operations in any future reporting periods. On April 6, 2016, the Company and the plaintiff entered into a settlement agreement, which required the Company to (1) make a payment of $45,000 and (2) comply with enhanced product labeling requirements within a set implementation period as defined in the consent judgment. The settlement cost was included in selling, general and administrative expenses for the six months ended June 30, 2016. The settlement payment was made on May 2, 2016.

 

Other Matters

 

On March 2, 2016, Hudson Bay Master Fund Ltd. (“HB”), filed an action against the Company in the Supreme Court of the State of New York, County of New York, captioned Hudson Bay Master Fund Ltd. versus Vapor Corp., Index No. 651094/2016. This action alleged that the Company failed to timely effect exercises of its Series A Warrants delivered by the plaintiff and sought damages of $339,810. On May 10, 2016, solely to avoid the costs, risks and uncertainties inherent in litigation, the Company entered into a settlement agreement with respect to all claims included in the action by HB (the “HB Settlement”). The HB Settlement provided, among other things, that the parties would enter into and file a stipulation of discontinuance that provides for the dismissal of the action against the Company (the “HB Stipulation”). This action by HB was dismissed with prejudice.

 

  F- 27  
 

  

On June 2, 2016, four Series A Warrant holders, filed an action against the Company in the Supreme Court of the State of New York, County of New York, captioned Empery Asset Master, LTD, Empery Tax Efficient, LP, Empery Tax Efficient II, LP and Intracoastal Capital, LLC versus Vapor Corp., Index No. 652950/2016. This action alleged that the Company failed to timely effect exercises of its Series A Warrants delivered by the plaintiffs and sought aggregate damages of approximately $603,000. Between June 17, 2016 and June 22, 2016, solely to avoid the costs, risks and uncertainties inherent in litigation, the Company entered into settlement agreements with respect to all claims included in the Complaints (the “Settlements”). The Settlements provide, among other things, that the parties would enter into and file a stipulation of discontinuance that provides for the dismissal of the Complaint (the “Stipulation”), and the holders would surrender the balance of their Series A Warrant upon receipt of settlement payments. These actions were dismissed with prejudice.

 

Purchase Commitments

 

At December 31, 2016 and 2015, the Company had vendor deposits of $7,000 and $127,609, respectively, and which are included as a component of prepaid expenses and vendor deposits on the consolidated balance sheets included herewith.

 

Note 11. STOCKHOLDERS’ EQUITY (DEFICIT)

 

Amendments to Certificate of Incorporation

 

On July 7, 2015, the Company filed an amendment to its Certificate of Incorporation to effectuate a one-for-five reverse stock split to its Common Stock. On February 1, 2016, the Company filed an amendment to its Certificate of Incorporation to increase its authorized Common Stock to 5,000,000,000, and change the par value to $0.0001. On March 4, 2016, the Company filed an amendment to its Certificate of Incorporation to effectuate a one-for-seventy reverse stock split to its Common Stock. On June 1, 2016, the Company filed an amendment to its Certificate of Incorporation to effectuate a one-for-twenty thousand reverse stock split to its Common Stock. On August 4, 2016, the Company filed an amendment to its Amended and Restated Certificate of Incorporation to increase the number of shares of the authorized common stock from 5,000,000,000 to 750,000,000,000. Each share entitles the holder to one vote.

 

All warrant, convertible preferred stock, option, common stock shares and per share information included in these consolidated financial statements gives retroactive effect to the aforementioned reverse splits of the Company’s common stock.

 

Equity Plans 

 

On July 7, 2015, the stockholders approved the 2015 Equity Incentive Plan (the “2015 Plan”), which is a broad-based plan and awards granted may be restricted stock, restricted stock units, options and stock appreciation rights. On November 21, 2016, the 2015 Plan was amended to increase the number of shares of common stock available for grants to 100,000,000,000. The 2015 Plan had 94,998,999,996 shares of common stock available for grant as of December 31, 2016.

 

The Company’s 2009 Equity Incentive Plan (the “2009 Plan”) was duly adopted by the stockholders on November 24, 2009. The 2009 Plan provides for the granting of incentive stock options to employees, the granting of non-qualified stock options to employees, non-employee directors and consultants, and the granting of restricted stock to employees, non-employee directors and consultants in connection with their retention and/or continued employment by the Company. Options issued under the 2009 Plan generally have a ten-year term and generally become exercisable over a four-year period. Shares subject to awards that expire unexercised or are forfeited or terminated will again become available for issuance under the 2009 Plan. No participant in the 2009 Plan can receive option grants and/or restricted shares for more than 20% of the total shares subject to the 2009 Plan. The 2009 Plan had no shares of common stock available for grant as of December 31, 2016.

 

Preferred Stock

 

The Company’s amended and restated articles of incorporation authorizes the Company’s Board of Directors to issue up to 1,000,000 shares of “blank check” preferred stock, having a $0.001 par value, in one or more series without stockholder approval. Each such series of preferred stock may have such number of shares, designations, preferences, voting powers, qualifications, and special or relative rights or privileges as determined by the Company’s Board of Directors. See below for details associated with the designation of the 1,000,000 shares of the Series A preferred stock.

 

Series A Unit Public Offering 

 

On July 29, 2015, the Company closed a public offering of Units for gross proceeds of approximately $41.4 million and net proceeds of approximately $38.7 million. On January 25, 2016, the Units automatically separated into an aggregate of 0.672 shares of Series A.

 

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Preferred Stock, which were convertible in to an aggregate of 27 shares of common stock, and five-year Series A Warrants, exercisable into 54 shares of common stock. Except in the event of a “cashless exercise” as described below, each Series A Warrant is exercisable into one share of common stock at an exercise price of $1,736,000 per share and expires on July 23, 2020. See the Warrants section of this footnote for details related to 2016 warrant activity.

 

The Series A Preferred Stock (a) ranks equal to the common stock on an as converted basis with regard to the payment of dividends or upon liquidation; (b) automatically converts into common stock upon the consummation of a Fundamental Transaction, as defined; (c) has no voting rights, except related to the amendment of the terms of the Series A preferred stock; and (d) has conversion limits whereby the holder may not beneficially own in excess of 4.99% of the common stock. Through December 31, 2016, 0.630 shares of Series A Preferred Stock were converted and the Company issued 26 shares of common stock to settle these conversions, leaving 0.042 shares of Series A Preferred Stock outstanding.

 

The Series A warrants were originally determined to be derivative liabilities because there is a potential cash settlement provision which isn’t under the Company’s control (see Note 12). Utilizing a Monte Carlo valuation method, the issuance date value of the Series A warrant liabilities was calculated to be $79.4 million. Since the value of the Series A warrant liabilities exceeded the gross proceeds from the public offering, the Company recorded a $38.1 million deemed dividend on the preferred stock. Each Series A warrant may be exercised on a cashless basis for the Black Scholes value defined in the warrant agreement. The number of shares of common stock that the Company will issue in connection with the exercise of the Series A warrants is primarily based on the closing bid price of the common stock two days prior to the date of the exercise. If (a) all of the warrants were exercised simultaneously when the Company’s common stock traded below a certain price per share, or (b) the Company does not continue to meet certain Equity Conditions (as defined), the Company may not have sufficient authorized common stock and could be required to use cash to pay warrant holders.

 

In connection with the closing of this offering, the Company incurred $4,779,003 of issuance costs, including cash underwriting fees of $2,722,687, other cash costs of approximately $503,898, and the issuance date value of $1,552,418 (utilizing the Black-Scholes-Merton valuation model) of the underwriter’s five-year Series A unit purchase option, which gives the underwriter the option to purchase 0.034 shares of Series A Convertible Preferred Stock, which were convertible into 1 share of common stock, plus Series A Warrants, which would be currently exercisable into an aggregate of approximately 40,813,223,000 shares of common stock. The shares issuable upon the exercise of the Series A Warrants are calculated (1) using a Black Scholes Value of $1,519,297 per share and a closing stock bid price of $0.0001 per share and (2) assuming the Company delivers only common stock upon exercise of the Series A Warrants and not cash payments as permitted under the terms of the Series A Warrants. All of the issuance costs were allocated to the Series A warrant liabilities because no carrying value was attributed to the Series A preferred stock and, as a result, the issuance costs were expensed immediately.

 

In connection with the closing of this offering, on August 3, 2015, the Company paid Chardan Capital Markets, LLC (“Chardan”) $500,000 in satisfaction of an agreement between Chardan and the Company pursuant to which Chardan waived certain rights to participate in the public offering that were granted to Chardan under its previous agreements with the Company. The $500,000 cost was recorded in other expenses on the consolidated statement of operations for the year ended December 31, 2015.   

 

Common Stock

 

Issuance of Common Stock

 

On February 3, 2014, the Company entered into a consulting agreement (the “Consulting Agreement”) with Knight Global Services, LLC (“Knight Global”) pursuant to which the Company retained Knight Global to assist the Company with increasing awareness of its electronic cigarette brands as well as assisting the Company to expand and diversify its relationships with large retailers and national chains. Knight Global is a wholly owned subsidiary of Knight Global, LLC of which Ryan Kavanaugh is an investor and principal. Effective March 5, 2014, the Board of Directors of the Company elected Mr. Kavanaugh as a member of the Board of Directors in accordance with the Consulting Agreement. Knight Global serves as the family office for Mr. Kavanaugh.

 

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Under the terms of the Consulting Agreement, the Company issued to Mr. Kavanaugh 0.057 shares of its common stock, of which 0.007 shares vested immediately while the remaining 0.050 shares vest in installments of 0.007 shares per quarterly period beginning on the 90th day following February 3, 2014 and each ensuing quarterly period thereafter so long as the Consulting Agreement has not been terminated and during each quarterly period Knight Global has presented the Company with a minimum of six (6) bona fide opportunities for activities specified in the Consulting Agreement that are intended to increase awareness of the Company’s electronic cigarettes. In addition, during the term of the Consulting Agreement, which is 2 years, and during an 18-month post-termination period, the Company has agreed to pay Knight Global commissions payable in cash equal to 6% of “net sales” (as defined in the Consulting Agreement) of its products to retailers introduced by Knight Global and to retailers with which the Company has existing relationships and with which Knight Global is able, based on its verifiable efforts, to increase net sales of the Company’s products.

 

The grant date fair value of the common shares issued on February 3, 2014 was $3,080,000 based on closing price per share of the Company’s common stock, as reported on the OTC Bulletin Board, on February 3, 2014. On January 24, 2015, the Company and Knight Global mutually agreed to terminate the Consulting Agreement as it was in the best interests of both parties to do so. As a result of such termination, the Company cancelled 0.021 shares that were not vested that had been previously issued to Mr. Kavanaugh. In addition, on January 24, 2015, the Company received notice from Ryan Kavanaugh, a director of the Company that he had resigned from the Company’s board of directors, effective immediately.

 

 During the year ended December 31, 2015, the Company recognized Knight Global stock-based compensation of $1,602,933, which was included in selling, general and administrative expense.

 

Private Placement of Common Stock 

 

In connection with the Merger, on March 3, 2015, the Company entered into a Securities Purchase Agreement (the “Purchase Agreement”) with certain accredited investors providing for the sale 0.490 shares of the Company’s common stock for aggregate gross proceeds of $3,500,960. The Company also issued five-year Warrants to purchasers of the shares to acquire an aggregate of 0.392 shares of the Company’s common stock with an exercise price of $8,960,000 per share. The Warrants were deemed to be derivative liabilities due to a potential cash settlement provision which is not in the Company’s control and as a result, the issuance date fair value of $2,494,639 was recorded as a derivative liability. The shares and Warrants were issued and sold through an exempt private security offering to certain accredited investors. The Company incurred aggregate offering costs of $559,000 in connection with the private placement, of which $350,000 was paid to Palladium Capital Advisors, the Company’s placement agent. The initial Form S-3 was filed on April 17, 2015 and was declared effective by the SEC on June 5, 2015, thus meeting the requirements of the Purchase Agreement.

 

  F- 30  
 

  

Shares Issued in Connection with Waiver Agreements  

 

On June 19, 2015, the Company entered into agreements (the “Waivers”), with certain investors in each of its private placement offerings under the Securities Purchase Agreement dated March 3, 2015 (the “2015 Agreement”) and the Securities Purchase Agreement dated November 14, 2014 (the “2014 Agreement,” and with the 2015 Agreement, the “Agreements”). Under the terms of the Waivers, the signatories thereto (the “Prior Investors”) agreed to amend the Agreements and waive or modify certain terms thereunder, including certain restrictions on the completion of subsequent securities offerings by the Company. In exchange, the Company agreed to issue the Prior Investors a total of 0.463 shares of common stock (including 0.101 shares issued to the lead investor under each of the Agreements in its capacity as lead investor) and 0.426 five-year warrants exercisable at $3,535,000 per share. The grant date fair value of the common stock and warrants issued with the Waivers was $1,328,196 and $1,086,354, respectively, and was recorded in other expenses on the consolidated statement of operations for the year ended December 31, 2015.

 

The warrants issued in connection with the Waivers were determined to be derivative instruments because (a) their exercise prices may be lowered if the Company issues securities at a lower price in the future; and (b) there is a potential cash settlement provision which is not in the Company’s control (see Note 12). The aggregate fair value of the warrants was $1,086,354 and was recorded as a derivative liability on the consolidated balance sheet on the date the warrants were issued. The Waivers also resulted in the equity warrants issued pursuant to the 2014 Agreement having their exercise priced adjusted from $14,000,000 to $1,540,000 per share.  The Company recognized a 2015 charge of $36,432 for the incremental value of the modified warrants as compared to the original warrants. 

 

In the event that, prior to November 14, 2015, the Company issued shares of common stock, or securities convertible into common stock, at an effective price per share of less than $3,780,000, the Prior Investors were entitled to the issuance of additional shares (the “Additional Shares”), the exact amount of which depended on the effective price per share of such subsequent issuance. The Company could not issue any Additional Shares of common stock requiring stockholder approval under the Rules of the Nasdaq Stock Market without receipt of such approval.

 

Subsequently the Company issued shares of common stock in connection with a registered public offering on July 29, 2015. This effectively triggered the need to issue Additional Shares that were calculated by the Company as 1.855 common shares. Pursuant to the Rules of the Nasdaq Stock Market, the Company needed to seek stockholder approval before issuing 1.285 of these shares and such approval was obtained on October 16, 2015. The Company recognized a 2015 charge of $1,297,081 in connection with the issuance of the Additional Shares.

 

Warrants

 

Through December 31, 2016, Series A Warrants to purchase 4 shares of common stock have been exercised through the cashless exercise provision in the Series A Warrants, resulting in the issuance of 15,619,771,347 shares of the Company’s common stock. In addition, Series A Warrants to purchase 8 shares of common stock were repurchased, which could have resulted in the issuance of approximately 116,704,766,499 shares of the Company’s common stock if such Series A Warrants had not been repurchased as of the date of this report. As of December 31, 2016, Series A Warrants to purchase 42 shares of common stock remained outstanding, they have a remaining weighted average term of 3.6 years and they currently have the potential to result in the issuance of approximately 634,754,364,551 shares of common stock. The shares issuable upon the exercise of the Series A Warrants are calculated (1) using a Black Scholes Value of $1,519,297 per share and a closing stock bid price of $0.0001 per share and (2) assuming the Company delivers only common stock upon exercise of the Series A Warrants and not cash payments as permitted under the terms of the Series A Warrants. See Note 16 – Subsequent Events for details related to the January 2017 repurchase of Series A Warrants via a tender offer.

 

Holders (the “Holders”) of approximately 90% of the Series A Warrants are subject to the Amended and Restated Standstill Agreements (the “Standstill Agreements). These Standstill Agreements permit the Holders to effect a “cashless” exercise of the Series A Warrants only on dates when the closing bid price used to determine the “net number” of shares to be issued upon exercise is at or above $0.0001 per share. Pursuant to the terms of the Standstill Agreements, the Holders agreed in certain circumstance to receive only common stock (and not cash) pursuant to such cashless exercise pursuant to Section 1(d) of their Series A Warrants. Those circumstances include if the Company is deemed not to meet the “Equity Conditions” of the Series A Warrants because of the failure of the Company common stock to be listed or quoted on an eligible national securities exchange.

 

  F- 31  
 

 

A summary of warrant activity for the years ended December 31, 2016 and 2015 is presented below:

 

          Weighted     Weighted        
          Average     Average     Aggregate  
    Number of     Exercise     Remaining     Intrinsic  
    Warrants     Price     Term (Yrs)     Value  
Outstanding at January 1, 2015     -     $ 14,083,400                  
Warrants granted     54       1,803,600                  
Warrants exercised     -       -                  
Warrants assumed in Merger     -       36,711,600                  
Warrants forfeited or expired     -       -                  
Outstanding at December 31, 2015     54     $ 1,736,000                  
Warrants granted     -       -                  
Warrants exercised     (5 )     1,736,000                  
Warrants repurchased     (7 )     1,736,000                  
Warrants forfeited or expired     -       -                  
Outstanding at December 31, 2016     42     $ 1,736,000       3.6     $ -  
                                 
Exercisable at December 31, 2016     42     $ 1,736,000       3.6     $ -  

 

See Note 12 – Fair Value Measurements for additional details related to the Series A Warrants that were exchanged

 

  F- 32  
 

 

Compensatory Common Stock Summary 

 

During the years ended December 31, 2016 and 2015, the Company recognized stock-based compensation expense related to compensatory Common Stock in the amount of $75,000 and $582,000, respectively. Stock-based compensation expense is included as part of selling, general and administrative expense in the accompanying consolidated statements of operations.

 

A summary of compensatory common stock activity for the years ended December 31, 2016 and 2015 is presented below:

 

          Weighted        
          Average        
          Issuance Date     Total  
    Number     Fair Value     Issuance Date  
    of Shares     per share     Fair Value  
Non-vested, January 1, 2015   0.0     $ 53,900,000     $ 1,540,000  
Granted     0.3       7,336,843       2,439,736  
Vested     (0.3 )     8,385,754       (2,668,736 )
Forfeited     (0.0 )     47,240,000       (1,181,000 )
Non-vested, December 31, 2015     -     $ 7,280,000     $ 130,000  
Granted     -       -       -  
Vested     (0.0 )     7,280,000       (130,000 )
Forfeited     -       -       -  
Non-vested, December 31, 2016   -     $ -     $ -  

 

Stock Options

 

During December 2016, the Company granted options for the purchase of 5,001,000,004 shares of its common stock to employees, at an aggregate grant date value of $500,100 or $0.0001 per option share.

 

The fair value of employee stock options was estimated using the following Black-Scholes assumptions:

 

    For the Year Ended
    December 31,
    2016   2015
Expected term (years)   5 - 6 years   n/a
Risk free interest rate   1.98% - 2.03%   n/a
Dividend yield   0%   n/a
Volatility   428.10%   n/a

 

  F- 33  
 

 

A summary of option activity during the years ended December 31, 2016 and 2015 is as follows: 

 

          Weighted     Weighted        
          Average     Average        
    Number of     Exercise     Remaining     Intrinsic  
    Options     Price     Term (Yrs)     Value  
                         
Outstanding, January 1, 2015     0.192     $ 5,101,040                  
Options granted     -                          
Options replaced in merger     0.003     $ 7,860,000                  
Options exercised     -                          
Options forfeited or expired     (0.167 )   $ 4,618,600                  
Outstanding, December 31, 2015     0.028     $ 5,101,040                  
Options granted     5,001,000,004.000       0.0001                  
Options replaced in merger     -                          
Options exercised     -                          
Options forfeited or expired     (0.017 )     11,625,400                  
Outstanding, December 31, 2016     5,001,000,004.011     $ 0.0001     10.0     $ -  
                                 
Exercisable at December 31, 2016     0.011     $ 20,505,301     4.80     $ -  

 

The following table presents additional information related to options as of December 31, 2016:

 

      Options Outstanding     Options Exercisable  
      Weighted           Weighted     Weighted        
Range of     Average     Outstanding     Average     Average     Exercisable  
Exercise     Exercise     Number of     Exercise     Remaining Life     Number of  
Price     Price     Options     Price     In Years     Options  
$0.0001     $ 0.0001       5,001,000,004.000     $ -       -       -  
$ 7,000,000-$13,999,800     $ 8,380,200       0.006     $ 8,380,200       5.6       0.006  
$14,000,000     $ 14,000,000       0.002     $ 14,000,000       2.5       0.002  
$ 30,449,800-$67,410,000     $ 45,000,600       0.003     $ 45,000,600       4.4       0.003  
                  5,001,000,004.011               4.8       0.011  

 

During the years ended December 31, 2016 and 2015, the Company recognized stock-based compensation expense of $13,636 and $288, respectively, in connection with the amortization of stock options, net of recovery of stock-based charges for forfeited stock options. Stock-based compensation expense is included as part of selling, general and administrative expense in the accompanying consolidated statements of operations. There were no options granted during the year ended December 31, 2015. The weighted average grant date fair value of options granted during the year ended December 31, 2016 was $0.0001 per share.

 

At December 31, 2016, the amount of unamortized stock-based compensation expense on unvested stock options granted to employees, directors and consultants was $486,464 which will be amortized over a weighted average period of 1.7 years.

 

  F- 34  
 

 

Income (Loss) per Share

 

Basic income (loss) per share is computed by dividing the net income (loss) available to common stockholders by the weighted average number of common shares outstanding during the period. Diluted income (loss) per share is computed using the weighted average number of common shares and, if dilutive, potential common shares outstanding during the period. Potential common shares consist of the incremental common shares issuable upon (a) the exercise of stock options (using the treasury stock method); (b) the conversion of Series A convertible preferred stock; (c) the exercise of warrants (using the if-converted method); (d) the vesting of restricted stock units; and (e) the conversion of convertible notes payable. Diluted income (loss) per share excludes the potential common shares, as their effect is antidilutive. The following table summarizes the Company’s securities that have been excluded from the calculation of basic and dilutive income (loss) per share as their effect would be anti-dilutive:

 

    December 31,  
    2016     2015  
             
Stock options     -       0  
Series A convertible preferred stock     -       27  
Warrants     -       55  
Total     -       82  

 

Shares used in calculating basic and diluted net income (loss) per share are as follows:

 

    Year Ended December 31,  
    2016     2015  
             
Basic     4,102,959,032       6  
Effect of exercise stock options     5,000,999,976       -  
Effect of exercise warrants     631,552,260,513       -  
Diluted     640,656,219,521       6  

 

Significant dilution may occur upon the exercise of the warrants or on the cashless exercise feature described and quantified in Note 11, Warrants section. 

 

On February 1, 2017, pursuant to the 2015 Plan, the Company issued a total of 77,000,000,000 options to purchase common stock to certain officers and directors. Twenty-five percent of the options vested upon issuance and the remainder vest equally at the end of the next three calendar quarters.

 

Note 12. FAIR VALUE MEASUREMENTS

 

The fair value framework under the FASB’s guidance requires the categorization of assets and liabilities into three levels based upon the assumptions used to measure the assets or liabilities. Level 1 provides the most reliable measure of fair value, whereas Level 3, if applicable, would generally require significant management judgment. The three levels for categorizing assets and liabilities under the fair value measurement requirements are as follows:

 

· Level 1: Fair value measurement of the asset or liability using observable inputs such as quoted prices in active markets for identical assets or liabilities;

 

· Level 2: Fair value measurement of the asset or liability using inputs other than quoted prices that are observable for the applicable asset or liability, either directly or indirectly, such as quoted prices for similar (as opposed to identical) assets or liabilities in active markets and quoted prices for identical or similar assets or liabilities in markets that are not active; and

 

· Level 3: Fair value measurement of the asset or liability using unobservable inputs that reflect the Company’s own assumptions regarding the applicable asset or liability.

 

Nonfinancial assets such as goodwill, other intangible assets, and long-lived assets held and used are measured at fair value when there is an indicator of impairment and recorded at fair value only when impairment is recognized or for a business combination.

 

The following table presents nonfinancial assets measured and recorded at fair value on a nonrecurring basis during the years ended December 31, 2016 and 2015:

 

    2016   2015
Description   Fair Value
Measurements Using
Significant
Unobservable Inputs
(Level 3) 		  Loss   Fair Value
Measurements Using
Significant
Unobservable Inputs
(Level 3) 		  Loss
Goodwill     $ -     $ (3,177,017 )   $ 3,177,017     $ (14,455,000 ) 
Intangible assets       

-

     

(778,345

)    

929,000

     

(948,833

)
Total     $

-

    $

(3,955,362

)   $

4,106,017

    $

(15,403,833

)
                                   

 

The following table summarizes the liabilities measured at fair value on a recurring basis as of December 31, 2016:

 

    Level 1     Level 2     Level 3     Total  
LIABILITIES:                                
Warrant liabilities   $ -     $ 12,868,079     $ -     $ 12,868,079  
Total derivative liabilities   $ -     $ 12,868,079     $ -     $ 12,868,079  

 

The following table summarizes the liabilities measured at fair value on a recurring basis as of December 31, 2015:

 

    Level 1     Level 2     Level 3     Total  
LIABILITIES:                                
Warrant liabilities   $ -     $ -     $ 41,089,580     $ 41,089,580  
Total derivative liabilities   $ -     $ -     $ 41,089,580     $ 41,089,580  

 

  F- 35  
 

 

Level 3 Valuation Techniques

 

Level 3 financial liabilities consist of the derivative liabilities for which there is no current market for these securities such that the determination of fair value requires significant judgment or estimation and the use of at least one significant unobservable input. The development and determination of the unobservable inputs for Level 3 fair value measurements and fair value calculations are the responsibility of the Company’s accounting and finance department and are approved by the Chief Financial Officer. Changes in fair value measurements categorized within Level 3 of the fair value hierarchy are analyzed each period based on changes in estimates or assumptions and recorded as appropriate.

 

The Company deems financial instruments to be derivative instruments if they (a) do not have fixed settlement provisions; or (b) have potential cash settlement provisions which are not within the Company’s control. The embedded conversion feature within the Debentures (see Note 9) and the common stock purchase warrants (a) issued by the Company in connection with the Merger; (b) issued in connection with the March 3, 2015 financing (see Note 3); (c) granted in connection with the Waivers (see Note 11); and (d) issued in connection with the underwritten offering (see Note 3); have all been deemed to be derivative liabilities. In accordance with FASB ASC Topic No. 815-40, “Derivatives and Hedging - Contracts in an Entity’s Own Stock”, the embedded conversion options and the warrants were accounted for as derivative liabilities at the date of issuance and adjusted to fair value through earnings at each reporting date. In accordance with ASC 815, the Company has bifurcated the conversion feature of the convertible Debentures and warrant derivative instruments and recorded derivative liabilities on their issuance date. The Company used a Monte Carlo model and a Binomial Lattice model to value the derivative liabilities. These derivative liabilities are then revalued on each reporting date.

 

The Company’s derivative liabilities are carried at fair value and were classified as Level 3 in the fair value hierarchy due to the use of unobservable inputs.

 

The following tables summarizes the values of certain assumptions used by the Company’s custom models to estimate the fair value of the embedded conversion options and warrant liabilities during the years ended December 31, 2016 and 2015:

 

    December 31, 2016  
Stock price   $ 0.00-756,000.00  
Strike price   $ 1,540,000 – $1,736,000  
Remaining term (years)     3.42 - 4.29  
Volatility     418 % -445 %
Risk-free rate     1.10% -1.15 %
Dividend yield     0.0 %

 

    2015  
    July 31,     July 29,     June 25,     March 3,  
Stock price   $ 1,218,000     $ 1,400,000     $ 2,380,000     $ 7,700,000  
Strike price   $ 3,500,000     $ 1,736,000     $ 3,535,000     $ 8,960,000  
Remaining term (years)     0.40       5.00       5.00       5.00  
Volatility     107 %     107 %     108 %     115 %
Risk-free rate     0.12 %     1.62 %     1.70 %     1.61 %
Dividend yield     0.0 %     0.0 %     0.0 %     0.0 %

 

    December 31, 2015  
Stock price   $ 756,000  
Strike price   $ 1,540,000 - 8,960,000  
Remaining term (years)     4.17 - 4.58  
Volatility     128 %
Risk-free rate     1.76 %
Dividend yield     0.0 %

 

  F- 36  
 

 

The following table sets forth a summary of the changes in the fair value of our Level 3 financial liabilities that are measured at fair value on a recurring basis:

 

    For the Year Ended
December 31, 2015 		 
Balance at January 1, 2015   $ -  
Issuance of Series A warrant liabilities     79,445,308  
Issuance of other warrant liabilities and conversion options     3,878,990  
Warrants issued in connection with the Waivers     (13,300 )
Change in fair value of derivative liabilities     (42,221,418 )
Balance at December 31, 2015   $ 41,089,580  
Cash paid to repurchase warrants     (3,278,827 )
Gain on repurchase of warrants     (5,189,484 )
Fair value of Series A Warrants repurchased     (8,468,311 )
Warrant exercises     (4,498,048 )
Change in fair value of derivative liabilities     (15,255,142 )
Reclassification of Series A warrant liability to additional paid in capital     —
Reclassification of Series A warrant liability to Level 2     (12,868,079 )
Balance at December 31, 2016     —  

 

During the year ended December 31, 2016, Series A warrants to purchase an aggregate of 4 and 7 shares of Common Stock which had been accounted for as a derivative liability were exercised and exchanged, respectively. The exercised warrants had an aggregate exercise date value of $4,498,048, which was reclassified to stockholders’ deficit. The exchanged warrants had an aggregate value at exchange date of $8,468,310 which was derecognized and the Company paid $3,278,827 of cash plus Series B warrants with a nominal value, with a resulting extinguishment gain of $5,189,484. The terms of the Series B warrant were agreed upon, but the warrants have not been issued. During the year ended December 31, 2016, certain holders of Series A Warrants executed Standstill Agreements, which were subsequently amended and restated whereby the holders agreed not to exercise Series A Warrants for a specified period of time and under certain circumstances.

 

As of December 31, 2016, the Company transferred the remaining derivative liability related to its Series A Warrants out of Level 3 and into Level 2 in the fair value hierarchy. Level 2 financial liabilities consist of derivative liabilities for which the determination of fair value is based on observable inputs for the liability. Specifically, the Company determined that its offer to purchase its Series A Warrants for $0.22 per warrant was the best indicator of the fair value of the derivative liability as of December 31, 2016. Accordingly, the Company transferred $12,868,079 from the Level 3 fair value hierarchy to the Level 2 fair value hierarchy as of December 31, 2016.

 

The Company uses a sensitivity analysis model to measure the impact of a 10% movement in the per share fair value per warrant. A hypothetical 10% change in the per share fair value of the warrant as of December 31, 2016 would result in $1,286,808 recorded other income (expenses).

  

Note 13. INCOME TAXES

 

The Company did not have a provision for income taxes (current or deferred tax expense) for tax year ended December 31, 2016 and December 31, 2015. The following is a reconciliation of the expected tax expense (benefit) at the U.S. statutory rate to the actual tax expense (benefit) reflected in the accompanying statement of operations:

 

    For the Years Ended December 31,
    2016   2015
U.S. federal statutory rate     3,632,727       612,254  
State and local taxes, net of federal benefit     (227,984 )     (308,119 )
Change in fair value of derivatives     (5,186,749 )     (14,355,282 )
Settlement of warrants     (1,764,424 )     —    
Goodwill impairment     1,080,186       4,914,700  
Change in valuation allowance     2,756,495       5,525,665  
True-up & deferred adjustment     (220,327 )     110,006  
Stock based compensation     15,826       (144,770 )
Other permanent items     (214,142 )     71,623  
Forfeitures & expiration of stock comp     118,691       356,090  
Stock issuance costs & compensation  wavers     78,640       2,830,944  
Change in tax rate     (36,381 )     468,571  
Other     (32,558 )     (81,682 )
      0       0  

 

 

  F- 37  
 

 

As of December 31, 2016 and 2015, the Company’s deferred tax assets and liabilities consisted of the effects of temporary differences attributable to the following:

 

         
    Years Ended December 31,
    2016   2015
Current deferred tax assets:                
NOL & AMT credit carryforward   $ 15,853,308     $ 13,560,973  
Inventory reserves and allowances     504,104       122,782  
Accrued expenses & deferred income     35,413       771,803  
Charitable contribution     2,110       1,409  
Stock based compensation     46,168       149,793  
Net book value of intangible assets     931,417       —    
Net book value of fixed assets     24,010       5,533  
Total current deferred tax assets     17,396,530       14,612,293  
Current deferred tax liabilities:                
Net book value of intangible assets     —         (277,903 )
Total current deferred tax liabilities     —         (277,903 )
Net current deferred tax assets     17,396,530       14,334,390  
Valuation allowance     (17,396,530 )     (14,334,390 )
Net deferred tax assets   $ —       $ —    

 

In assessing the realization of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. Management considers the scheduled reversal of deferred tax liabilities, projected future taxable income and tax planning strategies in making this assessment. After consideration of all of the positive and negative evidence available, management has determined that a valuation allowance of $17,396,530 and $14,334,390 are required at December 31, 2016 and 2015, respectively, to reduce the deferred tax assets to amounts that are more likely than not to be realized. Should the factors underlying management’s analysis change, future valuation adjustments to the Company’s net deferred tax assets may be necessary.

 

At December 31, 2016 the Company had U.S. federal and state net operating loss carryforwards (“NOLS”) of $43,058,505 and $31,760,278, respectively. These NOLs expire beginning in 2030. Utilization of our NOLS may be subject to an annual limitation under section 382 and similar state provisions of the Internal Revenue Code due to changes of ownership that may have occurred or that could occur in the future, as defined under the regulations.

 

  F- 38  
 

 

As required by the provisions of ASC 740, the Company recognizes the financial statement benefit of a tax position only after determining that the relevant tax authority would more likely than not sustain the position following an audit. For tax positions meeting the more likely than not threshold, the amount recognized in the consolidated financial statements is the largest benefit that has a greater than 50 percent likelihood of being realized upon ultimate settlement with the relevant tax authority. Differences between tax positions taken or expected to be taken in a tax return and the net benefit recognized and measured pursuant to the interpretation are referred to as “unrecognized benefits.” A liability is recognized (or amount of NOL or amount of tax refundable is reduced) for an unrecognized tax benefit because it represents an enterprise’s potential future obligation to the taxing authority for a tax position that was not recognized as a result of applying the provisions of ASC 740.

 

If applicable, interest costs and penalties related to unrecognized tax benefits are required to be calculated and would be classified as interest and penalties in general and administrative expense in the statement of operations. As of December 31, 2016 and 2015, no liability for unrecognized tax benefit was required to be reported. No interest or penalties were recorded during the years ended December 31, 2016 and 2015. The Company does not expect any significant changes in its unrecognized tax benefits in the next year. The Company files U.S. federal and Alabama, Connecticut, Florida, Georgia, Massachusetts, New York, North Carolina, and Tennessee state income tax returns. As of December 31, 2016, the Company’s U.S. and state tax returns remain subject to examination by tax authorities beginning with the tax year ended December 31, 2013.

 

Note 14. CERTAIN RELATIONSHIPS AND RELATED PARTY TRANSACTIONS

 

On July 29, 2016, the Company, entered into an Asset Purchase Agreement (the “Wholesale Business Purchase Agreement”) with VPR Brands, L.P. (the “Purchaser”) and the Purchaser’s Chief Executive Officer, Kevin Frija (the former Chief Executive Officer of the Company) pursuant to which the Company sold its wholesale vapor inventory and the related business operations (collectively, “Wholesale Business Assets”), which previously operated at 3001Griffin Road, Dania Beach, FL 33012 and to purchase 1,405,910,203 shares of the Company’s Common Stock held by Mr. Frija. The sale transaction was approved by the Company’s Board of Director’s on July 26, 2016 and completed on July 31, 2016. The consideration for the Wholesale Business Assets is (i) the transfer to the Company by Mr. Frija of 1,405,910,203 shares of the Company’s common stock that he had acquired on the open market; (ii) a secured, one-year promissory note in the principal amount of $370,000 (the “Acquisition Note”) bearing an interest rate of 4.5%, which payments thereunder are $10,000 monthly, with such payments commencing on October 28, 2016, with a balloon payment of the remainder of principal and interest on July 29, 2017; (iii) A secured, 36-month promissory note in the principal amount of $500,000 bearing an interest rate of prime plus 2%, resetting annually on July 29 th ,which payments thereunder are $14,000 per month, with such payments deferred and commencing on January 26, 2017, with subsequent installments payable on the same day of each month thereafter and in the 37 th  month, a balloon payment for all remaining accrued interest and principal; and (iv) the assumption by the Purchaser of certain liabilities related to the Company’s wholesale operations, including but not limited to the month-to-month lease for the premises. Pursuant to the Wholesale Business Purchase Agreement, the Company shall continue to collect the accounts receivable from its wholesale operations as of July 29, 2016. The Company agreed to use its commercially reasonable efforts, consistent with standard industry practice, to collect such accounts receivable, and any and all amounts so collected (i) up to $150,000 (net of any refunds) in the aggregate shall be credited against payment of the Acquisition Note; and (ii) in excess of $150,000 (up to $95,800) will be transferred to the Purchaser’s Chief Executive Officer. The Company incurred costs to buy back it shares of its Common Stock in conjunction with the sale of its wholesale vapor business. The costs include approximately $43,000 of discounts on the notes receivable to related party, that were issued at below market rates, and $35,000 of professional fees. These costs were recorded as incurred as selling general and administrative expense, a component of the loss from discontinued operations.

 

On April 8, 2016, Gregory Brauser informed the Board of his decision to resign from the Board and as President of the Company. Mr. Brauser’s resignation was not due to any disagreement with the Company on any matters relating to the Company’s operations, policies or practices.  Through GAB Management Group, Inc., Mr. Brauser will serve as a consultant to the Company pursuant to an

 

  F- 39  
 

 

Executive Services Consulting Agreement dated as of April 11, 2016, (the “Consulting Agreement”), the term of which is two years. Under the Consulting Agreement, GAB Management Group, Inc., will receive the following benefits in connection with consulting services that its principal, Mr. Brauser, will provide to the Company beginning on April 11, 2016: (1) an engagement fee of $50,000 payable at the time the Consulting Agreement is executed, and (2) thereafter monthly installments of $10,000 for 24 months.

 

As of June 22, 2015, Mr. Michael Brauser, the father of the Company’s President, loaned the Company $400,000, through a company he jointly manages, on identical terms as other investors in the offering (see Note 9 - Notes Payable). The Debentures: (i) mature December 22, 2015, (ii) accrue interest at 10% per year, (iii) are convertible into common stock at $3,500,000 per share and (iv) are secured by a second lien on substantially all of the Company’s assets. The Debentures, accrued interest, and prepayment penalties were repaid on July 31, 2015. The company Mr. Brauser jointly manages, received $104,932 of aggregated prepayment penalties and interest.

 

In November 2014 and March 2015, the Company had engaged in two private placements each of which precluded the Company from using capital or otherwise issuing shares of common stock or common stock equivalents below $14,000,000 and $7,140,000, respectively. In order to raise further capital in the June 2015 private placement, the Company was required to enter into agreements with prior investors (including Mr. Michael Brauser and Alpha Capital Anstalt, a then 5% holder) modifying these covenants. In connection with these modifications, Mr. Brauser received 0.0447 shares of common stock and 0.0527 warrants, a company which Mr. Brauser (the father of the Company’s President) jointly manages received 0.0040 shares and 0.0047 warrants and another company, Alpha Capital Anstalt, which acted as the lead investor in the November 2014 and March 2015 private placements, received 0.1879 shares of common stock and 0.1018 warrants, at an aggregate cost of approximately $59,600 to the Company.

 

The Company issued shares of common stock in connection with a registered public offering on July 29, 2015. This effectively triggered the need to issue additional shares under the agreements with prior investors (including Mr. Michael Brauser and Alpha Capital Anstalt). Pursuant to the Rules of the Nasdaq Stock Market, the Company needed to seek stockholder approval before issuing a number of these Waiver shares and such approval was obtained on October 16, 2015. On August 18, 2015 and November 10, 2015, the Company issued shares of common stock to certain investors under Waiver agreements. Mr. Brauser received 0.1924 of common stock, a company which Mr. Brauser jointly manages received 0.0171 shares and another company, Alpha Capital Anstalt, which acted as the lead investor in the November 2014 and March 2015 private placements, received 0.4810 shares of common stock, at an aggregate cost of approximately $504,000 to the Company.

 

On March 27, 2015, Harlan Press notified the Company of his intention to resign from the Company, effective April 10, 2015. Mr. Press previously served as Chief Financial Officer of the Company. In connection with the Company’s previously disclosed merger with Vaporin, Inc. in March 2015, Mr. Press was appointed Vice-President of Finance of the Company. Mr. Press received severance compensation and accrued vacation in accordance with his employment agreement in the total amount of $159,810, which is divided into equal weekly payments that ended on January 29, 2016. As of December 31, 2016, $17,503 of accrued expenses was paid to Mr. Press.

 

During 2015, the Company purchased, e-liquids sold in its vape retail stores and wholesale operations, respectively from Liquid Science, Inc., a company in which Jeffrey Holman (the Company’s Chief Executive Officer), Gregory Brauser (the Company’s former President) and Michael Brauser each had a 15% beneficial ownership interest. During the twelve months ended December 31, 2016, the Company made approximately $_356,000 or_23% of its purchases of e-liquid from Liquid Science for its continuing operations. Jeffrey Holman sold his ownership interest in Liquid Science, Inc. in April 2016. During 2016, the Company received royalty income from Liquid Science pursuant to the terms of a royalty agreement; approximately $52,000 received during the three months ended March 31, 2016 and $42,000 of royalty income received in July 2016. Pursuant to the royalty agreement between the Company and Liquid Science, as consideration for use of a Company trademark, Liquid science paid a 15% royalty on sales of licensed products sold directly to consumers. The royalty revenue was recorded when received. On July 21, 2016, Liquid Science entered into an asset purchase and license agreement with the Company, whereby the Company irrevocably sold, assigned, transferred, certain trademark, intellectual property, formulations, technology and granted rights to sell and distribute certain brand named products internationally. In conjunction with the sale, the royalty agreement between the Company and Liquid Science was terminated

 

On August 13, 2015, the Company entered into consulting agreements with each of GRQ Consultants, Inc. and Grander Holdings, Inc. GRQ Consultants, Inc. will primarily focus on investor relations and presenting the Company and its business plans, strategy and personnel to the financial community. Grander Holdings, Inc. will primarily assist the Company in further developing and executing its acquisitions strategy, focusing on the Company’s “The Vape Store” properties. Mr. Michael Brauser is the Chief Executive Officer of Grander Holdings, Inc. Pursuant to the agreements, each consultant received an initial fee of $50,000, payable immediately, and $20,000 monthly throughout the 12-month term of each agreement. The Company made payments of $130,000 each to Grander Holdings, Inc. and GRQ Consultants, Inc. during the year ended December 31, 2015. The consulting agreements with Grander Holdings, Inc. and GRQ Consultants were terminated effective February 29, 2016.

 

  F- 40  
 

 

Note 15. SEGMENT INFORMATION 

 

Prior to the second quarter of 2016, the Company had a single reportable business segment, as it was a distributor and retailer of vapor products including vaporizers, e-liquids and electronic cigarettes. On June 1, 2016, the Company completed the Grocery Acquisition and added a reportable segment. On July 31, 2016, the Company sold its wholesale inventory and related operations. The Company has excluded the results for the wholesale business, as discontinued operations, from the Company’s continuing operations for all periods presented. Management determines the reportable segments based on the internal reporting used by our Chief Operating Decision Makers to evaluate performance and to assess where to allocate resources. The Company evaluates segment performance based on the segment gross profit before corporate expenses.

 

Summarized below are the Net Sales and Segment Operating Profit for each reporting segment: 

  

    Year Ended  
    Net Sales     Segment Gross Profit  
    December 31, 2016     December 31, 2015     December 31, 2016     December 31, 2015  
Vapor   $ 6,722,052     $ 5,252,611     $ 3,742,443     $ 3,080,164  
Grocery     3,843,111       -       1,490,910       -  
Total   $ 10,565,163     $ 5,252,611       5,233,353       3,080,164  
Corporate expenses                     14,095,621       25,628,481  
Operating income loss                     (8,862,268 )     (22,548,317 )
Corporate other income (expense), net                     21,136,563     30,549,668  
Net income (loss) from continuing operations                     12,274,295   $ 8,001,351  
Net loss from discontinued operations                     (1,589,803 )     (6,200,598 )
Net income (loss)                     10,684,492     1,800,753  
Deemed Dividend                     -       (38,068,021 )
Net income (loss) allocable to common stockholders                   $ 10,684,492   $ (36,267,268 )

 

For the year ended December 31, 2016 depreciation and amortization was $174,376 and $200,012 for Vapor and Grocery, respectively.

 

NOTE 16. SUBSEQUENT EVENTS

 

The Company evaluates events that have occurred after the balance sheet date but before the consolidated financial statements are issued. Based upon the evaluation, the Company did not identify any recognized or non-recognized subsequent events that would have required adjustment or disclosure in the accompanying consolidated financial statements other than those set forth below.

 

On February 1, 2017, pursuant to the 2015 Plan, the Company issued a total of 77,000,000,000 options to purchase common stock to certain officers and directors. Twenty-five percent of the options vested upon issuance and the remainder vest equally at the end of the next three calendar quarters.

 

On January 31, 2017, the Company entered into a new employment agreement (the “Employment Agreement”) with the Company’s President and Chief Operating Officer, Christopher Santi. Pursuant to the Employment Agreement, Mr. Santi will continue to be employed as the Company’s President and Chief Operating Officer for a three-year term beginning January 30, 2017, and, unless sooner terminated as provided therein, ending January 29, 2020; provided that such term of employment shall automatically extend for successive one-year periods unless either party gives at least thirty days’ advance written notice of its intention not to extend the term of employment. Mr. Santi will receive a base salary of $225,000, increasing to $250,000 and $275,000, respectively, for the second and third years of the Employment Agreement. Mr. Santi shall be eligible to earn an annual bonus at the discretion of the Company’s Board of Directors. During the employment period, Mr. Santi’s employment with the Company may be terminated by the Company for Cause (as defined in the Employment Agreement) or by Mr. Santi at any time and for any reason. In the event that Mr. Santi’s employment is terminated by the Company for any reason other than for Cause or following a Change of Control (as defined in the Employment Agreement), then the Company shall pay to Mr. Santi (i) his accrued but unpaid salary and (ii) severance payments for the applicable Severance Period (as defined in the Employment Agreement). The Employment Agreement also contains customary non-competition, non-solicitation and confidentiality provisions.

 

On December 7, 2016, the Company filed a Tender Offer Statement on Schedule TO pursuant to which the Company offered to purchase up to 32,262,152 Series A warrants for $0.22 per warrant in cash from all holders of its outstanding Series A warrants. The Tender Offer expired on January 17, 2017. As a result of the Tender Offer, a total of 10,073,884 Series A warrants were tendered for a total purchase price of approximately $2.16 million.

 

The above warrant amounts are not reflective of the stock splits that occurred during the calendar year 2016.

 

On March 3, 2017, the Company filed a Certificate of Amendment to its Certificate of Incorporation (as amended) to effect a change of its corporate name to Healthier Choices Management Corp.

 

  F- 41  
 

 

SIGNATURES

 

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, on March 23, 2017.

 

  Healthier Choices Management Corp.
     
  By: /s/ Jeffrey Holman
    Jeffrey Holman
   

Chief Executive Officer

(Principal Executive Officer)

 

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.

 

Signature   Title   Date
         
/s/ Jeffrey Holman   Principal Executive Officer   March 23, 2017
Jeffrey Holman   and Director    
         
/s/ John A. Ollet   Chief Financial Officer   March 23, 2017
John A. Ollet   (Principal Financial and Accounting Officer)    
         
/s/ Clifford J. Friedman   Director   March 23, 2017
Clifford J. Friedman        
         
/s/ Anthony Panariello   Director   March 23, 2017
Anthony Panariello        

 

52

 

EXHIBIT INDEX

 

Exhibit       Incorporated by Reference   Filed or
Furnished
No.   Exhibit Description   Form   Date   Number   Herewith
                     
1.1   Form of Underwriting Agreement   S-1   7/10/15   1.1    
2.1(a)   Business Sale Offer and Acceptance Agreement, dated April 11, 2016, by and between Vapor Corp. and Ada’s Whole Food Market LLC   8-K   5/23/16   2.1    
2.1(b)   Asset Purchase Agreement, dated July 29, 2016, by and between Vapor Corp. and VPR Brands, L.P.   8-K   8/3/16   1.1    
3.1   Certificate of Incorporation   10-Q   11/16/15   3.1    
3.1(a)   Certificate of Amendment to Certificate of Incorporation   8-K   3/03/17   3.1    
3.1(b)   Certificate of Amendment to Certificate of Incorporation   S-1   7/10/15   3.2    
3.1(c)   Certificate of Amendment to Certificate of Incorporation   S-4   12/11/15   3.2    
3.1(d)   Certificate of Amendment to Certificate of Incorporation   8-K   2/2/16   3.1    
3.1(e)   Certificate of Amendment to Certificate of Incorporation   8-K   3/9/16   3.1    
3.1(f)   Certificate of Amendment to Certificate of Incorporation   8-K   6/1/16   3.1    
3.1(g)   Certificate of Amendment to Certificate of Incorporation   8-K   8/5/16   3.1    
3.1(h)   Certificate of Designation of Series A Preferred Stock   S-1   7/10/15   3.4    
3.1(i)   Certificate of Correction to the Certificate of Designation of Series A Preferred Stock   8-A12B   7/27/15   3.5    
3.2   Bylaws   8-K   12/31/13   3.4    
4.1   Form of Series A Warrant   S-1   7/10/15   4.2    
4.2   Form of Unit Purchase Agreement   S-1   7/10/15   4.3    
4.3   Form of Exchange Warrant   S-4   12/11/15   4.2    
10.1   Form of Securities Purchase Agreement dated January 20, 2015   8-K   1/26/15   10.1    
10.2   Form of Note dated January 20, 2015   8-K   1/26/15   10.2    
10.3   Form of Convertible Note dated January 29, 2015   8-K   2/03/15   10.1    
10.4   Form of Securities Purchase Agreement dated March 3, 2015   8-K   3/05/15   10.1    
10.5   2015 Equity Incentive Plan   S-1   6/01/15   10.28    
10.6   Form of Securities Purchase Agreement dated June 22, 2015   8-K   6/25/15   10.1    
10.7   Form of Security Agreement dated June 22, 2015   8-K   6/25/15   10.2    
10.8   Form of Debenture dated June 22, 2015   8-K   6/25/15   10.3    
10.9   Form of Letter Agreement dated June 19, 2015   8-K   6/25/15   10.4    
10.10   Form of Letter Agreement dated June 19, 2015   8-K   6/25/15   10.5    
10.11   Form of Warrant dated June 22, 2015   8-K   6/25/15   10.6    
10.12   Form of Registration Rights Agreement dated June 22, 2015   8-K   6/25/15   10.7    
10.13   Employment Agreement with Gina Hicks*   8-K   9/16/15   10.1    
10.14   Employment Agreement with Jeffrey Holman*   10-Q   11/16/15   10.1    
10.15   Employment Agreement with Gregory Brauser*   10-Q   11/16/15   10.2    
10.16   Employment Agreement with Christopher Santi*   8-K   2/1/17   10.1    
10.17   Form of Fifth Amended and Restated Series A Standstill Agreement               Filed
10.18   Executive Service Consulting Agreement, dated April 11, 2016, by and between Gregory Brauser and Vapor Corp.   8-K   4/11/16   10.1    
10.19   Amendment to Vapor Corp. 2015 Equity Incentive Plan   8-K   2/8/17   4.2  
21.1   List of Subsidiaries               Filed
23.1   Consent of Morrison, Brown, Argiz & Farra, LLC               Filed
23.2   Consent of Marcum L.L. P               Filed
31.1   Certification of Principal Executive Officer (302)               Filed
31.2   Certification of Principal Financial Officer (302)               Filed
32.1   Certification of Principal Executive Officer and Principal Financial Officer (906)               Furnished**
101.INS   XBRL Instance Document               Filed
101.SCH   XBRL Taxonomy Extension Schema Document               Filed
101.CAL   XBRL Taxonomy Extension Calculation Link base Document               Filed
101.DEF   XBRL Taxonomy Extension Definition Link base Document               Filed
101.LAB   XBRL Taxonomy Extension Label Link base Document               Filed
101.PRE   XBRL Taxonomy Extension Presentation Link base Document               Filed

 

* Management contract or compensatory plan or arrangement.

 

53

 

** This exhibit is being furnished rather than filed and shall not be deemed incorporated by reference into any filing, in accordance with Item 601 of Regulation S-K.

 

Copies of this report (including the financial statements) and any of the exhibits referred to above will be furnished at no cost to our stockholders who make a written request to our Corporate Secretary at 3800 North 28th Way, Hollywood, Florida 33020.

 

54

 

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