Washington, D.C. 20549
☒ ANNUAL REPORT PURSUANT TO SECTION 13
OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
☐ TRANSITION REPORT PURSUANT TO SECTION
13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from __________________________
to __________________________
Indicate by check mark if the registrant
is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ☒ 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 ☐ 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. 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). 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. See the definitions
of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2
of the Exchange Act.
Indicate by check mark whether the registrant is an emerging
growth company as defined in Rule 405 of the Securities Act of 1933 (17 CFR §230.405) or Rule 12b-2 of the Securities Exchange
Act of 1934 (17 CFR §240.12b-2). ☒
If an emerging growth company, indicate
by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial
accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
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,
or the average bid and asked price of such common equity, as of the last business day of the registrant’s most recently completed
second fiscal quarter was $7,251,999.
The number of shares outstanding of each
of the registrant’s classes of common stock, as of the latest practicable date was 21,673,403 shares of common stock as
of September 12, 2017.
PART I
ITEM 1. BUSINESS
Forward-Looking Statements
This Annual Report
on Form 10-K includes a number of forward-looking statements that reflect management’s current views with respect to future events
and financial performance. Forward-looking statements are projections in respect of future events or our future financial performance.
In some cases, you can identify forward-looking statements by terminology such as “may,” “should,” “expects,”
“plans,” “anticipates,” “believes,” “estimates.” “predicts,” “potential”
or “continue” or the negative of these terms or other comparable terminology. Those statements include statements regarding
the intent, belief or current expectations of us and members of our management team, as well as the assumptions on which such statements
are based. Prospective investors are cautioned that any such forward-looking statements are not guarantees of future performance
and involve risk and uncertainties, and that actual results may differ materially from those contemplated by such forward-looking
statements. These statements are only predictions and involve known and unknown risks, uncertainties and other factors, including
the risks in the section entitled “Risk Factors” set forth in this Annual Report on Form 10-K for the fiscal year ended
May 31, 2017, any of which may cause our company’s or our industry’s actual results, levels of activity, performance
or achievements to be materially different from any future results, levels of activity, performance or achievements expressed or
implied by these forward-looking statements. These risks include, by way of example and without limitation:
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our ability to successfully commercialize and our products and services on a large enough scale
to generate profitable operation;
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our ability to maintain and develop relationships with customers and suppliers;
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our ability to successfully integrate acquired businesses or new brands;
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the impact of competitive products and pricing;
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supply constraints or difficulties;
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the retention and availability of key personnel;
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general economic and business conditions;
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substantial doubt about our ability to continue as a going concern;
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our need to raise additional funds in the future;
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our ability to successfully recruit and retain qualified personnel in order to continue our operations;
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our ability to successfully implement our business plan;
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our ability to successfully acquire, develop or commercialize new products and equipment;
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intellectual property claims brought by third parties; and
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the impact of any industry regulation.
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Although we believe
that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of
activity, or performance. Except as required by applicable law, including the securities laws of the United States, we do not intend
to update any of the forward-looking statements to conform these statements to actual results.
Readers are urged to
carefully review and consider the various disclosures made by us in this report and in our other reports filed with the Securities
and Exchange Commission (the “SEC”). We undertake no obligation to update or revise forward-looking statements to reflect
changed assumptions, the occurrence of unanticipated events or changes in the future operating results over time except as required
by law. We believe that our assumptions are based upon reasonable data derived from and known about our business and operations.
No assurances are made that actual results of operations or the results of our future activities will not differ materially from
our assumptions.
As used in this Annual
Report on Form 10-K and unless otherwise indicated, the terms “Company,” “we,” “us,” and “our”
refer to Arkados Group, Inc. and our wholly-owned subsidiaries: Arkados, Inc. and SolBright Energy Solutions, LLC (formerly Arkados
Energy Solutions, LLC). Unless otherwise specified, all dollar amounts are expressed in United States dollars.
Corporate History and Overview
Arkados Group, Inc.,
a Delaware corporation, was incorporated in 1998. We underwent a significant restructuring after December 23, 2010 when substantially
all of our then-existing assets were acquired by STMicroelectronics, Inc., a Delaware corporation (“ST Micro”). We
currently carry out our activities through our wholly-owned subsidiaries, Arkados, Inc., a Delaware corporation (“Arkados”),
and SolBright Energy Solutions, LLC (formerly Arkados Energy Solutions, LLC), a Delaware limited liability company (“SES”).
We deliver technology solutions for building and machine automation and energy conservation and provide energy conservation services
such as LED lighting retrofits, HVAC system retrofits and solar engineering, procurement and construction services. Our focus is
towards the development and commercialization of an Internet of Things software platform that supports Big Data applications that
complement our energy management services that lower costs for commercial and industrial facilities owners and managers. Our principal
offices are located in Newark, New Jersey at the Economic Development Corporation at the New Jersey Institute of Technology.
On May 1, 2017, we
acquired substantially all of the assets and certain liabilities of SolBright Renewable Energy, LLC (“SolBright RE”),
used in the operation of SolBright RE’s solar engineering, procurement and construction business (the “SolBright Assets”).
Our Markets
We seek to combine
technology products and energy services that can position our company to be a leading provider for turnkey, cutting-edge solutions
that immediately bring value to our customers by reducing costs, conserving energy and seamlessly integrating our product offerings
into their existing systems. In order to effectively compete in today’s markets, we believe businesses need to continually
focus on increasing productivity and efficiency - essentially getting more from less. One of the main areas where businesses can
increase their efficiency is in the management of their long-term assets, particularly machinery and real estate. New technology
advancements are able to help owners not only decrease the cost of ownership of these assets, but can also extend the life of them,
both driving a much higher return on assets through increased output and reducing operational costs, thus increasing productivity
and creating a high return on investment. Our solutions and software seek to capitalize on these technology enhancements by leveraging
the network of physical objects connected to the internet that have the ability to process information and communicate with the
external world. This area of technology is referred to as Industrial Internet of Things (“IIoT), and we apply IIoT principals
to help commercial customers increase their return on investment in facilities by reducing energy and maintenance costs, extending
asset life and enhancing sustainability.
We believe, in terms
of energy efficiency, that applying an IIoT approach by using internet-connected gateways and sensors to gather data, extract intelligence
and enable more efficient usage of energy-consuming machines and devices can reduce energy expenditures by up to 25% and potentially
much more when combined with implementing other energy conservation measures, such as conversion to LED lighting and installation
of commercial solar. According to Gartner Group, there will be over 21 billion “things” connected to the internet by
2020, or in other words, 3 things per each human being on earth. The Gartner Group reported that the market size for services is
expected to be $235 billion in 2016, with the majority coming from business services. In addition to energy efficiency, IIoT can
reduce operating expenses, particularly operating and maintenance of long term assets. These hard expenses can equate to up to
10% of the overall operating budget, and any reduction in this cost falls directly to the bottom line for most businesses. Furthermore,
IIoT can also enhance conditions within the workplace and increase productivity and sustainability. Many businesses are increasingly
under pressure to continue to squeeze more productivity from operations in order to remain competitive, and social pressures are
forcing businesses to do so while caring for our environment. According to a McKinsey & Company survey, 33% of companies stated
that the top reasons for addressing sustainability include improving operational efficiency and lowering costs. By employing IIoT
solutions to optimize conditions and increase productivity, businesses may be able to balance their goals to increase productivity
with maintaining a cleaner, safer environment for workers and the community in which they operate.
Our corporate strategy
is to leverage the capabilities of our technology platform to enhance the offerings of our service business and deliver a unique
value proposition to our commercial customers defined in terms of return on investment, operational cost savings and unmatched
service. Since beginning these undertakings in 2013, we have developed our Arktic
TM
software platform, which is unique
in its open, scalable and interoperable design. We have integrated this software with hardware products of our partner, Tatung
Company of America, Inc. (Tatung). Our services business has completed a number of large scale LED lighting projects and is expanding
its services to include oil-to-natural gas boiler conversions and solar PV system installations. In addition, through our acquisition
of the SolBright Assets, our strategic focus within the solar industry has been strengthened to significantly increase our design-build
competencies for commercial solar projects to enable us to develop solutions to simplify technically challenging projects and deliver
unparalleled service and quality to our clients.
We believe our combination
of technology products, energy services and commercial solar business has positioned our Company as a source for turnkey, cutting-edge
solutions that immediately bring value to our customers by reducing costs, conserving energy and seamlessly integrating into their
existing systems and has set the stage for additional improvements in the future.
Arkados
Arkados, our software
development subsidiary, was organized in 2004. It develops proprietary, cloud-based device and system management software solutions,
which we refer to as the Arktic
TM
software platform, and delivers software services and support. Arktic
TM
is an open, scalable and interoperable software platform that supports industrial applications, including applications for smart
manufacturing, measurement and verification, as well as predictive analysis, or data gathering for baselining machine performance
data and reporting of anomalies. Arkados has licensed its software directly to Tatung Co., a Taiwan corporation (“Tatung”)
for use in their manufacturing facility, as well as through SES to end customers as part of an integrated solution with Tatung
hardware products.
Efficient software
technology enables innovative smart monitoring of devices and features energy management and intelligent control over cloud services.
This is ideal for many IIot applications as follows:
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Smart Building – data gathering and analysis to improve performance of commercial building
systems, such as lighting, HVAC, access control and energy management. Data includes temperature, humidity, illumination and air
quality, including CO2 and Volatile Organic Compounds.
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Smart Machine – data gathering and analysis to improve industrial and commercial machinery
performance. Data includes, but is not limited to, temperature, humidity, vibration, energy consumption and run cycles.
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Smart Manufacturing – data gathering and analysis to improve efficiency for manufacturing
items. Data includes, but is not limited to, specific machine performance, input/output measurements and defect analysis.
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SES
SES, formerly known
as AES, our energy conservation services subsidiary, was organized in 2013 and commenced operations in early 2015. SES provides
energy conservation services and solutions, including solar engineering, procurement and construction, to commercial and buildings
throughout the eastern United States. These services include energy consumption assessments and recommendations, as well as acting
as the general contractor for light-emitting diode (“LED”) lighting retrofits, oil-to-natural gas boiler conversions
and solar photovoltaic (“PV”) system installation. SES also markets and sells the technology solutions of Arkados to
help building owners save money. SES sells its services directly to building owners and managers.
SES focuses on the
systems throughout commercial and industrial buildings that consume large amounts of energy and operates as an engineering, procurement
and construction general contractor, directly with commercial, institutional and industrial clients. After the completion of an
energy efficiency audit, we offer customers recommendations on reducing energy demand costs (such as converting to LED lighting),
reducing energy supply costs (such as installing a solar PV system) and improving the efficiency across all systems using our advanced
building automation system. Additionally, SES’s aim is to increase the return on investment of heating plants and solar PV
systems by offering long-term operating and maintenance agreements to clients, supported by cutting-edge tools built on the Arktic
TM
software platform.
As a consequence of
our acquisition of the SolBright Assets, we have augmented our existing energy service business with solar engineering, procurement
and construction. Through our wholly-owned subsidiary, SolBright Energy Solutions, LLC, or SES, formally known as Arkados Energy
Solutions, LLC, we have integrated all of these offerings, and changed the name of this operating subsidiary on June 23, 2017 to
better reflect our newly acquired business.
SES is a turnkey developer
of solar photovoltaic and solar thermal projects for long term, stable, distributed power solutions. We expect that SES’s
primary market focus, capitalizing on SolBright RE’s historical activities, will be military and commercial scale projects,
primarily in the 100 kWp to 5,000 kWp size range. SES will offer market assessment, design/engineering, installation, operation
& maintenance/monitoring, financing and project ownership (where desired). SES will have distinct competitive advantages for
ground, parking canopy and roof-top solar applications that ensure continuity with existing/new roof warranties. SES expects to
offer a broad range of U.S. and internationally manufactured products, including zero-penetration rooftop solar solutions and innovative,
space-leveraging parking canopy/parking garage solar solutions and ground mount systems.
From site assessments
to permitting, incentive program guidance and advocacy, feasibility analyses, interconnection studies, lease or purchase agreement
execution, full service financing, engineering, procurement, construction, and operations and maintenance after project commissioning,
SES will strive to be a full service turnkey development firm that will offer, among other things, an industry unique single-point-of-contact
for facilities managers to address both roofing and solar service and warranty related requirements.
SES provides the following
products and services in the named sectors:
Renewable Energy Services:
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Engineering, Procurement and Construction
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Existing Asset/Building Portfolio Analyses
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Site Evaluations & Feasibility Studies
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Energy Audits & Assessments
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Third Party System Verification
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Budgetary & Financial Modeling/Projections
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Federal/State/Treasury Incentive Navigation
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Conventional and Private Investor Financing
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Local, State, Federal Authority Coordination
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Leasing & Power Purchase Agreements
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Renewable Energy Systems:
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Crystalline Panel Photovoltaics
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Free Standing Parking Canopy Systems
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Pre-cast Parking Deck Canopy Systems
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Solar Hot Water Systems
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Solar Tracking Systems & Arrays
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Thin Film Building Integrated Photovoltaics
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High Wind Zone Mounting Solutions
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Construction Service/Management:
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Solar Integration – Existing and New Construction
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Parking Canopy Footings/Piers/Steel Erection
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Roofing - New Construction & Design-Build
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Re-Roofing & Roof Renovations
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Electrical Permitting and Installation
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Warranty Repair Services
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Operation & Maintenance
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Competitive Advantage:
SES provides turnkey
project development, project management, technology expertise, utility compliance, contract administration, procurement and integration
expertise to the emerging field of solar energy. SES has a proven and successful set of skills, manpower and experience supporting
the government, military, industrial and commercial building spaces. We expect that our leadership, subject matter expertise, and
execution and project coordination skills will enable us to continuously exceed expectations for our acquired and prospective customers.
SES’s mission is to design, build and exceed expectations as a top tier, power-generating facility constructor throughout
the Southeast, Mid-Atlantic, New England and military sites nationwide.
We believe that our
key competitive advantages in the solar space include:
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Comprehensive, turnkey project expertise
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Experienced design-build team
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Solution based offering – exclusive and non-exclusive
product options
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Registered PE stamped/sealed drawings
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Existing manufacturer’s roof warranty preservation
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Extensive safety documentation and fall protection plans
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NABCEP certified installation personnel
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Simplified facilities management: Single point of contact
for service and warranty on all renewable energy assets.
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Single entity contract leadership, implementation and
accountability
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Exceptional U.S.-based sourcing partnerships for solar
(including foundations, structural steel, roofing, site work, pile driving).
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Industry leading EMR rates and safety records
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Local, regional and super-regional implementation and
service capabilities
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Comprehensive project development resources from concept
to financing
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With our SolBright’s
history of experience in the military market, we believe that SES now possesses specific competitive advantages in this sector,
including:
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UFC experience and compliance knowledge base
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FAR/BAA/Davis-Bacon/Certified Payroll compliance
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Experienced and successful design-build and “mid
project mod pick-up” team
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Expedited submittal process
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SOW related spec sections and approved training submittals
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Locally and regionally based workforce – with
existing base clearances
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Small business entity status (self-certified, CCR, ORCA,
SAM)
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Target Markets, Sales and Marketing
Arkados
Our target market consists
of commercial and industrial facilities’ owners and managers. While we can operate nationally, our primary geographic focus
is the Eastern United States with a focus on health care, retail, office, education and municipal properties.
We anticipate conducting
the majority of our future sales in conjunction with the sales activities of SES. The scope of our sales activities for Arkados
will include acting as a technical sales representative and providing technology support and implementation services and other
services in support of the activities of SES.
SES
We developed a direct
sales force to focus mainly on opportunities in the Northeastern region of the United States. These sales activities target commercial
facilities owners and managers of virtually all kinds, including commercial office buildings, hospitals, schools, warehouses, hotels,
etc. We expect to regularly work with partners in the construction and property management industries to reach the end customers.
For the foreseeable future, we expect to maintain our focus on the current region and penetrate the large number of opportunities
that exist there. We anticipate supplementing our direct sales force with other representatives and channel partners. The scope
and development of our sales and marketing organization will depend, among other things, on the amount of capital available to
us in the future.
With respect to SES’s
solar business, our target market consists of commercial and industrial facilities’ owners and managers. While we can operate
nationally, our primary geographic focus is the Eastern United States with a focus on health care, retail, office, education and
municipal properties.
Strategic Relationships
Tatung Corporation
We continue to foster
our relationship with Tatung and believe that this strategic relationship is a key competitive advantage for Arkados as we develop
IIoT solutions.
SparkFund
In February 2017, we
formed a partnership with SparkFund, a financial technology company located in Washington, DC to offer commercial and industrial
facilities managers and owners a unique subscription model for energy conservation services. Through the As-A-Service model, the
large capital expenditure associated with energy conservation measures, such as an LED lighting retrofit, is converted into a no-money-down
subscription service. The benefits of this model include a reduction in upfront costs, a reduction in operations and maintenance
costs and protection from obsolete materials. Additionally, the Company’s Arktic
TM
Energy Measurement and Verification
(EM&V) platform is embedded with this subscription model to provide verification of energy savings with granular, real-time
data gathering and provide insights into additional ways to reduce energy consumption. We believe that the introduction of the
As-A-Service model is unique in that it revolutionizes how customers pay for energy conservation by eliminating the upfront cost
associated with these activities, provides for a single monthly payment that covers installation, repairs, monitoring and ongoing
service. Within this model, the Arktic
TM
EM&V platform offers customers a state-of-the-art, advanced Internet of
Things platform that leverages data gathering and analytics to further reduce energy consumption.
Competition
Arkados
Arkados faces competition
in the IIoT market for smart building/smart grid industries segments from multiple companies. There are several large players within
the smart building market including, but not limited to, Johnson Controls, Siemens, Honeywell International and General Electric.
These companies provide sophisticated building management systems for large commercial facilities and have essentially dominated
the playing field for many years. We believe the landscape, however, is changing as technology advances and legacy systems become
outdated and expensive to maintain. As the paradigm shifts to open and scalable solutions for building management, we believe that
Arkados can gain a competitive advantage over time. Initially, we seek to integrate our systems as a value-added upgrade or enhancement
to existing management systems. In the future, depending on conditions, we may seek to expand our offerings to compete head on
with the larger players.
Additionally, there
are early stage technology companies that represent direct competition to Arkados, including Optimum Energy and Enertiv. These
companies are focused on data gathering and analytics to improve building efficiency and ultimately save money. We believe that
we are unique initially in our approach. Our turnkey solutions are very flexible and highly customizable. Secondly, we believe
that our business model and strategic relationships allow us to be price competitive, which drives higher return on investment
for our customers. Finally, we believe that the best competitive advantage is high customer satisfaction and that our dedication
to delivering the best, most innovative solutions to our customers ultimately allows us to compete favorably.
SES
The competition for
LED lighting and building automation solutions is highly competitive. Large LED lighting companies such as General Electric, Phillips
and Cree, as well as a large number of China-based manufacturers, represent significant competition to SES for LED lighting. In
addition, companies such as Johnson Controls, Rockwell Automation and Schneider Electric represent significant competition to SES
for building automation solutions. While these companies potentially represent sources of product for SES as a system integrator,
there are situations where these companies are competing directly with SES, particularly for large commercial customer opportunities.
We also face competition from a large number of Energy Savings Companies (“ESCOs”) in the Northeast region of the United
States.
The competition related
to the SolBright Assets business is highly competitive. Large companies such as SolarCity, SunPower, Vivint Solar and others represent
significant competition to SES as fully-integrated solar companies. While these companies potentially represent sources of product
for SES as an EPC company, there are situations where these companies are competing directly with SES, particularly for large commercial
or utility-grade solar installations.
Research and Development
Arkados
Research and development
in a rapidly changing technology environment is one of the keys to our success. We allocate resources as much as possible within
our current operational limits to explore and exploit advancements in mobile and cloud computing, data processing technologies,
wireless and broadband technologies and energy storage technologies that will lead to new products and services within our core
competencies. These include the development of new software with a focus on M2M bridges, building networks and the Internet of
Things within the smart building/smart machine areas via our strategic partnerships. We plan to engage in certain activities in
pursuit of further commercial development as opportunities arise from these relationships.
In 2015, we introduced
our Process and Event Management System for Smart Factory, or PEMS-SF. This system is intended to improve efficiency of a factory
by use of Arkados’ software solutions residing in the factory’s computer systems and in Arkados’ cloud computing
platform. This was the introduction of what we now call our Arktic
TM
software platform.
In May 2016, our focus
shifted to applying our Arktic
TM
platform to the commercial building market to complement our energy services business,
and we rolled out a new product for smart buildings called Energy Management Panel, or EMP. EMP is a measurement and verification
process for quantifying the savings achieved by energy conservation measures. We expect to also continuously explore ways of improving
this initial version of the EMP and expand new product offerings in the future.
Arkados and SES had
aggregate research and development expenses of $68,439 and $337,375 for the years ended July 31, 2017 and 2016, respectively.
Intellectual Property
We maintain the federal
registration of our “Arkados” trademark and own the “Arktic” trademark through use in commerce. In addition,
through the acquisition of the SolBright Assets, we own the corporate name and logo for “SolBright Renewable Energy, LLC,”
the slogan “The most dependable EPC in the industry,” the tradenames “SolBright” and “SolBright
Renewable Energy” and the website
www.solbrightre.com.
Other than the foregoing, we do not own any other patents,
licenses or trademarks during the periods covered by this report.
Government Approvals and Regulations
We are not subject
to any governmental regulation and are not required to maintain any specific licenses.
Subsidiaries
The Company has two
wholly-owned subsidiaries including Arkados, Inc. and SolBright Energy Solutions, LLC.
Employees
As of May 31, 2017,
we had 13 full-time employees and 2 part-time employees. We intend to hire additional staff and to engage consultants in general
administration on an as-needed basis. We also intend to engage experts in operations, finance and general business to advise us
in various capacities. None of our employees are covered by a collective bargaining agreement, and we believe our relationship
with our employees is good to excellent.
Our future success
depends, in part, on our ability to continue to attract, retain and motivate highly qualified technical, marketing, and management
personnel and, as of the end of the period covered by this report and as of the date of filing, we continue to rely on the services
of independent contractors for much of our sales/marketing. We believe technical, accounting and other functions are also critical
to our continued and future success.
ITEM 1A. RISK FACTORS
You should carefully
consider the risks described below together with all of the other information included in our public filings before making an investment
decision with regard to our securities. The statements contained in or incorporated into this document that are not historic facts
are forward-looking statements that are subject to risks and uncertainties that could cause actual results to differ materially
from those set forth in or implied by forward-looking statements. If any of the following events described in these risk factors
actually occurs, our business, financial condition or results of operations could be harmed. In that case, the trading price of
our common stock could decline, and you may lose all or part of your investment. Moreover, additional risks not presently known
to us or that we currently deem less significant also may impact our business, financial condition or results of operations, perhaps
materially. For additional information regarding risk factors, see Item 1 – “Forward-Looking Statements.”
Risks Related to Our Company
There is substantial
doubt about our ability to continue as a going concern.
We have not generated
any profit from combined operations since our inception. We expect that our operating expenses will increase over the next twelve
months to continue our development activities. Based on our average monthly expenses and current burn rate of $120,000 per month,
we estimate that our cash on hand as of May 31, 2017 will not be able to support our operations through the next fiscal year. This
amount could increase if we encounter difficulties that we cannot anticipate at this time or if we acquire other businesses. As
of the date of this filing, we had cash of approximately $300,000. We do not expect to raise capital through debt financing from traditional
lending sources since we are not currently generating a profit from operations. Therefore, we only expect to raise money through
equity financing via the sale of our common stock or equity-linked securities such as convertible debt. If we cannot raise the
money that we need in order to continue to operate our business beyond the period indicated above, we will be forced to delay,
scale back or eliminate some or all of our proposed operations. If any of these were to occur, there is a substantial risk that
our business would fail. If we are unsuccessful in raising additional financing, we may need to curtail, discontinue or cease operations.
We have limited
operating history with our subsidiaries, and as a result, we may experience losses and cannot assure you that we will be profitable.
We have a limited operating
history with our subsidiaries on which to evaluate our business. Our operations are subject to all of the risks inherent in the
establishment and expansion of a business enterprise. Accordingly, the likelihood of our success must be considered in the light
of the problems, expenses, difficulties, complications, and delays frequently encountered in connection with the starting and expansion
of a business and the relatively competitive environment in which we operate. Unanticipated delays, expenses and other problems
such as setbacks in product development, product manufacturing, and market acceptance are frequently encountered in establishing
a business such as ours. There can be no assurance that the Company will be successful in addressing such risks, and any failure
to do so could have a material adverse effect on the Company’s business, results of operations and financial condition.
Because of our limited
operating history with our subsidiaries, we have limited historical financial data on which to base planned operating expenses.
Accordingly, our expense levels, which are, to a large extent, variable, will be based in part on our expectations of future revenues.
As a result of the variable nature of many of our expenses, we may be unable to adjust spending in a timely manner to compensate
for any unexpected delays in the development and marketing of our products or any subsequent revenue shortfall. Any such delays
or shortfalls will have an immediate adverse impact on our business, operating results and financial condition.
We have not achieved
profitability on a quarterly or annual basis to date. To the extent that net revenue does not grow at anticipated rates or that
increases in our operating expenses precede or are not subsequently followed by commensurate increases in net revenue, or that
we are unable to adjust operating expense levels accordingly, our business, results of operations and financial condition will
be materially and adversely affected. There can be no assurance that our operating losses will not increase in the future or that
we will ever achieve or sustain profitability.
No Assurance of
Sustainable Revenues.
There can be no assurance
that our subsidiaries will generate sufficient and sustainable revenues to enable us to operate at profitable levels or to generate
positive cash flow. As a result of our limited operating history and the nature of the markets in which we compete, we may not
be able to accurately predict our revenues. Any failure by us to accurately make such predictions could have a material adverse
effect on our business, results of operations and financial condition. Further, our current and future expense levels are based
largely on our investment plans and estimates of future revenues. We expect operating results to fluctuate significantly in the
future as a result of a variety of factors, many of which are outside of our control. Factors that may adversely affect our operating
results include, among others, demand for our products and services, the budgeting cycles of potential customers, lack of enforcement
of or changes in governmental regulations or laws, the amount and timing of capital expenditures and other costs relating to the
expansion of our operations, the introduction of new or enhanced products and services by us or our competitors, the timing and
number of new hires, changes in our pricing policy or those of our competitors, the mix of products, increases in the cost of raw
materials, technical difficulties with the products, incurrence of costs relating to future acquisitions, general economic conditions,
and market acceptance of our products. As a strategic response to changes in the competitive environment, we may, from time to
time, make certain pricing, service or marketing decisions or business combinations that could have a material adverse effect on
our business, results of operations and financial condition. Any seasonality is likely to cause quarterly fluctuations in our operating
results, and there can be no assurance that such patterns will not have a material adverse effect on our business, results of operations
and financial condition. We may be unable to adjust spending in a timely manner to compensate for any unexpected revenue shortfall.
We may need to raise
additional funds in the future that may not be available on acceptable terms or at all.
We may consider issuing
additional debt or equity securities in the future to fund our business plan, for potential acquisitions or investments, or for
general corporate purposes. If we issue equity or convertible debt securities to raise additional funds, our existing stockholders
may experience dilution, and the new equity or debt securities may have rights, preferences and privileges senior to those of our
existing stockholders. If we incur additional debt, it may increase our leverage relative to our earnings or to our equity capitalization,
requiring us to pay additional interest expenses. We may not be able to obtain financing on favorable terms, or at all, in which
case, we may not be able to develop or enhance our products, execute our business plan, take advantage of future opportunities
or respond to competitive pressures.
Our margins fluctuate
which leads to further uncertainty in our profitability model.
While we have the potential
to negotiate prices that benefit our clients and affect our profitability as we seek to gain market-share and increase our book
of business, margins in the energy and software solutions business are fluid, and our margins vary based upon the supplier and
the customer. This will lead to continued uncertainty in margins from quarter to quarter.
If demand for energy
efficiency and our specialized software solutions does not develop as expected, our projected revenues and profits will be affected.
Our future profits
are influenced by many factors, including economics, and will be predicated on a stable and/or growing market and consumption of
energy efficiency and software solutions and products. We believe, and our growth expectations assume, that the market for energy
efficiency and software solutions will continue to grow, that we will increase our penetration of this market and that our anticipated
revenue from selling into this market will continue to increase. If our expectations as to the size of this market and our ability
to sell our products and services in this market are not correct, our revenue may not materialize and our business will be harmed.
Projects generally
require significant capital, for which financing may not be available.
Our projects are occasionally
financed by our customers. The costs of these projects to our customers are costly. If our customers are unable to budget for or
raise funds on acceptable terms when needed for any particular project, we may be unable to secure customer contracts, the size
of contracts we do obtain may be smaller, or we could be required to delay the development and construction of projects, reduce
the scope of those projects or otherwise restrict our operations. Any inability by our customers to raise the funds necessary to
finance our projects could materially harm our business, financial condition and operating results.
Operating results
may fluctuate and may fall below expectations in any fiscal quarter.
Our operating results
are difficult to predict and are expected to fluctuate from quarter to quarter due to a variety of factors, many of which are outside
of our control. As a result, comparing our operating results on a period-to-period basis may not be meaningful, and investors should
not rely on our past results or future predictions prepared by the Company as an indication of our future performance. If our revenue
or operating results fall in any period, the value of our common stock would likely decline.
Factors that may cause
our operating results to fluctuate include:
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our customers’ ability to finance projects;
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our ability to acquire products to resell to our customers;
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the timing of work we do on projects where we recognize revenue on a percentage of completion basis;
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seasonality in demand for our products and services;
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poor weather inhibiting sales;
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a customer’s decision to delay our work on, or other risks involved with, a particular project;
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availability and costs of labor and equipment;
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the addition of new customers or the loss of existing customers;
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the size and scale of new customer projects;
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the availability of bonding for our projects;
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our ability to control costs, including operating expenses;
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changes in the mix of our products and services;
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the length of our sales cycle;
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the productivity and growth of our sales force;
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changes in pricing by us or our competitors, or the need to provide discounts to win business;
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costs related to the acquisition and integration of companies or assets;
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general economic trends, including changes in energy efficiency spending or geopolitical events
such as war or incidents of terrorism; and
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future accounting pronouncements and changes in accounting policies.
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Our business is
at risk if we lose key personnel or we are unable to attract and integrate additional skills personnel.
The success of our
business depends, in large part, on the skill of our personnel. Accordingly, it is critical that we maintain, and continue to build,
a highly-experienced management team and specialized workforce, including engineers, experts in project management and business
development, and sales professionals. Competition for personnel, particularly those with expertise in the energy services and software
industries, is high, and identifying candidates with the appropriate qualifications can be difficult. We may not be able to hire
the necessary personnel to implement our business strategy given our anticipated hiring needs, or we may need to provide higher
compensation or more training to our personnel than we currently anticipate.
In the event, we are
unable to attract, hire and retain the requisite personnel and subcontractors, we may experience delays in completing projects
in accordance with project schedules and budgets, which may have an adverse effect on our financial results, harm our reputation
and cause us to curtail our pursuit of new projects. Further, any increase in demand for personnel and specialty subcontractors
may result in higher costs, causing us to exceed the budget on a project, which in turn may have an adverse effect on our business,
financial condition and operating results and harm our relationships with our customers.
Our future success
is particularly dependent on the vision, skills, experience and effort of our senior management team, including our president and
chief executive officer. If we were to lose the services of our president and chief executive officer or any of our key employees,
our ability to effectively manage our operations and implement our strategy could be harmed and our business may suffer.
We operate in a
highly competitive industry and competitors may compete more effectively.
The industries in which
we operate are highly competitive, with many companies of varying size and business models, many of which have their own proprietary
technologies, competing for the same business as we do. Many of our competitors have longer operating histories and greater resources
than us, and could focus their substantial financial resources to develop a competing business model, develop products or services
that are more attractive to potential customers than what we offer or convince our potential customers that they require financing
arrangements that would be impractical for smaller companies to offer. Our competitors may also offer similar products and services
at prices below cost and/or devote significant sales forces to competing with us or attempt to recruit our key personnel by increasing
compensation, any of which could improve their competitive positions. Any of these competitive factors could make it more difficult
for us to attract and retain customers; cause us to lower our prices in order to compete, and reduce our market share and revenue,
any of which could have a material adverse effect on our financial condition and operating results. We can provide no assurance
that we will continue to effectively compete against our current competitors or additional companies that may enter our markets.
We also expect to encounter competition in the form of potential customers electing to develop solutions or perform services internally
rather than engaging an outside provider such as us.
We may be unable
to manage our growth effectively.
We expect our business
and operations to expand rapidly and we anticipate that further expansion of our organization and operations will be required to
achieve our expectations for future growth. In order to manage our expanding operations, we will also need to improve our management,
operational and financial controls and our reporting systems and procedures. All of these measures will require significant expenditures
and will demand the attention of management. If we do not continue to enhance our management personnel and our operational and
financial systems and controls in response to growth in our business, we could experience operating inefficiencies that could impair
our competitive position and could increase our costs more than we had planned. If we are unable to manage growth effectively,
our business, financial condition and operating results could be adversely affected.
We plan to expand
our business, in part, through future acquisitions.
We plan to continue
to seek-out companies or assets to expand our project skill-sets and capabilities, expand our geographic markets, add experienced
management and increase our product and service offerings. However, we may be unable to implement this growth strategy if we cannot
identify suitable acquisition candidates, reach agreement with acquisition targets on acceptable terms or arrange required financing
for acquisitions on acceptable terms. In addition, the time and effort involved in attempting to identify acquisition candidates
and consummate acquisitions may divert members of our management from the operations of our company.
Any future acquisitions
could disrupt business.
If we are successful
in consummating acquisitions, those acquisitions could subject us to a number of risks, including:
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the purchase price we pay could significantly deplete our cash reserves or result in dilution to
our existing stockholders;
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we may find that the acquired company or assets do not improve our customer offerings or market
position as planned;
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we may have difficulty integrating the operations and personnel of the acquired company;
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key personnel and customers of the acquired company may terminate their relationships with the
acquired company as a result of the acquisition;
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we may experience additional financial and accounting challenges and complexities in areas such
as tax planning and financial reporting;
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we may assume or be held liable for risks and liabilities as a result of our acquisitions, some
of which we may not discover during our due diligence or adequately adjust for in our acquisition arrangements;
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we may incur one-time write-offs or restructuring charges in connection with the acquisition;
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we may acquire goodwill and other intangible assets that are subject to amortization or impairment
tests, which could result in future charges to earnings; and
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we may not be able to realize the cost savings or other financial benefits we anticipated.
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These factors could
have a material adverse effect on our business, financial condition and operating results.
We may incur a variety
of costs to engage in future acquisitions of companies, products or technologies, and the anticipated benefits of those acquisitions
may never be realized.
As a part of our business
strategy, we may make acquisitions of, or significant investments in, complementary companies, products or technologies, although
no acquisitions or investments are currently pending. Any future acquisitions would be accompanied by risks such as:
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difficulties in assimilating the operations and personnel of acquired companies;
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diversion of our management’s attention from ongoing business concerns;
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our potential inability to maximize our financial and strategic position through the successful
incorporation of acquired technology and rights into our products and services;
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additional expense associated with amortization of acquired assets;
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charges at the time of acquisitions related to the expensing of in process research and development;
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the exposure to additional debt to fund an acquisition;
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dilution to existing shareholders should the Company raise additional equity;
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maintenance of uniform standards, controls, procedures and policies; and
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impairment of existing relationships with employees, suppliers and customers as a result of the
integration of new management personnel.
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We cannot guarantee
that we will be able to successfully integrate any business, products, technologies or personnel that we might acquire in the future,
and our failure to do so could have a material adverse effect on our business, financial condition and operational results.
We may be subject
to liability claims for damages and other expenses not covered by insurance that could reduce our earnings and cash flows.
Our business, profitability
and growth prospects could suffer if we pay damages or defense costs in connection with a liability claim that is outside the
scope of any applicable insurance coverage. We intend to maintain, but do not yet have, general and product liability insurance.
There is no assurance that we will be able to obtain insurance in amounts, or for a price, that will permit us to purchase desired
amounts of insurance. Additionally, if our costs of insurance and claims increase, then our earnings could decline. Further, market
rates for insurance premiums and deductibles have been steadily increasing, which may prevent us from being adequately insured.
A product liability or negligence action in excess of insurance coverage could harm our profitability and liquidity.
Insurance and contractual
protections may not always cover lost revenue.
We possess insurance,
warranties from suppliers, and our subcontractors make contractual obligations to meet certain performance levels, and we also
attempt, where feasible, to pass risks we cannot control to our customers, the proceeds of such insurance, warranties, performance
guarantees or risk sharing arrangements may not be adequate to cover lost revenue, increased expenses or liquidated damages payments
that may be required in the future.
We currently carry
customary insurance for business liability. For our work as a general contractor, we carry workers comp insurance for our employees
and we have performance bonding insurance. Certain losses of a catastrophic nature such as from floods, tornadoes, thunderstorms
and earthquakes are uninsurable or not economically insurable. Such “Acts of God,” work stoppages, regulatory actions
or other causes, could interrupt operations and adversely affect our business.
We rely on outside
consultants, employees, manufacturers and suppliers.
We will rely on the
experience of outside consultants, employees, manufacturers and suppliers. In the event that one or more of these consultants or
employees terminates employment with the Company, or becomes unavailable, suitable replacements will need to be retained and there
is no assurance that such employees or consultants could be identified under conditions favorable to us.
We rely on strategic
relationships to promote our products.
We rely on strategic
partnerships with outside companies and individuals to promote and supply certain of our products and services, thus making the
future success of our business particularly contingent on the efforts of other parties. An important part of our strategy is to
promote acceptance of our products through technology and product alliances with certain distributors who we feel could assist
us with our promotion strategies. Our dependence on outside distributors, however, raises potential risks with respect to the future
success of our business. Our success is dependent on the successful completion and commercial deployment of our products and services
and on the future commitment of our distributors to our products and technology.
We rely on our suppliers.
We will rely on key
vendors and suppliers to provide high quality products and services on a consistent basis. Our future success is contingent on
the efforts and performance of these suppliers. Although in the past we have obtained adequate quantities of raw materials and
finished product on acceptable terms to meet our requirements, we may have difficulty in locating or using alternative resources
should supply problems arise with the current suppliers. An interruption or reduction in the source of supply of any of the component
materials, or an unanticipated increase in vendor prices, could materially affect our operating results and damage customer relationships
as well as our business.
If we fail to protect
our intellectual property, our planned business could be adversely affected.
Despite our efforts
to protect our proprietary rights, unauthorized parties may attempt to copy aspects of our products or obtain and use information
that we regard as proprietary. Unauthorized use of our proprietary technology could harm our business. Litigation to protect our
intellectual property rights can be costly and time-consuming to prosecute, and there can be no assurance that we will have the
financial or other resources necessary to enforce or defend a patent infringement or proprietary rights violation action.
There has been substantial
litigation regarding patent and other intellectual property rights in the fields in which we operate. From time to time, we may
be forced to defend ourselves against other claims and legal actions alleging infringement of the intellectual property rights
of others. Adverse determinations in any such litigation could subject us to significant liabilities, which could have a material
adverse effect on us. Third parties could also obtain patents that may require us to obtain certain licenses. If we are unable
to redesign products or are unable to obtain a license, our business and financial condition would be adversely affected.
Although we perform
investigations of the intellectual property of third parties, we cannot be certain that we have not infringed the intellectual
property rights of such third parties. Any such infringement or misappropriation claim could result in significant costs, substantial
damages, and our inability to operate our business. We also could be forced to obtain licenses from third parties or to develop
a non-infringing alternative, which could be costly and time-consuming. A court could also order us to pay compensatory damages
for such infringement, plus prejudgment interest, and could, in addition, treble the compensatory damages and award attorney fees.
These damages could be substantial and could harm our reputation, business, financial condition, and operating results.
Because intellectual
property litigation can be costly and time consuming, our intellectual property litigation expenses could be significant, even
if we are successful in defending our intellectual property rights. Even invalid claims alone could materially adversely affect
our financial condition.
We may be subject
to lawsuits related to products we purchase from our suppliers or the services performed by our providers.
In the future, we may
be a party to, or may be otherwise responsible for, pending or threatened lawsuits or other claims related to products we purchase
from our approved manufacturers and suppliers. We intend to require our approved providers to have product liability insurance,
but there can be no assurance that such product liability insurance will be sufficient to protect us against potential liability.
Additionally, there is no certainty that we will not be named in an action for product liability. Such cases and claims may raise
difficult and complex factual and legal issues and may be subject to many uncertainties and complexities, including, but not limited
to, the facts and circumstances of each particular case or claim, the jurisdiction in which each suit is brought, and differences
in applicable law. Upon resolution of any pending legal matters or other claims, we may incur charges in excess of established
reserves. Product liability lawsuits and claims, safety alerts or product recalls in the future, regardless of their ultimate outcome,
could have a material adverse effect on our business and reputation and on our ability to attract and retain customers and joint
venture partners. Our business, profitability and growth prospects could suffer if we face such negative publicity.
Risks Related to Arkados’ Business
The market for our
products and Arktic
TM
software platform is new and unproven, may decline or may experience limited growth and is dependent
in part on companies continuing to adopt our platform and use our products.
We have been developing
and providing a software platform that enables organizations to integrate measurement and verification of data usage as well as
predictive analytics for baseline machine performance in their hardware products and systems. This market is relatively new and
unproven and is subject to a number of risks and uncertainties. The utilization of software platforms by organizations to build
measurement, verification, reporting and predictive analytics functionality into their industrial applications is still relatively
new, and organizations may not recognize the need for, or benefits of, our products and platform. Moreover, if they do not recognize
the need for and benefits of our products and platform, they may decide to adopt alternative products and services to satisfy some
portion of their business needs. In order to grow our business and extend our market position, we intend to focus on educating
potential customers about the benefits of our products and platform, expanding the functionality of our products and bringing new
technologies to market to increase acceptance and use of our platform. The market for our products and platform could fail to grow
significantly or there could be a reduction in demand for our products as a result of lack of customer acceptance, technological
challenges, competing products and services, decreases in spending by current and prospective customers, weakening economic conditions
and other causes. If our market does not experience significant growth or demand for our products decreases, then our business,
results of operations and financial condition could be adversely affected.
We may be found
to infringe on the intellectual property rights of others.
The industry has many
participants that own, or claim to own, proprietary intellectual property. We license technology, intellectual property and software
from third parties for use in our products and may be required to license additional technology, intellectual property and software
in the future. In some cases, these licenses provide us with certain pass-through rights for the use of other third party intellectual
property. There is no assurance that we will be able to maintain our third-party licenses or obtain new licenses when required
and this inability could materially adversely affect our business and operating results and the quality and functionality of our
products.
Misappropriation
of our intellectual property could place us at a competitive disadvantage.
Our intellectual property
is important to our success. We rely or plan to relay on a combination of patent protection, copyrights, trademarks, trade secrets,
licenses, non-disclosure agreements and other contractual agreements to protect our intellectual property. Third parties may attempt
to copy aspects of our products and technology or obtain information we regard as proprietary without our authorization. If we
are unable to protect our intellectual property against unauthorized use by others it could have an adverse effect on our competitive
position. Our strategies to deter misappropriation could be inadequate due to the following risks:
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non-recognition of the proprietary nature
or inadequate protection of our methodologies in the foreign countries;
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undetected misappropriation of our intellectual
property;
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the substantial legal and other costs
of protecting and enforcing our rights in our intellectual property; and
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development of similar technologies by
our competitors.
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In addition, we could
be required to spend significant funds and management resources could be diverted in order to defend our rights, which could disrupt
our operations.
Failures or interruption
of our products or services due to design flaws and errors, component quality issues, manufacturing defects, technological malfunctions
or deficiencies, cyber-attack or other quality issues may result in unanticipated costs or otherwise harm our business.
Our products are comprised
of hardware and software that is technologically complex and we are reliant on third parties to provide important components for
our products and support for our cloud and connectivity services. It is possible that our products may contain undetected errors,
defects or vulnerabilities to hacking attempts, especially when introduced or when new versions are released. As a result, our
products may be rejected by our customers leading to loss of business, loss of revenue, additional development and customer service
costs, unanticipated warranty claims, payment of monetary damages under contractual provisions and damage to our reputation.
In addition, our cloud
and connectivity services, including information systems and telecommunications infrastructure, could be disrupted by technological
failures or cyber-attacks which could result in the inability of our customers to receive our services for an indeterminate period
of time. Any disruption to our services, such as failure of our network operations centers to function as required, or extended
periods of reduced levels of service could cause us to lose customers or revenue, result in delays or cancellations of future implementations
of our products and services, result in failure to attract customers, require customer service or repair work that would involve
substantial costs, result in loss of customer data, result in litigation, payment of monetary damages under contractual provisions
and distract management from operating our business.
We may have difficulty
responding to changing technology, industry standards and customer requirements, and therefore be unable to develop new products
or services in a timely manner which meet the needs of our customers.
The wireless communications
industry is subject to rapid technological change, including evolving industry standards, frequent new product inventions, constant
improvements in performance characteristics and short product life cycles. Our business and future success will depend, in part,
on our ability to accurately predict and anticipate evolving wireless technology standards and develop products that keep pace
with the continuing changes in technology, evolving industry standards and changing customer and end-user preferences and requirements.
Our products embody complex technology that may not meet those standards, preferences and requirements. Our ability to design,
develop and commercially launch new products depends on a number of factors including, but not limited to, the following:
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our ability to design and manufacture
products or implement solutions and services at an acceptable cost and quality;
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our ability to attract and retain skilled
technical employees;
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the availability of critical components
from third parties;
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our ability to successfully complete the
development of products in a timely manner; and
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the ability of third parties to complete
and deliver on outsourced product development engagements.
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A failure by us, or
our suppliers, in any of these areas or a failure of new products or services to obtain commercial acceptance, could mean we receive
less revenue than we anticipate and we may be unable to recover our research and development expenses.
In addition, wireless
communications service providers require that wireless data systems deployed on their networks comply with their own standards,
which may differ from the standards of other providers. We may be unable to successfully address these developments on a timely
basis or at all. Our failure to respond quickly and cost-effectively to new developments through the development of new products
or enhancements to existing products could cause us to be unable to recover significant research and development expenses and reduce
our revenues.
We depend on single
source suppliers for some components used in our products and if these suppliers are unable to meet our demand, the delivery of
our products to our customers may be interrupted.
From time to time,
certain components used in our products have been, and may continue to be, in short supply. Such shortages in allocation of components
may result in a delay in filling orders from our customers, which may adversely affect our business. In addition, our products
are comprised of components some of which are procured from single source suppliers, including where we have licensed certain software
embedded in a component. Our single source suppliers may experience damage or interruption in their operations due to unforeseen
events, become insolvent or bankrupt, or experience claims of infringement, all of which could delay or stop their shipment of
components to us, which may adversely affect our business, operating results and financial condition. If there is a shortage of
any such components and we cannot obtain an appropriate substitute from an alternate supplier of components, we may not be able
to deliver sufficient quantities of our products to our customers. If such shortages occur, we may lose business or customers and
our operating results and financial condition may be materially adversely affected.
We depend on a limited
number of third parties to manufacture our products. If they do not manufacture our products properly or cannot meet our needs
in a timely manner, we may be unable to fulfill our product delivery obligations and our costs may increase, and our revenue and
margins could decrease.
We outsource the manufacturing
of our products to contract manufacturers and depend on these manufacturers to meet our needs in a timely and satisfactory manner
at a reasonable cost. Third party manufacturers, or other third parties to which such third-party manufacturers in turn outsource
our manufacturing requirements, may not be able to satisfy our manufacturing requirements on a timely basis, including by failing
to meet scheduled production and delivery deadlines or to meet our product quality requirements or the product quality requirements
of our customers. Insufficient supply or an interruption or stoppage of supply from such third-party manufacturers or our inability
to obtain additional or substitute manufacturers when and if needed, and on a cost-effective basis, could have a material adverse
effect on our business, results of operations and financial condition. Our reliance on third party manufacturers subjects us to
a number of risks, including but not limited to the following:
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potential business interruption due to
unexpected events such as natural disasters, labor unrest or geopolitical events;
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the absence of guaranteed or adequate
manufacturing capacity;
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potential violations of laws and regulations
by our manufacturers that may subject us to additional costs for duties, monetary penalties, seizure and loss of our products or
loss of our import privileges, and damage to our reputation;
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reduced control over delivery schedules,
production levels, manufacturing yields, costs and product quality;
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the inability of our contract manufacturers
to secure adequate volumes of components in a timely manner at a reasonable cost; and
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unexpected increases in manufacturing
costs.
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If we are unable to
successfully manage any of these risks or to locate alternative or additional manufacturers or suppliers in a timely and cost-effective
manner, we may not be able to deliver products in a timely manner. In addition, our results of operations could be harmed by increased
costs, reduced revenues and reduced margins.
Under our manufacturing
agreements, in many cases we may be required to place binding purchase orders with our manufacturers well in advance of our receipt
of binding purchase orders from our customers. In this situation, we consider our customers’ good faith, non-binding forecasts
of demand for our products. As a result, if the number of actual products ordered by our customers is materially different from
the number of products we have instructed our manufacturer to build (and to purchase components in respect of), then, if too many
components have been purchased by our manufacturer, we may be required to purchase such excess component inventory, or, if an insufficient
number of components have been purchased by our manufacturer, we may not be in a position to meet all of our customers’ requirements.
If we are unable to successfully manage our inventory levels and respond to our customers’ purchase orders based on their forecasted
quantities, our business, operating results and financial condition could be adversely affected.
We depend on wireless
network carriers to promote and offer acceptable wireless data services.
Some of our products
and our wireless connectivity services can only be used over wireless data networks operated by third parties. Our business and
future growth depends, in part, on the successful deployment by network carriers of next generation wireless data and networks
and appropriate pricing of wireless data services. We also depend on successful strategic relationships with our network carrier
partners and our operating results and financial condition could be harmed if they increase the price of their services or experience
operational issues with their networks.
The transmission,
use and disclosure of user data and personal information could give rise to liabilities or additional costs as a result of laws,
governmental regulations and carrier and other customer requirements or differing views of personal privacy rights.
Our products are used
to transmit a large volume of data, including personal information. This information is increasingly subject to legislation and
regulations in numerous jurisdictions around the world that is intended to protect the privacy and security of personal information
as well as the collection, storage, transmission, use and disclosure of such information.
The interpretation
of privacy and data protection laws in a number of jurisdictions is unclear and in a state of flux. There is a risk that these
laws may be interpreted and applied in conflicting ways from country to country. Complying with these varying international requirements
could cause us to incur additional costs and change our business practices. In addition, because our products can be sold and used
worldwide, certain foreign jurisdictions may claim that we will be required to comply with their laws, even where we have no local
entity, employees, or infrastructure.
We could be adversely
affected if legislation or regulations are expanded to require changes in our products or business practices, if governmental authorities
in the jurisdictions in which we do business interpret or implement their legislation or regulations in ways that negatively affect
our business or if end users allege that their personal information was misappropriated as a result of a defect or vulnerability
in our products. If we are required to allocate significant resources to modify our products or our existing security procedures
for the personal information that our products transmit, our business, results of operations and financial condition may be adversely
affected.
Risks Related to SES’s Existing
Business and our Acquisition of the SolBright Assets and the Solar Engineering and Installation Sector
Our SES subsidiary
engages in Oil to Natural Gas boiler conversion services which are susceptible to fluctuations in energy costs.
The price of natural
gas versus oil are commodities and each varies a great deal based on supply and demand, economic conditions, political conditions,
regulation and other supply-related factors (i.e. new discoveries or technologies for extraction). As a result of these factors,
the comparative rates may become disadvantageous to a conversion to natural gas at any time, causing demand for conversion services
to drop dramatically for indeterminate periods of time.
The services of
SES require general contractor services and other supervision which may increase our liability exposure.
Natural gas installation
includes the attendant risks of carbon monoxide poisoning, combustibility, and other hazards, particularly those that may arise
as a result of improper installation. Our services require that we evaluate and recommend subcontractors, unrelated to us, and
outside of our control and to further act in a supervisory capacity on conversion projects. This involves potential additional
liability to us that may be mitigated by insurance and additional stringent controls. There is no guarantee however, that we will
be able to fully mitigate such liability.
At present, our
sales are concentrated in a few customers.
Both of our operating
subsidiaries, SES and Arkados Inc. have sales that are presently concentrated within a few customers. If any of these customers,
in particular, the customers that provide the most significant percentage of revenue no longer are customers, for any reason, and
these customers are not replaced, we will sustain additional losses as our fixed cost base will be left uncovered and consume working
capital leading to a significant cash flow problems. See also the risk described as “Dependence on Financing” below.
Existing electric
utility industry regulations, and changes to regulations, may present technical, regulatory and economic barriers to the purchase
and use of solar energy systems that may significantly reduce demand for our solar energy systems or adversely impact the economics
of existing energy contracts.
Federal, state and
local government regulations and policies concerning the electric utility industry, utility rate structures, interconnection procedures,
internal policies and regulations promulgated by electric utilities, heavily influence the market for electricity generation products
and services. These regulations and policies often relate to electricity pricing and the interconnection of customer-owned electricity
generation. In the United States, governments and utilities continuously modify these regulations and policies. These regulations
and policies could deter potential customers from purchasing renewable energy, including solar energy systems. This could result
in a significant reduction in demand for our solar energy systems. For example, utilities commonly charge fees to large, industrial
customers for disconnecting from the electric grid or for having the capacity to use power from the electric grid for back-up purposes.
These fees could increase our customers’ cost to use our systems and make our product offerings less desirable, thereby harming
our business, prospects, financial condition and results of operations. In addition, depending on the region, electricity generated
by solar energy systems competes most effectively with higher priced peak-hour electricity from the electric grid, rather than
the lower average price of electricity. Modifications to the utilities’ peak-hour pricing policies or other electricity rate
designs, such as a lower volumetric rate, would require us to lower the price of our solar energy systems to compete with the price
of electricity from the electric grid.
Future changes to government
or internal utility regulations and policies could also reduce our competitiveness, cause a significant reduction in demand for
our products and services, and threaten the economics of our existing energy contracts. For example, in October 2015, the Hawaii
Public Utilities Commission capped the state’s net metering program at existing levels and net energy metering no longer
is available to new customers.
We rely on net metering
and related policies to offer competitive pricing to our customers in our key states.
Forty-one states, Washington,
D.C. and Puerto Rico have a regulatory policy known as net energy metering, or net metering, available to new customers. Each of
the states where we currently serve customers has adopted a net metering policy except for Texas, where certain individual utilities
have adopted net metering or a policy similar to net metering. Net metering typically allows our customers to interconnect their
on-site solar energy systems to the utility grid and offset their utility electricity purchases by receiving a bill credit at the
utility’s retail rate for energy generated by their solar energy system that is exported to the grid in excess of the electric
load used by the customers. At the end of the billing period, the customer simply pays for the net energy used or receives a credit
at the retail rate if more energy is produced than consumed. Utilities operating in states without a net metering policy may receive
solar electricity that is exported to the grid when there is no simultaneous energy demand by the customer without providing retail
compensation to the customer for this generation.
Our ability to sell
solar energy systems and the electricity they generate may be adversely impacted by the failure to expand existing limits on the
amount of net metering in states that have implemented it, the failure to adopt a net metering policy where it currently is not
in place, the imposition of new charges that only or disproportionately impact customers that utilize net metering or reductions
in the amount or value of credit that customers receive through net metering. Our ability to sell solar energy systems and the
electricity they generate may also be adversely impacted by the unavailability of expedited or simplified interconnection for grid-tied
solar energy systems or any limitation on the number of customer interconnections or amount of solar energy that utilities are
required to allow in their service territory or some part of the grid. In addition, utilities in some states, such as SRP in Arizona,
imposed additional monthly charges on customers who interconnect solar energy systems installed on their homes. If such charges
are imposed, the cost savings associated with switching to solar energy may be significantly reduced and our ability to attract
future customers and compete with traditional utility providers could be impacted. If such charges are imposed on existing customers
in a way that adversely impacts the economics of existing energy contracts, we could further see an increase in the default rate
of existing energy contracts or we may find it necessary to renegotiate our pricing of affected customers.
Limits on net metering,
interconnection of solar energy systems and other operational policies in key markets could limit the number of solar energy systems
installed in those markets. For example, in late December 2015, the Nevada Public Utilities Commission (PUCN) effectively capped
the state’s net metering program at existing levels and net metering no longer was available to new customers. Subsequently,
the PUCN modified portions of the new rules to be more favorable for solar customers, including providing grandfathering treatment
for existing net metering customers and reopening a specified capacity of net metering for new customers in northern Nevada. However,
at this time net metering still is not available to new customers in southern Nevada. If the caps on net metering in key markets
are reached and not extended or if the amount or value of credit that customers receive for net metering is significantly reduced
or eliminated, future customers will be unable to recognize the current cost savings associated with net metering and existing
customers may not recognize the economic benefits that were available at the time their energy contracts were entered into. We
rely substantially on net metering when we establish competitive pricing for our prospective customers and the absence of net metering
for new customers could greatly limit demand for our solar energy systems.
Our business currently
depends on the availability of rebates, tax credits and other financial incentives. The expiration, elimination or reduction of
these rebates, credits and incentives may adversely impact our business.
U.S. federal, state
and local government bodies provide incentives to end users, distributors, system integrators and manufacturers of solar energy
systems to promote solar electricity in the form of rebates, tax credits and other financial incentives such as system performance
payments, payments for renewable energy credits associated with renewable energy generation and the exclusion of solar energy systems
from property tax assessments. We rely on these governmental rebates, tax credits and other financial incentives to lower our cost
of capital and to encourage fund investors to invest in our funds. These incentives enable us to lower the price we charge customers
for energy and for our solar energy systems. However, these incentives may expire on a particular date, end when the allocated
funding is exhausted or be reduced or terminated as solar energy adoption rates increase. These reductions or terminations often
occur without warning.
The federal government
currently offers a 30% investment tax credit under Section 48(a)(3) and Section 25D of the IRC, or the Federal ITC, for the installation
of certain solar power facilities. Additionally, under Section 48, energy storage systems that are installed at the time of the
solar power facility and, as required by IRS guidelines, store the energy of the solar power facility, are also eligible for the
Federal ITC. The credit under Section 48(a)(3) has been modified to remain at 30% of qualified expenditures for a commercial solar
energy system that commences construction by December 31, 2019, then decline to 26% for systems that commence construction by December
31, 2020 and to 22% for systems that commence construction by December 31, 2021. The credit is scheduled to decline to a permanent
10% effective January 1, 2022. Historically, we have utilized the Section 48 commercial credit when available for both our residential
and commercial leases and power purchase agreements, based on ownership of the solar energy system. The credit under Section 25D
has been modified to remain 30% of qualified expenditures for a residential solar energy system owned by the homeowner that is
placed in service by December 31, 2019, then decline to 26% for systems placed in service by December 21, 2020, and to 22% for
systems placed in service by December 31, 2021. The credit is scheduled to expire effective January 1, 2022. Loan product customers
can currently claim the Section 25D investment tax credit. Customers who purchase their solar energy systems for cash are also
eligible to claim the Section 25D investment tax credit.
Reductions in, eliminations
of, or expirations of, governmental incentives could adversely impact our results of operations and ability to compete in our industry
by increasing our cost of capital, causing us to increase the prices of our energy and solar energy systems and reducing the size
of our addressable market. In addition, this would adversely impact our ability to attract investment partners and to form new
financing funds and our ability to offer attractive financing to prospective customers.
Our business depends
in part on the regulatory treatment of third-party owned solar energy systems.
Our leases and power
purchase agreements are third-party ownership arrangements. Sales of electricity by third-parties face regulatory challenges in
some states and jurisdictions. Other challenges pertain to whether third-party owned systems qualify for the same levels of rebates
or other non-tax incentives available for customer-owned solar energy systems, whether third-party owned systems are eligible at
all for these incentives and whether third-party owned systems are eligible for net metering and the associated significant cost
savings. In some states and utility territories, third-parties that own solar energy systems are limited in the way that they may
deliver solar energy to their customers. In jurisdictions such as Arizona, Florida, Kentucky, North Carolina, Oklahoma and the
Los Angeles Department of Water and Power service territory, laws have been interpreted to prohibit the sale of electricity pursuant
to our standard power purchase agreement. This has led us and other solar energy system providers that utilize third-party ownership
arrangements to offer leases rather than power purchase agreements in such jurisdictions. Imposition of such limitations in additional
jurisdictions or reductions in, or eliminations of, incentives for third-party owned systems could reduce demand for our systems,
adversely impact our access to capital and cause us to increase the price we charge our customers for energy.
We need to enter
into additional and substantial financing arrangements to facilitate our customers’ access to our solar energy systems, and
if this financing is not available to us on acceptable terms, if and when needed, our ability to grow our business would be materially
adversely impacted.
Our future success
depends on our ability to raise capital from third-party fund investors to help finance the deployment of our residential and commercial
solar energy systems. In particular, our strategy is to reduce the cost of capital through these arrangements to improve our margins,
offset future reductions in government incentives and maintain the price competitiveness of our solar energy systems. If we are
unable to establish new financing funds for third-party ownership arrangements when needed, or on desirable terms, to enable our
customers’ access to our solar energy systems with little or no upfront cost, we may be unable to finance installation of
our customers’ systems, or our cost of capital could increase and our liquidity may be significantly constrained, any of
which would have a material adverse effect on our business, financial condition and results of operations. To date, we have raised
capital sufficient to finance installation of our customers’ solar energy systems from a number of financial institutions
and other large companies (including some that may be considered competitors to Tesla). In the past, challenges raising new funds
have caused us to delay customer installations for brief periods of time.
The availability of
this tax-advantaged financing depends upon many factors, including:
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the continued confidence of banks and other financing sources in the solar energy industry and
the quality of our customer contracts;
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the state of financial and credit markets, and the liquidity needs of banks and other financing
sources;
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our ability to compete with other renewable energy companies for the limited number of potential
fund investors, each of which has limited funds and limited appetite for the tax benefits associated with these financings;
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changes in the legal or tax risks associated with these financings;
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non-renewal of government incentives or decreases in the associated benefits; and
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no adverse changes in the regulatory environment affecting the economics of our existing energy
contracts.
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Under current law,
the Federal ITC will be reduced from 30% of the cost of solar energy systems to 26% of the cost of solar energy systems for systems
that commence construction by December 31, 2020, and then reduced again to 22% of the cost of solar energy systems for systems
that commence construction by December 31, 2021, until the Section 25D investment tax credit expires and the Section 48(a)(3) investment
tax credit declines to a permanent 10% effective January 1, 2022.
In addition, U.S. Treasury
grants are no longer available for new solar energy systems. Moreover, potential fund investors must remain satisfied that the
structures we offer make the tax benefits associated with solar energy systems available to these investors, which depends both
on the investors’ assessment of the tax law and the absence of any unfavorable interpretations of that law. Changes in existing
law and interpretations by the Internal Revenue Service and the courts could reduce the willingness of fund investors to invest
in funds associated with these solar energy system investments. In addition, changes by state energy regulators impairing the economics
of existing energy contracts causing an increased risk of default may also reduce the willingness of fund investors to invest.
We cannot assure you that this type of financing will be available to us. If, for any reason, we are unable to finance solar energy
systems through tax-advantaged structures or if we are unable to realize or monetize depreciation benefits, we may no longer be
able to provide solar energy systems to new customers on an economically viable basis. This would have a material adverse effect
on our business, financial condition and results of operations.
Solar energy has yet
to achieve broad market acceptance and depends on continued support in the form of performance-based incentives, rebates, tax credits
and other incentives from federal, state, local and foreign governments. If this support diminishes, our ability to obtain external
financing, on acceptable terms or otherwise, could be materially adversely affected.
Our ability to draw
on financing commitments is subject to the conditions of the agreements underlying our financing funds, including the mix of types
of energy contracts that we contribute and measures of customer credit. If we do not satisfy such conditions due to events related
to our business or a specific financing fund, developments in our industry (including related to the Department of Treasury Inspector
General investigation) or otherwise, and as a result we are unable to draw on existing commitments, it could have a material adverse
effect on our business, liquidity, financial condition and prospects. If any of the financial institutions or large companies that
currently invest in our financing funds decide not to invest in future financing funds due to general market conditions, concerns
about our business or prospects, the pendency of the Department of Treasury Inspector General investigation or any other reason,
or materially change the terms under which they are willing to provide future financing, we may be unable to raise sufficient financing
to engage in the third-party ownership arrangements that have fueled our growth to date.
We may be unable
to successfully integrate the SolBright Assets or the SolBright business that we have acquired.
Our failure to successfully
complete the integration of the SolBright Assets and the related SolBright business projects that we acquired on May 1, 2017 could
have an adverse effect on our prospects, business activities, cash flow, financial condition, results of operations and stock price.
Integration challenges may include the following:
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assimilating the acquired business’ operations products and personnel with existing operations,
products and personnel;
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estimating the capital, personnel and equipment required for the acquired business based on the
historical experience of our management and SolBright’s former management team that now works for us with the business they
are familiar with;
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minimizing potential adverse effects on existing business relationships with other suppliers and
customers;
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successfully developing and marketing the SolBright-branded products and services;
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entering markets in which we have limited or no prior experience; and
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coordinating our efforts throughout various distant localities and time zones.
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Our acquisition
of the SolBright Assets may subject us to additional unknown risks which may affect our future business and cause a reduction in
our revenues.
In completing the SolBright
Assets acquisition, we relied on the representations and warranties and indemnities made by the sellers with respect to the acquisition
as well as our own due diligence investigation. We cannot assure you that such representations and warranties were true and correct
in all material respects or that our due diligence did not fail to uncover all materially adverse facts relating to the operations
and financial condition of the acquired SolBright Assets or the related ongoing SolBright projects.
A material drop
in the retail price of utility-generated electricity would particularly adversely impact our ability to attract commercial customers.
We expect that commercial
customers will comprise a significant component of the new business we expect to develop through SES as a result of our acquisition
of the SolBright Assets. The commercial market for energy is particularly sensitive to price changes, and if we are unable to offer
solar energy systems in commercial markets that are competitive with retail electricity available through local sources, our new
SES business would be harmed because we would be at a competitive disadvantage compared to other energy providers and may be unable
to attract new commercial customers.
A material drop
in the retail price of utility-generated electricity or electricity from other sources would harm the business we expect to develop
with the acquisition of the SolBright Assets and as a result, our financial condition and results of operations could suffer.
We believe that a customer’s
decision to buy a renewable energy system from SES will primarily be driven in part by their desire to pay less for electricity.
The customer’s decision may also be affected by the cost of other renewable energy sources. Decreases in the retail prices
of electricity from the utilities or other renewable energy sources would harm SES’s ability to offer competitive systems’
pricing and could harm our business. The price of electricity from utilities could decrease as a result of:
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the construction of a significant number of new power generation plants, including nuclear, coal,
natural gas or renewable energy technologies;
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the construction of additional electric transmission and distribution lines;
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a reduction in the price of natural gas, including as a result of new drilling techniques or a
relaxation of associated regulatory standards;
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the development of energy conservation technologies and public initiatives to reduce electricity
consumption; and
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the development of new renewable energy technologies that provide less expensive energy.
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A reduction in utility
electricity prices would make the purchase of our solar energy systems less economically attractive. In addition, a shift in the
timing of peak rates for utility-generated electricity to a time of day when solar energy generation is less efficient could make
our solar energy system offerings less competitive and reduce demand for our products and services. If the retail price of energy
available from utilities were to decrease for any reason, we would be at a competitive disadvantage. As a result of these or similar
events impacting the economics of our newly acquired business, we may be unable to attract customers.
Existing electric
utility industry regulations, and changes to regulations, may present technical, regulatory and economic barriers to the purchase
and use of solar energy systems that may significantly reduce demand for solar energy systems such as those we expect to sell through
SES as a result of the acquisition of the SolBright Assets.
Federal, state and
local government regulations and policies concerning the electric utility industry, utility rate structures, interconnection procedures,
internal policies and regulations promulgated by electric utilities, heavily influence the market for electricity generation products
and services. These regulations and policies often relate to electricity pricing and the interconnection of customer-owned electricity
generation. In the United States, governments and utilities continuously modify these regulations and policies. These regulations
and policies could deter potential customers from purchasing renewable energy, including solar energy systems. This could result
in a significant difficulty in our ability to sell our new solar energy systems. For example, utilities commonly charge fees to
large, industrial customers for disconnecting from the electric grid or for having the capacity to use power from the electric
grid for back-up purposes. These fees could increase our customers’ cost to use our systems and make our product offerings
less desirable, thereby harming our business, prospects, financial condition and results of operations. In addition, depending
on the region, electricity generated by solar energy systems competes most effectively with higher priced peak-hour electricity
from the electric grid, rather than the lower average price of electricity. Modifications to the utilities’ peak-hour pricing
policies or other electricity rate designs, such as a lower volumetric rate, could require us to lower the prices of our solar
energy systems to compete with the price of electricity from the electric grid.
Future changes to government
or internal utility regulations and policies could also reduce our competitiveness, cause a significant reduction in demand for
products and services such as those we expect to offer through SES.
We depend on a limited
number of suppliers of solar energy system components and technologies to adequately meet anticipated demand for our solar energy
systems. Due to the limited number of suppliers in our industry, the acquisition of any of these suppliers by a competitor or any
shortage, delay, price change, imposition of tariffs or duties or other limitation in our ability to obtain components or technologies
we use could result in sales and installation delays, cancellations and damage to our reputation.
We purchase solar panels,
inverters and other system components from a limited number of suppliers, making us susceptible to quality issues, shortages and
price changes. If we fail to develop, maintain and expand our relationships with our suppliers, our ability to adequately meet
anticipated demand for our solar energy systems may be adversely affected, or we may only be able to offer our systems at higher
costs or after delays. If one or more of the suppliers that we rely upon to meet anticipated demand ceases or reduces production
due to its financial condition, acquisition by a competitor or otherwise, is unable to increase production as industry demand increases
or is otherwise unable to allocate sufficient production to us, it may be difficult to quickly identify alternative suppliers or
to qualify alternative products on commercially reasonable terms, and our ability to satisfy this demand may be adversely affected.
There are a limited number of suppliers of solar energy system components and technologies. While we believe there are other sources
of supply for these products available, transitioning to a new supplier may result in additional costs and delays in acquiring
our solar products and deploying our systems, and may require us to obtain the approval of our financing partners in order to utilize
new products. These issues could harm our business or financial performance.
There have also been
periods of industry-wide shortages of key components, including solar panels, in times of rapid industry growth. The manufacturing
infrastructure for some of these components has a long lead-time, requires significant capital investment and relies on the continued
availability of key commodity materials, potentially resulting in an inability to meet demand for these components. The solar industry
is growing and, as a result, shortages of key components, including solar panels, may be more likely to occur, which in turn may
result in price increases for such components. Even if industry-wide shortages do not occur, suppliers may decide to allocate key
components with high demand or insufficient production capacity to more profitable customers, customers with long-term supply agreements
or customers other than us and our supply of such components may be reduced as a result.
Our suppliers often
incur a significant amount of their costs by purchasing raw materials and generating operating expenses in foreign currencies,
if the value of the U.S. dollar depreciates significantly or for a prolonged period of time against these other currencies this
may cause our suppliers to raise the prices they charge us, which could harm our financial results. In addition, the U.S. government
has imposed tariffs on solar cells produced and assembled in China and Taiwan, and it is unclear what actions the new U.S. presidential
administration may take with respect to existing and proposed trade agreements, or restrictions on trade generally. The existing
tariffs, and any new tariffs, duties or other restraints, or shortages, delays, price changes or other limitation in our ability
to obtain components or technologies we use could limit our growth, cause cancellations or adversely affect our profitability,
and result in loss of market share and damage to our brand.
If we cannot compete
successfully against other solar and energy companies, we may not be successful in maximizing our acquisition of the SolBright
Assets and our business will suffer.
The solar and energy
industries are characterized by intense competition and rapid technological advances, both in the United States and internationally.
We will compete with a number of existing and future technologies, product candidates developed, manufactured and marketed by others
and other renewable energy systems providers. Many of these competitors have validated technologies with products already in various
stages of development and large system installations in place. In addition, many of these competitors, either alone or together
with their collaborative partners, operate larger research and development programs and/or have substantially greater financial
resources than we do, as well as significantly greater experience.
We compete with solar
companies with business models that are similar to ours. In addition, we compete with solar companies in the downstream value chain
of solar energy. For example, we face competition from purely finance driven organizations that acquire customers and then subcontract
out the installation of solar energy systems, from installation businesses that seek financing from external parties, from large
construction companies and utilities, and increasingly from sophisticated electrical and roofing companies. Some of these competitors
specialize in the commercial, municipal and military solar energy markets, and some may provide energy solutions at lower costs
than we do. Further, some of our competitors are integrating vertically in order to ensure supply and to control costs. Many of
our competitors also have significant brand name recognition and have extensive knowledge of our target markets. For us to be competitive
in our new renewable energy sector pursuits, we must distinguish ourselves from our competitors through fully exploiting our competitive
advantages acquired with the SolBright Assets at various points in the value chain. If our competitors develop an integrated approach
similar to ours including sales, financing, engineering, manufacturing, installation, maintenance and monitoring services, this
could reduce our marketplace differentiation.
Because we will be
competing against significantly larger companies with established track records and much greater financial resources, we will have
to demonstrate that, based on experience, and other factors, our products, are competitive with other products or we may not be
able to reach or maintain profitable sales levels.
Risks Related to Our Financial Condition
Dependence on financing
and losses for the foreseeable future.
Our independent registered
public accounting firm has issued its audit opinion on our consolidated financial statements appearing in this Annual Report on
Form 10-K, including an explanatory paragraph as to substantial doubt with the respect to our ability to continue as a going concern.
The accompanying consolidated financial statements have been prepared in conformity with accounting principles generally accepted
in the United States of America, assuming we will continue as a going concern, which contemplates the realization of assets and
satisfaction of liabilities in the normal course of business. For the fiscal year ended May 31, 2017, our net loss was $3,347,606.
As of May 31, 2017, we had an accumulated deficit of $46,548,545 and a working capital deficit of $1,761,728. These factors raise
substantial doubt about our ability to continue as a going concern, within one year from the issuance date of this filing. Our
ability to continue as a going concern is dependent on our ability to raise the required additional capital or debt financing to
meet short and long-term operating requirements. We may also encounter business endeavors that require significant cash commitments
or unanticipated problems or expenses that could result in a requirement for additional cash. If we raise additional funds through
the issuance of equity or convertible debt securities, the percentage ownership of our current shareholders could be reduced, and
such securities might have rights, preferences or privileges senior to our common stock. Additional financing may not be available
upon acceptable terms, or at all. If adequate funds are not available or are not available on acceptable terms, we may not be able
to take advantage of prospective business endeavors or opportunities, which could significantly and materially restrict our operations.
If we are unable to obtain the necessary capital, we may have to cease operations. For additional information, see Item 7 –
Management’s Discussion and Analysis of Financial Condition and Results of Operations – “Going Concern.”
Dependence on financing
and losses for the foreseeable future.
Although we have started
to generate revenue, such revenue is not sufficient to cover our operating expenses, and we expect that operating losses will continue
into the near term. As of May 31, 2017, we had current liabilities of $4,962,424 and current assets of $3,200,696. We had a working
capital deficiency of $1,761,728. Our ability to continue as a going concern is dependent upon raising capital from financing transactions.
To stay in business, we will need to raise additional capital through public or private sales of our securities, debt financing
or short-term bank loans, or a combination of the foregoing. In the past, we have financed our operations by issuing secured and
unsecured convertible debt and equity securities in private placements, in some cases with equity incentives for the investor in
the form of warrants to purchase our common stock and have borrowed from related parties. We have sought, and will continue to
seek, various sources of financing, but there are no commitments from anyone to provide us with financing. We can provide no assurance
as to whether our capital raising efforts will be successful or as to when, or if, we will be profitable in the future. Even if
the Company achieves profitability, it may not be able to sustain such profitability. If we are unable to obtain financing or achieve
and sustain profitability, we may have to suspend operations, sell assets and will not be able to execute our business plan. Failure
to become and remain profitable may adversely affect the market price of our common stock and our ability to raise capital and
continue operations.
Our ability to generate
positive cash flows is uncertain.
To develop and expand
our business, we will need to make significant up-front investments in our manufacturing capacity and incur research and development,
sales and marketing and general and administrative expenses. In addition, our growth will require a significant investment in working
capital. Our business will require significant amounts of working capital to meet our project requirements and support our growth.
We cannot provide any
assurance that we will be able to raise the capital necessary to meet these requirements. If adequate funds are not available or
are not available on satisfactory terms, we may be required to significantly curtail our operations and may not be able to fund
our current production requirements - let alone fund expansion, take advantage of unanticipated acquisition opportunities, develop
or enhance our products, or respond to competitive pressures. Any failure to obtain such additional financing could have a material
adverse effect on our business, results of operations and financial condition.
Because we may never
have net income from our operations, our business may fail.
We have no history
of profitability from operations. There can be no assurance that we will ever operate profitably. Our success is significantly
dependent on uncertain events, including successful development of our technologies, establishing satisfactory manufacturing arrangements
and processes, and distributing and selling our products. If we are unable to generate significant revenues from sales of our products,
we will not be able to earn profits or continue operations. We can provide no assurance that we will generate any revenues or ever
achieve profitability. If we are unsuccessful in addressing these risks, our business will fail and investors may lose all of their
investment in our Company.
We need to raise
additional funds and such funds may not be available on acceptable terms or at all.
We may consider issuing
additional debt or equity securities in the future to fund our business plan, for potential acquisitions or investments, or for
general corporate purposes. If we issue equity or convertible debt securities to raise additional funds, our existing stockholders
may experience dilution, and the new equity or debt securities may have rights, preferences and privileges senior to those of our
existing stockholders. If we incur additional debt, it may increase our leverage relative to our earnings or to our equity capitalization,
requiring us to pay additional interest expenses. We may not be able to obtain financing on favorable terms, or at all, in which
case, we may not be able to develop or enhance our products, execute our business plan, take advantage of future opportunities
or respond to competitive pressures.
Our margins fluctuate
which leads to further uncertainty in our profitability model.
While we will have
the potential ability to negotiate prices that benefit our clients and affect our profitability as it garners market-share and
increases our book of business, margins in the software and solar businesses are fluid, and our margins vary based upon production
volume and the customer. This may lead to continued uncertainty in margins from quarter to quarter.
Risks Related to Our Common Stock and
Its Market Value
We have limited
capitalization and may require financing, which may not be available.
We have limited capitalization,
which increases our vulnerability to general adverse economic and industry conditions, limits our flexibility in planning for or
reacting to changes in our business and industry and may place us at a competitive disadvantage to competitors with sufficient
or excess capitalization. If we are unable to obtain sufficient financing on satisfactory terms and conditions, we will be forced
to curtail or abandon our plans or operations. Our ability to obtain financing will depend upon a number of factors, many of which
are beyond our control.
A limited public
trading market exists for our common stock, which makes it more difficult for our stockholders to sell their common stock in the
public markets. Any trading in our shares may have a significant effect on our stock prices.
Although our common
stock is listed for quotation on the OTC Marketplace, Pink Tier, under the symbol “AKDS”, the trading volume of our
stock is limited and a market may not develop or be sustained. As a result, any trading price of our common stock may not be an
accurate indicator of the valuation of our common stock. Any trading in our shares could have a significant effect on our stock
price. If a more liquid public market for our common stock does not develop, then investors may not be able to resell the shares
of our common stock that they have purchased and may lose all of their investment. No assurance can be given that an active market
will develop or that a stockholder will ever be able to liquidate its shares of common stock without considerable delay, if at
all. Many brokerage firms may not be willing to effect transactions in the securities. Even if an investor finds a broker willing
to effect a transaction in our securities, the combination of brokerage commissions, state transfer taxes, if any, and any other
selling costs may exceed the selling price. Furthermore, our stock price may be impacted by factors that are unrelated or disproportionate
to our operating performance. These market fluctuations, as well as general economic, political and market conditions, such as
recessions, interest rates or international currency fluctuations may adversely affect the market price and liquidity of our common
stock.
Our stock price
may be volatile.
The market price of
our common stock is likely to be highly volatile and could fluctuate widely in price in response to various factors, many of which
are beyond our control, including the following:
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our stock being held by a small number of persons whose sales (or lack of sales) could result in
positive or negative pricing pressure on the market price for our common stock;
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actual or anticipated variations in our quarterly operating results;
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changes in our earnings estimates;
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our ability to obtain adequate working capital financing;
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changes in market valuations of similar companies;
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publication (or lack of publication) of research reports about us;
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changes in applicable laws or regulations, court rulings, enforcement and legal actions;
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loss of any strategic relationships;
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additions or departures of key management personnel;
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actions by our stockholders (including transactions in our shares);
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speculation in the press or investment community;
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increases in market interest rates, which may increase our cost of capital;
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changes in our industry;
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competitive pricing pressures;
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our ability to execute our business plan; and
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economic and other external factors.
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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.
Our stock is categorized
as a penny stock. Trading of our stock may be restricted by the SEC’s penny stock regulations which may limit a stockholder’s
ability to buy and sell our stock.
Our stock is categorized
as a “penny stock”, as that term is defined in SEC Rule 3a51-1, which generally provides that “penny stock”,
is any equity security that has a market price (as defined) less than US$5.00 per share, subject to certain exceptions. Our securities
are covered by the penny stock rules, including Rule 15g-9, which impose additional sales practice requirements on broker-dealers
who sell to persons other than established customers and accredited investors. The penny stock rules require a broker-dealer, prior
to a transaction in a penny stock not otherwise exempt from the rules, to deliver a standardized risk disclosure document in a
form prepared by the SEC which provides information about penny stocks and the nature and level of risks in the penny stock market.
The broker-dealer also must provide the customer with current bid and offer quotations for the penny stock, the compensation of
the broker-dealer and its salesperson in the transaction and monthly account statements showing the market value of each penny
stock held in the customer’s account. The bid and offer quotations, and the broker-dealer and salesperson compensation information,
must be given to the customer orally or in writing prior to effecting the transaction and must be given to the customer in writing
before or with the customer’s confirmation. In addition, the penny stock rules require that prior to a transaction in a penny
stock not otherwise exempt from these rules, the broker-dealer must make a special written determination that the penny stock is
a suitable investment for the purchaser and receive the purchaser’s written agreement to the transaction. These disclosure
requirements may have the effect of reducing the level of trading activity in the secondary market for the stock that is subject
to these penny stock rules. Consequently, these penny stock rules may affect the ability of broker-dealers to trade our securities
and reduces the number of potential investors. We believe that the penny stock rules discourage investor interest in and limit
the marketability of our common stock.
According to SEC Release
No. 34-29093, the market for “penny stocks” has suffered in recent years from patterns of fraud and abuse. Such patterns
include: (1) control of the market for the security by one or a few broker-dealers that are often related to the promoter or issuer;
(2) manipulation of prices through prearranged matching of purchases and sales and false and misleading press releases; (3) boiler
room practices involving high-pressure sales tactics and unrealistic price projections by inexperienced sales persons; (4) excessive
and undisclosed bid-ask differential and markups by selling broker-dealers; and (5) the wholesale dumping of the same securities
by promoters and broker-dealers after prices have been manipulated to a desired level, along with the resulting inevitable collapse
of those prices and with consequent investor losses. The occurrence of these patterns or practices could increase the future volatility
of our share price.
FINRA sales practice
requirements may also limit a stockholder’s ability to buy and sell our stock.
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 customers. The FINRA requirements make it more difficult for broker-dealers to recommend that their customers buy our
common stock, which may limit your ability to buy and sell our stock and have an adverse effect on the market for our shares.
To date, we have
not paid any cash dividends and no cash dividends will be paid in the foreseeable future.
We do not anticipate
paying cash dividends on our common stock in the foreseeable future and we may not have sufficient funds legally available to pay
dividends. Even if the funds are legally available for distribution, we may nevertheless decide not to pay any dividends. We presently
intend to retain all earnings for our operations.
The existence of
indemnification rights to our directors, officers and employees may result in substantial expenditures by our Company and may discourage
lawsuits against our directors, officers and employees.
Our bylaws contain
indemnification provisions for our directors, officers and employees, although we have not entered into indemnification agreements
with our sole officer and director, Terrence DeFranco. The foregoing indemnification obligations could result in us incurring substantial
expenditures to cover the cost of settlement or damage awards against directors and officers, which we may be unable to recoup.
These provisions and resultant costs may also discourage us from bringing a lawsuit against directors and officers for breaches
of their fiduciary duties, and may similarly discourage the filing of derivative litigation by our stockholders against our directors
and officers even though such actions, if successful, might otherwise benefit us and our stockholders.
If we fail to develop
or maintain an effective system of internal controls, we may not be able to accurately report our financial results or prevent
financial fraud. As a result, current and potential stockholders could lose confidence in our financial reporting.
We are subject to the
risk that sometime in the future, our independent registered public accounting firm could communicate to the board of directors
that we have deficiencies in our internal control structure that they consider to be “significant deficiencies.” A
“significant deficiency” is defined as a deficiency, or a combination of deficiencies, in internal controls over financial
reporting such that there is more than a remote likelihood that a material misstatement of the entity’s financial statements
will not be prevented or detected by the entity’s internal controls.
Effective internal
controls are necessary for us to provide reliable financial reports and effectively prevent fraud. If we cannot provide reliable
financial reports or prevent fraud, we could be subject to regulatory action or other litigation and our operating results could
be harmed. We are required to document and test our internal control procedures to satisfy the requirements of Section 404 of the
Sarbanes-Oxley Act of 2002 (the “Sarbanes-Oxley Act” or “SOX”), which requires our management to annually
assess the effectiveness of our internal control over financial reporting.
We currently are not
an “accelerated filer” as defined in Rule 12b-2 under the Securities Exchange Act of 1934, as amended. Section 404
of the Sarbanes-Oxley Act of 2002 (“Section 404”) requires us to include an internal control report with our Annual
Report on Form 10-K. That report must include management’s assessment of the effectiveness of our internal control over financial
reporting as of the end of the fiscal year. This report must also include disclosure of any material weaknesses in internal control
over financial reporting that we have identified. As of March 31, 2017, the management of the Company assessed the effectiveness
of the Company’s internal control over financial reporting based on the criteria for effective internal control over financial
reporting established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway
Commission (“COSO”) and SEC guidance on conducting such assessments. Management concluded, during the fiscal year ended
March 31, 2017, that the Company’s internal controls and procedures were not effective to detect the inappropriate application
of U.S. GAAP rules. Management realized there were deficiencies in the design or operation of the Company’s internal control
that adversely affected the Company’s internal controls which management considers to be material weaknesses. A material
weakness in the effectiveness of our internal controls over financial reporting could result in an increased chance of fraud and
the loss of customers, reduce our ability to obtain financing and require additional expenditures to comply with these requirements,
each of which could have a material adverse effect on our business, results of operations and financial condition. For additional
information, see Item 9A – Controls and Procedures.
Our intended business,
operations and accounting are expected to be substantially more complex than they have been in the past. It may be time consuming,
difficult and costly for us to develop and implement the internal controls and reporting procedures required by the Sarbanes-Oxley
Act. We may need to hire additional financial reporting, internal controls and other finance personnel in order to develop and
implement appropriate internal controls and reporting procedures. If we are unable to comply with the internal controls requirements
of the Sarbanes-Oxley Act, then we may not be able to obtain the independent accountant certifications required by such act, which
may preclude us from keeping our filings with the SEC current.
If we are unable to
maintain the adequacy of our internal controls, as those standards are modified, supplemented, or amended from time to time, we
may not be able to ensure that we can conclude on an ongoing basis that we have effective internal control over financial reporting
in accordance with Section 404. Failure to achieve and maintain an effective internal control environment could cause us to face
regulatory action and cause investors to lose confidence in our reported financial information, either of which could adversely
affect the value of our common stock.
A sale of a substantial
number of shares of our common stock may cause the price of our common stock to decline.
If our stockholders
sell substantial amounts of our common stock in the public market, including shares issued upon the exercise of outstanding options
or warrants, the market price of our common stock could fall. These sales also may make it more difficult for us to sell equity
or equity-related securities in the future at a time and price that we deem reasonable or appropriate. Amendments to Rule 144,
effective in February 2008, also substantially reduce holding periods and eliminate burdens such as filing notices sale for non-affiliated
holders. The amendments to Rule 144 are applicable to the purchasers of securities prior to and following the effective date of
the amendments.
ITEM 1B. UNRESOLVED STAFF COMMENTS
Not Applicable.
ITEM 2. PROPERTIES
Our principal executive
offices are located at 211 warren Street, Suite 219, Newark, NJ 07103. Effective October 1, 2014, and as amended on January 15,
2015 and January 15, 2016, we entered into a lease agreement for 960 square feet office space located at such address for a total
monthly rental of $2,034. On January 15, 2017, we renewed the lease for 385 square feet for an additional one-year term for a total
monthly rental of $930.
Through our SES subsidiary,
we lease the following properties:
●
Office lease located at 500 North Broadway, Suites 155 Jericho, New York 11753. The facility is approximately 1,850 square feet,
occupied pursuant to a lease that commenced on August 1, 2015 and expires on September 30, 2018. The average annual rent over the
term of the lease is approximately $57,300. This amount does not include taxes and other occupancy costs for the premises.
●
Office lease located at 701 East Bay Street, Suite 302, Charleston, South Carolina. The facility is approximately 1,910 square
feet and occupied pursuant to a lease that commenced on May 1, 2016 and expires on August 31, 2021. The average annual rent over
the term is $66,326. This amount does not include taxes and other occupancy costs for the premises.
Our registered agent
is Registered Office Service Company, located at 203 NE Front Street, Suite 101, Milford, Delaware 19963.
ITEM 3. LEGAL PROCEEDINGS
We may be involved
in legal proceedings in the ordinary course of our business. Although our management cannot predict the ultimate outcome of these
legal proceedings with certainty, it believes that the ultimate resolution of our legal proceedings, including any amounts we may
be required to pay, will not have a material effect on our consolidated financial statements. We know of no material proceedings
in which we or either of our subsidiaries is a party. We may be involved in legal proceedings in the ordinary course of our business.
Although our management cannot predict the ultimate outcome of these legal proceedings with certainty, it believes that the ultimate
resolution of our legal proceedings, including any amounts we may be required to pay, will not have a material effect on our consolidated
financial statements.
ITEM 4. MINE SAFETY DISCLOSURES
Not applicable.
PART III
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
Set forth below are
the present directors and executive officers of the Company. Except as set forth below, there are no other persons who have been
nominated or chosen to become directors, nor are there any other persons who have been chosen to become executive officers. Other
than as set forth below, there are no arrangements or understandings between any of the directors, officers and other persons
pursuant to which such person was selected as a director or an officer.
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Name
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Age
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Position
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Since
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Terrence DeFranco
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51
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Chairman of the Board, President, Chief Executive Officer and Principal Accounting Officer
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2013
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The Board of Directors
is comprised of only one class. Our sole director, Mr. DeFranco, serves for a term of one year and until his successor(s) is/are
elected at the Company’s annual shareholders meeting and are qualified, subject to removal by the Company’s shareholders.
Our sole executive officer, Mr. DeFranco, serves at the pleasure of the Board of Directors, for a term of one year and until his
successor is elected at a meeting of the Board of Directors and is qualified.
Our Board of Directors
believes that all members of the Board and all executive officers encompass a range of talent, skill, and experience sufficient
to provide sound and prudent guidance with respect to our operations and interests. The information below with respect to our sole
officer and director includes his experience, qualifications, attributes, and skills necessary for him to serve as a director and/or
executive officer.
Biographies
Set forth below are
brief accounts of the business experience during the past five years of our sole director, executive officer and significant employee
of the Company.
Terrence DeFranco – Chairman of
the Board, President, Chief Executive Officer and Principal Accounting Officer
Mr. DeFranco was appointed
as President and Chief Executive Officer on January 2, 2013. Since, 2013 he has been the Managing Member of Gary Lee Company, LLC,
a corporate consulting firm focused on providing strategic advisory services to boards of directors of public companies. Previously,
from 2004 to 2012, Mr. DeFranco was Chief Executive Officer and founder of Edentify, Inc., an identity management software company.
Prior to that, he was Chairman and CEO of Titan International Partners, a merchant banking and research firm focused on providing
corporate and strategic advisory services and equity and debt financing to small-cap and middle market companies. Mr. DeFranco’s
background is primarily in the area of corporate finance and capital raising, previously serving as head of investment banking
for Baird, Patrick & Co., Inc., a 50-year old NYSE-member firm and head of investment banking and founding partner of Burlington
Securities Corp., a New York based investment banking and institutional equity trading firm. Mr. DeFranco began his career on Wall
Street in 1991 with PaineWebber, Inc., now UBS PaineWebber. He has been an active principal investor, senior manager and advisor
to many early-stage companies and has extensive experience in dealing with issues related to the management and operations of small
public companies. Mr. DeFranco is a graduate of the University of North Carolina at Chapel Hill with a BA in Economics.
We believe that Mr.
DeFranco’s significant experience relating to operational management and the public markets and his years of involvement
with our company, makes him suitable to serve as a director of our company.
Family Relationships
There are no other
family relationships between or among any of our sole director and executive officer and any incoming directors or executive officers.
Key Personnel
Patrick B. Hassell
,
President of SES. Patrick Hassell, the President of SolBright who co-founded SolBright in 2009 was appointed the Chief Executive
Officer and President of our subsidiary, SES, subsequent to our purchase of the SolBright Assets on May 1, 2017. Prior to founding
SolBright, Mr. Hassell served as President and CEO of Akrometrix, LLC (Atlanta, GA) from April 2003 through July 2008, growing
the business over 500% during his tenure. Mr. Hassell is a former employee of the Advanced Technology Development Center (ATDC)
at the Georgia Institute of Technology, a nationally recognized science and technology company incubator, where he was responsible
for business plan evaluations focusing on technical feasibility and market viability. Mr. Hassel has a BS in Civil Engineering
from the University of Virginia and a Master’s of Science in Management from the Georgia Institute of Technology.
Involvement in Certain Legal Proceedings
No director, executive
officer, significant employee or control person of the Company has been involved in any legal proceeding listed in Item 401(f)
of Regulation S-K in the past 10 years.
Committees of the Board
Our Board of Directors
held no formal meeting in the fiscal year-ended May 31, 2017. Otherwise, all proceedings of the Board of Directors were conducted
by resolutions consented to in writing by the sole director and filed with the minutes of the Company.
Due to the limited
size of our Board of Directors, we do not currently have a standing Audit or Compensation Committee. We hope to appoint new directors
in the near future, however, and expect to re-establish both an Audit Committee and Compensation Committee promptly thereafter.
The charters of the Audit and Compensation Committees were filed as exhibits to our report on Form 10-K for the period ended May
31, 2010.
Board Nominations and Appointments
In considering whether
to nominate any particular candidate for election to the Board of Directors, we will use various criteria to evaluate each candidate,
including an evaluation of each candidate’s integrity, business acumen, knowledge of our business and industry, experience,
diligence, conflicts of interest and the ability to act in the interests of our stockholders. The Board of Directors plans to evaluate
biographical information and interview selected candidates in the next fiscal year and also plans to consider whether a potential
nominee would satisfy the listing standards for “independence” of The Nasdaq Stock Market and the SEC’s definition
of “audit committee financial expert.” The Board of Directors does not plan to assign specific weights to particular
criteria and no particular criterion will be a prerequisite for each prospective nominee.
We do not have a formal
policy with regard to the consideration of director candidates recommended by our stockholders, however, stockholder recommendations
relating to director nominees may be submitted in accordance with the procedures set forth below under the heading “Communicating
with the Board of Directors”.
Communicating with the Board of Directors
Stockholders who wish
to send communications to the Board of Directors may do so by writing to Mr. Terrence DeFranco, CEO, Arkados Group, Inc., 211 Warren
Street, Suite 320, Newark, New Jersey 07103. The mailing envelope must contain a clear notation indicating that the enclosed letter
is a “Stockholder-Board Communication.” All such letters must identify the author as a stockholder and must include
the stockholder’s full name, address and a valid telephone number. The name of any specific intended recipient should be
noted in the communication. We will forward any such correspondence to the intended recipients; however, prior to forwarding any
such correspondence, and we will review such correspondence, and in our discretion, may not forward communications that relate
to ordinary business affairs, communications that are primarily commercial in nature, personal grievances or communications that
relate to an improper or irrelevant topic or are otherwise inappropriate for the Board of Director’s consideration.
Compensation of Directors
We have no standard
arrangement to compensate directors for their services in their capacity as directors. Directors are not paid for meetings attended.
However, we intend to review and consider future proposals regarding board compensation. All travel and lodging expenses associated
with corporate matters are reimbursed by us, if and when incurred.
Compensation Committee Interlocks and
Insider Participation
No interlocking relationship
exists between our Board of Directors and the board of directors or compensation committee of any other company, nor has any interlocking
relationship existed in the past.
Code of Ethics
As part of our system
of corporate governance, our Board of Directors has adopted a Code of Business Conduct and Ethics (the “Code”) for
directors and executive officers of the Company. This Code is intended to focus each director and executive officer on areas of
ethical risk, provide guidance to directors and executive officer to help them recognize and deal with ethical issues, provide
mechanisms to report unethical conduct, and help foster a culture of honesty and accountability. Each director and executive officer
must comply with the letter and spirit of this Code. We have also adopted a Code of Ethics for Financial Executives applicable
to our Chief Executive Officer and senior financial officers to promote honest and ethical conduct; full, fair, accurate, timely
and understandable disclosure; and compliance with applicable laws, rules and regulations. We intend to disclose any changes in
or waivers from our Code of Business Conduct and Ethics and our Code of Ethics for Financial Executives by filing a Form 8-K or
by posting such information on our website.
Compliance with Section 16(a) of the
Securities Exchange Act of 1934
Section 16(a) of the
Securities Exchange Act requires our executive officers and directors, and persons who own more than 10% of our common stock, to
file reports regarding ownership of, and transactions in, our securities with the Securities and Exchange Commission and to provide
us with copies of those filings.
Based solely on our
review of the copies of such forms received by us, or written representations from certain reporting persons, we believe that during
the fiscal year ended May 31, 2017, two of our greater than 10% percent beneficial owners failed to comply on a timely basis with
all applicable filing requirements under Section 16(a) of the Exchange Act.
ITEM 11. EXECUTIVE COMPENSATION
General Philosophy
Our Board of Directors
is responsible for establishing and administering the Company’s executive and director compensation.
Executive Compensation
The following summary
compensation table indicates the cash and non-cash compensation earned from the Company during the fiscal years ended May 31, 2017
and 2016 for our Chief Executive Officer. There were no executive officers of the Company whose total compensation exceeded $100,000
during those periods.
Summary Compensation Table
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Deferred
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Salary
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Option
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All Other
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Total
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Name/ Principal Position
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Year
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Salary
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Paid
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Award
(2)
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Compensation
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Compensation
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Terrence DeFranco
(1)
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2017
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$
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198,000
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$
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—
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$
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—
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$
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—
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$
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198,000
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President and Chief Executive Officer
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2016
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$
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198,000
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$
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—
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$
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150,000
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$
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—
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$
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348,000
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(1)
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The
amounts in the table do not include amounts received for serving on our Board of Directors.
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(2)
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Reflects
the aggregate grant date fair value computed in accordance with FASB ASC 718.
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Employment Agreements
Mr. DeFranco does not have an employment
agreement. He is an at-will employee of the Company by virtue of an oral agreement entered into by the previous sitting Board of
Directors. The agreement requires Mr. DeFranco to serve on a full-time basis and provides for bi-weekly compensation, based on
a rate determined by comparison to executives of similarly sized companies in our industry. In addition, Mr. DeFranco is paid a
reimbursement of business-related expenses. Determinations with regard to bonus or option grants are made by Mr. DeFranco, the
Company’s sole director at this time.
Key Employee Employment Agreements
On May 1, 2017, as
amended and restated on August 29, 2017, we and our wholly owned subsidiary, SES, entered into a three-year employment agreement
(the “Employment Agreement”) with Patrick Hassel, the President and founder of SolBright RE, pursuant to which Mr.
Hassell will serve as the Chief Executive Officer and President of SES for an annual base salary of $225,000, subject to increases
and bonuses as the board of directors of SES may determine. Under the Employment Agreement, Mr. Hassell will be granted options
to purchases up to 7,500,000 shares of our Common Stock over a three-year period, assuming Mr. Hassell continues to be employed
by SES during that period, at exercise prices ranging from $1.00 per share to $10.00 per share, with options to acquire five hundred
thousand (500,000) shares of our Common Stock exercisable at $1.00 per share vesting immediately. Mr. Hassell is also entitled
to receive benefits that may be provided to, and is eligible to participate in any other bonus or incentive program established
by SES for, SES executives. Health benefits offered to Mr. Hassell include an allowance of up to $1,500 per month for family health
insurance coverage. In the event that Mr. Hassel’s employment is terminated by SES without Cause or he resigns for Good
Reason (as those terms are defined in Employment Agreement) during the term of his employment, he will be entitled to severance
equal to his annual base salary then in effect for a period of six (6) months.
Potential Payments Upon Termination
or Change-in-Control
SEC regulations state
that we must disclose information regarding agreements, plans or arrangements that provide for payments or benefits to our executive
officers in connection with any termination of employment or change in control of the Company. Our sole executive officer and
director has neither received, nor do we have any arrangements to pay out, any bonus, stock awards, option awards, non-equity
incentive plan compensation, or non-qualified deferred compensation to him.
Equity Compensation Plans
Outstanding Equity Awards at Fiscal
Year End
The following table
summarizes the outstanding equity awards held by each named executive officer of our company as of May 31, 2017 as issued under
our 2004 Stock Option and Restricted Stock Plan (the “2004 Plan”). There were no exercises of options by executives
or directors in the year ended May 31, 2017. No additional stock vested under previously issued options, except as noted below.
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Number
of
Securities
Underlying
Unexercised
Options
(#)
Exercisable
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Number
of
Securities
Underlying
Unexercised
Options
Unexercisable
(#)
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Equity
Incentive
Plan
Awards:
Number
of
Securities
Underlying
Unexercised
Unearned
Options
(#)
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Option
Exercise
Price
($)
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Option
Expir-
ation
Date
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Number
of
Shares
or
Units
of
Stock
that
have
not
Vested
(#)
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Market
Value
of
Shares
or
Units
of
Stock
that
have
not
Vested
(#)
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Equity
Incentive
Plan
Awards:
Number
of
Unearned
Shares,
Units
or
Other
Rights
that
have
not
Vested
(#)
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Equity
Incentive
Plan
Awards:
Market
or
Payout
Value
of
Unearned
Shares,
Units
or
Other
Rights
that
Have
not
Vested
($)
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Terrence
DeFranco,
CEO and
Director
(1)
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2,775,000
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0.60
to
2.00
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6/25/18
to
4/22/26
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(1)
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On
June 25, 2015, Mr. DeFranco was granted options to purchase 1,000,000 shares of the Company’s common stock at an exercise
price of $0.60 per shares, that expire on June 25, 2018. On April 22, 2016, he was granted options to purchase 500,000
shares of the Company’s common stock at an exercise price of $0.60 per shares, that expire on April 22, 2016. On
April 8, 2014, he was granted options to purchase 675,000 shares of the Company’s common stock at an exercise price of $1.20
per shares, that expire on April 8, 2014. On April 22, 2016, he was granted options to purchase 300,000 shares of the
Company’s common stock at an exercise price of $1.20 per shares, that expire on April 22, 2026 and 300,000 shares of the
Company’s common stock at an exercise price of $2.00 per shares, that expire on April 22, 2026, respectively.
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Equity Compensation Plan Information
and Issuances
Our current policy
is that all full time key employees are considered annually for the possible grant of stock options, depending upon employee performance.
The criteria for the awards are experience, uniqueness of contribution to our business and the level of performance shown during
the year. Stock options are intended to generate greater loyalty and help make each employee aware of the importance of their business
success of the Company.
2004 Stock Option and Restricted Stock
Plan
Our 2004 Plan, which
was, in April 2014 extended for an additional 10 years, is currently administered by our sole director. Our sole director designates
the persons to receive options, the number of shares subject to the options and the terms of the options, including the option
price and the duration of each option, subject to certain limitations. All stock options grants during 2014 were made from the
2004 Plan. The 2004 Plan also permits the issuance of restricted stock which is subject to vesting and forfeiture at such times,
amounts and conditions. Because the 2004 Plan, as extended, has been in existence for more than 10 years, incentive stock options
cannot be granted under the 2004 Plan
The maximum number
of shares of Common Stock available for issuance under the 2004 Plan, as amended, is 3,333,333 shares. The plan is subject to adjustment
in the event of stock splits, stock dividends, mergers, consolidations and the like. Common Stock subject to options granted under
the 2004 Plan that expire or terminate will again be available for options to be issued under each Plan.
The option price is
payable in cash or by check or under cashless exercise provision determined by the Board of Directors in lieu of a Compensation
Committee.
In the absence of a
contrary provision in option agreements adopted by the Board of Directors, under the 2004 Plan, upon termination of an optionee’s
employment or consultancy, all options held by such optionee will terminate, except that any option that was exercisable on the
date employment or consultancy terminated may, to the extent then exercisable, be exercised within three months thereafter (or
six months thereafter if the termination is the result of permanent and total disability of the holder), and except such three
month period may be extended by our Board in its discretion. If an optionee dies while he is an employee or a consultant or during
such three-month period, the option may be exercised within six months after death by the decedent’s estate or his legatees
or distributees, but only to the extent exercisable at the time of death.
The 2004 Plan provides
that outstanding options shall vest and become immediately exercisable in the event consolidation, merger or acquisition of stock,
the result of which our stockholders will own less than 50% of the voting power of the reorganized, merged or consolidated company
or the sale of substantially all of our assets and the options are not assumed by the surviving company. In such event, the holder
will have 15 days to exercise the option and options will terminate on the expiration of such fifteen-day period.
The Company will no
longer issue awards under the 2004 Plan following the approval of the 2017 Equity Incentive Plan on April 28, 2017.
Under the 2004 Plan,
on June 25, 2015, Mr. DeFranco was granted options to purchase 1,000,000 shares of the Company’s common stock at an exercise
price of $0.60 per shares, that expire on June 25, 2018. On April 8, 2014, he was granted options under the 2004 Plan to purchase
675,000 shares of the Company’s common stock at an exercise price of $1.20 per shares, that expire on April 8, 2014.
On October 16, 2015,
the Company issued options under its 2004 Plan to certain employees to purchase 700,000 shares of its common stock at $1.00 per
share.
As of May 31, 2017,
there were options to purchase 5,112,500 shares of the Company’s Common Stock outstanding, 3,012,500 of which were issued
under the 2004 Plan.
Non-Plan Option Grants
On April 22, 2016,
the Company issued options outside of its 2004 Plan to employees to purchase 2,100,000 shares of its common stock at various exercise
prices ranging from $0.60 to $2.00. Of these non-2004 Plan issuances, the Company granted to Terrence DeFranco (i) options to purchase
500,000 shares of the Company’s common stock at an exercise price of $0.60 per shares, that expire on April 22, 2016 and
(ii) options to purchase 300,000 shares of the Company’s common stock at an exercise price of $1.20 per shares, that expire
on April 22, 2026 and options to purchase 300,000 shares of the Company’s common stock at an exercise price of $2.00 per
shares, that expire on April 22, 2026.
As of May 31, 2017,
there were options to purchase 2,100,000 shares of our Common Stock outstanding that were issued outside of the 2004 Plan.
2017 Equity Incentive Plan
The Board of Directors
approved the Company’s 2017 Equity Incentive Plan (the “2017 Plan”) on April 27, 2017 and the stockholders
of the Company holding a majority in interest of the outstanding voting capital stock of the Company approved and adopted the 2017
Plan on April 28, 2017. The 2017 Plan is designed to provide a vehicle under which a variety of stock-based and other awards can
be granted to the Company’s employees, consultants and directors, which will align the interests of award recipients with
those of our stockholders, reinforce key goals and objectives that help drive stockholder value, and attract, motivate and retain
experienced and highly qualified individuals who will contribute to the Company’s financial success. The Board believes that
the 2017 Plan will serve a critical role in attracting and retaining high caliber employees, consultants and directors essential
to our success and in motivating these individuals to strive to meet our goals.
The maximum number
of shares of our Common Stock that may be issued under our 2017 Plan, is 10,000,000 shares. Shares subject to stock awards granted
under our 2017 Plan that expire or terminate without being exercised in full, or that are paid out in cash rather than in shares,
do not reduce the number of shares available for issuance under our 2017 Plan. Additionally, shares become available for future
grant under our 2017 Plan if they were issued under stock awards under our 2017 Plan and if we repurchase them or they are forfeited.
This includes shares used to pay the exercise price of a stock award or to satisfy the tax withholding obligations related to a
stock award.
Plan
Administration.
Our Board of Directors, or a duly authorized committee of our Board of Directors, will administer our 2017
Plan. Our Board of Directors may also delegate to one or more of our officers the authority to (1) designate employees (other
than officers) to receive specified stock awards and (2) determine the number of shares subject to such stock awards. Under
our 2017 Plan, our Board of Directors has the authority to determine and amend the terms of awards and underlying agreements, including:
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the exercise, purchase, or strike price of stock awards, if any;
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the number of shares subject to each stock award;
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the vesting schedule applicable to the awards, together with any vesting acceleration; and
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the form of consideration, if any, payable on exercise or settlement of the award.
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Under
the 2017 Plan, the Board of Directors also generally has the authority to effect, with the consent of any adversely affected participant:
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the reduction of the exercise, purchase, or strike price of any outstanding award;
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the cancellation of any outstanding award and the grant in substitution therefore of other awards,
cash, or other consideration; or
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any other action that is treated as a repricing under generally accepted accounting principles.
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Section 162(m) Limits.
At such time as necessary for compliance with Section 162(m) of the Code, in a calendar year, no participant may be granted a performance
stock award covering more than 250,000 shares of our Common Stock or a performance cash award having a maximum value in excess
of $250,000. These limitations are designed to allow us to grant compensation that will not be subject to the $1,000,000 annual
limitation on the income tax deductibility of compensation paid to a covered executive officer imposed by Section 162(m) of
the Code.
Stock
Options
. Incentive stock options and non-statutory stock options are granted under stock option agreements adopted by the plan
administrator. The plan administrator determines the exercise price for stock options, within the terms and conditions of
the 2017 Plan, provided that the exercise price of a stock option generally cannot be less than 100% of the fair market value of
our Common Stock on the date of grant. Options granted under the 2017 Plan vest at the rate specified in the stock option agreement
as determined by the plan administrator.
Restricted Stock
Unit Awards.
RSUs are granted under restricted stock unit award agreements adopted by the plan administrator. RSUs may be granted
in consideration for any form of legal consideration that may be acceptable to our Board of Directors and permissible under applicable
law. An RSU may be settled by cash, delivery of stock, a combination of cash and stock as deemed appropriate by the plan administrator,
or in any other form of consideration set forth in the RSU agreement. Additionally, dividend equivalents may be credited in respect
of shares covered by an RSU. Except as otherwise provided in the applicable award agreement, RSUs that have not vested will be
forfeited once the participant’s continuous service ends for any reason
Restricted Stock
Awards.
Restricted stock awards are granted under restricted stock award agreements adopted by the plan administrator. A restricted
stock award may be awarded in consideration for cash, check, bank draft or money order, past services to us, or any other form
of legal consideration that may be acceptable to our Board of Directors and permissible under applicable law. The plan administrator
determines the terms and conditions of restricted stock awards, including vesting and forfeiture terms. If a participant’s
service relationship with us ends for any reason, we may receive any or all of the shares of Common Stock held by the participant
that have not vested as of the date the participant terminates service with us through a forfeiture condition or a repurchase right.
Stock
Appreciation Rights.
Stock appreciation rights are granted under stock appreciation grant agreements adopted by the plan administrator.
The plan administrator determines the purchase price or strike price for a stock appreciation right, which generally cannot be
less than 100% of the fair market value of our Common Stock on the date of grant. A stock appreciation right granted under the
2017 Plan vests at the rate specified in the stock appreciation right agreement as determined by the plan administrator.
Performance
Awards.
The 2017 Plan permits the grant of performance-based stock and cash awards that may qualify as performance-based compensation
that is not subject to the $1,000,000 limitation on the income tax deductibility imposed by Section 162(m) of the Code. Our compensation
committee, or in the absence of a compensation Committee our Board of Directors, may structure awards so that the stock or cash
will be issued or paid only following the achievement of certain pre-established performance goals during a designated performance
period.
The
performance goals that may be selected include one or more of the following: (a) net earnings or net income (before or after taxes);
(b) basic or diluted earnings per share (before or after taxes); (c) net revenue or net revenue growth; (d) gross revenue; (e)
gross profit or gross profit growth; (f) net operating profit (before or after taxes); (g) return on assets, capital, invested
capital, equity, or sales; (h) cash flow (including, but not limited to, operating cash flow, free cash flow, and cash flow return
on capital); (i) earnings before or after taxes, interest, depreciation and/or amortization; (j) gross or operating margins; (k)
improvements in capital structure; (l) budget and expense management; (m) productivity ratios; (n) economic value added or other
value added measurements; (o) share price (including, but not limited to, growth measures and total shareholder return); (p) expense
targets; (q) margins; (r) operating efficiency; (s) working capital targets; (t) enterprise value; (u) safety record; (v) completion
of acquisitions or business expansion; (w) achieving research and development goals and milestones; (x) achieving product commercialization
goals; and (y) other criteria as may be set by the Board of Directors from time to time.
The
performance goals may be based on company-wide performance or performance of one or more business units, divisions, affiliates,
or business segments, and may be either absolute or relative to the performance of one or more comparable companies or the performance
of one or more relevant indices. To the extent required under Section 162(m) of the Code, the Board of Directors shall, within
the first 90 days of a performance period (or, if longer or shorter, within the maximum period allowed under Section 162(m) of
the Code), define in an objective fashion the manner of calculating the performance criteria it selects to use for such performance
period. In addition, the board or committee (as applicable) retains the discretion to reduce or eliminate the compensation or economic
benefit due on attainment of performance goals and to define the manner of calculating the performance criteria it selects to use
for such performance period. Partial achievement of the specified criteria may result in the payment or vesting corresponding to
the degree of achievement as specified in the award agreement or the written terms of a performance cash award.
Other
Stock Awards
. The plan administrator may grant other awards based in whole or in part by reference to our Common Stock.
The plan administrator will set the number of shares under the stock award and all other terms and conditions of such awards.
Changes
to Capital Structure
. In the event there is a specified type of change in our capital structure, such as a stock split, reverse
stock split, or recapitalization, appropriate adjustments will be made to (1) the class and maximum number of shares reserved for
issuance under the 2017 Plan, (2) the class and maximum number of shares by which the share reserve may increase automatically
each year, (3) the class and maximum number of shares that may be issued on the exercise of incentive stock options, (4) the
class and maximum number of shares subject to stock awards that can be granted in a calendar year (as established under the 2017
Plan under Section 162(m) of the Code), and (5) the class and number of shares and exercise price, strike price, or purchase
price, if applicable, of all outstanding stock awards.
Corporate
Transactions
. Our 2017 Plan provides that in the event of certain specified significant corporate transactions, including:
(1) a sale of all or substantially all of our assets, (2) the sale or disposition of more than 90% of our outstanding
securities, (3) the consummation of a merger or consolidation where we do not survive the transaction, and (4) the consummation
of a merger or consolidation where we do survive the transaction but the shares of our common stock outstanding before such transaction
are converted or exchanged into other property by virtue of the transaction, unless otherwise provided in an award agreement or
other written agreement between us and the award holder, the administrator may take one or more of the following actions with respect
to such stock awards:
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arrange for the assumption, continuation, or substitution of a stock award by a successor corporation;
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arrange for the assignment of any reacquisition or repurchase rights held by us to a successor
corporation;
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accelerate the vesting, in whole or in part, of the stock award and provide for its termination
before the transaction;
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arrange for the lapse, in whole or in part, of any reacquisition or repurchase rights held by us;
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cancel or arrange for the cancellation of the stock award before the transaction in exchange for
a cash payment, or no payment, as determined by the board; or
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make a payment, in the form determined by our board of directors, equal to the excess, if any,
of the value of the property the participant would have received on exercise of the awards before the transaction over any exercise
price payable by the participant in connection with the exercise.
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The
plan administrator is not obligated to treat all stock awards or portions of stock awards, even those that are of the same type,
in the same manner and is not obligated to treat all participants in the same manner.
In
the event of a change in control, awards granted under the 2017 Plan will not receive automatic acceleration of vesting and exercisability,
although this treatment may be provided for in an award agreement. Under the 2017 Plan, a change in control is defined to include
(1) the acquisition by any person or company of more than 50% of the combined voting power of our then outstanding stock,
(2) a merger, consolidation, or similar transaction in which our stockholders immediately before the transaction do not own,
directly or indirectly, more than 50% of the combined voting power of the surviving entity (or the parent of the surviving entity),
(3) a sale, lease, exclusive license, or other disposition of all or substantially all of our assets other than to an entity
more than 50% of the combined voting power of which is owned by our stockholders, and (4) an unapproved change in the majority
of the board of directors.
Transferability
.
A participant may not transfer stock awards under our 2017 Plan other than by will, the laws of descent and distribution, or as
otherwise provided under our 2017 Plan.
Plan
Amendment or Termination
. Our Board of Directors has the authority to amend, suspend, or terminate our 2017 Plan, provided
that such action does not materially impair the existing rights of any participant without such participant’s written consent.
Certain material amendments also require the approval of our stockholders. No incentive stock options may be granted after
the tenth anniversary of the date our Board of Directors adopted our 2017 Plan. No stock awards may be granted under our 2017
Plan while it is suspended or after it is terminated.
U.S. Federal Income Tax Consequences
The following paragraphs
are a summary of the general federal income tax consequences to U.S. taxpayers and the Company of awards granted under the 2017
Plan. Tax consequences for any particular individual may be different.
Incentive Stock
Options.
A participant recognizes no taxable income as the result of the grant or exercise of an incentive stock option qualifying
under Section 422 of the Internal Revenue Code (unless the participant is subject to the alternative minimum tax). If the participant
exercises the option and then later sells or otherwise disposes of the shares acquired through the exercise of the option after
both the two-year anniversary of the grant date and the one-year anniversary of the exercise date, the difference between the sale
price and the exercise price will be taxed as capital gain or loss. If the participant exercises the option and then later sells
or otherwise disposes of the shares on or before the two- or one-year anniversaries described above (a “disqualifying disposition”),
he or she generally will have ordinary income at the time of the sale equal to the fair market value of the shares on the exercise
date (or the sale price, if less) minus the exercise price of the option.
Nonstatutory Stock
Options
. A participant generally recognizes no taxable income on the date of grant of a nonstatutory stock option with an exercise
price equal to the fair market value of the underlying stock on the date of grant. Upon the exercise of a nonstatutory stock option,
the participant generally will recognize ordinary income equal to the excess of the fair market value of the shares on the exercise
date over the exercise price of the option. If the participant is an employee, such ordinary income generally is subject to withholding
of income and employment taxes. Upon the sale of shares acquired through the exercise of a nonstatutory stock option, any subsequent
gain or loss (generally based on the difference between the sale price and the fair market value on the exercise date) will be
treated as long-term or short-term capital gain or loss, depending on how long the shares were held by the participant.
Stock Appreciation
Rights.
A participant generally recognizes no taxable income on the date of grant of a stock appreciation right with an exercise
price equal to the fair market value of the underlying stock on the date of grant. Upon exercise of the stock appreciation right,
the participant generally will be required to include as ordinary income an amount equal to the sum of the amount of any cash received
and the fair market value of any shares received upon the exercise. If the participant is an employee, such ordinary income generally
is subject to withholding of income and employment taxes. Upon the sale of shares acquired by an exercise of the stock appreciation
right, any gain or loss (generally based on the difference between the sale price and the fair market value on the exercise date)
will be treated as long-term or short-term capital gain or loss, depending on how long the shares were held by the participant.
Restricted Stock,
Restricted Stock Units, Performance Awards, and Performance Shares.
A participant generally will not have taxable income at
the time an award of restricted stock, restricted stock units, performance shares, or performance units is granted. Instead, he
or she generally will recognize ordinary income in the first taxable year in which his or her interest in the shares underlying
the award has been transferred to him or her and becomes either (i) freely transferable, or (ii) no longer subject to substantial
risk of forfeiture. If the participant is an employee, such ordinary income generally is subject to withholding of income and employment
taxes. However, the recipient of a restricted stock award may elect to recognize income at the time he or she receives the award
in an amount equal to the fair market value of the shares underlying the award (less any cash paid for the shares) on the date
the award is granted.
Section 409A.
Section 409A of the Code (
“Section 409A”
) provides certain requirements for non-qualified deferred compensation
arrangements with respect to an individual’s deferral and distribution elections and permissible distribution events. Awards
granted under the Plans with a deferral feature will be subject to the requirements of Section 409A. If an award is subject to
and fails to satisfy the requirements of Section 409A, the recipient of that award may recognize ordinary income on the amounts
deferred under the award, to the extent vested, which may be prior to when the compensation is actually or constructively received.
Also, if an award that is subject to Section 409A fails to comply with Section 409A’s provisions, Section 409A imposes an
additional 20% tax on compensation recognized as ordinary income, as well as interest on such deferred compensation.
Tax Effect for the
Company.
We generally will be entitled to a tax deduction in connection with an award under the 2017 Plan in an amount equal
to the ordinary income realized by a participant and at the time the participant recognizes such income (for example, the exercise
of a nonqualified stock option). However, special rules limit the deductibility of compensation paid to our chief executive officer
and other “covered employees” as determined under Section 162(m) of the Code and applicable guidance. Under Section
162(m), the annual compensation paid to any of these specified executives will be deductible only to the extent that it does not
exceed $1,000,000. However, we can preserve the deductibility of certain compensation in excess of $1,000,000 if the conditions
of Section 162(m) are met. These conditions include (among others) stockholder approval of the 2017 Plan and its material terms,
setting certain limits on the number of shares subject to awards and, for awards other than options and stock appreciation rights,
establishing performance criteria that must be met before the award actually will vest or be paid. The 2017 Plan has been designed
to permit (but not require) the administrator to grant awards that are intended to qualify as performance-based for purposes of
satisfying the conditions of Section 162(m).
Director Compensation
The following table
sets forth for each director certain information concerning his compensation for the year ended December 31, 2016.
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Fees
Earned or
Paid in
Cash
($)
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Stock
Awards
($)
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Option
Awards
($)
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Non-Equity
Incentive Plan
Compensation
($)
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Change in
Pension Value
and
Nonqualified
Deferred
Compensation
Earnings
($)
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All other
Compensation
($)
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Total
($)
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Terrence DeFranco
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Our sole director receives
reimbursement for reasonable out of pocket expenses in attending board of directors’ meetings and for promoting our business.
From time to time we may need him to perform services on our behalf. Mr. DeFranco receives compensation for his services as an
executive officer of the Company, but not as a director.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN
BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS.
Except
as otherwise stated, the table below sets forth information concerning the beneficial ownership of Common Stock as of September
12, 2017 for: (1) each director currently serving on our Board of Directors; (2) each of our named executive officers;
(3) our directors and executive officers as a group; and (4) each person known to the Company to beneficially own more
than 5% of the outstanding shares of Common Stock. As of September 12, 2017, there were 21,673,403 shares of Common Stock outstanding.
Except as otherwise noted, each stockholder has sole voting and investment power with respect to the shares beneficially owned.
Name of Stockholder
(1)
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Shares of Common Stock
Beneficially Owned
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Percentage of
Ownership
(2)
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5% or more Stockholders
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Tai Jee Pan
(3)
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3,327,512
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(4)
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15.4
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%
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Richmake International Ltd.
(5)
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2,477,545
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11.4
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%
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SolBright Renewable Energy, LLC
(6)
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8,000,000
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(7)
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31.2
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%
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AIP Asset Management Inc.
(8)
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7,291,668
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(9)
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25.9
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%
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Officers and Directors
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Terrence DeFranco, CEO, sole director
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3,383,333
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(10)
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13.8
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%
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Officers and Directors as a Group (1 total)
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3,383,333
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13.8
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%
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(1)
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Unless otherwise indicated, the address for all beneficial owners is c/o Arkados Group, Inc., 211 Warren Street, Suite 320, Newark, New Jersey 07103.
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(2)
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Beneficial ownership is determined in accordance with the rules of the Commission, including Rule 13d-3(d)(1) of the Exchange Act, and generally includes voting or investment power with respect to securities. Under the rules of the Commission, a person (or group of persons) is deemed to be a “beneficial owner” of a security if he or she, directly or indirectly, has or shares a power to vote or to direct the voting of such security. Accordingly, more than one person may be deemed to be a beneficial owner of the same security. In accordance with Commission rules, shares of Common Stock that may be acquired upon exercise of stock options or warrants which are currently exercisable or which become exercisable within 60 days of the date of the table are deemed beneficially owned by the optionees. Subject to community property laws, where applicable, we believe the persons or entities named in the table above have sole voting and investment power with respect to all shares of the Common Stock indicated as beneficially owned by them.
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(3)
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The stockholder’s business address is: 15265 NW Perimeter Drive, Beaverton, Oregon 97006.
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(4)
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Consists of 2,660,846 shares
of common stock owned by Tai Jee Pan directly and 666,666 shares of common stock owned by MAT Research LLC, an entity
controlled by Tai Jee Pan. The stockholder’s business address is: 10F, No. 69 Sec 3 Heui Jung Road, Taichung,
Taiwan.
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(5)
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The stockholder’s business address is: 701 East Bay Street, Suite 302, Charleston, SC 29403.
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(6)
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Consists of 4,000,000 shares of Common Stock, plus an additional 4,000,000 shares of Common Stock issuable upon conversion of Series A Convertible Preferred Stock (initially convertible at a Conversion Price of $1.50 per share) automatically issuable upon the conversion of the Preferred Stock Note upon filing of the Certificate of Designation. Mr. Patrick Hassell exercises sole voting and dispositive powers with respect to the shares of common stock owned by and issuable to SolBright Renewable Energy, LLC.
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(7)
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The stockholder’s business address is: c/o AIP Asset Management Inc. (“AIP”) is TD North Tower, 77 King Street W, Suite 4140, Toronto, ON M5K 1E7. AIP refers to AIP plus the affiliated entities over which AIP has dispositive and voting control.
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(8)
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Consists of 833,334 shares of Common Stock purchased in the Company’s 2017 private placement, plus 3,125,000 shares of Common Stock issuable to AIP upon conversion of certain Secured Notes, 2,500,000 shares of Common Stock issuable upon exercise of the warrants issued in connection with the Secured Notes and 833,334 shares of Common Stock issuable upon the exercise of warrants issued in connection with the 2017 private placement. Mr. Jay Bala exercises sole voting and dispositive powers with respect to the shares of Common Stock issuable to AIP.
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(9)
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Consists of 608,333 shares of Common Stock and options to purchase 2,775,000 shares of Common Stock.
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Changes in Control.
There are currently
no arrangements which may result in a change of control of our company.
Non-Cumulative Voting
The holders of our
shares of common stock do not have cumulative voting rights, which means that the holders of more than 50% of such outstanding
shares, voting for the election of Directors, can elect all of the Directors to be elected, if they so choose. In such event, the
holders of the remaining shares will not be able to elect any of our Directors.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED
TRANSACTIONS, AND DIRECTOR INDEPENDENCE
Transactions with Related Persons
Except as set out below,
as of May 31, 2017, there have been no transactions, or currently proposed transactions, in which we were or are to be a participant
and the amount involved exceeds the lesser of $120,000 or one percent of the average of our total assets at year-end for the last
two completed fiscal years, and in which any of the following persons had or will have a direct or indirect material interest:
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any director or executive officer of our company;
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any person who beneficially owns, directly or indirectly, shares carrying more than 5% of the voting
rights attached to our outstanding shares of common stock;
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any promoters and control persons; and
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any member of the immediate family (including spouse, parents, children, siblings and in laws)
of any of the foregoing persons.
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Named Executive Officers and Current
Directors
For information regarding
compensation for our named executive officers and current directors, see “Executive Compensation.”
Director Independence
Our board of directors
consists of one director, Terrence DeFranco, who is also our sole executive officer. Our securities are quoted on the OTC Markets
Group, Pink Tier, which does not have any director independence requirements. We evaluate independence by the standards for director
independence established by applicable laws, rules, and listing standards including, without limitation, the standards for independent
directors established by The New York Stock Exchange, Inc., the NASDAQ National Market, and the Securities and Exchange Commission.
Subject to some exceptions,
these standards generally provide that a director will not be independent if (a) the director is, or in the past three years has
been, an employee of ours; (b) a member of the director’s immediate family is, or in the past three years has been, an executive
officer of ours; (c) the director or a member of the director’s immediate family has received more than $120,000 per year
in direct compensation from us other than for service as a director (or for a family member, as a non-executive employee); (d)
the director or a member of the director’s immediate family is, or in the past three years has been, employed in a professional
capacity by our independent public accountants, or has worked for such firm in any capacity on our audit; (e) the director or a
member of the director’s immediate family is, or in the past three years has been, employed as an executive officer of a
company where one of our executive officers serves on the compensation committee; or (f) the director or a member of the director’s
immediate family is an executive officer of a company that makes payments to, or receives payments from, us in an amount which,
in any twelve-month period during the past three years, exceeds the greater of $1,000,000 or two percent of that other company’s
consolidated gross revenues. Based on these standards, we have determined that our sole director is not an independent director.
ITEM 14. PRINCIPAL ACCOUNTING FEES AND
SERVICES
Audit and Accounting Fees
The following tables
set forth the fees billed to the Company for professional services rendered by RBSM LLP (“RBSM”) for the years ended
May 31, 2017 and 2016:
Services
|
|
2017
|
|
|
2016
|
|
Audit fees
|
|
$
|
47,000
|
|
|
$
|
29,000
|
|
Audit related fees
|
|
|
—
|
|
|
|
—
|
|
Tax fees
|
|
|
3,500
|
|
|
|
4,000
|
|
All other fees
|
|
|
—
|
|
|
|
—
|
|
Total fees
|
|
$
|
50,500
|
|
|
$
|
33,000
|
|
Audit Fees
The aggregate audit
fees billed and unbilled for the fiscal years ended May 31, 2017 and 2016 were for professional services rendered by RBSM for the
audits of our annual financial statements and the review of our financial statements included in our quarterly reports on Form
10-Q.
Audit-Related Fees
The aggregate audit-related
fees billed for the fiscal years ended May 31, 2017 and 2016 were for financial information system design and implementation. These
services, which include designing or implementing a system that aggregates source data underlying the financial statements or generates
information that is significant to our financial statements, are provided internally or by other service providers.
Tax and Other Fees
The aggregate tax and
other fees billed for the fiscal years ended May 31, 2017 and 2016 were for tax related or other services rendered by our principal
accountants in connection with the preparation of our federal and state tax returns.
Pre-Approval Policies and Procedures
We do not have an audit
committee. Our sole Chief Executive Office and sole director pre-approves all services, including both audit and non-audit services,
provided by our independent accountants. For audit services, each year the independent auditor provides our sole director with
an engagement letter outlining the scope of the audit services proposed to be performed during the year, which must be formally
accepted by the sole director before the audit commences.
THE ACCOMPANYING NOTES ARE AN INTEGRAL
PART OF THESE CONSOLIDATED FINANCIAL STATEMENTS.
THE ACCOMPANYING NOTES ARE AN INTEGRAL
PART OF THESE CONSOLIDATED FINANCIAL STATEMENTS.
THE ACCOMPANYING NOTES ARE AN INTEGRAL
PART OF THESE CONSOLIDATED FINANCIAL STATEMENTS.
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE
1 – DESCRIPTION OF BUSINESS
Arkados
Group, Inc. (the “Parent”) conducts business activities principally through its two wholly-owned subsidiaries, Arkados,
Inc. (“Arkados”) and SolBright Energy Solutions, LLC (“SES”), formerly known as Arkados Energy Solutions,
LLC (“AES”) (collectively, the “Company”).
The
Company underwent a significant restructuring following December 23, 2010, during which substantially all of its assets were acquired
by STMicroelectronics, Inc. (sometimes referred to hereinafter as the “Asset Sale”). Settlements reached in connection
with the Asset Sale and the fulfillment of obligations in connection therewith, have been substantially completed.
Following
the Asset Sale, the Company shifted its focus towards the following businesses:
Arkados
– Arkados develops proprietary, cloud-based device and system management software solutions, which the Company refers to
as the Arktic
TM
software platform, and delivers software services and support. Arktic
TM
is an open, scalable
and interoperable software platform that supports industrial applications, including applications for smart manufacturing, measurement
and verification, as well as predictive analysis, or data gathering for baselining machine performance data and reporting of anomalies.
SES
- Formerly known as AES, the Company’s energy conservation services subsidiary, SES provides energy conservation services
and solutions to commercial and buildings throughout the eastern United States. These services include energy consumption assessments
and recommendations, as well as acting as the general contractor for light-emitting diode (“LED”) lighting retrofits,
oil-to-natural gas boiler conversions and solar photovoltaic (“PV”) system installation. SES also markets and sells
the technology solutions of Arkados to help building owners save money. SES sells its services directly to building owners and
managers.
On
May 1, 2017, the Company acquired substantially all of the assets and certain liabilities of SolBright Renewable Energy, LLC (“SolBright
RE”), used in the operation of SolBright RE’s solar engineering, procurement and construction business (the “SolBright
Assets”). The Company is engaging in this business through its wholly owned subsidiary formerly known as Arkados Energy
Solutions, LLC, whose name it formally changed on June 23, 2017 to SolBright Energy Solutions, LLC, or SES, to better reflect
its newly acquired business.
NOTE
2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Going Concern
The
accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern.
The Company has incurred net losses of approximately $47 million since inception, including a net loss of approximately $3.3 million
for the year ended May 31, 2017. Additionally, the Company still had both working capital and stockholders’ deficiencies
at May 31, 2017 and 2016 and negative cash flow from operations since inception. These conditions raise substantial doubt about
the Company’s ability to continue as a going concern. Management expects to incur additional losses in the foreseeable future
and recognizes the need to raise capital to remain viable. The accompanying audited consolidated financial statements do not include
any adjustments that might be necessary should the Company be unable to continue as a going concern.
The
Company’s plan, through potential acquisitions and the continued promotion of its services to existing and potential customers,
is to generate sufficient revenues to cover its anticipated expenses. The Company is currently exploring several options to meet
its short-term cash requirements, including an equity raise or loan funding from third parties. Although no assurances can be
given as to the Company’s ability to deliver on its revenue plans, or that unforeseen expenses may arise, the management
of the Company believes that the revenue to be generated from operations together with potential equity and debt financing or
other potential financing will provide the necessary funding for the Company to continue as a going concern.
Principles
of Consolidation
The
consolidated financial statements include the accounts of the Parent, and its wholly-owned subsidiaries, which include SES and
Arkados. Intercompany accounts and transactions have been eliminated in consolidation.
Revenue
Recognition
Arkados
The
Company enters into arrangements with end users for items which may include software license fees, services, maintenance and royalties
or various combinations thereof. For each arrangement, revenues will be recognized when evidence of an agreement has been documented,
the fees are fixed or determinable, collection of fees is probable, delivery of the product has occurred and no other significant
obligations remain.
Revenues
from software licensing are recognized in accordance with Accounting Standards Codification (“ASC”) 985-605, “Software
Revenue Recognition.” Accordingly, revenue from software licensing is recognized when all of the following criteria are
met: persuasive evidence of an arrangement exists, delivery has occurred, the fee is fixed or determinable, and collectability
is probable.
License
revenues are recognized at the time of delivery of the software and all other revenue recognition criteria discussed above have
been met. Deferred revenue represents license revenues billed but not yet earned. Sales of products are recognized when the products
are shipped and the customer takes risk of ownership and assumes the risk of loss. Royalty income is recognized as it is earned
and recorded when reported by the customer.
SES
Sales
of products are recognized when the products are shipped and the customer takes risk of ownership and assumes the risk of loss.
Service revenue is recognized when the service is completed. Deferred revenue represents revenues billed but not yet earned.
Cash
and Cash Equivalents
The
Company considers investments in highly liquid instruments with a maturity of three months or less to be cash equivalents. The
Company did not have any cash equivalents at both May 31, 2017 and 2016.
Accounts
Receivable
Accounts
receivable are reported at their outstanding unpaid principal balances net of allowances for uncollectible accounts. The Company
provides for allowances for uncollectible receivables based on management’s estimate of uncollectible amounts considering
age, collection history, and any other factors considered appropriate. The Company writes off accounts receivable against the
allowance for doubtful accounts when a balance is determined to be uncollectible. At May 31, 2017 and 2016, the Company determined
that an allowance for doubtful accounts was not needed.
Fair
Value of Financial Instruments
The
carrying value of cash, accounts receivable, other receivables, accounts payable and accrued expenses approximate their fair values
based on the short-term maturity of these instruments. The carrying amounts of debt were also estimated to approximate fair value.
As defined in ASC 820, “Fair Value Measurements and Disclosures,” fair value is the price that would be received to
sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (exit
price). The Company utilizes market data or assumptions that market participants would use in pricing the asset or liability,
including assumptions about risk and the risks inherent in the inputs to the valuation technique. These inputs can be readily
observable, market corroborated, or generally unobservable. ASC 820 establishes a fair value hierarchy that prioritizes the inputs
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 measurement) and the lowest priority to unobservable inputs (level 3 measurement). This fair value
measurement framework applies at both initial and subsequent measurement.
The
three levels of the fair value hierarchy defined by ASC 820 are as follows:
●
Level 1 – Quoted prices are available in active markets for identical assets or liabilities as of the reporting date. Active
markets are those in which transactions for the asset or liability occur in sufficient frequency and volume to provide pricing
information on an ongoing basis. Level 1 primarily consists of financial instruments such as exchange-traded derivatives, marketable
securities and listed equities.
●
Level 2 – Pricing inputs are other than quoted prices in active markets included in Level 1, which are either directly or
indirectly observable as of the reported date. Level 2 includes those financial instruments that are valued using models or other
valuation methodologies. These models are primarily industry-standard models that consider various assumptions, including quoted
forward prices for commodities, time value, volatility factors and current market and contractual prices for the underlying instruments,
as well as other relevant economic measures. Substantially all of these assumptions are observable in the marketplace throughout
the full term of the instrument, can be derived from observable data or are supported by observable levels at which transactions
are executed in the marketplace. Instruments in this category generally include non-exchange-traded derivatives such as commodity
swaps, interest rate swaps, options and collars.
●
Level 3 – Pricing inputs include significant inputs that are generally less observable from objective sources. These inputs
may be used with internally developed methodologies that result in management’s best estimate of fair value.
Earnings
(Loss) Per Share (“EPS”)
Basic
EPS is computed by dividing net income (loss) by the weighted average number of shares of common stock outstanding. Diluted EPS
includes the effect from potential issuance of common stock, such as stock issuable pursuant to the exercise of stock options
and warrants and the assumed conversion of convertible notes.
The
following table summarizes the securities that were excluded from the diluted per share calculation because the effect of including
these potential shares was antidilutive even though the exercise price could be less than the average market price of the common
shares:
|
|
Year ended
|
|
|
|
May 31,
|
|
|
|
2017
|
|
|
2016
|
|
|
|
|
|
|
|
|
Convertible notes
|
|
|
3,389,437
|
|
|
|
85,320
|
|
Stock options
|
|
|
7,437,500
|
|
|
|
3,012,500
|
|
Warrants
|
|
|
10,474,871
|
|
|
|
5,225,987
|
|
Potentially dilutive securities
|
|
|
21,301,808
|
|
|
|
8,323,807
|
|
Stock
Based Compensation
In
computing the impact, the fair value of each option and/or warrant is estimated on the date of grant based on the Black-Scholes
options-pricing model utilizing certain assumptions for a risk-free interest rate; volatility; and expected remaining lives of
the awards. The assumptions used in calculating the fair value of share-based payment awards represent management’s best
estimates, but these estimates involve inherent uncertainties and the application of management judgment. As a result, if factors
change and the Company uses different assumptions, the Company’s stock-based compensation expense could be materially different
in the future. In addition, the Company is required to estimate the expected forfeiture rate and only recognize expense for those
shares expected to vest. In estimating the Company’s forfeiture rate, the Company analyzed its historical forfeiture rate,
the remaining lives of unvested options, and the amount of vested options as a percentage of total options outstanding. If the
Company’s actual forfeiture rate is materially different from its estimate, or if the Company reevaluates the forfeiture
rate in the future, the stock-based compensation expense could be significantly different from what the Company has recorded in
the current period. During the year ended May 31, 2017, 208,596 shares of the Company’s common stock were issued to satisfy
accounts payable obligations amounting to $253,003 in stock compensation and 610,000 shares issued for consulting services amounting
to $511,300 in stock based compensation. Additionally, the Company recorded $590,661 in compensation expense related to stock
options granted to an employee. There were no additional issuances of warrants for services during the year ended May 31, 2017.
Stock
based compensation expense for the years ended May 31, 2017 and 2016 was $1,101,961 and $1,968,084, respectively, and is included
in selling, general and administrative expense.
Use
of Estimates
The
preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets, liabilities, equity based transactions and disclosure of contingent
liabilities at the date of the financial statements and revenues and expenses during the reporting period. Actual results could
differ from those estimates.
The
Company believes the following critical accounting policies affect its more significant judgments and estimates used in the preparation
of the financial statements. Significant estimates include the allowance for doubtful accounts, the useful life of plant and equipment
and intangible assets, deferred tax asset and valuation allowance, and assumptions used in Black-Scholes-Merton, or BSM, valuation
methods, such as expected volatility, risk-free interest rate, and expected dividend rate.
Inventory
Inventory,
which consists of finished goods and work-in-process (“WIP”) of SES, is valued at the lower of cost on a first-in,
first-out basis or market. Inventory consists of the following at May 31, 2017 and 2016.
|
|
May 31,
|
|
|
|
2017
|
|
|
2016
|
|
Finished goods
|
|
$
|
—
|
|
|
$
|
60,012
|
|
Work-in-process (unbilled labor and consulting)
|
|
|
—
|
|
|
|
60,398
|
|
Total
|
|
$
|
—
|
|
|
$
|
120,410
|
|
Property
and Equipment
Property
and equipment is recorded at cost. Depreciation is computed using straight-line and accelerated methods over the estimated useful
lives of the related assets. Expenditures that enhance the useful lives of the assets are capitalized and depreciated. Maintenance
and repairs are expensed as incurred. When properties are retired or otherwise disposed of, related costs and related accumulated
depreciation are removed from the accounts.
Research
and Development
All
research and development costs are expensed as incurred.
Foreign
Currency Transactions
The
Company accounts for foreign currency translation pursuant to ASC 830. The functional currency of the Company is the United States
dollar. Under ASC 830, all assets and liabilities denominated in foreign currencies are translated into United States dollars
using the current exchange rate at the end of each fiscal period. Revenues and expenses are translated using the average exchange
rates prevailing throughout the respective periods. All transaction gains and losses from the measurement of monetary balance
sheet items denominated in foreign currencies are reflected in the statement of operations as gain (loss) on foreign currency
transactions.
Deferred
Financing Costs
Costs
incurred in connection with obtaining financing are deferred and amortized on a straight-line basis over the term of the related
loan.
Convertible
Instruments
The
Company evaluates and accounts for conversion options embedded in its convertible instruments in accordance with accounting standards
for “Accounting for Derivative Instruments and Hedging Activities.”
Accounting
standards generally provides three criteria that, if met, require companies to bifurcate conversion options from their host instruments
and account for them as free standing derivative financial instruments. These three criteria include circumstances in which (a)
the economic characteristics and risks of the embedded derivative instrument are not clearly and closely related to the economic
characteristics and risks of the host contract, (b) the hybrid instrument that embodies both the embedded derivative instrument
and the host contract is not re-measured at fair value under otherwise applicable generally accepted accounting principles with
changes in fair value reported in earnings as they occur, and (c) a separate instrument with the same terms as the embedded derivative
instrument would be considered a derivative instrument. Professional standards also provide an exception to this rule when the
host instrument is deemed to be conventional as defined under professional standards as “The Meaning of Conventional Convertible
Debt Instrument.”
The
Company accounts for convertible instruments (when it has determined that the embedded conversion options should not be bifurcated
from their host instruments) in accordance with professional standards when “Accounting for Convertible Securities with
Beneficial Conversion Features,” as those professional standards pertain to “Certain Convertible Instruments.”
Accordingly, the Company records, when necessary, discounts to convertible notes for the intrinsic value of conversion options
embedded in debt instruments based upon the differences between the fair value of the underlying common stock at the commitment
date of the note transaction and the effective conversion price embedded in the note. Original issue discounts (“OID”)
under these arrangements are amortized over the term of the related debt to their earliest date of redemption. The Company also
records when necessary deemed dividends for the intrinsic value of conversion options embedded in preferred shares based upon
the differences between the fair value of the underlying common stock at the commitment date of the note transaction and the effective
conversion price embedded in the note.
ASC
815-40 provides that, among other things, generally, if an event is not within the entity’s control could or require net
cash settlement, then the contract shall be classified as an asset or a liability.
Reclassifications
Certain
reclassifications have been made to conform the prior period data to the current presentations.
Recent
Accounting Pronouncements
On May 10, 2017, the
Financial Accounting Standards Board (“FASB”) issued an Accounting Standards Update (“ASU”) 2017-09 “Compensation—Stock
Compensation (Topic 718): Scope of Modification Accounting”, which provides guidance to clarify when to account for a change
to the terms or conditions of a share-based payment award as a modification. Under the new guidance, modification accounting is
required only if the fair value, the vesting conditions, or the classification of the award (as equity or liability) changes as
a result of the change in terms or conditions. The guidance is effective prospectively for all companies for annual periods beginning
on or after December 15, 2017. Early adoption is permitted. The Company is currently evaluating the impact of adopting this guidance.
In January 2017, FASB
issued ASU 2017-01, “Business Combinations (Topic 805) Clarifying the Definition of a Business”. The amendments in
this Update 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
November 2016, the FASB issued ASU 2016-18, “Statement of Cash Flows (Topic 230) Restricted Cash”. The new guidance
requires that the reconciliation of the beginning-of-period and end-of-period amounts shown in the statement of cash flows include
restricted cash and restricted cash equivalents. If restricted cash is presented separately from cash and cash equivalents on
the balance sheet, companies will be required to reconcile the amounts presented on the statement of cash flows to the amounts
on the balance sheet. Companies will also need to disclose information about the nature of the restrictions. The guidance is effective
for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years. The Company is currently evaluating
the impact of adopting this guidance.
In
August 2016, the FASB issued ASU 2016-15, “Statement of Cash Flows (Topic 230) Classification of Certain Cash Receipts and
Cash Payments”. The new guidance is intended to reduce diversity in practice in how certain transactions are classified
in the statement of cash flows. ASU 2016-15 is effective for the Company beginning in the first quarter of fiscal 2019. Early
adoption is permitted, provided that all of the amendments are adopted in the same period. The guidance requires application using
a retrospective transition method. The Company is currently evaluating the impact of adopting this guidance.
In
April 2016, the FASB issued ASU 2016 – 10 “Revenue from Contract with Customers: identifying Performance Obligations
and Licensing”. The amendments in this Update clarify the two following aspects (a) contracts with customers to transfer
goods and services in exchange for consideration and (b) determining whether an entity’s promise to grant a license provides
a customer with either a right to use the entity’s intellectual property (which is satisfied at a point in time) or a right
to access the entity’s intellectual property (which is satisfied over time). The amendments in this Update are intended
to reduce the degree of judgement necessary to comply with Topic 606. This guidance has no effective date as yet. The Company
is currently evaluating the impact of adopting this guidance.
In
March 2016, the FASB issued authoritative guidance regarding the accounting for share-based payment transactions, including income
tax consequences, classification of awards as either equity or liabilities, and classification on the statement of cash flows.
The guidance is to be applied for annual periods beginning after December 15, 2016 and interim periods within those annual periods,
and early adoption is permitted. The guidance requires companies to apply the requirements retrospectively, modified retrospectively,
or prospectively depending on the amendment(s) applied. The Company is currently evaluating the impact of adopting this guidance.
In
February 2016, the FASB issued ASU 2016-02, “Leases” (Topic 842). This guidance will be effective for public entities
for fiscal years beginning after December 15, 2018 including the interim periods within those fiscal years. Early application
is permitted. Under the new provisions, all lessees will report a right-of-use asset and a liability for the obligation to make
payments for all leases with the exception of those leases with a term of 12 months or less. All other leases will fall into one
of two categories: (i) Financing leases, similar to capital leases, which will require the recognition of an asset and liability,
measured at the present value of the lease payments and (ii) Operating leases which will require the recognition of an asset and
liability measured at the present value of the lease payments. Lessor accounting remains substantially unchanged with the exception
that no leases entered into after the effective date will be classified as leveraged leases. For sale leaseback transactions,
the sale will only be recognized if the criteria in the new revenue recognition standard are met. The Company is currently evaluating
the impact of adopting this guidance.
In
January 2016, the FASB issued ASU 2016-01, which amends the guidance relating to the classification and measurement of financial
instruments. Changes to the current guidance primarily affect the accounting for equity investments, financial liabilities under
the fair value option, and the presentation and disclosure requirements for financial instruments. In addition, the ASU clarifies
guidance related to the valuation allowance assessment when recognizing deferred tax assets resulting from unrealized losses on
available-for-sale debt securities. The new standard is effective for fiscal years and interim periods beginning after December
15, 2017, and upon adoption, an entity should apply the amendments by means of a cumulative-effect adjustment to the balance sheet
at the beginning of the first reporting period in which the guidance is effective. Early adoption is not permitted except for
the provision to record fair value changes for financial liabilities under the fair value option resulting from instrument-specific
credit risk in other comprehensive income. The Company is currently evaluating the impact of adopting this guidance.
In
August 2015, the FASB issued ASU 2015-14, “Revenue From Contracts With Customers (Topic 606)”. The amendments in this
ASU defer the effective date of ASU 2014-09 “Revenue From Contracts With Customers (Topic 606)”. Public business entities
should apply the guidance in ASU 2014-09 to annual reporting periods beginning after December 15, 2017, including interim reporting
periods within that reporting period. Earlier application is permitted only as of annual reporting periods beginning after December
15, 2016, including interim reporting periods within that reporting period. The Company is still evaluating the impact of adopting
this guidance.
All
newly issued but not yet effective accounting pronouncements have been deemed to be not applicable or immaterial to the Company.
NOTE
3 - ACQUISITIONS, GOODWILL AND INTANGIBLE ASSETS
Acquisition
of SolBright Renewable Energy, LLC
On
May 1, 2017, the Company completed an acquisition (the “Asset Purchase”) pursuant to an Asset Purchase Agreement dated
May 1, 2017 (the “Asset Purchase Agreement”) with SolBright Renewable Energy, LLC (“SolBright”), pursuant
to which the Company acquired substantially all of the assets, and certain specified liabilities, of SolBright used in the operation
of SolBright’s solar engineering, procurement and construction business (the “SolBright Assets”, the transaction
shall collectively be referred to herein as the “Acquisition”).
In
consideration for the purchase of the SolBright Assets, the Company delivered to SolBright (i) $3,000,000 in cash (the “Cash
Payment”), (ii) a Senior Secured Promissory Note in the principal amount of $2,000,000 (the “Secured Promissory Note”),
described below, (iii) a Convertible Promissory Note in the principal amount of $6,000,000 (“Preferred Stock Note”),
described below, and (iv) the Common Stock Consideration, described below.
The
Secured Promissory Note matures on May 1, 2020 barring any events of default, and that maturity date shall accelerate and the
Secured Promissory Note along with accrued but unpaid interest shall be paid in full on the closing of an equity financing in
which the Company issues equity securities which yield gross cash proceeds to the Company of at least $10,000,000 (excluding redeemable
or convertible notes) or results in a change of control of the Company. The Company shall make prepayments of principal on a quarterly
basis pursuant to the terms of the Secured Promissory Note if such funds are available. The Secured Promissory Note bears interest
at 15% per annum, payable on a quarterly basis with the first payment due on May 31, 2017. The Secured Promissory Note is secured
with a second priority lien on the Company’s accounts receivable relating to the solar engineering, procurement and construction
business of SolBright acquired by it pursuant to the Asset Purchase Agreement, with such lien being junior only to the first priority
security position granted pursuant to the AIP Note Purchase Agreement and the Security Agreement, both dated May 1, 2017.
The
Preferred Stock Note matures on July 31, 2018 barring any demands following an event of default, provided that the Company shall
make prepayments of principal on a quarterly basis pursuant to the terms of the Preferred Stock Note if such funds are available.
The Preferred Stock Note bears interest at 4% per annum, provided that upon and during an event of default it shall bear interest
at 12% per annum. Interest is payable quarterly in arrears commencing on May 1, 2017 and on the first business day of each August,
November, February and May thereafter. The Preferred Stock Note will automatically convert, on the date that the Company’s
Certificate of Designation for the Company’s 4% Series A Convertible Preferred Stock is filed with the Secretary of State
of the State of Delaware and becomes effective, into a number of shares of the Company’s Series A 4% Convertible Preferred
Stock, par value $0.0001 per share, equal to the outstanding principal and interest on the Preferred Stock Note divided by $1.50
per share, as adjusted for any stock splits, stock dividends, recapitalizations, combinations and the like that may occur prior
to such conversion. The Company has agreed in the Asset Purchase Agreement to take the actions required for the automatic conversion
of the Preferred Stock Note promptly following the closing of the Asset Purchase.
In
connection with the Asset Purchase Agreement, and in addition to the consideration represented by the Cash Payment, the Secured
Promissory Note and the Preferred Stock Note, the Company issued to SolBright 4,000,000 shares of the Company’s common stock
at a fair value of $1.28 per share (the “Common Stock Consideration”). The Common Stock Consideration is subject to
anti-dilution protection if, within 120 days of the closing of the Asset Purchase, the Company sells shares of its common stock
at a price per share that is less than one dollar per share, in which case it shall issue additional shares of common stock to
SolBright so that the total number of shares the Company has issued to SolBright equals $4,000,000 divided by such lower price
per share.
The
Company’s non-exclusive placement agent for the AIP Financing and the 2017 Convertible Notes Private Placement and earned
a fee equal to 8% of the aggregate gross cash proceeds from each of these transactions.
The
purchase price for the SolBright Renewable Energy, LLC acquisition was allocated as follows:
Costs in
excess of billing
|
|
$
|
1,001,083
|
|
Other current assets
|
|
|
33,175
|
|
Property and equipment
|
|
|
21,101
|
|
Intangible assets
|
|
|
2,764,000
|
|
Goodwill
|
|
|
13,039,399
|
|
Total
assets acquired
|
|
$
|
16,858,758
|
|
|
|
|
|
|
Accounts payable and
accrued liabilities
|
|
|
635,832
|
|
Billings
in excess of WIP
|
|
|
102,926
|
|
Total
liabilities assumed
|
|
|
738,758
|
|
Net
assets acquired
|
|
$
|
16,120,000
|
|
|
|
|
|
|
The purchase price
consists of the following:
|
|
|
|
|
Cash
|
|
|
3,000,000
|
|
Convertible note
|
|
|
6,000,000
|
|
Senior Secured Promissory
Note
|
|
|
2,000,000
|
|
Common
stock
|
|
|
5,120,000
|
|
Total purchase
price
|
|
$
|
16,120,000
|
|
The application
of the acquisition method of accounting is dependent upon certain valuations and other studies that have yet to be completed.
The purchase price allocation will remain preliminary until management determines the fair values of assets acquired and liabilities
assumed. The final determination of the purchase price allocation is anticipated to be completed as soon as practicable after
completion of the transaction and will be based on the fair values of the assets acquired and liabilities assumed as of the transaction
closing date. The final amounts allocated to assets acquired and liabilities assumed could differ significantly from the amounts
presented.
The
following unaudited pro forma consolidated results of operations have been prepared, as if the Asset Purchase had occurred as
of June 1, 2016 and 2015:
|
|
For the Years May 31,
|
|
|
|
2017
|
|
|
2016
|
|
|
|
(Unaudited)
|
|
|
(Unaudited)
|
|
Revenues
|
|
$
|
8,748,262
|
|
|
$
|
13,988,356
|
|
Net loss from continuing operations
|
|
$
|
(3,320,081
|
)
|
|
$
|
(4,461,701
|
)
|
Weighted average number of common shares – Basic and diluted
|
|
|
14,370,519
|
|
|
|
12,126,367
|
|
Net loss per share from continuing operations
|
|
$
|
(0.23
|
)
|
|
$
|
(0.37
|
)
|
NOTE
4 - ASSET SALE AND DEBT SUBJECT TO EQUITY BEING ISSUED
In
December 2010, the Company entered into an agreement to sell substantially all of the assets (the “Asset Sale”) to
STMicroelectronics, Inc. (“ST US”), a subsidiary of STMicroelectronics N.V. (“ST”). The Asset Sale was
predicated on the Company settling its secured debt and a significant part of its unsecured debt and closed in June 2011.The Company
is negotiating with its remaining unsecured debt holders to compromise, extend the due date or convert outstanding debt into equity.
Debt holders who have agreed to settle through receipt of the Company’s equity are labeled as “Debt Subject to Equity
Being Issued” on the balance sheet. Except as set forth above, there is no binding commitment on anyone’s part to
complete the transactions.
Debt
Subject to Equity Being Issued
As
a direct result of the Sale of the License and IP Agreements to ST US and the mandate to obtain debt releases, the Company has
been able to reach settlements with its secured creditors and employees, with cash payments to the secured creditors made as of
the December 2010 and June 2011 closings. Nothing further is owed to the Company’s secured creditors. There remains, however,
approximately $179,000 of payments due the former employees as of May 31, 2017 and 2016.
As
of May 31, 2017 and 2016, there remained $456,930 of debts that have been settled with debt holders who have agreed to accept
equity for their remaining debt.
NOTE
5 - ACCOUNTS PAYABLE AND ACCRUED EXPENSES
As
of May 31, 2017 and 2016, accounts payable and accrued expenses consist of the following amounts:
|
|
May
31,
|
|
|
May
31,
|
|
|
|
2017
|
|
|
2016
|
|
Accounts
payable
|
|
$
|
2,146,516
|
|
|
$
|
782,654
|
|
Accrued
interest payable
|
|
|
236,351
|
|
|
|
116,035
|
|
Accrued
payroll
|
|
|
15,129
|
|
|
|
28,320
|
|
Accrued
other
|
|
|
145,946
|
|
|
|
95,373
|
|
|
|
$
|
2,543,942
|
|
|
$
|
1,022,382
|
|
NOTE
6 – NOTE PAYABLE
Notes
Payable
Notes
payable transactions include the following:
Fiscal
Year 2016 (Year Ended May 31, 2016) Transactions
In
January 2016, the Company executed a promissory note for a loan in the principal amount of $60,000. The promissory note bears
interest at 6% per year, compounded quarterly, and matures on January 15, 2017 (the “January Note”). The proceeds
from the January Note were used to partially repay two convertible notes as discussed below. In January 2017, the Company and
holder amended this promissory note to extend the maturity date to March 31, 2017. Effective March 31, 2017, the Company and holder
amended this promissory note further to extend the maturity date to June 15, 2017.
On January 8, 2016,
the Company entered into an Exchange Agreement with the noteholders of two 6% convertible notes in the aggregate principle amount
of $130,000 (collectively the “Convertible Notes”) that were in default. On January 15, 2016, the Company applied
the proceeds of the 2016 Notes together with the issuance of 50,000 shares of the Company’s common stock, to the payment
of the Convertible Notes. In exchange for the payment and the shares, the holders of the Convertible Notes surrendered their notes,
and the Company issued a new 6% Convertible Note to them in the original principal amount of $40,000 (“Reissued Note”).
The holders further agreed that their extension of the maturity of the Convertible Notes had been effective from October 31, 2015
until January 15, 2016. The Reissued Note bears interest at the rate of 6% per year, compounded quarterly, and matured on December
31, 2016. In January 2017, the Company and holder agreed to extend the maturity date of the Reissued Note to March 31, 2017. Effective
March 31, 2017, the Company and holder amended this promissory note further to extend the maturity date to May 15, 2017. The Reissued
Note was in default as of May 31, 2017. At any time during the term of the Reissued Note, the holders have the right to convert
any unpaid portion of the Reissued Note and accrued interest into shares of common stock at an original conversion price of $1.20
per share. The Company has evaluated the conversion terms and determined that a beneficial conversion feature is not applicable
for this exchange transaction. As of May 31, 2017 the balance of the convertible loan amounted to $ 40,000. This note was paid
in full through repayments made in June 2017 and August 2017.
On March 31, 2016
and May 6, 2016, the Company executed promissory notes for loans, each in the amount of $10,000 (collectively with the January
Note, the “2016 Notes”). The promissory notes bear interest at 6% per year, compounded quarterly. Both notes matured
on June 30, 2016. The proceeds from the promissory notes were used to partially repay the Convertible Notes as discussed above.
The holders further agreed that their extension of the maturity of the outstanding promissory notes had been effective from June
30, 2016 until January 15, 2017. In January 2017, the Company executed an amendment to the promissory notes to extend the maturity
date to March 31, 2017. Effective March 31, 2017, the Company and holder amended this promissory note further to extend the maturity
date to May 15, 2017. Effective August 29, 2017, the Company and holder amended this promissory note further to extend the maturity
date to December 31, 2017. As of May 31, 2017 the balance of these loans amounted to $ 20,000.
Fiscal
Year 2017 (Year Ended May 31, 2017)
In August 2016, the
Company issued a promissory note in the amount of $150,000 with a maturity date in January 15, 2017. The loan bears interest at
10% per annum compounded quarterly. In January 2017, the Company and holder amended this promissory note to extend the maturity
date to March 31, 2017. Effective March 31, 2017, the Company and holder amended this promissory note to extend the maturity date
to May 15, 2017, and subsequently amended this promissory note to extend the maturity date to December 31, 2017. As of May 31,
2017 the balance of the promissory loan amounted to $ 150,000.
On October 28, 2016,
the Company issued a convertible promissory note for an aggregate principal amount of $38,500 (which includes an Original Issue
Discount (“OID”) of $3,500) with a maturity date of January 30, 2017. The debenture is convertible only upon default
after January 30, 2017 at a conversion price of 65% of the average of the three lowest traded prices occurring during the 25 consecutive
trading days immediately preceding the applicable conversion date. As additional consideration, the Company issued 20,000 shares
of common stock upon execution of this agreement. Accordingly, the Company recorded debt discount of $11,793 related to the restricted
shares issued, and an original issue discount of $3,500. The debt discount and OID is amortized on a straight-line basis over the
term of the loan and amounted to $15,293 as of May 31, 2017. On January 27, 2017, the Company and holder amended this promissory
note to extend maturity date to March 31, 2017. On March 31, 2017, the Company and holder amended this promissory note to extend
the maturity date to April 21, 2017 and the conversion rate to $0.60. As a result, the Company recorded a debt discount of $26,707
which was fully amortized upon settlement. This note was settled in full on April 27, 2017 for $35,000 and 30,000 shares of the
Company’s common stock.
On January 27, 2017,
the Company issued a convertible promissory note for an aggregate principal amount of $38,500 (which includes an OID of $3,500)
with a maturity date of March 31, 2017. The debenture is convertible only upon default after March 31, 2017 at a conversion price
of 65% of the average of the three lowest traded prices occurring during the 25 consecutive trading days immediately preceding
the applicable conversion date. As additional consideration, the Company issued 20,000 shares of common stock upon execution of
this agreement. Accordingly, the Company recorded debt discount of $14,398 related to the restricted shares issued, and an original
issue discount of $3,500. The debt discount and OID is amortized on a straight-line basis over the term of the loan and amounted
to $17,898 as of May 31, 2017. On March 31, 2017, the Company and holder amended this promissory note to extend the maturity date
to April 21, 2017 and the conversion rate to $0.60. As a result, the Company recorded a debt discount of $24,101 which was fully
amortized upon settlement. This note was settled in full on April 27, 2017 for $35,000 and 20,000 shares of the Company’s
common stock.
On February 1, 2017,
the Company issued a convertible promissory note for an aggregate principal amount of $125,000 (which includes an OID of $12,000)
with a maturity date of October 1, 2017. The debenture is convertible only upon default after October 1, 2017 at a conversion
price of 60% of the of the lowest traded price occurring during the 20 consecutive trading days immediately preceding the applicable
conversion date. Accordingly, the Company recorded a debt discount of $121,886 related to the beneficial conversion feature, and
OID. The debt discount and OID is amortized on a straight-line basis over the term of the loan and amounted to $59,935 as of May
31, 2017. Net discount and net loan balance amounted to $61,950 and $63,050 respectively, as of May 31, 2017 and is recorded in
convertible debentures.
Long-Term
Convertible Debenture
On November 11, 2016,
the Company entered into a Securities Purchase Agreement whereas, the buyer wishes to purchase from the Company securities consisting
of the Company’s convertible debentures due three years from issuance for an aggregate principal amount of up to $500,000
(which includes an aggregate purchase price of $450,000 and 10% OID of $50,000) (the “Debentures“). The Debentures
are to be issued in three tranches. On November 11, 2016, the Company issued the first of the three Debentures amounting to $150,000
of principal, consisting of $135,000 in proceeds and $15,000 OID. The debenture is convertible at a conversion price of $0.65 up
to 150 days after the issuance date and if no event of default. If an Event of Default, as such term is defined in the Debentures,
has occurred, or 150 days after the Issuance Date, as such term is defined in the Debentures, the conversion price is the lesser
of (a) $0.65 or (b) sixty five percent (65%) of the lowest closing bid price of the common stock for the twenty (20) trading days
immediately preceding the date of the date of conversion of the Debentures. Accounting for derivatives will be evaluated after
180 days of issuance or upon default, if applicable where at that point the conversion price becomes variable. As additional consideration,
the Company issued 50,000 shares of common stock upon execution of this agreement. In relation to this transaction the Company
also incurred deferred financed costs totaling $6,000 for legal fees and commitment fees. Accordingly, the Company recorded debt
discount of $38,337 related to the restricted shares issued, a debt discount of $74,530 related to the beneficial conversion feature,
an OID of $15,000 and deferred finance cost of $6,000. As of May 31, 2017, total straight-line amortization for these transactions
amounted to $24,573 which resulted in a net discount of $109,294 and a net loan balance of $40,706 classified as long-term convertible
debt.
On March 1, 2017, the
Company issued a 10% promissory note in the principal amount of $100,000 due March 31, 2017 to an accredited investor, along with
warrants to purchase 100,000 shares of the Company’s common stock with a three-year term and an exercise price of $.60 per
share. Accordingly, the Company recorded debt discount of $40,120 related to the warrants issued which was fully amortized as of
May 31, 2017. Effective March 31, 2017, the Company and the accredited investor entered into an amendment to 10% promissory note,
pursuant to which the parties agreed to extend the maturity date of the promissory note to May 15, 2017. Effective August 29, 2017,
the Company and holder amended this promissory note further to extend the maturity date to December 31, 2017. The net loan balance
of $100,000 is classified in short-term notes payable.
On March 3, 2017, the
Company issued a 10% convertible promissory note in the principal amount of $103,000 due November 3, 2017 to an accredited investor
(the “Convertible Promissory Note“), along with warrants to purchase 50,000 shares of the Company’s common stock
with a three-year term and an exercise price of $.60 per share. The Convertible Promissory Note may be converted pursuant to the
provisions of the Convertible Promissory Note upon a Prepayment Default or an Event of Default, as such terms are defined in the
Convertible Promissory Note, at a 40% discount to the lowest trading price during the previous (20) trading days to the date of
a Conversion Notice, as such term is defined in the Convertible Promissory Note. Accordingly, the Company recorded debt discount
of $89,337 related to the warrants and a $3,000 related to the deferred financing costs. As of May 31, 2017, total straight-line
amortization for these transactions amounted to $33,543, resulting in a net discount of $58,794 and a net loan balance of $44,206
classified as short-term convertible debentures, net of debt discount.
On March 7, 2017,
the Company issued a 10% promissory note in the principal amount of $100,000 due March 31, 2017 to an accredited investor, along
with warrants to purchase 100,000 shares of the Company’s common stock with a three-year term and an exercise price of $.60
per share. Accordingly, the Company recorded debt discount of $40,120 related to the warrants issued which was fully amortized
as of May 31, 2017. On April 20, 2017, the Company and the accredited investor entered into an amendment to 10% promissory note,
pursuant to which the parties agreed to extend the maturity date of the promissory note to April 21, 2017. The note was converted
in full to 169,886 shares of common stock on May 31, 2017. This note was settled in full effective March 31
st
for 169,886
shares of common stock and 169,886 warrants to purchase common stock at $1.00 per share.
AIP
Financing
On
May 1, 2017, the Company completed a financing transaction with AIP Asset Management Inc. (the “Security Agent”),
AIP Global Macro Fund, LP (“AGMF”), AIP Global Macro Class (“AGMC”) and AIP Canadian Enhance Income Class
(“ACEIC” and together with AGMF and AGMC, collectively, “AIP”), pursuant to which we raised capital by
issuing 10% Secured Convertible Promissory Notes (the “10% Secured Convertible Notes”) in the aggregate principal
amount of $2,500,000 to AIP and AIP Private Capital Inc. (collectively, the “Holders”) in accordance with the terms
of the AIP Note Purchase Agreement dated May 1, 2017 (the “AIP Note Purchase Agreement”) with AIP (the “AIP
Financing”). In connection with the issuance of the 10% Secured Convertible Notes, the Company and its subsidiaries entered
into a Security Agreement dated May 10, 2017 (the “Security Agreement”) with the Security Agent, pursuant to which
the Company granted the Security Agent a security interest in substantially all the Company’s assets the those of the Company’s
subsidiaries. In addition, pursuant to the AIP Note Purchase Agreement, the Company issued warrants (the “AIP Warrants”)
to the Holders to purchase 2,500,000 shares of the Company’s common stock, subject to adjustment for certain events, such
as stock splits and stock dividends, at an exercise price of $1.00 per share, and which have five year terms.
The
principal amount of the 10% Secured Convertible Notes exceeds the cash consideration paid by the Holders for such notes, with
such excess representing a 15% original issue discount. The 10% Secured Convertible Notes mature on May 1, 2018 unless earlier
converted pursuant to the terms of the AIP Note Purchase Agreement. The 10% Secured Convertible Notes bear interest at 10% per
annum, provided that during an Event of Default (as defined in the AIP Note Purchase Agreement) it shall bear interest at 20%
per annum, payable on a monthly basis. The 10% Secured Convertible Notes are secured with a first priority lien as set forth in
the Security Agreement. The outstanding principal and interest under the 10% Secured Convertible Notes is convertible at the option
of the Holder of each of the 10% Secured Convertible Notes into shares of the Company’s common stock at $0.80 per share,
or $0.60 if the Company has not raised $500,000 in the 90 days following the closing (which it has done), or, upon an uncured
Event of Default (as defined in the AIP Note Purchase Agreement), the lesser of the closing bid of the Company’s common
stock on the day notice of conversion is given or 75 percent of the price of Shares in any registered offering.
In
connection with the AIP Financing, the Company and the Holders entered into a Registration Rights Agreement under which the Company
required, in no event later than 75 calendar days after the closing of the AIP Financing, to file a registration statement with
the SEC covering the resale of the shares of the Company’s common stock issuable on conversion of the 10% Secured Convertible
Notes and exercise of the AIP Warrants and to use reasonable best efforts to have the registration declared effective as soon
as practicable, but in no event later than 120 days after the closing of the AIP Financing. The Company will be subject to certain
monetary penalties, as set forth in the Registration Rights Agreement, if the registration statement is not filed, does not become
effective on a timely basis, or does not remain available for the resale (subject to certain allowable grace periods) of the Registrable
Securities, as such term is defined in the Registration Rights Agreement.
In
relation to this transaction, the Company recorded debt discount of $1,250,000 related to the warrants issued, a debt discount
of $250,000 related to the beneficial conversion feature, an OID of $375,000 and deferred finance cost of $175,833. As of May
31, 2017, total straight-line amortization for these transactions amounted to $168,562 which resulted in a net discount of $1,882,274
and a net loan balance of $617,727 classified as convertible debentures, net of debt discount.
9%
Convertible Notes
On
April 21, 2017, the Company closed a private placement (the “2017 Convertible Notes Private Placement”) of $899,999
principal amount of its 9% Convertible Promissory Notes (the “9% Convertible Notes”) and common stock purchase warrants
(the “2017 Notes Offering Warrants”) issued to L2 Capital LLC (“L2”) and SBI Investments LLC 2014-1 (“SBI”
and together with L2, the “Note Investors”). The 9% Convertible Notes and the 2017 Notes Offering Warrants were issued
pursuant to Note Purchase Agreements (the “Note Purchase Agreements”), dated April 21, 2017, to each of the Note Investors,
in substantially the same form.
The
9% Convertible Notes mature on October 21, 2017 unless earlier converted pursuant to the terms of the Note Purchase Agreements.
The 9% Convertible Notes bear interest at 9% per annum. The outstanding principal and interest under the 9% Convertible Notes,
solely upon an Event of Default (as defined in the 9% Convertible Notes) that is not cured within five business days, are convertible
at the option of each of the Note Investors into shares of the Company’s common stock at an exercise price equal to 60%
of the lowest traded price of the common stock on the OTC Pink Marketplace during the 30 trading days prior to the conversion
date (the “Market Price”).
As
a part of the 2017 Convertible Notes Private Placement, the Company issued 2017 Notes Offering Warrants to the Note Investors
providing them with the right to purchase, in the aggregate, up to 1,279,998 shares of the Company’s common stock at an
initial exercise price equal to the lesser of (i) $0.60 and (ii) 75% of the offering price of the Company’s common stock
in the Company’s next publicly registered offering, subject to adjustment for certain events such as stock splits and stock
dividends. Subject to certain limitations, the 2017 Notes Offering Warrants are exercisable on any date after the date of issuance
for a term of five years. As of the date of this filing, these warrants have been exercised. On May 16, 2017, L2 exercised their
831,168 warrants in a cashless exercise for 447,552 shares of the Company’s common stock at $0.60 per share.
In
relation to this transaction, the Company recorded debt discount of $560,343 related to the warrants issued, a debt discount of
$339,656 related to the beneficial conversion feature, an OID of $107,999 and deferred finance cost of $12,000. As of May 31,
2017, total straight-line amortization for these transactions amounted to $226,666 which resulted in a net discount of $793,332
and a net loan balance of $106,667 classified as convertible debentures, new of debt discount.
SolBright
Notes
As
part of the consideration for the purchase of the SolBright Assets, the Company delivered to SolBright a Senior Secured Promissory
Note in the principal amount of $2,000,000 and a Convertible Promissory Note in the principal amount of $6,000,000 and are classified
as long-term convertible notes payable and long-term convertible debt (See Note 3).
NOTE
7 – INCOME TAXES
There
was no provision for federal or state taxes for both of the years ended May 31, 2017 and 2016.
The
components of deferred taxes were as follows:
|
|
May 31,
|
|
|
May 31,
|
|
|
|
2017
|
|
|
2016
|
|
Deferred tax assets:
|
|
|
|
|
|
|
|
|
Net operating loss carry forward
|
|
$
|
7,832,000
|
|
|
$
|
7,219,000
|
|
Changes in prior year estimates
|
|
|
42,000
|
|
|
|
150,000
|
|
Valuation allowance
|
|
|
(7,874,000
|
)
|
|
|
(7,369,000
|
)
|
Net deferred tax asset
|
|
$
|
—
|
|
|
$
|
—
|
|
The
Company has a valuation allowance against the full amount of its net deferred taxes due to the uncertainty of realization of the
deferred tax assets due to operating loss history of the Company. The Company currently provides a valuation allowance against
deferred taxes when it is more likely than not that some portion, or all of its deferred tax assets will not be realized. The
valuation allowance could be reduced or eliminated based on future earnings and future estimates of taxable income.
A
reconciliation of the statutory federal income tax benefit to actual tax benefit for the years ended May 31, 2017 and 2016 is
as follows:
|
|
2017
|
|
|
2016
|
|
Federal statutory income tax rates
|
|
|
(35
|
)%
|
|
|
(35
|
)%
|
State statutory income tax rate, net of federal benefit
|
|
|
(5
|
)
|
|
|
(5
|
)
|
Permanent differences – equity rights
|
|
|
6
|
|
|
|
24
|
|
Incentive stock options
|
|
|
7
|
|
|
|
—
|
|
Non-deductible amortization of debt discount
|
|
|
8
|
|
|
|
—
|
|
Goodwill amortization
|
|
|
(1
|
)
|
|
|
—
|
|
Other
|
|
|
—
|
|
|
|
3
|
|
Change in valuation allowance
|
|
|
20
|
|
|
|
13
|
|
|
|
|
|
|
|
|
|
|
Effective tax rate
|
|
|
—
|
%
|
|
|
—
|
%
|
As of May 31, 2017,
the Company has federal net operating loss carryforwards of approximately $20,000,000 subject to expiration between fiscal years
2027 and 2037. The Company may have had a greater than 50% change in ownership of certain stock holdings by shareholders of the
Company pursuant to Section 382 of the Internal Revenue Code. The net operating losses may be limited as to its utilization on
an annual basis. Currently, no such evaluation has been performed.
The
Company has not been audited by the Internal Revenue Service (“IRS”) or any states in connection with income taxes.
The periods from fiscal 2013 through 2017 remain open to examination by the IRS and state jurisdictions. The Company believes
it is not subject to any tax audit risk beyond those periods. The Company’s policy is to recognize interest and penalties
accrued on any unrecognized tax benefits as a component of interest expense. The Company does not have any accrued interest or
penalties associated with any unrecognized tax benefits, nor was any interest expense recognized during the years ended May 31,
2017 and 2016.
NOTE
8 - STOCKHOLDERS’ DEFICIENCY
Preferred
Stock
On
April 28, 2017, the Company’s Board of Directors adopted resolutions authorizing an amendment (the “Amendment”)
to the Company’s amended certificate of incorporation to authorize the Board of Directors, without further vote or action
by the stockholders, to create out of the unissued shares of the Company’s preferred stock, par value $0.001 per share (“Preferred
Stock”), series of Preferred Stock and, with respect to each such series, to fix the number of shares, designations, preferences,
voting powers, qualifications, and special or relative rights or privileges as the Board of Directors shall determine, which may
include, among others, dividend rights, voting rights, liquidation preferences, conversion rights and preemptive rights (the “Board
Authorization”). The certificate of incorporation authorizes the issuance of 5,000,000 shares of Preferred Stock, none of
which are issued or outstanding as of May 31, 2017.
Upon
effectiveness of the Amendment, the Board of Directors will have the authority to issue shares of Preferred Stock from time to
time on terms it may determine, to divide shares of preferred stock into one or more series and to fix the designations, preferences,
privileges, and restrictions of preferred stock, including dividend rights, conversion rights, voting rights, terms of redemption,
liquidation preference, and the number of shares constituting any series or the designation of any series to the fullest extent
permitted by the General Corporation Law of Delaware. The issuance of Preferred Stock could have the effect of decreasing the
trading price of the Common Stock, restricting dividends on the capital stock, diluting the voting power of the Common Stock,
impairing the liquidation rights of the capital stock, or delaying or preventing a change in control of the Company.
Series
A Convertible Preferred Stock
As
described above, upon the effectiveness of the Amendment, the Board shall authorize the filing of the Certificate of Designation
in the form filed as an exhibit to this registration statement for its Series A Convertible Preferred Stock in order to meet its
obligations to SolBright under the Asset Purchases Agreement and the Preferred Stock Note. The rights, preferences, privileges
and restrictions of the shares of Series A Convertible Preferred Stock and the qualifications, limitations and restrictions thereof
are summarized as follows:
|
●
|
The
shares of Series A Convertible Preferred Stock have a stated value of $1.50 per share
(the “Stated Value”).
|
|
●
|
Each
holder of a share of Series A Convertible Preferred Stock shall be entitled to receive
dividends (“
Accruing Dividends
”) on such share equal to four percent
(4%) per annum (the “
Dividend Rate
”) of the stated value before any
Dividends shall be declared, set apart for or paid upon any junior stock or parity stock.
Dividends on a share of Series A Convertible Preferred Stock shall accrue daily at the
Dividend Rate, commence accruing on the issuance date thereof, compound annually, be
computed on the basis of a year consisting of twelve 30-day months and payable in cash.
|
|
●
|
Each
share of Series A Convertible Preferred Stock is convertible, at the option of the holders,
into that number of shares of Common Stock determined by dividing the Stated Value by
the Conversion Price which the parties agreed would be $1.50 (subject to stock splits,
stock dividends, recapitalizations, combinations and the like that may occur prior to
such conversion).
|
|
●
|
The
Company may redeem any or all of the outstanding Series A Convertible Preferred Stock
(a “Company Redemption”) from time to time but only if “Redemption
Funds” (defined below) are available for such redemption at a redemption price
that shall equal the Stated Value per share, plus any Accruing Dividends accrued but
unpaid thereon through the date chosen by the Company for the redemption. The Company’s
Board of Directors shall determine no later than 20 days after the end of each fiscal
quarter if Redemption Funds are available for a Company Redemption for such quarter,
and if Redemption Funds are deemed available, then the Company shall notify the holders
no later than 30 days after the end of the respective Company fiscal quarter. The Company
is under no obligation to redeem any Series A Convertible Preferred Stock shares if such
redemption would result in a violation of law, including any violation of the Delaware
General Corporation Law. “Redemption Funds” means (a) during the period from
the closing date of the Asset Purchase transaction (the “Closing Date”) until
any and all amounts due under that certain 15% Secured Promissory Note (“Buyer
Promissory Note”), which note was issued concurrently with the Preferred Stock
Note as part of the consideration paid to Buyer, has been fully paid and the Buyer Promissory
Note has been extinguished, the amount that equals (i) 50% of the earnings before interest,
taxes, depreciation and amortization (“EBITDA”) of the “Business”
(as defined in the Asset Purchase Agreement), calculated in accordance with generally
accepted accounting principles, for the last four quarters preceding the Redemption Funds
calculation, minus (ii) the sum of all dividend payments paid by the Company to the holder
for the Series A Convertible Preferred Stock during the last 12 months preceding the
Redemption Funds calculation, minus (iii) $1,200,000; and (b) during the period from
the date the Buyer Promissory Note has been extinguished until the Series A Convertible
Preferred Stock has been fully redeemed, the amount that equals (x) 100% of the EBITDA
of the “Business” (as defined in the Asset Purchase Agreement), calculated
in accordance with generally accepted accounting principles, for the last four quarters
preceding the Redemption Funds calculation, minus (y) the sum of all dividend payments
paid by the Company to the holder for the Series A Convertible Preferred Stock during
the last 12 months preceding the Redemption Funds calculation, minus (z) $1,200,000;
provided, however, since the Redemption Funds calculation is intended to cover a full
twelve-month period, until the Redemption Funds calculation period includes a full twelve-month
period after the Closing Date, the calculation of the Redemption Funds shall be adjusted
for each of (a)(i) and (ii), and (b)(x) and (y) above, by dividing the amount so calculated
in such subsection by the number of days between the Closing Date and the end of such
calculation period, and then multiplying such amount by 365.
|
|
●
|
The
shares of Series A Convertible Preferred Stock are senior in liquidation preference to
all shares of the Company’s common stock, all classes of the Company’s securities
established prior to the original issue date of the Series A Convertible Preferred Stock
(the “Original Issue Date”) and each other capital stock or series of Company’s
preferred stock established after the Original Issue Date by the Board of Directors,
the terms of which do not expressly provide that such class or series ranks senior to
or on a parity with the Series A Preferred Stock as to dividend rights or rights upon
the liquidation, winding-up or dissolution of the Company.
|
|
●
|
The
shares of Series A Convertible Preferred Stock shall have no voting rights except as
required by law. However, the consents of the holders of a majority of the shares of
Series A Convertible Preferred Stock is necessary for us to amend the Series A Convertible
Preferred Stock certificate of designation.
|
Common
Stock
Each
outstanding share of Common Stock entitles the holder thereof to one vote per share on all matters. Holders of Common Stock do
not have preemptive rights to purchase shares in any future issuance of Common Stock. Upon the Company’s liquidation, dissolution
or winding up, and after payment of creditors and preferred stockholders, if any, the Company’s assets will be divided pro-rata
on a share-for-share basis among the holders of Common Stock.
Increase
in Authorized Shares
A
majority of the Company’s stockholders authorized, at the recommendation of the Company’s Board of Directors, an increase
the number of shares of common stock from 100,000,000 to 600,000,000. The increase became effective on March 17, 2014.
Reverse
Stock Split
Effective
March 18, 2015, the Company implemented a reverse stock split of its outstanding common stock at a ratio of 1-for-30 shares. In
connection with the reverse stock split, the Company’s Certificate of Incorporation was amended such that the Company’s
issued and outstanding common stock was proportionally reduced. The number of authorized shares and the par value of the Company’s
common stock and preferred stock were not affected by the reverse stock split. Stockholders will not receive fractional shares
but instead will receive cash in an amount equal to the fraction of a share that stockholder would have been entitled to receive
multiplied by the sale price of the common stock as last reported on February 12, 2015, the last business day prior to the first
public disclosure/announcement of the reverse stock split.
Fiscal
Year 2016 (Year Ended May 31, 2016)
The
following transactions affected the Company’s Stockholders’ Deficiency for Fiscal Year 2016:
a. On
June 25, 2015, the Company issued 108,333 shares of common stock to its chairman/chief executive officer and 35,000 shares of
common stock to an officer/former director for services rendered to the Company’s board of directors in fiscal 2015. The
shares were valued at $1.75 per share. The value of the shares totaling $250,833 was charged as stock compensation in fiscal 2015.
b. For
the period June 1, 2015 through May 31, 2016, 838,334 shares of common stock were subscribed for under the PPO and the Company
received proceeds of $503,000. These shares were issued in July and August 2015.
c. On
January 8, 2016, the Company issued 50,000 shares as part of a debt conversion and refinance whereby $130,000 of note principle
and accrued interest of $11,332 were extinguished and a new note of $100,000 was issued.
d. On
February 23, 2016, the Company entered into a consulting agreement with LPF Communications under which LPF Communications is to
provide certain investor relations services for a period of up to six months. The Company has agreed to pay for the services by
issuing two tranches of 150,000 shares of the Company’s Common Stock each, with the second tranche becoming issuable only
if the Company does not terminate the consulting agreement on or prior to June 8, 2016. Pursuant to the agreement, the Company
issued the first tranche of 150,000 shares to the consultant on April 8, 2016.
e. On
April 22, 2016, the Company issued 675,000 shares of common stock to its key employees, including 500,000 shares to its chairman/chief
executive officer, for services rendered to the Company in fiscal 2016. The shares were valued at $0.51 per share. The value of
the shares totaling $344,250 was charged as stock compensation in fiscal 2016.
f. On
April 28, 2016, the Company entered into an asset purchase agreement pursuant to which the Company purchased intangible assets
valued at $249,113 in exchange for 166,667 shares of the Company’s common stock and a warrant to purchase 166,667 shares
of the Company’s common stock at $2.00 per share. As a result of management’s evaluation, the intangible asset was
deemed impaired and thus fully written off to selling, general and administrative expense of the income statement.
Fiscal
Year 2017 (Year Ended May 31, 2017)
The following transactions
affected the Company’s Stockholders’ Deficiency for Fiscal Year 2017:
a. On October 13, 2016, the Company issued 400,000 shares of its common stock for consulting services to two consulting firms. The
shares were valued at $0.67 at the time resulting in $268,000 in stock based compensation.
b. On October 28, 2016, the Company issued 20,000 shares of its common stock as part of a promissory note entered into with an investor
(see Note 6).
c. On November 11, 2016, the Company issued 50,000 shares of its common stock as part of a promissory note entered into with an investor
(see Note 6).
d. In December 2016, the Company issued 50,000 shares of common stock for consulting services valued at $55,000.
e. In January 2017, the Company issued 15,000 valued at shares of common stock $14,398 to a noteholder as consideration for an inducement
to amend the maturity date of a loan. This amount was recorded in interest expense as of May 31, 2017.
f. In January 2017, the Company issued 20,000 shares of common stock as part of a promissory note entered into with an investor valued
at $14,400 for an inducement to amend the loan and recorded in interest expense as of May 31, 2017.
g. On February 15, 2017, the Company issued 208,596 shares of its common stock as payment to satisfy accounts payable balances of
two vendors totaling $253,003.
h. On March 23, 2017, the Company issued 44,403 shares of its common stock to an employee in connection with their cashless exercise
of stock options.
i. On May 1, 2017, the Company completed a financing transaction pursuant to which the Company sold its 10% Secured Convertible Promissory
Notes in the aggregate principal amount of $2,500,000 to certain accredited investors. The Company issued warrants to the investors
in this offering to purchase 2,500,000 shares of the Company’s common stock.
j. On April 27, 2017, the Company closed a private placement of $899,999 in principal amount of its 9% Convertible Promissory Notes
and common stock purchase warrants to purchase 1,279,998 shares of the Company’s common stock to two accredited investor
entities.
k. On May 1, 2017, the Company closed a private placement of its common stock and units to accredited investors in which it raised
$1,230,000 through the sale of 2,050,002 shares of its common stock and three-year warrants to purchase 2,050,002 shares of its
common stock at an exercise price of $1.00 per share. An additional investor participated in this offering by converting $100,000
in aggregate principle amount of an outstanding convertible note, plus accrued but unpaid interest, into 169,886 shares of Company
common stock and warrants to purchase 169,886 shares of Company common stock.
l. In connection with the May 1, 2017 Asset Purchase Agreement, the Company issued to SolBright 4,000,000 shares of the Company’s
common stock at one dollar per share (the “Common Stock Consideration”). The Common Stock Consideration is subject
to anti-dilution protection if, within 120 days of the closing of the Asset Purchase, the Company sells shares of its common stock
at a price per share that is less than one dollar per share, in which case the Company shall issue additional shares of common
stock to SolBright so that the total number of shares the Company has issued to SolBright equals $4,000,000 divided by such lower
price per share. The shares were valued at $1.28 per share which relates to the stock price on date of sale totaling $5,120,000.
m. On May 1, 2017, the Company issued 100,000 shares of its common stock to a law firm for services with a fair value of $128,000.
n. On May 16, 2017, the Company issued 447,552 shares of its common stock to a note holder in a cashless exercise of 831,168 warrants.
o. On May 22, 2017, the Company issued 60,000 shares of its common stock to a consultant for services with a fair value of $60,300.
p. In April and May 2017, the Company issued a total of 104,796 shares of its common stock to a note holder in connection with the
amendment and settlement of two convertible promissory notes totaling $77,000. The value of the additional shares amounted to $79,454
and is recorded as interest expense.
q. On
May 11, 2017 the Company issued a total of 50,000 shares of its common stock to a noteholder in connection with the amendment
of a convertible loan totaling $150,000. The value of the additional shares amounted to $62,500 and are recorded as interest expense.
NOTE
9 – STOCK-BASED COMPENSATION
The
Company accounted for its stock based compensation in accordance with the fair value recognition provisions of FASB ASC Topic
718, “Compensation – Stock Compensation.”
2017
Equity Incentive Plan
The
Board of Directors approved the Company’s 2017 Equity Incentive Plan (the “2017 Plan”) on April 27, 2017 and
the stockholders of the Company holding a majority in interest of the outstanding voting capital stock of the Company approved
and adopted the 2017 Plan on April 28, 2017. The maximum number of shares of the Company’s Common Stock that may be issued
under the Company’s 2017 Plan, is 10,000,000 shares.
Options
The
Company issued options to purchase an aggregate of 4,100,000 shares of the Company’s common stock during the year ended
May 31, 2016, 2,100,000 of which were granted outside of the 2004 Stock Option and Restricted Stock Plan (the “2004 Plan”).
During the year ended May 31, 2017, the Company granted 2,500,000 options of which were granted under the 2017 Plan.
The
options issued were valued using the Black-Scholes option pricing model under the following assumptions: stock price - $1.20 to
$1.30; strike price - $1.00 to $2.00; expected volatility - 93.24% to 100.05%; risk-free interest rate - 1.5% to 2.3%; dividend
rate - 0%; and expected term – 2 to 5.75 years.
The
expected life is the number of years that the Company estimates, based upon history, that options will be outstanding prior to
exercise or forfeiture. Expected life is determined using the “simplified method” permitted by Staff Accounting Bulletin
No. 107. The Company did not use the volatility rate of its common stock price. Instead, the volatility rate was based on a blended
rate of the Company’s common stock price as well as the stock prices of companies providing similar services.
Compensation
based stock option activity for qualified and unqualified stock options are summarized as follows:
|
|
|
|
|
Weighted
|
|
|
|
|
|
|
Average
|
|
|
|
Shares
|
|
|
Exercise
Price
|
|
Outstanding at May 31, 2015
|
|
|
1,012,500
|
|
|
$
|
1.20
|
|
Granted
|
|
|
4,100,000
|
|
|
|
0.94
|
|
Exercised
|
|
|
—
|
|
|
|
—
|
|
Expired
or cancelled
|
|
|
—
|
|
|
|
—
|
|
Outstanding at May
31, 2016
|
|
|
5,112,500
|
|
|
$
|
0.99
|
|
Granted
|
|
|
2,500,000
|
|
|
|
1.60
|
|
Exercised
|
|
|
(175,000
|
)
|
|
|
1.00
|
|
Expired
or cancelled
|
|
|
—
|
|
|
|
—
|
|
Outstanding at May
31, 2017
|
|
|
7,437,500
|
|
|
$
|
1.19
|
|
The
following table summarizes information about options to purchase shares of the Company’s common stock outstanding and exercisable
at May 31, 2017:
|
|
|
|
|
|
Weighted-
|
|
|
Weighted-
|
|
|
|
|
|
|
|
|
|
|
Average
|
|
|
Average
|
|
|
|
|
Range
of
|
|
|
Outstanding
|
|
|
Remaining
Life
|
|
|
Exercise
|
|
|
Number
|
|
exercise
prices
|
|
|
Options
|
|
|
In
Years
|
|
|
Price
|
|
|
Exercisable
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
0.60
|
|
|
|
2,300,000
|
|
|
|
4.47
|
|
|
$
|
0.60
|
|
|
|
2,300,000
|
|
$
|
1.00
|
|
|
|
1,025,000
|
|
|
|
5.54
|
|
|
$
|
1.00
|
|
|
|
1,025,000
|
|
$
|
1.20
|
|
|
|
1,562,500
|
|
|
|
7.58
|
|
|
$
|
1.20
|
|
|
|
1,562,500
|
|
$
|
1.50
|
|
|
|
1,000,000
|
|
|
|
9.92
|
|
|
$
|
1.50
|
|
|
|
1,000,000
|
|
$
|
2.00
|
|
|
|
1,550,000
|
|
|
|
8.20
|
|
|
$
|
2.00
|
|
|
|
1,550,000
|
|
|
|
|
|
|
7,437,500
|
|
|
|
6.78
|
|
|
$
|
1.19
|
|
|
|
7,437,500
|
|
The
compensation expense attributed to the issuance of the options will be recognized as they vested/earned. These stock options are
exercisable for three to ten years from the grant date.
The
employee stock option plan stock options are exercisable for ten years from the grant date and vest over various terms from the
grant date to three years.
The
aggregate intrinsic value totaled $345,000 and was based on the Company’s closing stock price of $0.75 as of May 31, 2017,
which would have been received by the option holders had all option holders exercised their options as of that date.
Total
compensation expense related to the options was $590,661 and $1,068,125 for the years ended May 31, 2017 and 2016, respectively.
As of May 31, 2017, there was future compensation cost of $1,871,127 related to non-vested stock options.
On
June 25, 2015, the Company issued options under the 2004 Plan to its chairman/chief executive officer and a former director for
services rendered to the Company’s board of directors in fiscal 2015 to purchase a total of 1,300,000 shares of common stock
as follows:
|
1.
|
Chairman/chief
executive officer – options to purchase 1,000,000 shares of common stock at $0.60
per share; and
|
|
2.
|
Former director – options to purchase 300,000
shares of common stock at $0.60 per share.
|
The options vested
immediately and are exercisable for three years. The options issued were valued using the Black-Scholes option pricing model under
the assumptions below. The value of the options totaling $1,622,778 was charged as stock compensation in fiscal 2015.
On October 16, 2015,
the Company issued options under its 2004 Plan to employees to purchase 700,000 shares of its common stock at $1.00 per share.
On April 22, 2016,
the Company issued options outside of its 2004 Plan, which vested immediately and are exercisable for ten years, to certain of
its key employees, including its chairman/chief executive officer for services rendered to the Company during fiscal 2016 for a
total of 1,100,000 shares of its common stock as follows:
|
1.
|
Chairman/chief executive officer – options to purchase 500,000 shares of the Company’s common
stock at $0.60 per share.
|
|
2.
|
Chairman/chief executive officer – options to purchase 300,000 shares of the Company’s common
stock at $1.20 per share.
|
|
3.
|
Chairman/chief executive officer – options to purchase 300,000 shares of the Company’s common
stock at $2.00 per share.
|
The options issued
were valued using the Black-Scholes option pricing model under the following assumptions: stock price - $1.75; strike price - $0.60;
expected volatility – 91.35%; risk-free interest rate - 0.73%; dividend rate - 0%; and expected term – 1.5 years.
On April 28, 2017,
the Company granted 2,500,000 options to the President of SES (the “SES President”) in connection with his employment
agreement dated April 28, 2017, with exercise prices ranging from $1.00 to $2.00 per share. The employment agreement calls for
additional grants of 2,500,000 options on the first and second anniversary of the SES President’s continuous service. The
options issued were valued using the Black-Scholes option pricing model under the following assumptions: stock price - $1.30; strike
price - $1.00 to $2.00; expected volatility - 100.05%; risk-free interest rate - 2.3%; dividend rate - 0%; and expected term –
5 to 5.75 years. Total expense related to these options was $590,661 for the year ended May 31, 2017.
Warrants
The issuance of warrants to purchase shares
of the Company’s common stock including those attributed to debt issuances are summarized as follows:
|
|
|
|
|
Weighted
|
|
|
|
|
|
|
Average
|
|
|
|
Shares
|
|
|
Exercise Price
|
|
Outstanding at May 31, 2015
|
|
|
3,937,986
|
|
|
$
|
1.45
|
|
Granted
|
|
|
1,288,001
|
|
|
|
1.78
|
|
Exercised
|
|
|
—
|
|
|
|
—
|
|
Expired or cancelled
|
|
|
—
|
|
|
|
—
|
|
Outstanding at May 31, 2016
|
|
|
5,225,987
|
|
|
$
|
1.53
|
|
Granted
|
|
|
6,249,886
|
|
|
|
0.90
|
|
Exercised
|
|
|
(831,168
|
)
|
|
|
0.60
|
|
Expired or cancelled
|
|
|
(169,833
|
)
|
|
|
3.14
|
|
Outstanding at May 31, 2017
|
|
|
10,474,872
|
|
|
$
|
1.20
|
|
The following table summarizes information
about warrants outstanding and exercisable at May 31, 2017:
|
|
|
Outstanding
and exercisable
|
|
|
|
|
|
|
|
Weighted-
|
|
|
Weighted-
|
|
|
|
|
Range
of
|
|
|
|
|
|
Average
|
|
|
Average
|
|
|
|
|
Exercise
|
|
|
Number
|
|
|
Remaining
Life
|
|
|
Exercise
|
|
|
Number
|
|
Prices
|
|
|
Outstanding
|
|
|
in
Years
|
|
|
Price
|
|
|
Exercisable
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
0.60
|
|
|
|
698,830
|
|
|
|
4.13
|
|
|
$
|
0.60
|
|
|
|
698,830
|
|
$
|
1.00
|
|
|
|
5,002,889
|
|
|
|
3.84
|
|
|
$
|
1.00
|
|
|
|
5,002,889
|
|
$
|
1.20
|
|
|
|
2,934,822
|
|
|
|
2.20
|
|
|
|
1.20
|
|
|
|
2,934,822
|
|
$
|
2.00
|
|
|
|
1,838,331
|
|
|
|
1.07
|
|
|
|
2.00
|
|
|
|
1,838,331
|
|
|
|
|
|
|
10,474,872
|
|
|
|
2.91
|
|
|
$
|
1.20
|
|
|
|
10,474,872
|
|
The expense attributed
to the issuances of the warrants was recognized as they vested/earned. These warrants are exercisable for three to five years from
the grant date.
Issuances of warrants
to purchase shares of the Company’s common stock were as follows:
Fiscal Year 2016 (Year Ended May 31,
2016)
a. As discussed in Note 8, in addition to common stock, the Company also issued warrants to purchase 833,334 shares of the Company’s
common stock under the PPO.
b. In November 2015, a warrant to purchase 250,000 shares of the Company’s common stock at $1.00 per share was issued to a vendor
as a bonus payment for services rendered in connection with a software development agreement. The warrant issued was valued using
the Black Scholes option pricing model under the following assumptions: stock price $1.00; strike price $1.00; expected volatility
87.54%; risk free interest rate 1.21%; dividend rate 0%; and expected term 3 years. The value of the warrant totaling $139,928
was charged as research and development.
c. In November 2015, a warrant to purchase 33,000 shares of the Company’s common stock at $1.00 per share was issued to a consultant
for services rendered under a consulting contract. The warrant issued was valued using the Black Scholes option pricing model under
the following assumptions: stock price $1.00; strike price $1.00; expected volatility 87.54%; risk free interest rate 1.21%; dividend
rate 0%; and expected term 3 years. The value of the warrant totaling $18,471 was charged as consulting fees. See Note 11.
d. On April 28, 2016, the Company entered into an asset purchase agreement pursuant to which the Company purchased intangible assets
in exchange for 166,667 shares of the Company’s common stock and a warrant to purchase 166,667 shares of the Company’s common stock
at $2.00 per share. The warrant issued was valued using the Black Scholes option pricing model under the following assumptions:
stock price $0.75; strike price $2.00; expected volatility 293%; risk free interest rate .93%; dividend rate 0%; and expected term
3 years. The value of the warrant totaling $124,000 was included in the cost of the intangible which was fully impaired as of May
31, 2016.
Fiscal Year 2017 (Year Ended May 31,
2017)
a.
On March 1, 2017, the Company issued a 10% promissory note in the principal amount of $100,000 due March 31, 2017 to an accredited
investor, along with warrants to purchase 100,000 shares of the Company’s common stock with a three-year term and an exercise
price of $.60 per share.
b.
On March 3, 2017, the Company issued a 10% convertible promissory note in the principal amount of $103,000 due November 3, 2017
to an accredited investor (the “Convertible Promissory Note”), along with warrants to purchase 50,000 shares of the
Company’s common stock with a three-year term and an exercise price of $.60 per share.
c.
On March 7, 2017, the Company issued a 10% promissory note in the principal amount of $100,000 due March 31, 2017 to an accredited
investor, along with warrants to purchase 100,000 shares of the Company’s common stock with a three-year term and an exercise
price of $.60 per share.
d.
In April and May of 2017 the Company issued a total of 2,219,888 warrants issued in connection with the Company’s 2017 Common
Stock Private Placement to accredited investors. The warrants have a three-year term and an exercise price of $1.00.
e.
On April 21, 2017, as a part of the 2017 Convertible Notes Private Placement, the Company issued 2017 Notes Offering Warrants to
the Note Investors providing them with the right to purchase, in the aggregate, up to 1,279,998 shares of the Company’s common
stock at an initial exercise price equal to the lesser of (i) $0.60 and (ii) 75% of the offering price of the Company’s common
stock in the Company’s next publicly registered offering. The 2017 Notes Offering Warrants are exercisable on any date after
the date of issuance for a term of five years. On May 16, 2017, one of these Note Investors exercised 831,168 warrants at a price
of $0.60.
f.
On May 1, 2017, the Company issued 2,500,000 warrants in connection with the AIP Financing at an exercise price of $1.00 per share
and a five-year term.
g.
On May 16, 2017, the Company issued 447,552 shares of its common stock to a note holder in a cashless exercise of 831,168 warrants.
NOTE 10 – LICENSE AGREEMENTS
Master Agreement – License of
(“PEMS-SF”)
On July 10, 2014, the
Company entered into a Master Agreement to license the Company’s Process and Event Management System (“PEMS-SF”)
with Tatung Corporation (“Tatung”). The basic fee generation structure of the Master Agreement allows for (1) a one-time
licensing fee for each PEMS-SF-enabled stations or subsystems installed, (2) separate fees of up to 10% of the software fees for
software updates, maintenance and technical support, (3) on-going service fees based on units of products manufactured utilizing
PEMS-SF; and (4) an annual service fee for cloud-based services and data storage. The Master Agreement has a year-to-year term
but can be terminated by either party upon sixty (60) days’ advance written notice. Upon termination or expiration of this
agreement, the Company is not required to provide any continuing or ongoing processing of data or other services that, pursuant
to a sub-agreement, are discontinued upon termination, however, the customer shall retain any perpetual rights granted in a sub-agreement
or schedule. The term of any sub-agreements is concomitant and co-terminus with the Master Agreement term.
Revenue recognized
under the Master Agreement amounted to $14,793 and $172,600 for the years ended May 31, 2017 and 2016, respectively.
Agreement – License of Meter Collar
and Bridge Programmable Logic
In October 2014, the
Company entered into a year-to-year term agreement with Tatung to license its meter collar and bridge programmable logic controllers.
The license is paid on a per copy (ordered) fee, and is on a perpetual, worldwide, non-exclusive, transferable basis.
Revenue recognized
under the agreement amounted to $0 and $87,500 for the years ended May 31, 2017 and 2016, respectively.
In March 2015, the
Company entered into a one-year agreement, with automatic one-year renewals until terminated by either party with sixty (60) days’
notice, with Tatung to provide services in the area of business development and as a representative to sell its products. Tatung
will pay a monthly retainer fee for this service. Revenue recognized under this agreement was $60,000 and $395,000 for the years
ended May 31, 2017 and 2016, respectively.
NOTE 11 – COMMITMENTS
Leases
Effective October 1,
2014 as amended on January 15, 2015, the Company entered a lease for its office space at a total monthly rental of $1,874. The
lease expired on January 15, 2016. The Company renewed this lease until January 15, 2017 at a monthly rental of $2,034. In January
2017, the Company renewed this lease until January 15, 2018, with an option to renew for one additional year upon its expiration.
The Company’s
SES subsidiary leases offices in Jericho, New York. The facility is approximately 1,850 square feet, occupied pursuant to a lease
that commenced on August 1, 2015 and expires September 30, 2018. The average annual rent over the term of the lease is approximately
$57,300. This amount does not include taxes for the premises.
In May 2016, SES entered
into a new facilities lease with a third party with a lease term of 64 months for its corporate office. The first two months were
abated and then the monthly base rent is $5,176 per month for 10 months. The base rent has gradual increases until $6,000 per month
in months 61-64. Monthly rent payment also includes common area maintenance charges, taxes, parking and other charges. The Company
also paid a security deposit of $7,166 which is recorded as a prepaid expense on the accompanying balance sheet.
Rent expense for all
locations including occupancy costs for the years ended May 31, 2017 and 2016 was $89,208 and $80,992, respectively.
Future minimum rental
commitments of non-cancelable operating leases (including the Jericho lease) are as follows:
For the twelve-month
period ended May 31,
|
|
Office
Rent
|
|
|
|
|
|
|
2018
|
|
$
|
152,502
|
|
2019
|
|
|
93,832
|
|
2020
|
|
|
68,041
|
|
2021
|
|
|
70,075
|
|
2022
|
|
|
18,000
|
|
Thereafter
|
|
|
—
|
|
|
|
$
|
402,450
|
|
Consulting Agreements
On November 15, 2015,
the Company entered into a one-year consulting agreement to provide advisory services whereby the consultant received a payment
of a warrant to purchase 33,000 shares of the Company’s common stock at $1.00 per share.
On February 23, 2016,
the Company entered into a consulting agreement with LPF Communications under which LPF Communications is to provide certain investor
relations services for a period of up to six months. The Company has agreed to pay for the services by issuing two tranches of
150,000 shares of the Company’s Common Stock each, with the second tranche becoming issuable only if the Company does not
terminate the consulting agreement on or prior to June 8, 2016. Pursuant to the agreement, the Company issued 300,000 shares valued
at $205,000 which was recorded in prepaid expense and amortized over the term of the agreement.
On May 15, 2016, the
Company entered into a two-year consulting agreement whereby consultant is to perform certain consulting and advisory services.
The Company issued 100,000 shares of common stock valued at $69,000 as compensation which was recorded as prepaid expenses and
amortized over the life of the contract.
On September 15, 2016,
the Company entered into two consulting agreements with two consultants, pursuant to which the Company agreed to issue 200,000
shares of common stock to each consultant in exchange for certain consulting services.
On December 13, 2016,
the Company entered into a consulting agreement with a consultant, pursuant to which the Company agreed to issue 50,000 shares
of common stock to each consultant in exchange for certain consulting services for twelve months.
NOTE 12 - CONCENTRATIONS OF CREDIT RISK
Cash
The Company maintains
principally all cash balances in two financial institutions which, at times, may exceed the amount insured by the Federal Deposit
Insurance Corporation. The exposure to the Company is solely dependent upon daily bank balances and the respective strength of
the financial institutions. The Company has not incurred any losses on these accounts.
Net Sales
Three customers accounted for 85% of net
sales for the year ended May 31, 2017, as set forth below:
Customer 1
|
|
|
37
|
%
|
Customer 2
|
|
|
29
|
%
|
Customer 2
|
|
|
19
|
%
|
Two customers
accounted for 60% of net sales for the year ended May 31, 2016, as set forth below:
Customer 1
|
|
|
29
|
%
|
Customer 2 (related
party, see Note 13)
|
|
|
31
|
%
|
Accounts Receivable
Two customers accounted for 91% of the accounts
receivable as of May 31, 2017, as set forth below:
Customer 1
|
|
|
50
|
%
|
Customer 2
|
|
|
41
|
%
|
Two customers accounted for 94% of the accounts receivable as of May 31, 2016, as set forth below:
Customer
1
|
|
|
83
|
%
|
Customer 2
|
|
|
11
|
%
|
NOTE 13 - RELATED PARTY TRANSACTIONS
The Company performed
consulting services for an entity that is controlled by a former director. Consulting services for the fiscal years ended May 31,
2017 and 2016 were $0 and $78,872, respectively.
There were no related
party transactions during the year ended May 31, 2017.
NOTE 14 - BUSINESS SEGMENT INFORMATION
As of May 31, 2017,
the Company had two operating segments, Arkados and SES.
The Company’s
reportable segments are distinguished by types of service, customers and methods used to provide their services. The operating
results of these business segments are regularly reviewed by the Company’s chief operating decision maker.
The accounting policies
of each of the segments are the same as those described in the Summary of Significant Accounting Policies in Note 2. The Company
evaluates performance based primarily on income (loss) from operations
Operating results for the business segments
of the Company were as follows:
|
|
Arkados
|
|
|
SES
|
|
|
Total
|
|
Fiscal-Year Ended May 31, 2017
|
|
|
|
|
|
|
|
|
|
Revenues
|
|
$
|
79,327
|
|
|
$
|
2,267,484
|
|
|
$
|
2,346,811
|
|
(Loss) income from operations
|
|
$
|
(2,930,769
|
)
|
|
$
|
25,230
|
|
|
$
|
(2,905,539
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fiscal Year Ended May 31, 2016
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenues
|
|
$
|
730,249
|
|
|
$
|
1,140,781
|
|
|
$
|
1,871,030
|
|
Loss from operations
|
|
$
|
(2,171,333
|
)
|
|
$
|
(907,579
|
)
|
|
$
|
(3,078,912
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Assets
|
|
|
|
|
|
|
|
|
|
|
|
|
May 31, 2017
|
|
$
|
657,885
|
|
|
$
|
18,357,793
|
|
|
$
|
19,015,678
|
|
May 31, 2016
|
|
$
|
236,797
|
|
|
$
|
347,846
|
|
|
$
|
584,643
|
|
NOTE 15 – SUBSEQUENT EVENTS
On June 1, 2017, the
Company entered into a consulting agreement for services which included the issuance of 160,000 shares of the Company’s common
stock at a fair value of $0.70 per share.
On August 11, 2017,
the Company entered into a consulting agreement for services which included the issuance of 200,000 shares of the Company’s
common stock at a fair value of $0.62 per share.
On August 29, 2017,
the Company entered into an Agreement and Waiver (the “Waiver”) with AIG and issued an aggregate of 150,001 shares
to AIP as a monetary penalty for not filing a registration statement on Form S-1 by July 15, 2017 as set forth in the Registration
Rights Agreement dated May 1, 2017 (see Note 6). Additionally, under the Waiver, the Company agreed to reduce the conversion price
of the 2,500,000 warrants issued to AIG in connection with the AIG Financing from $0.80 to $0.60 per share.
On
July 28, 2017, the Company issued two convertible notes payable totaling $70,000, due January 28, 2018, with an annual interest
rate of 9%, convertible on or after an event of default at a conversion price equal to 60% of the lowest trading price during
the 30 trading days prior to conversion. In connection with the convertible notes payable, the Company issued a total of 233,332
warrants to purchase the Company’s common stock with an exercise price of $0.60 per share and have a five year term. The
notes include a total OID of $17,000 and $3,000 of deferred financing costs. The proceeds from these two notes totaled $50,000.