NOTES
TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE
1 – ORGANIZATION AND DESCRIPTION OF BUSINESS
Q2Power
Technologies, Inc. (hereinafter the “Company”) was incorporated in Delaware on August 26, 2004, and is currently engaged
in the business of waste-to-value technology development, product manufacturing and sales. Formerly, the Company’s name
was Anpath Group, Inc. (“Anpath”).
Q2Power
Corp. (the “Subsidiary” or “Q2P”) has operated as a renewable power R&D company focused on the conversion
of waste to energy and other valuable “reuse” products since July 2014. The operations of the Company have from the
time of the Merger (described below) until recently been essentially those of the Subsidiary. In 2017, the Company shifted its
focus from R&D to the acquisition and operation of facilities that manufacture compost and sustainable soils from waste resources.
On
November 12, 2015, the Company and its special purpose merger subsidiary completed a merger (the “Merger”) with Q2P.
As a result of the Merger, all outstanding shares of Q2P were exchanged for 24,034,475 shares of the Company’s common stock.
In addition, the Company assumed both the Q2P 2014 Founders Stock Option Plan and the 2014 Employees Stock Option Plan (the “Option
Plans”), and 1,095,480 options outstanding thereunder. Also pursuant to the Merger, the officers and directors of Q2P assumed
control over the management and Board of Directors of the Company. Subsequent to the Merger, the Company officially changed its
name to Q2Power Technologies, Inc.
On
December 1, 2015, in connection with the Merger the Company also sold its prior operating subsidiary, EnviroSystems Inc. (“ESI”),
to three former shareholders in exchange for a return of 470,560 shares of the Company’s common stock. ESI assumed all debt,
payables and a litigation judgment that was on its books as of the Merger date. On February 12, 2016, the Board of Directors of
the Company approved a change in the fiscal year end for the Company from March 31 to December 31. This change is a result of
the Merger, and reflects the fiscal year-end period for Q2P.
In
May 2016, the Company began exploring other synergistic business lines, such as compost and soil manufacturing from waste water
biosolids. Moving forward, the Company intends to phase out its R&D activities, including the possibly of selling its waste-to-power
technology, and focus entirely on the business of compost and engineered soils manufacturing and sales.
NOTE
2 – BASIS OF PRESENTATION AND GOING CONCERN
The
unaudited condensed consolidated financial statements include all accounts of the Company. The accompanying unaudited condensed
consolidated financial statements have been prepared in accordance with generally accepted accounting principles applicable to
interim financial information. Accordingly, they do not include all of the information and disclosures required by accounting
principles generally accepted in the United States of America for complete financial statements. Interim results are not necessarily
indicative of results for a full year. In the opinion of management, all adjustments considered necessary for a fair presentation
of the financial position and the results of operations and cash flows for the interim periods have been included. The December
31, 2016 condensed consolidated balance sheet information contained herein was derived from the audited consolidated financial
statements as of that date included in the Annual Report on Form 10-K filed on May 25, 2017.
The
Company has incurred net income of $186,023 for the three months ended March 31, 2017, which included a gain on extinguishment
of liabilities of $306,262 and a net gain from the change in fair value of derivative liabilities of $66,477, all
non-cash items. The accumulated deficit since inception is $6,677,079, which is comprised of operating losses (which were
paid in cash, stock for services and other equity instruments) and other expenses. The Company has a working capital deficit at
March 31, 2017 of $281,755. These conditions raise substantial doubt about the Company’s ability to continue as a
going concern. There is no guarantee whether the Company will be able to generate sufficient revenue and/or raise capital
sufficient to support its operations. The ability of the Company to continue as a going concern is dependent on management’s
plans which include implementation of its business model to generate revenue from product sales and royalties, acquisition of
cash-flowing businesses, and continuing to raise funds through debt or equity offerings. On March 31, 2017, the Company completed
the first $1,050,000 tranche of a $1,500,000 convertible bridge note offering (the “Bridge Offering”); and as of June
1, 2017, the Company closed an additional $400,000 of follow-on investments in the Bridge Offering. The proceeds from this offering
are expected to provide working capital for the Company through at least the end of 2017. See Note 12.
The
condensed consolidated financial statements do not include any adjustments that might result from the outcome of these uncertainties.
U.S.
Generally Accepted Accounting Principles (“GAAP”) requires the Company to make judgments, estimates and assumptions
that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of
the consolidated financial statements, the reported amounts of revenues and expenses, cash flows and the related footnote disclosures
during the period. On an on-going basis, the Company reviews and evaluates its estimates and assumptions, including, but not limited
to, those that relate to the realizable value of identifiable intangible assets and other long-lived assets, derivative liabilities,
income taxes and contingencies. Actual results could differ from these estimates.
NOTE
3 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles
of Consolidation
The
condensed consolidated financial statements include the accounts of the Company and its Subsidiary. All significant inter-company
transactions and balances have been eliminated in consolidation. References herein to the Company include the Company and its
Subsidiary, unless the context otherwise requires.
Cash
The
Company considers all unrestricted cash, short-term deposits, and other investments with original maturities of no more than ninety
days when acquired to be cash and cash equivalents for the purposes of the statement of cash flows. The Company maintains cash
balances at two financial institutions, and has experienced no losses with respect to amounts on deposit.
At
March 31, 2017, restricted cash consists of funds in escrow by an attorney in connection with the sale of debentures to investors.
These funds were released to the Company in April 2017 (see Note 7).
Revenue
Recognition
Revenue
from the Company’s waste-to-power operations is recognized at the date of shipment of engines and systems, engine prototypes,
engine designs or other deliverables to customers when a formal arrangement exists, the price is fixed or determinable, the delivery
or milestone deliverable is completed, no other significant obligations of the Company exist and collectability is reasonably
assured. Payments received before all of the relevant criteria for revenue recognition are satisfied are recorded as deferred
revenue. The Company will not allow its customers to return prototype products.
Revenue
for services from the Company’s compost and soil business is recognized at the date of delivery of deliverables to customers
when a formal arrangement exists, the price is fixed or determinable, the delivery or milestone deliverable is completed, no other
significant obligations of the Company exist and collectability is reasonably assured. Payments received before all of the relevant
criteria for revenue recognition are satisfied are recorded as deferred revenue.
Research
and Development
Research
and development activities for product development are expensed as incurred and are primarily comprised of salaries. Costs for
the three months ended March 31, 2017 and 2016 were $0 and $186,938, respectively.
Stock
Based Compensation
The
Company applies the fair value method of Financial Accounting Standards Board (“FASB”) Accounting Standards Codification
(“ASC”) 718, “
Share Based Payment
”, in accounting for its stock based compensation. This standard
states that compensation cost is measured at the grant date based on the fair value of the award and is recognized over the service
period, which is usually the vesting period. The Company values stock based compensation at the market price for the Company’s
common stock and other pertinent factors at the grant date.
The
Company accounts for transactions in which services are received from non-employees in exchange for equity instruments based on
the fair value of the equity instruments exchanged, in accordance with ASC 505-50, “
Equity Based payments to Non-employees
”.
The Company measures the fair value of the equity instruments issued based on the market price of the Company’s stock at
the time services or goods are provided.
Common
Stock Options
The
Black-Scholes option pricing valuation method is used to determine fair value of these options consistent with ASC 718, “
Share
Based Payment”.
Use of this method requires that the Company make assumptions regarding stock volatility, dividend yields,
expected term of the awards and risk-free interest rates.
Derivatives
Derivatives
are recognized initially at fair value. Subsequent to initial recognition, derivatives are measured at fair value, and changes
are therein generally recognized in profit or loss.
Property
and Equipment
Property
and equipment are recorded at cost. Depreciation is computed on the straight-line method, based on the estimated useful lives
of the assets as follows:
|
|
Years
|
|
Furniture and equipment
|
|
|
7
|
|
Computers
|
|
|
5
|
|
Expenditures
for maintenance and repairs are charged to operations as incurred.
Impairment
of Long Lived Assets
The
Company continually evaluates the carrying value of intangible assets and other long lived assets to determine whether there are
any impairment losses. If indicators of impairment are present and future cash flows are not expected to be sufficient to recover
the assets’ carrying amount, an impairment loss would be charged to expense in the period identified. To date, the Company
has not recognized any impairment charges.
Income
Taxes
Income
taxes are accounted for under the asset and liability method as stipulated by FASB ASC 740, “Income Taxes” (“ASC
740”). Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between
the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss
and tax credit carry forwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable
income in the years in which those temporary differences are expected to be recovered or settled. Under ASC 740, the effect on
deferred tax assets and liabilities or a change in tax rate is recognized in income in the period that includes the enactment
date. Deferred tax assets are reduced to estimated amounts to be realized by the use of a valuation allowance. A valuation allowance
is applied when in management’s view it is more likely than not (50%) that such deferred tax will not be utilized.
In
the event that an uncertain tax position exists in which the Company could incur income taxes, the Company would evaluate whether
there is a probability that the uncertain tax position taken would be sustained upon examination by the taxing authorities. Reserves
for uncertain tax positions would be recorded if the Company determined it is probable that a position would not be sustained
upon examination or if payment would have to be made to a taxing authority and the amount is reasonably estimated. As of March
31, 2017, the Company does not believe it has any uncertain tax positions that would result in the Company having a liability
to the taxing authorities. Interest and penalties related to any unrecognized tax benefits is recognized in the condensed consolidated
financial statements as a component of income taxes.
Basic
and Diluted Income (Loss) Per Share
Net
income (loss) per share is computed by dividing the net income (loss) less preferred dividends by the weighted average number
of common shares outstanding during the period. Diluted net income (loss) per share is calculated by dividing the net loss less
preferred dividends by the weighted average number of common shares outstanding during the period plus any potentially dilutive
shares related to the issuance of stock options, shares from the issuance of stock warrants, shares issued from the conversion
of redeemable convertible preferred stock and shares issued for the conversion of convertible debt. There were no potentially
dilutive shares as of March 31, 2017 and 2016.
At
March 31, 2017, there were the following potentially dilutive securities that were excluded from diluted net income per share
because their effect would be anti-dilutive: 6,115,480 shares from common stock options, 1,568,845 shares from common stock warrants,
1,100,000 shares from the conversion of debentures (not inclusive of shares that may be converted from the Bridge Round, as the
valuation and corresponding share price will not be determined until the closing of the next financing by the Company in an amount
of at least $5,000,000 or December 31, 2017, whichever is sooner), 1,090,252 shares from the conversion of notes payable, and
4,000,000 shares from the conversion of redeemable convertible preferred stock. At March 31, 2016, there were the following potentially
dilutive securities that were excluded from diluted net loss per share because their effect would be anti-dilutive: 5,015,480
shares from common stock options, 1,568,845 shares from common stock warrants, 1,734,524 shares from the conversion of debentures
and 2,857,142 shares from the conversion of redeemable convertible preferred stock.
Recent
Accounting Pronouncements
In
May 2014, the FASB issued Accounting Standards Update (“ASU”), No. 2014-09, “
Revenue from Contracts with
Customers
”, to replace the existing revenue recognition criteria for contracts with customers and to establish the disclosure
requirements for revenue from contracts with customers. The ASU is effective for interim and annual periods beginning after December
15, 2017. Adoption of the ASU is either retrospective to each prior period presented or retrospective with a cumulative adjustment
to retained earnings or accumulated deficit as of the adoption date. The Company is currently assessing the future impact of the
ASU on its consolidated financial statements; however, in light of the material changes in the Company’s business model
which have occurred, the Company expects to do further review in the second or third quarter of 2017.
In
November 2015, the FASB issued ASU No. 2015-17, “
Balance Sheet Classification of Deferred Assets
”, requiring
management to provide a classification of all deferred taxes as noncurrent assets or noncurrent liabilities. This ASU is effective
for annual periods beginning after December 15, 2016. The adoption of this ASU did not have a material impact to the Company’s
financial position, results of operations or cash flows.
In
January 2016, the FASB issued ASU No. 2016-01, “
Recognition and Measurement of Financial Assets and Financial Liabilities
”,
requiring management to address certain aspects of recognition, measurement, presentation, and disclosure of financial instruments.
This ASU is effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years.
The Company is currently assessing the impact of the ASU on its financial position, results of operations and cash flows.
In
February 2016, the FASB issued ASU No. 2016-02, “
Leases (Topic 842) (the Update)
”, requiring management to
recognize any right-to-use-asset and lease liability on the statement of financial position for those leases previously classified
as operating leases. The criteria used to determine such classification is essentially the same as under the previous guidance,
but it is more subjective. The lessee would classify the lease as a finance lease if certain criteria at lease commencement are
met. This ASU is effective for fiscal years beginning after December 15, 2018. The Company is currently assessing the impact of
the ASU on its financial position, results of operations and cash flows.
In
March 2016, the FASB issued ASU 2016-06, “
Derivatives and Hedging (Topic 815): Contingent Put and Call Options in Debt
Instruments (a consensus of the FASB Emerging Issues Task Force)
”, which applies to all entities that are issuers of
or investors in debt instruments (or hybrid financial instruments that are determined to have a debt host) with embedded call
(put) options, and requires that embedded derivatives be separated from the host contract and accounted for separately as derivatives
if certain criteria are met. One criterion is that the economic characteristics and risks of the embedded derivatives are not
clearly and closely related to the economic characteristics and risks of the host contract. This ASU is effective for financial
statements issued for fiscal years beginning after December 15, 2016, and interim periods within those fiscal years. The adoption
of this ASU did not have a material impact to the Company’s financial position, results of operations or cash flows.
In
March 2016, the FASB issued ASU 2016-09, “
Improvements to Employee Share-Based Payment Accounting
,” which amends
ASC Topic 718, “
Compensation – Stock Compensation
.” The ASU includes provisions intended to simplify
various aspects related to how share-based payments are accounted for and presented in the financial statements, including the
income tax effects of share-based payments and accounting for forfeitures. This ASU is effective for public business entities
for annual reporting periods beginning after December 15, 2016, and interim periods within that reporting period. The adoption
of this ASU did not have a material impact to the Company’s financial position, results of operations or cash flows.
In
August 2016, the FASB issued ASU 2016-15, Statement of Cash Flows (Topic 230) Classification of Certain Cash Receipts and Cash
Payments. This standard amends and adjusts how cash receipts and cash payments are presented and classified in the statement of
cash flows. ASU 2016-15 is effective for fiscal years beginning after December 15, 2017, and interim periods within those fiscal
years and will require adoption on a retrospective basis unless impracticable. If impracticable the Company would be required
to apply the amendments prospectively as of the earliest date possible. The Company is currently evaluating the impact that ASU
2016-15 will have on its financial position, results of operations and cash flows.
In
November 2016, the FASB issued ASU No. 2016-18, Statement of Cash Flows (Topic 230): Restricted Cash, which clarifies the presentation
of restricted cash in the statements of cash flows. Under ASU 2016-18, restricted cash is included with cash and cash equivalents
when reconciling the beginning-of-period and end-of-period total amounts shown on the statements of cash flows.
This
standard is effective for fiscal years beginning after December 15, 2017, including interim periods within that reporting period.
The Company is currently evaluating ASU 2016-18, but does not expect this guidance to have a material impact on its financial
position, results of operations and cash flows.
In
May 2017, the FASB issued ASU 2017-09, Compensation - Stock Compensation (Topic 718) Scope of Modification Accounting. The amendments
in ASU 2017-09 provide guidance about which changes to the terms or conditions of a share-based payment award require an entity
to apply modification accounting in Topic 718. The adoption of ASU 2017-09 will become effective for annual periods beginning
after December 15, 2017; and
the Company is currently
evaluating the impact that it will have on its financial position, results of operations and cash flows
.
Concentration
of Risk
The
Company does not have any off-balance sheet concentrations of credit risk. The Company expects cash and accounts receivable to
be the two assets most likely to subject the Company to concentrations of credit risk. The Company’s policy is to maintain
its cash with high credit quality financial institutions to limit its risk of loss exposure.
The
Company historically purchased much of its machined parts through Precision CNC, a related party company that sublet office space
to Q2P through June 27, 2016, and owns a non-controlling interest in the Company. See Note 6.
NOTE
4 –PROPERTY AND EQUIPMENT, NET
Property
and equipment, net consists of the following:
|
|
March
31, 2017
|
|
|
December
31, 2016
|
|
Furniture and Computers
|
|
$
|
1,328
|
|
|
$
|
1,328
|
|
Shop Equipment
|
|
|
9,540
|
|
|
|
9,540
|
|
Total
|
|
|
10,868
|
|
|
|
10,868
|
|
Accumulated depreciation
and amortization
|
|
|
(4,619
|
)
|
|
|
(4,136
|
)
|
Net software,
property and equipment
|
|
$
|
6,249
|
|
|
$
|
6,732
|
|
Depreciation
and amortization expense for the three months ended March 31, 2017 and 2016 was $483 and $13,266, respectively.
NOTE
5 – CYCLONE SEPARATION, LICENSE RIGHTS AND DEFERRED REVENUE
In
2014, Q2P purchased for $175,000 certain licensing rights to use Cyclone Power Technologies’ (“Cyclone”) patented
technology on a worldwide, exclusive basis for 20 years with two 10-year renewal terms for Q2P’s waste heat and waste-to-power
business. This agreement contains a royalty provision equal to 5% of gross sales payable to Cyclone on sales of engines derived
from technology licensed from Cyclone. Also, as part of a separation agreement with Cyclone, Q2P assumed a license agreement between
Cyclone and Phoenix Power Group (“Phoenix”), which included deferred revenue of $250,000 from payments previously
made to Cyclone for undelivered products. The net balances as of March 31, 2017 and December 31, 2016 for the Cyclone licensing
rights were $58,333 and $69,271, respectively; and the net balances as of March 31, 2017 and December 31, 2016 for the Phoenix
deferred revenue were $0 and $250,000, respectively, which are included as a component of deferred revenue on the condensed consolidated
balance sheets. The licensing rights are amortized over its estimated useful life of 4 years. Amortization expense for the three
months ended March 31, 2017 and 2016 was $10,938 and $10,938 respectively.
On
January 9, 2017, the Company transferred and assigned to Phoenix its Technology Sales Agreement with MagneGas Corporation (the
“MagneGas Agreement”) to deliver a waste-to-power system to this customer. Under the MagneGas Agreement, the Company
had been paid $90,000 as of the date of transfer, and $68,000 was still due from the customer based on milestones set forth in
the MagneGas Agreement. Phoenix assumed the MagneGas Agreement with all rights to receive the future payments thereunder, and
responsibility to perform the services and provide the products to the customer. The Company has no further responsibility under
the MagneGas Agreement. In consideration for this transfer, Phoenix agreed that the Company had completed and satisfied all financial
obligations associated with all past agreements between Phoenix and the Company, specifically: (1) $150,000 previously paid by
Phoenix for durability testing of the Q2P engine, and (2) delivery by the Company of the first ten (10) Q2P engines at the rate
of $10,000 per delivered Engine for $100,000 in total. This deferred revenue in the total amount of $250,000 was recorded as gain
from the extinguishment of liabilities in the condensed consolidated statement of operations for the three months ended March
31, 2017.
In
connection with the separation agreement with Cyclone, the Company also assumed a contract with Clean Carbon of Australia and
a corresponding $10,064 prepayment for services or other value to be provided in the future. This deposit has been presented as
deferred revenue on the March 31, 2017 and December 31, 2016 condensed consolidated balance sheets.
NOTE
6 – RELATED PARTY TRANSACTIONS
Through
June 2016, the Company sublet approximately 2,500 square feet of assembly, warehouse and office space within the Precision CNC
facility located at 1858 Cedar Hill Road in Lancaster, Ohio. The sublease provided for the Company to pay rent monthly in the
amount of $2,500, which covered space and some utilities. Occupancy costs for the three months ended March 31, 2017 and 2016 were
$0 and $7,500, respectively. The sublease was terminated as of June 27, 2016.
The
Company also purchased much of its machined parts through Precision CNC up until June 2016. Precision CNC owns a non-controlling
interest in the Company. For the three months ended March 31, 2017 and 2016, the amounts invoiced from Precision CNC totaled $0
and $34,427, respectively, and consisted of rent and research and development expenses for machined parts.
On
June 27, 2016, the Company and Precision CNC entered into an agreement to eliminate $49,299 in payables owed to Precision CNC
in return for the transfer of certain net assets of the Company with a remaining book value of $70,495, which included office
furniture, software and computer systems, and 50,000 shares of restricted common stock valued at $10,500. The Company recorded
a loss on this transaction in the amount of $31,696. There were no accounts payable and accrued expenses at March 31, 2017 and
December 31, 2016 to Precision CNC.
The
Company also maintains an executive office in Florida, which is leased by GreenBlock Capital LLC, an investment firm that the
Company’s CEO serves as a Managing Director, but holds no equity or voting rights. The Company has no formal agreement for
this space and pays no rent.
I
n
March 2017, all outstanding Director accounts payables, accrued expenses and notes payable – related parties
with an aggregate amount of $
156,368
were converted into the Company’s Bridge Offering
(see Note 7).
NOTE
7 – NOTES PAYABLE AND DEBENTURES
In
March 2017, the Company entered into a Modification and Extension Agreement with two holders of its Original Issue Discount Senior
Secured Convertible Debentures (the “Debentures”) to extend the maturity date to July 31, 2017, reset the conversion
price from $0.21 to $0.15, and waive any defaults under the Debentures from the expiration of the maturity date or otherwise.
The exercise price of the Warrants that were issued with the Debentures’ exercise price, which had been reset to $0.50 per
verbal agreement of the parties in the third quarter of 2016, was formally documented under this March 2017 modification agreement.
The Debentures do not bear interest, but contained an Original Issue Discount of $20,750.
All assets of the Company are secured under the Debentures, including our Subsidiary and its assets. The Debentures and warrants
contain certain anti-dilutive protection provisions in the instance that the Company issues stock at a price below the stated
conversion price of the Debentures, as well as other standard protections for the holder.
As of March 31, 2017 and December
31, 2016, the aggregate outstanding principal amount of the two Debentures was $165,000.
On
March 15, 2016, the Company entered into a 120-day term loan agreement with one accredited investor in the principal amount of
$150,000. The loan bears 20% interest with interest payments due monthly. The Company incurred loan issuance costs of 100,000
shares of common stock valued at $26,000, $3,000 cash and provided a second security interest in the assets of the Company to
the holders. The issuance costs were fully expensed in 2016. As of March 31, 2017, the loan balance was $150,000, and accrued
interest related to the loan was $19,167. This loan matured on July 15, 2016, and a 10% late penalty was assessed on July 15,
2016.
On
March 22, 2017, the Company and the term loan holder entered into an Addendum to the loan agreement which extended the maturity
date to December 31, 2017, allowed for conversion of the principal amount and accrued interest at the discretion of the holder
to common stock at a price of $0.15 per share, and waived all defaults in return for payment of $30,000 which included a $15,000
late penalty and $15,000 of accrued but unpaid interest. This payment was made in April 2017 and the loan is now current.
The Company determined that the new conversion feature has no intrinsic
value and that the amended terms did not result in a significantly different instrument, and, accordingly, accounted for the addendum
as a modification of debt.
On
March 31, 2017, the Company closed the initial $1,050,000 tranche in a Convertible Promissory Note “Bridge”
offering (the “Bridge Offering”). In addition, as part of that initial closing, three of the Company’s
directors and one shareholder converted $168,152 of prior notes and cash advances, including interest thereon, into the
Bridge Offering. The total size of the Bridge Offering is $1,500,000, with an additional $500,000 over-allotment
option at the Company’s discretion. As of March 31, 2017, $1,000,000 of these funds was released to the Company.
The balance of $50,000 remained in escrow with an attorney as of March 31, 2017, with a $15,000 fee paid from escrow in April
2017 to the Company’s law firm and escrow agent for the closing. As of June 13, 2017, the balance of $35,000
plus an additional $400,000 in new investments in the Bridge Offering remained in escrow and can be released at any time at
the instructions of the Company.
The
Convertible Promissory Notes (the “Notes”) from the Bridge Offering convert at a 50% discount to the post-funding
valuation of the Company at the closing of its next offering in the minimum amount of $5,000,000 (the “Equity Offering”).
The conversion valuation has a ceiling of $12,000,000, and a “floor” company value of $6,000,000 in the event there
is no Equity Offering before the Notes are able to be converted.
Pursuant
to ASC 825-10-25-1, Fair Value Option, the Company made an irrevocable election at the time of issuance to report the Notes
at fair value, with changes in fair value recorded through the Company’s condensed consolidated statements
of operations as other income (expense) in each reporting period. The fair value recorded as of March 31, 2017 was $1,218,152
(see Note 8) and the principal amount due was $1,218,152.
The
Notes convert into common stock, or preferred stock if received by investors in the Equity Offering, commencing on the earliest
of the Equity Offering closing or December 31, 2017, at the discretion of each holder. Maturity is 36 months from issuance with
15% annual interest which will be capitalized each year into the principal of the Notes and paid in kind. There are no warrants
issued in connection with the Offering
.
Funds
from the Bridge Offering will be used to secure acquisitions of compost and soil companies with closings expected to occur concurrently
with the closing of the Equity Offering, and up to 12 months of operating capital. A limited portion of the funds were also used
to eliminate liabilities on the Company’s balance sheet. The Bridge Offering was led by two accredited investors, and joined
by 22 additional accredited investors which included $50,000 of new cash investment by the Company’s Directors (plus an
additional $25,000 in May 2017), as well as conversion of $156,368 of old payables, notes and advances made by them in 2016 and
2017. Management conducted the Offering and no broker fees were paid in connection with the initial closing. All securities issued
in the Offering and debt settlements were issued pursuant to an exemption from registration under Section4(a)(2) under the Securities
Act of 1933.
NOTE
8 – FAIR VALUE MEASUREMENT AND DERIVATIVES
The
Company measures fair value in accordance with a fair value hierarchy that prioritizes the inputs to valuation techniques used
to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets
or liabilities (Level 1 measurements) and the lowest priority to unobservable inputs (Level 3 measurements). The three levels
of the fair value hierarchy are described below:
|
Level
1
|
Unadjusted
quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities;
|
|
|
|
|
Level
2
|
Quoted
prices in markets that are not active, or inputs that are observable, either directly or indirectly, for substantially the
full term of the asset or liability; and
|
|
|
|
|
Level
3
|
Prices
or valuation techniques that require inputs that are both significant to the fair value measurement and unobservable (supported
by little or no market activity).
|
All
derivatives recognized by the Company are reported as derivative liabilities on the condensed consolidated balance sheets and
are adjusted to their fair value at each reporting date. Unrealized gains and losses on derivative instruments are included in
change in value of derivative liabilities on the condensed consolidated statement of operations.
The
following table sets forth the Company’s condensed consolidated financial assets and liabilities measured at fair value
by level within the fair value hierarchy at March 31, 2017 and December 31, 2016. Assets and liabilities are classified in their
entirety based on the lowest level of input that is significant to the fair value measurement.
|
|
Fair
value at
|
|
|
|
|
|
|
|
|
|
|
|
|
March
31, 2017
|
|
|
Level
1
|
|
|
Level
2
|
|
|
Level
3
|
|
Preferred stock embedded
conversion feature
|
|
$
|
42,925
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
42,925
|
|
Anti-dilution provision in common stock warrants
included with preferred stock
|
|
|
69,957
|
|
|
|
-
|
|
|
|
-
|
|
|
|
69,957
|
|
Debenture embedded conversion feature
|
|
|
8,213
|
|
|
|
-
|
|
|
|
-
|
|
|
|
8,213
|
|
Anti-dilution provision in common stock warrants
included with debentures
|
|
|
25,470
|
|
|
|
-
|
|
|
|
-
|
|
|
|
25,470
|
|
Bridge Notes
|
|
|
1,218,152
|
|
|
|
-
|
|
|
|
-
|
|
|
|
1,218,152
|
|
Total
|
|
$
|
1,364,717
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
1,364,717
|
|
|
|
Fair
value at
|
|
|
|
|
|
|
|
|
|
|
|
|
December
31, 2016
|
|
|
Level
1
|
|
|
Level
2
|
|
|
Level
3
|
|
Preferred stock embedded
conversion feature
|
|
$
|
123,266
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
123,266
|
|
Anti-dilution provision in common stock
warrants included with preferred stock
|
|
|
52,904
|
|
|
|
-
|
|
|
|
-
|
|
|
|
52,904
|
|
Debenture embedded conversion feature
|
|
|
25,884
|
|
|
|
-
|
|
|
|
-
|
|
|
|
25,884
|
|
Anti-dilution
provision in common stock warrants included with debentures
|
|
|
10,988
|
|
|
|
-
|
|
|
|
-
|
|
|
|
10,988
|
|
Total
|
|
$
|
213,042
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
213,042
|
|
There
were no transfers between levels during the three months ended March 31, 2017.
As
part of the Merger, the Company assumed Debentures that are convertible into shares of common stock, which Anpath issued in July
2014 (see Note 7). The Debentures’ conversion price will be adjusted depending on various circumstances. The conversion
options embedded in these instruments contain no explicit limit to the number of shares to be issued upon settlement and as a
result are classified as derivative liabilities under ASC 815. Additionally, the Company issued in connection with the Debentures
415,000 warrants to purchase the Company’s common stock. The conversion price will be adjusted depending on various circumstances,
and as there is no explicit limit to the number of shares to be issued upon settlement they are classified as derivative liabilities
under ASC 815.
The
terms of the Company’s convertible redeemable preferred stock (the “Preferred Stock”) (see Note 9) include an
anti-dilution provision that requires an adjustment in the common stock conversion ratio should subsequent issuances of the Company’s
common stock be issued below the instruments’ original conversion price of $0.26 per share, subject to certain defined excluded
issuances. In 2015 per modification agreement with the holders, the conversion price was reset to $0.21, and then in March 2017,
the conversion price was reset again to $0.15. Accordingly, we bi-furcated the embedded conversion feature, which is shown as
a derivative liability recorded at fair value on the condensed consolidated balance sheets.
The
agreement setting forth the terms of the common stock warrants issued to the holders of the Preferred Stock (see Note 9) also
includes an anti-dilution provision that requires a reduction in the warrant’s exercise price, currently $0.50, should the
conversion ratio of the Preferred Stock be adjusted due to anti-dilution provisions. Accordingly, the warrants do not qualify
for equity classification, and, as a result, the fair value of the derivative is shown as a derivative liability on the condensed
consolidated balance sheets.
On
March 31, 2017, the Company issued $1,218,152 of Convertible Promissory Notes. The Convertible Promissory Notes (the “Notes”)
convert at a 50% discount to the post-funding valuation of the Company at the closing of its next offering in the minimum amount
of $5,000,000 (the “Equity Offering”). The conversion valuation has a ceiling of $12,000,000, and a “floor”
company value of $6,000,000 in the event there is no Equity Offering before the Notes are able to be converted.
The
fair value of the Bridge Notes was determined using various Monte Carlo simulations.
The
following table presents a reconciliation of the beginning and ending balances of items measured at fair value on a recurring
basis that use significant unobservable inputs (Level 3) and the related realized and unrealized gains (losses) recorded in the
condensed consolidated statement of operations during the period:
|
|
Preferred
stock embedded conversion feature
|
|
|
Anti-dilution
provision in common stock warrants included with preferred stock
|
|
|
Debenture
embedded conversion feature
|
|
|
Anti-dilution
provision in common stock warrants included with debentures
|
|
|
Bridge
Debentures
|
|
|
Total
|
|
Fair value, December 31,
2016
|
|
$
|
123,266
|
|
|
$
|
52,904
|
|
|
$
|
25,884
|
|
|
$
|
10,988
|
|
|
$
|
-
|
|
|
$
|
213,042
|
|
Net unrealized (gain)/loss on derivatives
|
|
|
(80,341
|
)
|
|
|
17,053
|
|
|
|
(17,671
|
)
|
|
|
14,482
|
|
|
|
-
|
|
|
|
(66,477
|
)
|
Issuances of debt
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
1,218,152
|
|
|
|
1,218,152
|
|
Fair value, March
31, 2017
|
|
$
|
42,925
|
|
|
$
|
69,957
|
|
|
$
|
8,213
|
|
|
$
|
25,470
|
|
|
$
|
1,218,152
|
|
|
$
|
1,364,717
|
|
The
Company’s derivative liabilities are valued by using Black Scholes methods which approximate Monte Carlo Simulation methods.
Where possible, the Company verifies the values produced by its pricing models to market prices. Valuation models require a variety
of inputs, including contractual terms, market prices, yield curves, credit spreads, measures of volatility and correlations of
such inputs. These derivative liabilities do not trade in liquid markets, and as such, model inputs cannot generally be verified
and do involve significant management judgment. Such instruments are typically classified within Level 3 of the fair value hierarchy.
The following assumptions were used to value the Company’s derivative liabilities at March 31, 2017: dividend yield of -0-%,
volatility of 93.68 – 107.80%, risk free rates of 0.76 - 1.50% and an expected term of 0.3 years to 3.8 years.
NOTE
9 – COMMON STOCK, PREFERRED STOCK AND WARRANTS
Common
Stock
During
the three months ended March 31, 2017, the Company issued 15,000,000 shares of restricted common stock subject to forfeiture to
its Chairman and CEO. The expense of these shares is not recorded until the terms of forfeiture have been satisfied by the respective
employees. Those terms of the stock issuances and forfeitures are materially as follows:
To
fully earn 10,000,000 shares, by July 2017, the Company’s Chairman must join the Company as a senior executive on a full-time
basis for a period of at least 12 months, during which 12 month or extended period: (1) the Company must complete at least $3
million in funding and (2) complete its first strategic acquisition. To fully earn 5,000,000 shares, the Company’s CEO must
continue to serve the Company as a senior executive on a full-time basis for a period of at least 18 months from December 2016,
during which 18 month or extended period: (1) the Company must complete at least $3 million in funding and (2) complete its first
strategic acquisition. If these conditions are not met, the executives may forfeit all of their shares at the discretion of the
Board.
Redeemable
Convertible Preferred Stock
The
Company has 600 shares of Preferred Stock issued and outstanding, which currently are convertible at $0.15 per share of the Company’s
common stock (the “Conversion Price”), as per the terms of the March 2017 Modification and Extension Agreement. The
Preferred Stock bears a 6% dividend per annum, calculable and payable per quarter in cash or additional shares of common stock
as determined in the Certificate of Designation. The Preferred Stock has no voting rights until converted to common stock, and
has a liquidation preference equal to the Purchase Price. On the second anniversary of the Original Issue Dates (the “Two
Year Redemption Date”), which occur in December 2017 and January 2018, the Company is obligated to redeem all of the then
outstanding Preferred Stock, for an amount in cash equal to the Two Year Redemption Amount (such redemption, the “Two Year
Redemption”). Each share of Preferred Stock received warrants (the “Warrants”) equal to one-half of the Purchase
Price to purchase common stock in the Company exercisable for five (5) years following closing at a price of $0.50 per share.
The
Preferred Stock has price protection provisions in the case that the Company issues any shares of stock not pursuant to an “Exempt
Issuance” at a price below the Conversion Price. Exempt Issuances include: (i) shares of Common Stock or common stock equivalents
issued pursuant to the Merger or any funding contemplated by the Merger; (ii) any common stock or convertible securities outstanding
as of the date of closing; (iii) common stock or common stock equivalents issued in connection with strategic acquisitions; (iv)
shares of common stock or equivalents issued to employees, directors or consultants pursuant to a plan, subject to limitations
in amount and price; and (v) other similar transactions. The Certificate of Designation contains restrictive covenants not to
incur certain debt, repurchase shares of common stock, pay dividends or enter into certain transactions with affiliates without
consent of holders of 67% of the Preferred Stock. The unconverted shares of Preferred Stock must be redeemed in two years from
issuance.
Management
has determined that the Preferred Stock is more akin to a debt security than equity primarily because it contains a mandatory
2-year redemption at the option of the holder, which only occurs if the Preferred Stock is not converted to common stock. Therefore,
management has presented the Preferred Stock outside of permanent equity as mezzanine equity, which does not factor in to the
totals of either liabilities or equity. The proceeds have been allocated between the three features of the stock offering: the
embedded conversion feature in the Preferred Stock, the warrants, and the Preferred Stock itself. The fair values of the embedded
conversion feature and warrants were recorded as a discount against the stated value of the Preferred Stock on the date of issuance.
This discount is amortized to interest expense over the term of the redemption period (2 years), which will result in the accretion
of the Preferred Stock to its full redemption value. Unamortized discount as of March 31, 2017 and December 31, 2016 was $91,556
and $126,217, respectively. Interest expense related to the preferred stock discount for the three months ended March 31, 2017
and 2016 was $34,661 and $33,600, respectively.
The
Preferred Stock also carries a 6% per annum dividend calculated on the stated value of the stock and is cumulative and payable
quarterly beginning July 1, 2016. These dividends are accrued at each reporting period. They add to the redemption value of the
stock; however, as the Company shows an accumulated deficit, the charge has been recognized in additional paid-in capital. The
Company has accrued but not paid these dividends beginning July 1, 2016.
Warrants
The
following is a summary of all outstanding common stock warrants as of March 31, 2017:
|
|
Number
of Warrants
|
|
|
Exercise
price per share
|
|
|
Average
remaining term in years
|
|
|
Aggregate
fair value
|
|
Warrants issued in connection
with issuance of Debentures
|
|
|
415,000
|
|
|
$
|
0.50
|
|
|
|
2.25
|
|
|
$
|
23,686
|
|
Warrants issued in connection with issuance
of Preferred Stock
|
|
|
1,153,845
|
|
|
$
|
0.50
|
|
|
|
3.60
|
|
|
$
|
60,878
|
|
NOTE
10 – STOCK OPTIONS AND RESTRICTED STOCK UNITS
On
July 31, 2014, the Board of Directors of Q2P approved the Founders Stock Option Plan (“Founders Plan”) and the 2014
Employee Stock Option Plan (the “2014 Plan”), collectively the “Option Plans”. The Option Plans were developed
to provide a means whereby directors and selected employees, officers, consultants, and advisors of the Company may be granted
incentive or non-qualified stock options to purchase restricted common stock of the Company. On February 25, 2016, to accommodate
the appointment of new Board members and additional incentive stock options and stock grants to key employees of the Company,
the Board approved the 2016 Omnibus Equity Incentive Plan (“2016 Plan”), which allowed for an additional 4 million
shares of common stock, stock options, stock rights (restricted stock units), or stock appreciation rights to be granted by the
Board in its discretion.
For
the three months ended March 31, 2017, the charge to the condensed consolidated statement of operations for the amortization of
stock option grants awarded under the Option Plans and 2016 Plan was $34,608. The remaining unamortized stock option expense for
all outstanding stock options at March 31, 2017 was $107,982.
A
summary of the common stock options issued under the Option Plans and the 2016 Plan for the period from December 31, 2016 through
March 31, 2017 follows:
|
|
Number
Outstanding
|
|
|
Weighted
Avg. Exercise Price
|
|
|
Weighted
Avg. Remaining Contractual Life (Years)
|
|
Balance, December 31, 2016
|
|
|
6,115,480
|
|
|
$
|
0.21
|
|
|
|
6.1
|
|
Options issued
|
|
|
—
|
|
|
|
|
|
|
|
|
|
Options exercised
|
|
|
—
|
|
|
|
|
|
|
|
|
|
Options cancelled
|
|
|
—
|
|
|
|
|
|
|
|
|
|
Balance, March 31, 2017
|
|
|
6,115,480
|
|
|
$
|
0.21
|
|
|
|
5.9
|
|
The
vested and exercisable options at period end follows:
|
|
Exercisable/
Vested Options Outstanding
|
|
|
Weighted
Avg. Exercise Price
|
|
|
Weighted
Avg. Remaining Contractual Life (Years)
|
|
Balance, March 31, 2017
|
|
|
4,992,147
|
|
|
$
|
0.21
|
|
|
|
5.9
|
|
NOTE
11 – COMMITMENTS AND CONTINGENCIES
On
April 1, 2017, the Company entered into new Employment Agreements with its Chairman and CEO. In the case of the CEO, this superseded
his previous employment agreement. The Chairman receives a $12,500 per month fee starting April 1 and continuing until he assumes
the role of CEO on a full-time basis, at which time, his base salary will be increased to $350,000 per year. The Company’s
current CEO receives a $10,000 per month fee starting on April 1, and at such time that the Chairman assumes the role of CEO,
he will move into the position of President and General Counsel at a base salary of $220,000 per year. Both agreements have provisions
for a 12-month severance in the instance either executive is terminated without cause or after a change in control.
NOTE
12 - SUBSEQUENT EVENTS
In
April 2017, the Company settled $370,816 in deferred payroll and fees owed to its former employees and CEO, which included the
issuance of 1,530,128 total shares of common stock, payment of $54,053 in cash, and forfeiture by the Company’s
CEO of $87,243. The Company’s CEO also forfeited a $25,553 deferred bonus payment from 2014. These forfeited
amounts will be recorded to additional paid in capital as previously contributed services, and may result in a gain in
the period ended June 30, 2017. Another former employee settled a $16,791 deferred bonus payment plus $2,113 in un-reimbursed
expenses for $4,500 in cash and forfeited the balance of $14,404. Finally, a consultant of the Company settled $15,600
in unpaid fees for $7,800 in cash and 52,000 shares of common stock. All these settlements were effective upon the issuance of
common stock and cash payment completed after the closing of the Bridge Offering in April 2017. The settlements are expected
to result in a decrease in accounts payable and accrued expenses from the balance at March 31, 2017.
In
May 2017, two notes held by third parties in the total principal amount of $22,000 plus an additional $1,756 in interest were
converted into the Bridge Offering.
In
May 2017, the Company settled past due invoices to a former contractor in the total amount of $36,903 for $13,500 in cash and
156,022 shares of common stock.
As
of June 1, 2017, the Company closed an addition $400,000 in new investments in its Bridge Offering, not inclusive of notes converted
into the offering, discussed above.