See accompanying notes to the condensed
consolidated financial statements.
See accompanying notes to the condensed
consolidated financial statements.
See accompanying notes to the condensed
consolidated financial statements.
See accompanying notes to the condensed
consolidated financial statements.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS
UNAUDITED
1.
|
ORGANIZATION AND BUSINESS
|
CV Sciences, Inc. (the “Company,” “CV Sciences,” “we,” “our” or “us”) was incorporated under the name Foreclosure Solutions, Inc. in the State
of Texas on December 9, 2010. On July 25, 2013, the Company’s predecessor, CannaVest Corp., a Texas corporation (“CannaVest
Texas”), merged with the Company, a wholly-owned Delaware subsidiary of CannaVest Texas, to effectuate a change in the Company’s
state of incorporation from Texas to Delaware. On January 4, 2016, the Company filed a Certificate of Amendment of Certificate
of Incorporation reflecting its corporate name change to “CV Sciences, Inc.”, effective on January 5, 2016. In addition,
on January 4, 2016, the Company amended its Bylaws to reflect its corporate name change to “CV Sciences, Inc.” The
Company previously operated under the corporate name of CannaVest Corp. The change in corporate name was undertaken in connection
with the acquisition of CanX Inc., a Florida-based, specialty pharmaceutical corporation (the “CanX Acquisition”) as
more fully set forth in our Current Report on Form 8-K filed with the U.S. Securities and Exchange Commission (the “SEC”)
on January 4, 2016. On June 8, 2016, the Company announced that the Financial Industry Regulatory Authority (“FINRA”)
had approved a change in the trading symbol for the Company’s common stock to “CVSI.” The Company’s common
stock formerly traded under the symbol “CANV.”
The Company operates two distinct business
segments: a consumer product segment in manufacturing, marketing and selling plant-based Cannabidiol (“CBD”) products
to a range of market sectors; and, a specialty pharmaceutical segment focused on developing and commercializing novel therapeutics
utilizing synthetic CBD. The specialty pharmaceutical segment began development activities during the second quarter of 2016.
2.
|
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
|
Basis of Presentation
–
The condensed consolidated financial statements include, as applicable, the accounts of CV Sciences, Inc. and its wholly-owned
subsidiaries Plus CBD, LLC and CANNAVEST Acquisition, LLC; and the accounts of a 70% interest in CannaVest Europe, GmbH (collectively,
as applicable, the “Company”). All intercompany accounts and transactions have been eliminated in consolidation. The
Company commenced commercial operations for its current business model on January 29, 2013. On January 20, 2017, the Company filed
for dissolution of CannaVest Europe, GmbH, an entity that, prior to dissolution, the Company had a 70% interest in, with the District
Court, Dusseldorf Germany, effective December 31, 2016. On April 27, 2018, the Company filed a Certificate of Cancellation for
its wholly-owned subsidiary, CANNAVEST Acquisition, LLC, with the Secretary of State of Delaware, effective as of April 27, 2018.
Neither CANNAVest Acquisition, LLC nor CannaVest Europe, GmbH had any material assets or liabilities at the time of their respective
dissolutions.
The unaudited condensed consolidated interim
financial statements have been prepared by the Company pursuant to the rules and regulations of the SEC. The information furnished
herein reflects all adjustments (consisting of normal recurring accruals and adjustments) which are, in the opinion of management,
necessary to fairly present the operating results for the respective periods and ensure that the financial statements are not misleading.
Certain information and footnote disclosures normally present in annual financial statements prepared in accordance with accounting
principles generally accepted in the United States of America (“GAAP”) have been omitted pursuant to such rules and
regulations. These unaudited condensed consolidated financial statements should be read in conjunction with the audited financial
statements and notes for the year ended December 31, 2017, filed with the SEC on the Company’s Annual Report on Form 10-K
filed on March 29, 2018. The results for the interim periods ended September 30, 2018, are not necessarily indicative of the results
to be expected for the full year ending December 31, 2018.
Liquidity
– For
the three months ended September 30, 2018 and 2017, the Company had net income (losses) of $3,294,973 and ($589,983),
respectively. For the nine months ended September 30, 2018 and 2017, the Company had net income (losses) of $7,100,217 and
($5,366,946), respectively. In addition, for the nine months ended September 30, 2018 and 2017, the Company had positive cash
flows from operations of $9,925,819 and $647,216, respectively. Management believes the Company has the funds necessary to
continue its consumer product and specialty pharmaceutical business segments and meet its other obligations over the next
year solely from current revenues and cash flow for the next 12-month period through November 6, 2019.
Derivative Financial Instruments
–
Derivative
financial instruments are initially recognized at fair value on the date a derivative contract is entered into and subsequently
remeasured at fair value on a quarter-end reporting basis. Changes in the fair value of derivative financial instruments are recognized
as a gain or loss in the Company’s Condensed Consolidated Statements of Operations.
Goodwill and Intangible Assets –
The Company evaluates the carrying value of goodwill and intangible assets annually during the fourth quarter in accordance
with Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 350,
Intangibles Goodwill and Other
and between annual evaluations if events occur or circumstances change that would more likely
than not reduce the fair value of the reporting unit below its carrying amount. Such circumstances could include, but are not limited
to (1) a significant adverse change in legal factors or in business climate, (2) unanticipated competition, or (3) an adverse action
or assessment by a regulator. When evaluating whether goodwill is impaired, the Company compares the fair value of the reporting
unit to which the goodwill is assigned to the reporting unit’s carrying amount, including goodwill. The fair value of the
reporting unit is estimated using a combination of the income, or discounted cash flows, approach and the market approach, which
utilizes comparable companies’ data. If the carrying amount of a reporting unit exceeds its fair value, then the amount of
the impairment loss must be measured. The impairment loss would be calculated by comparing the implied fair value of a reporting
unit’s goodwill to its carrying amount. In calculating the implied fair value of a reporting unit’s goodwill, the fair
value of the reporting unit is allocated to all of the other assets and liabilities of that unit based on their fair values. The
excess of the fair value of a reporting unit over the amount assigned to its other assets and liabilities is the implied fair value
of goodwill.
We make critical assumptions and estimates
in completing impairment assessments of goodwill and other intangible assets. Our cash flow projections look several years into
the future and include assumptions on variables such as future sales and operating margin growth rates, economic conditions, market
competition, inflation and discount rates.
We classify intangible assets into three
categories: (1) intangible assets with definite lives subject to amortization; (2) intangible assets with indefinite lives not
subject to amortization; and (3) goodwill. We determine the useful lives of our identifiable intangible assets after considering
the specific facts and circumstances related to each intangible asset. Factors we consider when determining useful lives include
the contractual term of any agreement related to the asset, the historical performance of the asset, our long-term strategy for
using the asset, any laws or regulations which could impact the useful life of the asset and other economic factors, including
competition and specific market conditions. Intangible assets that are deemed to have definite lives are amortized, primarily on
a straight-line basis, over their useful lives to their estimated residual values, generally five years. In process research and
development (“IPR&D”) has an indefinite life and is not amortized until completion and development of the project,
at which time the IPR&D becomes an amortizable asset. If the related project is not completed in a timely manner or the project
is terminated or abandoned, the Company may have an impairment related to the IPR&D, calculated as the excess of the asset’s
carrying value over its fair value. This method of amortization approximates the expected future cash flow generated from their
use. During the three and nine months ended September 30, 2018 and 2017, there were no impairments.
Use of Estimates
– The Company’s condensed consolidated financial statements have been prepared in accordance with GAAP. The
preparation of these condensed consolidated financial statements requires us to make significant estimates and judgments that
affect the reported amounts of assets, liabilities, revenues, expenses and related disclosures of contingent assets and
liabilities. We evaluate our estimates, including those related to contingencies, on an ongoing basis. We base our estimates
on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the
results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily
apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.
Significant estimates include the valuation of intangible assets, the amortization lives of intangible assets, valuation of
contingent consideration, inputs for valuing derivative financial instruments, inputs for valuing warrants, inputs for
valuing notes payable beneficial conversion features and stock-based compensation, valuation of inventory, classification of
current and non-current inventory amounts, the allowance for doubtful accounts and determining whether potential losses from
legal actions brought against the Company are probable and estimable.
Reportable
Segments
– The Company has two business segments; consumer products and specialty pharmaceuticals. Our consumer
products segment develops, manufactures and markets products based on plant-based CBD, including under the name PlusCBD™
in a variety of market sectors including nutraceutical, beauty care, specialty foods and beverages. Our specialty pharmaceutical
segment is developing drug candidates which use synthetic CBD as a primary active ingredient. The specialty pharmaceuticals segment
began development activities during the second quarter of 2016.
Cash and Cash Equivalents
– For purposes of the condensed consolidated statements of cash flows, the Company considers amounts held by financial institutions
and short-term investments with an original maturity of three months or less when purchased to be cash and cash equivalents. As
of September 30, 2018 and December 31, 2017, the Company had no cash equivalents.
Restricted Cash
–
The Company’s current and past arrangements with its credit card processors require that its credit card processors withhold
a cash reserve balance from the Company’s credit card receipt transactions for a period of time not to exceed 270 days,
for which the credit card processors will refund the Company the entire amounts withheld at its sole discretion. The Company had
$738,356 and $778,579 in restricted cash withheld by former credit card processors as of September 30, 2018 and December 31, 2017,
respectively. The following table provides a reconciliation of cash and restricted cash reported within the condensed consolidated
balance sheets to the total of the same amounts shown in the statement of cash flows:
|
|
September 30,
2018
|
|
|
December 31,
2017
|
|
|
|
|
|
|
|
|
Cash
|
|
$
|
10,271,599
|
|
|
$
|
2,012,965
|
|
Restricted cash
|
|
|
738,356
|
|
|
|
778,579
|
|
Total cash and restricted cash shown in the statement of cash flows
|
|
$
|
11,009,955
|
|
|
$
|
2,791,544
|
|
On October 22, 2018, the Company received
un-restricted control of $450,000 of restricted cash held at September 30, 2018 in connection with the settlement of a complaint
filed by the Company against a former credit card processor of the Company (Note 11). The Company recognized bad debt expense
of $40,223 in connection with this settlement during the three months ended September 30, 2018.
Concentrations of Credit Risk
– As of September 30, 2018, the Federal Deposit Insurance Corporation (“FDIC”) provided insurance coverage of
up to $250,000 per depositor per bank. The Company has not experienced any losses in such accounts and does not believe that the
Company is exposed to significant risks from excess deposits. The Company’s cash balance in excess of FDIC limits totaled
$10,027,090 as of September 30, 2018.
There was no concentration of accounts
receivable, revenue and purchases as of, and for the period and year ended September 30, 2018 and December 31, 2017.
Accounts Receivable
–
Generally, the Company requires payment prior to shipment. However, in certain circumstances, the Company extends credit to companies
located throughout the U.S. Accounts receivable consists of trade accounts arising in the normal course of business. Accounts for
which no payments have been received after 30 days are considered delinquent and customary collection efforts are initiated. Accounts
receivable are carried at original invoice amount less a reserve made for doubtful receivables based on a review of all outstanding
amounts on a quarterly basis.
Management has determined the allowance
for doubtful accounts by regularly evaluating individual customer receivables and considering a customer’s financial condition
and credit history, and current economic conditions. As of September 30, 2018 and December 31, 2017, the Company maintained an
allowance for doubtful accounts related to accounts receivable in the amount of $200,000.
Revenue Recognition
- Our
revenue is generated from the sale of products consisting primarily of nutritional supplements and beauty products. We recognize
revenue when control of our products is transferred to our customers in an amount that reflects the consideration we expect to
receive from our customers in exchange for those products. This process involves identifying the contract with a customer, determining
the performance obligations in the contract, determining the contract price, allocating the contract price to the distinct performance
obligations in the contract, and recognizing revenue when the performance obligations have been satisfied. We consider a performance
obligation satisfied once we have transferred control of a product to the customer or distributor, meaning the customer has the
ability to use and obtain the benefit of the product. We recognize revenue for satisfied performance obligations only when we determine
there are no uncertainties regarding payment terms or transfer of control. Revenue from product sales is generally recognized upon
shipment to the end customer, which is when control of the product is deemed to be transferred. Payment or invoicing typically
occurs upon shipment and the term between invoicing and when payment is due is not significant. Revenue is recorded net of discounts
and promotions.
Sales Tax
– The Company
is responsible for collecting tax on sales made directly to end customers without a valid sales tax exemption certificate, and
remitting these taxes to applicable jurisdictions. These taxes are assessed based on the location of the end customer and the
laws of the jurisdiction in which they reside. Such taxes are accounted for on a net basis, and not included in revenues.
Shipping and Handling
–
Shipping and handling expenses are recorded in cost of goods sold and totaled $490,881 and $265,685 for the three months ended
September 30, 2018 and 2017, respectively, and for the nine months ended September 30, 2018 and 2017 totaled $1,297,844 and $589,687,
respectively.
Returns
–
Finished Products
– Within ten (10) days of a customer’s receipt of the Company’s finished products, the customer may return (i)
finished products that do not conform to the Company’s product specifications or, (ii) finished products which are defective,
provided that notice of condition is given within five (5) days of the customer’s receipt of the finished products. The failure
to comply with the foregoing time requirements shall be deemed a waiver of customer’s claim for incorrect or defective shipments.
In the event of the existence of one or more material defects in any finished product upon delivery to the customer, the Company
shall, at its sole option and cost, either (a) take such measures as are required to cure the defect(s) designated in the customer’s
notice, or (b) replace such defective finished product(s). The Company may, at its sole option, require the return or destruction
of the defective finished products. The customer shall afford the Company the opportunity to verify that such defects existed prior
to shipment and were not, for purposes of example and not limitation, the result of improper transport, handling, storage, product
rotation or misuse by the customer.
Bulk Oil Products
–
Sales of bulk oil products are final and the Company does not accept returns under any circumstances.
There was no allowance for customer returns
as of September 30, 2018 or December 31, 2017 due to insignificant return amounts experienced during the nine months ended September
30, 2018 and the year ended December 31, 2017.
Compensation and Benefits
– The Company records compensation and benefits expense for all cash and deferred compensation, benefits, and related taxes
as earned by its employees. Compensation and benefits expense also includes compensation earned by temporary employees and contractors
who perform similar services to those performed by the Company’s employees, primarily information technology and project
management activities.
Stock-Based Compensation
– Certain employees, officers, directors, and consultants of the Company participate in various long-term incentive plans
that provide for granting stock options, restricted stock awards, restricted stock units, stock bonus awards and performance-based
awards. Stock options generally vest in equal increments over a two- to four-year period and expire on the tenth anniversary following
the date of grant. Performance-based stock options vest once the applicable performance condition is satisfied. Restricted stock
awards generally vest 100% at the grant date.
The Company recognizes stock-based compensation
for equity awards granted to employees, officers, directors, consultants and former directors as compensation and benefits expense
in the consolidated statements of operations. The fair value of stock options is estimated using a Black-Scholes valuation model
on the date of grant. The fair value of restricted stock awards is equal to the closing price of the Company’s stock on
the date of grant. Stock-based compensation is recognized over the requisite service period of the individual awards, which generally
equals the vesting period. For performance-based stock options, compensation is recognized once the applicable performance condition
is satisfied. Forfeited stock options are accounted for as they occur.
Inventory
– Inventory
is stated at lower of cost or net realizable value, with cost being determined on an average cost basis. As of September 30, 2018,
the Company had $312,626 of inventory in Germany and The Netherlands.
Property & Equipment
– Equipment is stated at cost less accumulated depreciation. Cost represents the purchase price of the asset and other costs
incurred to bring the asset into its existing use. Depreciation is provided on a straight-line basis over the assets’ estimated
useful lives. Tenant improvements are amortized on a straight-line basis over the remaining life of the related lease. Maintenance
or repairs are charged to expense as incurred. Upon sale or disposition, the historically-recorded asset cost and accumulated depreciation
are removed from the accounts and the net amount less proceeds from disposal is charged or credited to other income (expense).
Property and equipment, net, as of September
30, 2018 and December 31, 2017 were as follows:
|
|
Useful Lives
|
|
September 30,
2018
|
|
|
December 31,
2017
|
|
|
|
|
|
|
|
|
|
|
Office furniture and equipment
|
|
3 years
|
|
$
|
731,135
|
|
|
$
|
537,607
|
|
Laboratory and other equipment
|
|
5 years
|
|
|
536,570
|
|
|
|
398,997
|
|
Tenant improvements
|
|
14 to 39 months
|
|
|
1,639,138
|
|
|
|
1,545,885
|
|
|
|
|
|
|
2,906,843
|
|
|
|
2,482,489
|
|
Less: accumulated depreciation
|
|
|
|
|
(748,177
|
)
|
|
|
(399,056
|
)
|
|
|
|
|
$
|
2,158,666
|
|
|
$
|
2,083,433
|
|
Depreciation expense for the three months
ended September 30, 2018 and 2017 was $121,911 and $30,897, respectively, and for the nine months ended September 30, 2018 and
2017 was $349,121 and $117,744, respectively.
Fair Value of Financial Instruments
– In accordance with ASC Topic 825,
Financial Instruments
, the Company calculates the fair value of its assets and
liabilities which qualify as financial instruments and includes this additional information in the notes to its financial statements
when the fair value is different than the carrying value of those financial instruments. The estimated fair value of the Company’s
current assets and current liabilities approximates their carrying amount due to their readily available nature and short maturity.
Long-Lived Assets
–
In accordance with ASC Topic 360,
Accounting for the Impairment or Disposal of Long-Lived Assets
, the Company reviews property
and equipment for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not
be recoverable. Recoverability of property and equipment is measured by comparing its carrying value to the undiscounted projected
future cash flows that the asset(s) are expected to generate. If the carrying amount of an asset is not recoverable, we recognize
an impairment loss based on the excess of the carrying amount of the long-lived asset over its respective fair value, which is
generally determined as the present value of estimated future cash flows or at the appraised value. The impairment analysis is
based on significant assumptions of future results made by management, including revenue and cash flow projections. Circumstances
that may lead to impairment of property and equipment include a significant decrease in the market price of a long-lived asset,
a significant adverse change in the extent or manner in which a long-lived asset is being used or in its physical condition and
a significant adverse change in legal factors or in the business climate that could affect the value of a long-lived asset including
an adverse action or assessment by a regulator.
Debt Issuance Costs –
Debt issuance costs, when incurred, are capitalized as a discount to the related debt and are amortized to interest expense using
the interest method over the expected terms of the related debt agreements.
Earnings (net loss) per
Share
– The Company calculates earnings or loss per share (“EPS”) in accordance with ASC Topic 260,
Earnings
per Share
, which requires the computation and disclosure of two EPS amounts, basic and diluted. Basic EPS is computed
based on the weighted average number of shares of common stock outstanding during the period. Diluted EPS is computed based
on the weighted average number of shares of common stock outstanding plus all potentially dilutive shares of common stock
outstanding during the period. Potentially dilutive common shares from equity awards are determined using the average share
price for each period under the treasury stock method. The Company had 19,562,475 stock options and 79,891 warrants
outstanding that were potentially dilutive as of September 30, 2018. In addition, the Company may be required to issue
10,750,000 additional shares of common stock related to certain performance-based stock options outstanding.
Research and Development Expense
– Research and development costs are charged to expense as incurred and include, but are not limited to, employee
salaries and benefits, cost of inventory used in product development, consulting service fees, the cost of renting and maintaining
our laboratory facility and depreciation of laboratory equipment. Research and development expense for the consumer products segment
was $170,466 and $76,520 for the three months ended September 30, 2018 and 2017, respectively, and for the nine months ended September
30, 2018 and 2017 was $362,933 and $181,509, respectively. Research and development expense for the specialty pharmaceutical segment
was $359,096 and $102,818 for the three months ended September 30, 2018 and 2017, respectively, and for the nine months ended September
30, 2018 and 2017 was $762,337 and $392,192, respectively.
Advertising
– The Company
supports its products with advertising to build brand awareness of the Company’s various products in addition to other marketing
programs executed by the Company’s marketing team.
The Company believes the continual
investment in advertising is critical to the development and sale of its
PlusCBD™
brand
products.
Advertising costs of $231,715 and $152,687 were expensed as incurred during the three months ended September 30, 2018 and
2017, respectively, and for the nine months ended September 30, 2018 and 2017 were $634,274 and $261,462, respectively.
Income Taxes –
Income
taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the estimated
future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities
and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable
income in the years in which the related temporary differences are expected to be recovered or settled. The effect on deferred
tax assets and liabilities of a change in tax rates is recognized when the rate change is enacted. Valuation allowances are recorded
to reduce deferred tax assets to the amount that will more likely than not be realized. In accordance with ASC Topic 740,
Income
Taxes
, the Company recognizes the effect of uncertain income tax positions only if the positions are more likely than not of
being sustained in an audit, based on the technical merits of the position. Recognized uncertain income tax positions are measured
at the largest amount that is greater than 50% likely of being realized. Changes in recognition or measurement are reflected in
the period in which those changes in judgment occur. The Company recognizes both interest and penalties related to uncertain tax
positions as part of the income tax provision. As of September 30, 2018, and December 31, 2017, the Company did not have a liability
for unrecognized tax uncertainties. The Company is subject to routine audits by taxing jurisdictions. Management believes the Company
is no longer subject to tax examinations for the years prior to 2014.
Recently Issued and Newly Adopted
Accounting Pronouncements
In May 2014, the FASB issued Accounting
Standards Update (“ASU”) 2014-09,
Revenue from Contracts with Customers (Topic 606)
(“ASU 2014-09”),
as amended by ASU 2015-14,
Revenue from Contracts with Customers (Topic 606)
, ASU 2016-08,
Revenue from Contracts with
Customers (Topic 606),
ASU 2016-10,
Revenue from Contracts with Customers (Topic 606),
ASU 2016-12,
Revenue from
Contracts with Customers (Topic 606)
and ASU 2016-20,
Technical Corrections and Improvements to Topic 606, Revenue from
Contracts with Customers,
which completes the joint effort by the FASB and the International Accounting Standards Board to
improve financial reporting by creating common revenue recognition guidance for GAAP and the International Financial Reporting
Standards. ASU 2014-09 became effective for the Company beginning on January 1, 2018. The Company implemented ASU 2014-09 for the
interim and annual reporting periods of 2018, which resulted in no changes to how we recognize revenue.
In July 2015, the FASB issued ASU 2015-11,
Inventory: Simplifying the Measurement of Inventory
(“ASU 2015-11”), which requires inventory measured using
any method other than last-in, first out or the retail inventory method to be subsequently measured at the lower of cost or net
realizable value, rather than at the lower of cost or market. ASU 2015-11 is effective for annual reporting periods beginning after
December 15, 2016 and for interim periods within such annual periods. Early application is permitted. The Company implemented ASU
2015-11 during the annual reporting period of 2017.
In February 2016, the FASB issued ASU 2016-02,
Leases
(“ASU 2016-02”), which, for operating leases, requires a lessee to recognize a right-of-use asset and
a lease liability, initially measured at the present value of the lease payments, in its balance sheet. ASU 2016-02 also requires
a lessee to recognize a single lease cost, calculated so that the cost of the lease is allocated over the lease term, on a generally
straight-line basis. ASU 2016-02 is effective for public companies for fiscal years beginning after December 15, 2018, including
interim periods within those fiscal years. Early adoption is permitted. The Company is evaluating the potential impact of ASU 2016-02
on the Company’s consolidated financial statements.
In March 2016, the FASB issued ASU 2016-09,
Compensation – Stock Compensation
(“ASU 2016-09”), which involves multiple aspects of the accounting for
share-based transactions, including income tax consequences, classification of awards as either equity or liabilities, and classification
on the statement of cash flows. ASU 2016-09 is effective for public companies for fiscal years beginning after December 15, 2016,
including interim periods within those fiscal years. Early adoption is permitted. The Company implemented ASU 2016-09 during the
annual reporting period of 2017.
In August 2016, the FASB issued ASU 2016-15,
Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments (A Consensus of the FASB Emerging
Issues Task Force)
(“ASU 2016-15”), which provides amendments to specific statement of cash flows classification
issues. ASU 2016-15 is effective for public companies for fiscal years beginning after December 15, 2017, including interim periods
within those fiscal years. The Company implemented ASU 2016-15 for the interim and annual reporting periods of 2018.
In January 2017, the FASB issued ASU 2017-01,
Business Combinations (Topic 805): Clarifying the Definition of a Business
(“ASU 2017-01”), which revises the
definition of a business. ASU 2017-01 requires that for an acquisition to be considered a business, the business would have to
include an input and a substantive process that together significantly contribute to the ability to create outputs. ASU 2017-01
also narrows the definition of the term “outputs,” which are now considered the result of inputs and substantive processes
that provide goods and services to customers, other revenue, or investment income, such as dividends and interest. ASU 2017-01
is effective for public companies for annual periods beginning after December 15, 2017. Early adoption is permitted. The Company
adopted ASU 2017-01 for the interim and annual reporting periods of 2018.
In January 2017, the FASB issued ASU 2017-04,
Intangibles – Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment
(“ASU 2017-04”),
which eliminates Step 2 from the goodwill impairment test. Instead, an entity should perform its annual or interim goodwill impairment
test by comparing the fair value of a reporting unit with its carrying amount. An entity should then recognize an impairment charge
for the amount by which the carrying amount exceeds the reporting unit’s fair value; however, the loss recognized should
not exceed the total amount of goodwill allocated to that reporting unit. Additionally, an entity should consider income tax effects
from any tax deductible goodwill on the carrying amount of the reporting unit when measuring the goodwill impairment loss, if
applicable. ASU 2017-04 requires the entity to apply these amendments on a prospective basis for which it is required to disclose
the nature of and reason for the change in accounting upon transition. This disclosure shall be provided in the first annual period
and in the interim period within the first annual period when the entity initially adopts the amendments. The Company plans to
adopt these amendments for its annual or any interim goodwill impairment tests in fiscal years beginning after December 15, 2019.
Early adoption is permitted for interim or annual goodwill impairment tests performed on testing dates after January 1, 2017.
The Company is currently evaluating the potential impact of ASU 2017-04 on the Company’s consolidated financial statements.
In June 2018, the FASB issued ASU 2018-07,
Compensation – Stock Compensation (Topic 718): Improvement to Nonemployee Share-Based Payment Accounting
(“ASU
2018-07”), which is intended to reduce cost and complexity and to improve financial reporting for share-based payments to
nonemployees. Under ASU 2018-07, most of the guidance on share-based payments to nonemployees would be aligned with the requirements
for share-based payments granted to employees. ASU 2018-07 is effective for interim and annual reporting periods beginning after
December 15, 2018. The Company is currently evaluating the potential impact of ASU 2018-07 on the Company’s consolidated
financial statements.
Other recent accounting pronouncements
issued by the FASB (including its Emerging Issues Task Force), the American Institute of Certified Public Accountants, and the
SEC did not, or are not believed by management to have, a material impact on the Company’s present or future financial statements.
Inventory as of September 30, 2018 and
December 31, 2017 was comprised of the following:
|
|
September 30,
2018
|
|
|
December 31,
2017
|
|
|
|
|
|
|
|
|
Raw materials
|
|
$
|
4,202,493
|
|
|
$
|
6,648,144
|
|
Finished goods
|
|
|
2,328,176
|
|
|
|
1,841,542
|
|
|
|
$
|
6,530,669
|
|
|
$
|
8,489,686
|
|
Accrued expenses as of September 30, 2018
and December 31, 2017 were as follows:
|
|
September 30,
2018
|
|
|
December 31,
2017
|
|
|
|
|
|
|
|
|
Accrued payroll expenses
|
|
$
|
908,179
|
|
|
$
|
1,037,122
|
|
Other accrued liabilities
|
|
|
900,555
|
|
|
|
894,798
|
|
|
|
$
|
1,808,734
|
|
|
$
|
1,931,920
|
|
5.
|
INTANGIBLE ASSETS, NET
|
Intangible assets consisted of the following
at September 30, 2018 and December 31, 2017:
|
|
Original Fair Market Value
|
|
|
Accumulated Amortization
|
|
|
Net
|
|
|
Useful Life
(Years)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance - September 30, 2018:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
In-process research and development
|
|
$
|
3,730,000
|
|
|
$
|
–
|
|
|
$
|
3,730,000
|
|
|
|
–
|
|
Trade names
|
|
|
100,000
|
|
|
|
55,000
|
|
|
|
45,000
|
|
|
|
5
|
|
Non-compete agreements
|
|
|
77,000
|
|
|
|
42,350
|
|
|
|
34,650
|
|
|
|
5
|
|
|
|
$
|
3,907,000
|
|
|
$
|
97,350
|
|
|
$
|
3,809,650
|
|
|
|
|
|
Balance - December 31, 2017:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
In-process research and development
|
|
$
|
3,730,000
|
|
|
$
|
–
|
|
|
$
|
3,730,000
|
|
|
|
–
|
|
Trade names
|
|
|
100,000
|
|
|
|
40,000
|
|
|
|
60,000
|
|
|
|
5
|
|
Non-compete agreements
|
|
|
77,000
|
|
|
|
30,800
|
|
|
|
46,200
|
|
|
|
5
|
|
|
|
$
|
3,907,000
|
|
|
$
|
70,800
|
|
|
$
|
3,836,200
|
|
|
|
|
|
Amortization expense for the three months
ended September 30, 2018 and 2017 totaled $8,850 and $8,850, respectively and for the nine months ended September 30, 2018 and
2017 totaled $26,550 and $26,550, respectively.
During the nine months ended September
30, 2018 and 2017, the Company paid a Company stockholder who is a supplier of raw material inventory to the Company $0 and $9,060,
respectively.
During the three months ended September
30, 2018 and 2017, the Company paid $0 and $5,250, respectively, to a company partially owned by a Company director that provides
quality control and quality assurance consulting to the Company. During the nine months ended September 30, 2018 and 2017, the
Company paid the same company $10,500 and $15,750, respectively.
Iliad Secured Convertible Promissory
Notes Payable
On May 25, 2016 (the “Purchase Price
Date”), the Company entered into a Securities Purchase Agreement (“Iliad SPA”) with Iliad Research and Trading,
L.P. (the “Lender” or “Iliad”) pursuant to which the Lender loaned the Company $2,000,000. On the Purchase
Price Date, the Company issued to Lender a Secured Convertible Promissory Note (the “Iliad Note”) in the principal
amount of $2,055,000 in exchange for payment by Lender of $2,000,000. The principal sum of the Iliad Note reflected the amount
invested, plus a 2.25% “Original Issue Discount” (“OID”) and a $10,000 reimbursement of Lender’s
legal fees. Out of the proceeds from the Iliad Note, the Company paid the sum of $25,000 to its placement agent, Myers & Associates,
L.P., which is a registered broker-dealer. The Company received net proceeds of $1,975,000 in exchange for the Iliad Note. The
Iliad Note required the repayment of all principal and any interest, fees, charges and late fees on the date that was thirteen
months after the Purchase Price Date (the “Maturity Date”). Interest was to be paid on the outstanding balance at a
rate of ten percent (10%) per annum from the Purchase Price Date until the Iliad Note was paid in full. Interest was accrued during
the term of the Iliad Note and all interest calculations were computed on the basis of a 360-day year comprised of twelve (12)
thirty (30)-day months and compounded daily. Subject to adjustment as set forth in the Iliad Note, the conversion price for each
Lender conversion was $0.50 (the “Lender Conversion Price”), convertible into shares of fully paid and non-assessable
common stock. Beginning on the date that was six months after the Purchase Price Date and continuing until the Maturity Date, Iliad
had the right to redeem a portion of the Iliad Note in any amount up to the “Maximum Monthly Redemption Amount” ($275,000, which
was the maximum aggregate redemption amount that could be redeemed in any calendar month), for which payments could be made in
cash or by converting the redemption amount into shares of Company common stock at a conversion price which was the lesser of (a)
the Lender Conversion Price of $0.50 and (b) the Market Price, defined as 70% (“the Conversion Factor”), subject to
adjustment as follows: if at any time (1) the average of the three lowest closing bid prices in the previous twenty (20) trading
days was below $0.25 per share then the Conversion Factor would have been reduced by 10%, (2) the Company was not Deposit/Withdrawal
At Custodian eligible, then the Conversion Factor would have been reduced by an additional 5%, or (3) there occurred a “Major
Default” then the Conversion Factor would have been reduced by an additional 5%. The Company was permitted to prepay the
Iliad Note at any time by payment to Lender of 125% of the principal, interest and other amounts then due under the Note. The Company
was permitted to prepay the Iliad Note notwithstanding an earlier notice of conversion from the Lender, provided that in such event
the Lender could convert an amount not to exceed $300,000 under the Iliad Note. In connection with the Iliad Note, as set forth
above, the Company incurred an original issue discount of $45,000 and $35,000 of other debt issuance costs, which were amortized
over the Iliad Note term. The Iliad Note was securitized by the Company’s accounts receivable, inventory and equipment.
In November 2016, the Company entered into
an Amendment to the Iliad Note (the “Iliad Amendment”), whereby the Lender and the Company agreed that the Maximum
Monthly Redemption Amount for the period from November 2016 to January 2017 (the “Reduction Period”) be reduced from
$275,000 to $166,667 (the “Reduced Maximum Monthly Redemption Amount”). In addition, if the Lender failed to convert
the full Reduced Maximum Monthly Redemption Amount during any month in the Reduction Period, then any such unconverted amount would
increase the Reduced Maximum Monthly Redemption Amount in the following month or months. Furthermore, the Company was not allowed
to pay any of the Reduced Maximum Monthly Redemption Amounts in cash. As such, all amounts converted would be converted into “Redemption
Conversion Shares” of the Company’s common stock. Also, as part of the Iliad Amendment, the Lender agreed that, with respect
to any Redemption Conversion Shares received during the Reduction Period, in any given calendar week its Net Sales of such Redemption
Conversion Shares would not exceed the greater of (a) 10% of the Company’s weekly dollar trading volume in such week or (b)
$50,000 (the “Volume Limitation”). However, if the Lender’s Net Sales were less than the Volume Limitation for
any given week, then in the following week or weeks, the Lender would be allowed to sell an additional amount of Redemption Conversion
Shares equal to the difference between the amount the Lender was allowed to sell and the amount the Lender actually sold. For the
purpose of the Iliad Amendment, Net Sales was defined as the gross proceeds from sales of the Redemption Conversion Shares sold
in a calendar week during the Reduction Period minus any trading commissions or costs associated with clearing and selling such
Redemption Conversion Shares minus the purchase price paid for any shares of the Company’s common stock purchased in the
open market during such week. The Lender and the Company both agreed that in the event the Lender breached the Volume Limitation
where its Net Sales of Redemption Conversion Shares during any week during the Reduction Period exceeded the dollar volume the
Lender was permitted to sell during such week pursuant to the Volume Limitation (the “Excess Sales”), then the Company’s
sole and exclusive remedy for such breach was the reduction of the outstanding balance of the Iliad Note by an amount equal to
200% of the Excess Sales upon delivery of written notice to the Lender setting forth its basis for such reduction.
In January 2017, the Company entered into
Amendment #2 to the Iliad Note (the “Iliad Amendment 2”). In accordance with the Iliad Amendment 2, during the period
between January 27, 2017 and February 24, 2017, the Company agreed to allow the Lender to convert up to $500,000 (the “Additional
Redemption Amount”) in “Redemption Conversions” under the Note, provided that the Lender not effectuate a Redemption Conversion
of any Maximum Monthly Redemption Amount between January 27, 2017 and March 1, 2017. During this time period, the Company was not
allowed to pay any of the Additional Redemption Amount in cash and all such amounts had to be converted into Redemption Conversion
Shares of the Company’s common stock. In addition, the Lender agreed that the sale of any Redemption Conversion Shares between
January 27, 2017 and April 30, 2017 (the “Limitation Period”) was subject to the Volume Limitation. Immediately following
the expiration of the Limitation Period, the Volume Limitation was cancelled.
In March 2017, the Company entered into
Amendment #3 to the Iliad Note (the “Iliad Amendment 3”). In accordance with the Iliad Amendment 3, during the period
from March 1, 2017 to March 31, 2017, the Company agreed to allow the Lender to convert up to $500,000 (the “Additional Redemption
Amount 2”) in Redemption Conversions under the Note, provided that the Lender not effectuate a Redemption Conversion of any
Maximum Monthly Redemption Amount from March 1, 2017 until April 1, 2017. During this time period, the Company was not allowed
to pay any of the Additional Redemption Amount 2 in cash and all such amounts had to be converted into Redemption Conversion Shares
of the Company’s common stock. In addition, the Lender agreed that the sale of any Redemption Conversion Shares between March
1, 2017 and May 31, 2017 (the “Limitation Period 2”) was subject to the Volume Limitation. Immediately following the
expiration of the Limitation Period 2, the Volume Limitation was cancelled.
In August 2017, the Company entered
into Amendment #4 to the Iliad Note (the “Iliad Amendment 4”), whereby the Lender and the Company agreed to
extend the Maturity Date of the Iliad Note to April 1, 2018. In addition, the parties agreed to amend the Volume Limitation
in the Iliad Note, with respect to any “Conversion Shares”, such that in any given calendar week the
Lender’s Net Sales of such Conversion Shares would not exceed the greater of (a) 15% of the Company’s weekly
dollar trading volume in such week or (b) $50,000 (the “New Volume Limitation”). However, if the Lender’s
Net Sales were less than the New Volume Limitation for any given week, then in the following week or weeks, the Lender would
be allowed to sell an additional amount of Conversion Shares equal to the difference between the amount the Lender was
allowed to sell and the amount the Lender actually sold. For the purpose of the Iliad Amendment 4, Net Sales was defined as
the gross proceeds from sales of the Conversion Shares sold in a calendar week minus any trading commissions or costs
associated with clearing and selling such Conversion Shares minus the purchase price paid for any shares of the
Company’s common stock purchased in the open market during such week. The Lender and the Company both agreed that in
the event the Lender breached the New Volume Limitation where its Net Sales of Conversion Shares during any week exceeded
the dollar volume the Lender was permitted to sell during such week pursuant to the New Volume Limitation (the “Excess
Sales”), then the Company’s sole and exclusive remedy for such breach was the reduction of the outstanding
balance of the Iliad Note by an amount equal to 200% of the Excess Sales upon delivery of written notice to the Lender
setting forth its basis for such reduction. In connection with the Iliad Amendment 4, Lender confirmed that no Events of
Default or other material breaches existed under the Iliad Note and related Transaction Documents (as defined in the Iliad
SPA).
During the nine months ended September
30, 2017, the Company issued 5,793,791 shares of its common stock to Iliad in connection with the conversions of the Iliad Note
in the aggregate principal amount of $1,344,359 and $55,641 of accrued interest. The total of $1,400,000 was allocated to common
stock and additional paid-in capital.
The
Company’s borrowings and conversions under the Iliad SPA for the nine months ended September 30, 2018 and for the year ended
December 31, 2017 are summarized in the table below:
|
|
Maturity
|
|
|
September 30,
2018
|
|
|
December 31,
2017
|
|
|
Interest
Rate
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Secured promissory note payable
|
|
|
April 1, 2018
|
|
|
$
|
–
|
|
|
$
|
1,897,976
|
|
|
|
10%
|
|
Interest accrued
|
|
|
|
|
|
|
–
|
|
|
|
137,334
|
|
|
|
|
|
Unamortized original issue discount and debt issuance costs
|
|
|
|
|
|
|
–
|
|
|
|
35,335
|
|
|
|
|
|
Conversion of convertible promissory notes and accrued interest to common stock
|
|
|
|
|
|
|
–
|
|
|
|
(1,805,000
|
)
|
|
|
|
|
Conversion of convertible promissory notes and accrued interest to accrued liabilities
|
|
|
|
|
|
|
–
|
|
|
|
75,000
|
|
|
|
|
|
Cash repayment of promissory notes and accrued interest
|
|
|
|
|
|
|
–
|
|
|
|
(340,645
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net carrying amount of debt
|
|
|
|
|
|
|
–
|
|
|
|
–
|
|
|
|
|
|
Less current portion
|
|
|
|
|
|
|
–
|
|
|
|
–
|
|
|
|
|
|
Long-term borrowings - net of current portion
|
|
|
|
|
|
$
|
–
|
|
|
$
|
–
|
|
|
|
|
|
On the Purchase Price Date, the Company
recorded a beneficial conversion feature of $370,000 (the “Iliad Instrument”), which was originally recorded in additional
paid-in capital (“APIC”) and was scheduled for amortization over six months. The Company determined in 2016 that the
Iliad Instrument qualified for derivative accounting treatment. The $370,000 fair value of the Iliad Instrument at the Purchase
Price Date is unchanged as a result of the change in derivative accounting treatment, however, in 2016 we reclassified the Iliad
Instrument from APIC to a liability in accordance with derivative accounting treatment. During the three and nine months ended
September 30, 2017, the Company recorded a gain of $0 and $222,800, respectively, for the change in fair value of the Iliad
Instrument as part of a separate line item in the Company’s Condensed Consolidated Statement of Operations. The assumptions
used by the Company for calculating the fair value of the Iliad Instrument at the Purchase Price Date using the Binomial Lattice
valuation model were: (i) Volatility of 74.0%; (ii) Risk-Free Interest Rate of 0.44%; and (iii) Expected Term of five months;
and at September 30, 2017 were (i) Volatility of 61%, (ii) Risk-Free Interest Rate of 0.74%; and (iii) Expected Term of zero months.
In March 2017, the Company entered into
another Securities Purchase Agreement (“Iliad SPA 2”) with Iliad pursuant to which the Lender loaned the Company $750,000.
On March 1, 2017 (the “Subsequent Purchase Price Date”), the Company issued to Lender a Secured Convertible Promissory
Note (the “Iliad Note 2”) in the principal amount of $770,000 in exchange for payment by Lender of $750,000. The principal
sum of the Iliad Note 2 reflected the amount invested, plus a $15,000 OID and a $5,000 reimbursement of Lender’s legal fees.
The Company received net proceeds of $750,000 in exchange for the Iliad Note 2. The Iliad Note 2 required the repayment of all
principal and any interest, fees, charges and late fees on the date that was fourteen months after the Subsequent Purchase Price
Date (the “Maturity Date”). Interest was to be paid on the outstanding balance at a rate of eight percent (8%) per
annum from the Subsequent Purchase Price Date until the Iliad Note 2 was paid in full. Interest accrued during the term of the
Iliad Note 2 and all interest calculations were computed on the basis of a 360-day year comprised of twelve (12) thirty (30)-day
months and compounded daily. Subject to adjustment as set forth in the Iliad Note 2, the conversion price for each Lender conversion
was the Lender Conversion Price, convertible into shares of fully paid and non-assessable common stock. Beginning on the date that
was six months after the Subsequent Purchase Price Date and continuing until the Maturity Date, Iliad had the right to redeem a
portion of the Iliad Note 2 in an amount not to exceed $100,000. Provided the Company had not suffered an “Event of Default”
and was in compliance with certain “Equity Conditions” (unless waived by Iliad, in either case), the Company was permitted
to make payments on such redemptions in cash or by converting the redemption amount into shares of Company common stock at a conversion
price which was the lesser of (a) $0.50 per share and (b) 70% (“the Conversion Factor”) of the average of the three
(3) lowest closing bid prices in the previous 20 trading days, subject to adjustment as follows: if at any time (1) the average
of the three lowest closing bid prices in the previous twenty (20) trading days was below $0.25 per share then the Conversion Factor
would have been reduced by 10%, (2) the Company was not Deposit/Withdrawal At Custodian eligible, then the Conversion Factor would
have been reduced by 5%, (3) the Company was not DTC eligible, then the Conversion Factor would have been reduced by an additional
5% or (4) there occurred a “Major Default” then the Conversion Factor would have been reduced by an additional 5% for
each of the first three Major Defaults that occurred after the effective date. The Company was permitted to prepay the Iliad Note
2 at any time by payment to Lender of 125% of the principal, interest and other amounts then due under the Note. The Company was
permitted to prepay the Iliad Note notwithstanding an earlier notice of conversion from the Lender, provided that in such event
the Lender could have converted an amount not to exceed $200,000 under the Iliad Note 2. In connection with the Iliad Note 2, as
set forth above, the Company incurred an original issue discount of $15,000 and $5,000 of other debt issuance costs, which was
amortized over the Iliad Note 2 term. The Iliad Note 2 was securitized by the Company’s accounts receivable, inventory and
equipment.
The Company’s borrowings
under the Iliad SPA 2 for the nine months ended September 30, 2018 and for the year ended December 31, 2017 is summarized in the
table below:
|
|
Maturity
|
|
September 30,
2018
|
|
|
December 31,
2017
|
|
|
Interest
Rate
|
|
|
|
|
|
|
|
|
|
|
|
Secured promissory note payable
|
|
April 30, 2018
|
|
$
|
609,926
|
|
|
$
|
770,000
|
|
|
8%
|
Interest accrued
|
|
|
|
|
44,360
|
|
|
|
51,890
|
|
|
|
Unamortized original issue discount and debt issuance costs, net
|
|
|
|
|
5,714
|
|
|
|
(5,714
|
)
|
|
|
Conversion of convertible promissory notes and accrued interest to accrued liabilities
|
|
|
|
|
–
|
|
|
|
(75,000
|
)
|
|
|
Cash repayment of promissory notes and accrued interest
|
|
|
|
|
(660,000
|
)
|
|
|
(131,250
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net carrying amount of debt
|
|
|
|
|
–
|
|
|
|
609,926
|
|
|
|
Less current portion
|
|
|
|
|
–
|
|
|
|
(609,926
|
)
|
|
|
Long-term borrowings - net of current portion
|
|
|
|
$
|
–
|
|
|
$
|
–
|
|
|
|
On the Subsequent Purchase Price Date,
the Company recorded a derivative liability of $29,300 which was scheduled for amortization over 8 months. During the three and
nine months ended September 30, 2017, the Company recorded a gain of $10,987 and $26,075, respectively, for the change in fair
value of the derivative liability as part of a separate line item in the Company’s Condensed Consolidated Statement of Operations.
The assumptions used by the Company for calculating the fair value of the derivative liability at the Subsequent Purchase Price
Date and at September 30, 2017 using the Binomial Lattice valuation model were: (i) Volatility of 85.0%; (ii) Risk-Free Interest
Rate of 0.84%; and (iii) Expected Term of 8 months; and at September 30, 2017 were (i) Volatility of 84.0%, (ii) Risk-Free Interest
Rate of 0.93%; and (iii) Expected Term of 4 months. On April 24, 2018, the Company repaid all amounts outstanding under the Iliad
Note 2.
Current Unsecured Note Payable
In November 2017, the Company entered into
a new loan agreement with First Insurance Funding to fund a portion of the Company’s insurance policies. The amount financed
was $149,044 and bears interest at a rate of 4.65%. The Company was required to make nine monthly payments of $16,883 to satisfy
this current unsecured note payable. As of September 30, 2018 and December 31, 2017, the outstanding balance was $0 and $116,370,
respectively.
Unsecured Note Payable
On January 29, 2016, the Company issued
an unsecured promissory note to Wiltshire, LLC (“Wiltshire”) in the principal amount of $850,000 (the “Promissory
Note”) in consideration of a loan provided to the Company by Wiltshire. The Promissory Note accrued interest at 12% per annum,
and the Company was obligated to make monthly interest-only payments in the amount of $8,500, for which the interest-only payments
obligation commenced on March 1, 2016. All principal and accrued and unpaid interest was due under the Promissory Note on February
1, 2018. The Company had the right to prepay the Promissory Note without penalty or premium. In connection with the Promissory
Note, the Company incurred an original issue discount of $30,000 and $18,570 of other debt issuance costs, which were amortized
over the Promissory Note term.
On November 9, 2017, the Company extinguished
and replaced the Promissory Note with a new note to Wiltshire in the principal amount of $850,000 (the “Wiltshire Note 2”)
in consideration of a new loan to the Company by Wiltshire. The Wiltshire Note 2 bears interest at 16% per annum, the Company is
obligated to make monthly interest-only payments of $11,333, for which the interest-only payments obligation commenced on November
9, 2017. All principal and accrued interest is due under the Wiltshire Note 2 on May 9, 2019. In connection with the Wiltshire
Note 2, the Company incurred legal expenses of $12,500.
The Company’s borrowing under the
Promissory Note for the nine months ended September 30, 2018 and for the year ended December 31, 2017 is summarized in the table
below:
|
|
September 30,
2018
|
|
|
December 31,
2017
|
|
|
|
|
|
|
|
|
Unsecured promissory note payable
|
|
$
|
850,000
|
|
|
$
|
850,000
|
|
Debt extinguishment (Promissory Note)
|
|
|
–
|
|
|
|
(850,000
|
)
|
Cash repayment of Wiltshire Note 2
|
|
|
(850,000
|
)
|
|
|
–
|
|
Unsecured promissory note – principal amount (Wiltshire Note 2)
|
|
|
–
|
|
|
|
850,000
|
|
|
|
|
|
|
|
|
|
|
Net carrying amount of debt
|
|
|
–
|
|
|
|
850,000
|
|
Less current portion
|
|
|
–
|
|
|
|
–
|
|
Long-term borrowings - net of current portion
|
|
$
|
–
|
|
|
$
|
850,000
|
|
Pursuant to the terms of the
Promissory Note, the Company issued to Wiltshire a warrant with the right to purchase up to 2,000,000 shares of the
Company’s common stock (the “Warrant”). The Warrant is exercisable, subject to certain limitations,
subsequent to July 1, 2017 and before the date that is five years from the date of issuance at an exercise price of $0.20 per
share, subject to adjustment upon the occurrence of certain events such as stock splits and dividends. The Company recorded
the fair value of the Warrant of $266,800 as a debt discount associated with the Promissory Note. During the three months
ended each of September 30, 2018 and 2017, the Company recorded interest expense of $30,491 and $33,350, respectively, for
the amortization of the Warrant fair value. During the nine months ended each of September 30, 2018 and 2017, the Company
recorded interest expense of $98,491 and $100,500, respectively. The assumptions used by the Company for calculating the fair
value of the Warrant at inception using the Black-Scholes valuation model were: (i) Volatility of 83.3%; (ii) Risk-Free
Interest Rate of 2.12%; and (iii) Expected Term of five years.
Pursuant to the terms of the Wiltshire
Note 2, the Company issued to Wiltshire a warrant with the right to purchase up to 750,000 shares of the Company’s common
stock (the “Warrant 2”). The Warrant 2 is exercisable at any time subsequent to the date of issuance on November 9,
2017, and before the date that is five years from the date of issuance at an exercise price of $0.248 per share, subject to adjustment
upon the occurrence of certain events such as stock splits and dividends. The Company used extinguishment accounting to record
the repayment of the Promissory Note and issuance of the Wiltshire Note 2. As a result, the fair value of the Warrant 2 of $136,650
was included in the loss on extinguishment of debt amount totaling $188,822 that was included in the Company’s Consolidated
Statement of Operations for the year ended December 31, 2017. The assumptions used by the Company for calculating the fair value
of the Warrant 2 at inception using the Black-Scholes valuation model were: (i) Volatility of 95.9%; (ii) Risk-Free Interest Rate
of 2.59%; and (iii) Expected Term of five years. On August 22, 2018, the Company repaid all amounts outstanding under the Wiltshire
Note 2.
Common
Stock
The Company is
authorized to issue up to 190,000,000 shares of common stock (par value $0.0001). As of September 30, 2018 and December 31, 2017,
the Company had 94,355,178 and 90,512,563 shares of common stock issued and outstanding.
Preferred
Stock
The Company is
authorized to issue up to 10,000,000 shares of $0.0001 par value preferred stock with designations, rights and preferences to be
determined from time to time by the Board of Directors of the Company. Each such series or class shall have voting powers, if any,
and such preferences and/or other special rights, with such qualifications, limitations or restrictions of such preferences and/or
rights as shall be stated in the resolution or resolutions providing for the issuance of such series or class of shares of preferred
stock. As of September 30, 2018 and December 31, 2017, there was no preferred stock issued and outstanding.
Options/Warrants/RSU’s
On July 23, 2014, Company stockholders
approved the CV Sciences, Inc. Amended and Restated 2013 Equity Incentive Plan (the “Amended 2013 Plan”), which provides
for the granting of stock options, restricted stock awards, restricted stock units (RSU’s), stock bonus awards and performance-based
awards. On each of December 21, 2015, October 24, 2016, July 14, 2017 and August 4, 2018, the Company’s stockholders approved
an amendment to the Amended 2013 Plan to increase the number of shares that may be issued under the Amended 2013 Plan. There are
currently 28,000,000 shares of common stock authorized for issuance under the Amended 2013 Plan. This plan serves as the successor
to the 2013 Equity Incentive Plan. There were no option awards under the 2013 Equity Incentive Plan prior to it being amended and
restated.
During the three months ended September
30, 2018, warrants to purchase 2,750,000 were exercised on a net issuance basis, resulting in the issuance of 2,632,182 shares
of common stock.
9.
|
STOCK-BASED COMPENSATION
|
The Company’s Amended 2013 Plan
provides for the granting of stock options, restricted stock awards, RSU’s, stock bonus awards and performance-based
awards. As of September 30, 2018, the Company had 7,237,433 of authorized unissued shares reserved and available for
issuance upon exercise and conversion of outstanding awards under the Amended 2013 Plan.
The stock options are exercisable at no
less than the fair market value of the underlying shares on the date of grant, and restricted stock and restricted stock units
are issued at a value not less than the fair market value of the common stock on the date of the grant. Generally, stock options
awarded are vested in equal increments ranging from two to four years on the annual anniversary date on which such equity grants
were awarded. The stock options generally have a maximum term of 10 years.
The Company recognized Selling, General
and Administrative (“SG&A”) expenses of $237,882 and $1,328,096, relating to stock options and RSU’s issued
to employees, officers, directors and consultants for the three months ended September 30, 2018 and 2017, respectively. The Company
recognized SG&A expenses of $1,634,184 and $3,072,224, relating to stock options and RSU’s issued to employees, officer,
directors and consultants for the nine months ended September 30, 2018 and 2017, respectively. As of September 30, 2018, total
unrecognized compensation cost related to non-vested stock-based compensation arrangements granted to employees, officers, directors
and consultants was $2,286,415 which is expected to be recognized over a weighted-average period of 1.87 years.
The following table summarizes stock option
and RSU activity for the Amended 2013 Plan during the nine months ended September 30, 2018:
|
|
Number of Shares
|
|
|
Weighted Average Exercise Price
|
|
|
Weighted Average Remaining Contract Term (Years)
|
|
|
Aggregate Intrinsic Value
|
|
Outstanding - December 31, 2017
|
|
|
15,823,277
|
|
|
$
|
0.48
|
|
|
|
8.54
|
|
|
$
|
5,406,499
|
|
Granted
|
|
|
6,969,000
|
|
|
|
0.52
|
|
|
|
–
|
|
|
|
–
|
|
Exercised
|
|
|
(994,432
|
)
|
|
|
0.35
|
|
|
|
–
|
|
|
|
–
|
|
Cancelled/Forfeited
|
|
|
(1,035,278
|
)
|
|
|
0.36
|
|
|
|
–
|
|
|
|
–
|
|
Outstanding - September 30, 2018
|
|
|
20,762,567
|
|
|
|
0.50
|
|
|
|
7.78
|
|
|
|
89,820,535
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total exercisable - September 30, 2018
|
|
|
15,654,682
|
|
|
|
0.49
|
|
|
|
7.36
|
|
|
|
67,957,693
|
|
Total unvested - September 30, 2018
|
|
|
5,107,885
|
|
|
|
0.55
|
|
|
|
9.05
|
|
|
|
21,862,842
|
|
Total vested or expected to vest - September 30, 2018
|
|
|
20,762,567
|
|
|
|
0.50
|
|
|
|
7.78
|
|
|
|
89,820,535
|
|
The following table summarizes unvested
stock options as of September 30, 2018:
|
|
|
Number of
Shares
|
|
|
Weighted
Average
Fair
Value
Per Share on
Grant Date
|
|
|
Unvested
stock options - December 31, 2017
|
|
|
|
3,738,615
|
|
|
|
0.35
|
|
|
Granted
|
|
|
|
6,969,000
|
|
|
|
0.52
|
|
|
Vested
|
|
|
|
(4,564,452
|
)
|
|
|
0.36
|
|
|
Cancellations
|
|
|
|
(1,035,278
|
)
|
|
|
0.31
|
|
|
Unvested
stock options - September 30, 2018
|
|
|
|
5,107,885
|
|
|
|
0.55
|
|
The following table summarizes stock option activity outside
of the Amended 2013 Plan during the nine months ended September 30, 2018:
|
|
Number of
Shares
|
|
|
Weighted
Average
Exercise
Price
|
|
|
Weighted
Average
Remaining
Contract
Term
(Years)
|
|
|
Aggregate
Intrinsic
Value
|
|
Outstanding - December 31, 2017
|
|
|
7,250,000
|
|
|
$
|
0.37
|
|
|
|
8.03
|
|
|
$
|
32,336,000
|
|
Granted
|
|
|
–
|
|
|
|
–
|
|
|
|
–
|
|
|
|
–
|
|
Exercised
|
|
|
–
|
|
|
|
–
|
|
|
|
–
|
|
|
|
–
|
|
Forfeited
|
|
|
–
|
|
|
|
–
|
|
|
|
–
|
|
|
|
–
|
|
Expired
|
|
|
–
|
|
|
|
–
|
|
|
|
–
|
|
|
|
–
|
|
Outstanding - September 30, 2018
|
|
|
7,250,000
|
|
|
|
0.37
|
|
|
|
8.03
|
|
|
|
32,336,000
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total exercisable - September 30, 2018
|
|
|
7,250,000
|
|
|
|
0.37
|
|
|
|
8.03
|
|
|
|
32,336,000
|
|
Total unvested - September 30, 2018
|
|
|
–
|
|
|
|
–
|
|
|
|
–
|
|
|
|
–
|
|
Total vested or expected to vest - September 30, 2018
|
|
|
7,250,000
|
|
|
|
0.37
|
|
|
|
8.03
|
|
|
|
32,336,000
|
|
As of September 30, 2018, there were 10,750,000
remaining unvested stock options granted outside of the Amended 2013 Plan which vest upon the completion of future performance
conditions.
On December 22, 2017, tax reform legislation
known as the Tax Cuts and Jobs Act (the “Tax Legislation”) was enacted in the United States (the “U.S.”).
The Tax Legislation significantly revises the U.S. corporate income tax by lowering the statutory corporate tax rate to 21%, among
other changes.
The Company has preliminarily accounted for the effects of the
Tax Legislation and estimate that our effective tax rate exclusive of discrete items is 9.5% for 2018 because taxable income exclusive
of discrete items should be mostly offset by net operating loss carry forwards. Tax expense based on the estimated annual effective
tax rate was $710,000 for the nine months ended September 30, 2018, however, this amount is partially offset by a tax benefit on
discrete items of $470,000 for the nine months ended September 30, 2018 which is related to excess tax deductions for non-qualified
stock options exercised. Due to uncertainties in estimating our taxable income after 2018, we cannot determine that it is more
likely than not that net operating loss carry forwards and other deferred tax assets will be utilized after 2018.
Our income tax provision for the three and nine months ended
September 30, 2018 was $200,000 and $240,000, respectively, and was $0 and $0 for the three and nine months ended September 30,
2017, respectively.
11.
|
COMMITMENTS AND CONTINGENCIES
|
Commitments
The Company entered an 8-year lease agreement
(the “Lease”) consolidating its operations of approximately 24,000 square feet in San Diego, California that commenced
on February 1, 2018. The Company is required to pay monthly base rent, utilities and common area maintenance expenses. The Company
received a landlord rent incentive of $1,067,459 for tenant improvements. The Lease rent incentive is recorded as a deferred liability
and is amortized over the Lease term to rent expense.
The Company entered a 3-year lease
agreement for additional warehouse space of approximately 5,000 square feet in San Diego, California that commenced on April
1, 2018. In August 2018, the Company entered a lease agreement for additional office space of approximately
6,600 in San Diego, California that commenced on October 15, 2018.
The following table provides the Company’s
future minimum payments under all Company lease commitments as of September 30, 2018:
|
|
|
Operating Lease Commitment
|
|
|
|
|
|
|
|
2018 – for the three months ending December 31, 2018
|
|
|
$
|
178,232
|
|
|
2019
|
|
|
|
923,889
|
|
|
2020
|
|
|
|
955,048
|
|
|
2021
|
|
|
|
917,415
|
|
|
2022
|
|
|
|
922,638
|
|
|
Thereafter
|
|
|
|
3,024,659
|
|
|
|
|
|
$
|
6,921,881
|
|
The Company incurred rent expense of $164,397
and $110,938 for the three months ended September 30, 2018 and 2017, respectively, and incurred rent expense of $500,214 and $353,555
for the nine months ended September 30, 2018 and 2017, respectively.
Contingencies
On
April 23, 2014, Tanya Sallustro filed a purported class action complaint (the “Complaint”) in the Southern District
of New York (the “Court”) alleging securities fraud and related claims against the Company and certain of its officers
and directors and seeking compensatory damages including litigation costs. Ms. Sallustro alleges that between March 18-31, 2014,
she purchased 325 shares of the Company’s common stock for a total investment of $15,791. The Complaint refers to Current
Reports on Form 8-K and Current Reports on Form 8-K/A filings made by the Company on April 3, 2014 and April 14, 2014, in which
the Company amended previously disclosed sales (sales originally stated at $1,275,000 were restated to $1,082,375 - a reduction
of $192,625) and restated goodwill as $1,855,512 (previously reported at net zero). On March 19, 2015, the Court issued a ruling
appointing Steve Schuck as lead plaintiff. Counsel for Mr. Schuck filed a “consolidated complaint” on September 14,
2015, asserting two claims: (1) for violation of Section 10(b) of the Exchange Act and SEC Rule 10B-5 promulgated thereunder against
all defendants, and (2) for violation of Section 20(a) of the Exchange Act against the individual defendants. Plaintiffs sued the
Company, Michael Mona, Jr., Bart Mackay, Theodore Sobieski, Edward Wilson, Stuart Titus, and Michael Llamas.
On
December 11, 2015, the Company and the individuals (except for Messrs. Titus and Llamas) filed a motion to dismiss the consolidated
complaint. On April 2, 2018, the Court issued an order granting in part and denying in part the motion to dismiss. With respect
to the First Claim for violation of Section 10(b) of the Exchange Act, the court ruled that plaintiffs failed to allege misstatements
or omissions attributable to Messrs. Mackay, Sobieski, or Titus, and so granted the motion on that claim as to those parties. The
court found the allegations sufficient as to the Company and Messrs. Wilson, and Mona Jr., and so denied the motion as to those
parties. Under plaintiffs’ separate theory of “market manipulation,” the Court granted the motion in favor of
all defendants. The parties are currently awaiting entry of a case scheduling order by the Court. Management intends to vigorously
defend the allegations and an estimate of possible loss cannot be made at this time.
On
March 17, 2015, stockholder Michael Ruth filed a shareholder derivative suit in Nevada District Court alleging two causes of action:
1) Breach of Fiduciary Duty, and 2) “Gross Mismanagement.” The claims are premised on the same events as the already-pending
securities class action case in New York discussed above – it is alleged that the Form 8-K filings misstated goodwill and
sales of the Company, which when corrected, lead to a significant drop in stock price. The Company filed a motion to dismiss the
suit on June 29, 2015. Instead of opposing the Company’s motion, Mr. Ruth filed an amended complaint on July 20, 2015. Thereafter,
Mr. Ruth and the Company agreed to stay the action pending the outcome of the securities class action case in New York discussed
above. Mr. Ruth and the Company filed a stipulation and proposed order on June 20, 2018 asking the Nevada District Court to continue
the stay in the action pending a resolution on the securities class action case. Since no discovery has been conducted and the
case has been stayed for nearly three years, an estimate of the possible loss or recovery cannot be made at this time.
On
June 15, 2017, the SEC filed an enforcement action against the Company and its then-Chief Executive Officer, Michael Mona, Jr.
In the complaint, filed in the United States District Court of Nevada (Case No. 2:17-cv-01681), the SEC alleged that the Company
and Mr. Mona violated federal securities laws, including Section 10(b) of the Securities Exchange Act of 1934, as amended, and
SEC Rule 10b-5(b), through alleged misrepresentations made in certain SEC reports regarding the value of the Company’s assets
acquired by the Company from PhytoSphere Systems, LLC. On May 31, 2018, the Company and Mr. Mona settled all claims. Pursuant
to the terms of the settlement, without admitting or denying the allegations made by the SEC, the Company agreed to a consent judgment
pursuant to which (a) the Company agreed to pay a penalty in the amount of $150,000, and (b) the Company is permanently enjoined
from violations of federal securities laws. The Company has made this payment in full. Mr. Mona, without admitting
or denying any allegations, agreed to an order (a) prohibiting him from serving as an officer or director of a publicly held company
for five (5) years, (b) providing for payment in the aggregate amount of $50,000, payable in 12 installments commencing 30 days
after entry of final judgment, and (c) permanently enjoining him from violations of federal securities laws. Effective concurrent
with the settlement, Mr. Mona resigned as the Company’s President and Chief Executive Officer, and resigned his position
on the Company’s Board of Directors.
On October 21, 2016, Dun Agro B.V.
(“Dun Agro”) filed a complaint against the Company in the District Court of the North Netherlands, location Groningen,
The Netherlands, alleging non-performance under a contract, seeking compensatory damages of approximately 2,050,000 euros, excluding
interest and costs. The plaintiff alleges that the Company was obligated to perform under that certain Supply Agreement between
the Company and Dun Agro dated December 19, 2013, and to purchase 1,000,000 kilograms of harvested raw material related to
the 2016 crop. The Company settled this matter on August 31, 2018 with no compensatory damages.
The
Company is a plaintiff in a litigation matter involving a former credit card processor of the Company and recently settled another
matter involving a former credit card processor of the Company. On September 10, 2017, the Company filed a complaint against one
such credit card processor, PayToo Merchant Services, Corporation (“Pay Too”), a Florida corporation, in the Circuit
Court in Broward County, Florida, asserting breach of contract claims for PayToo’s failure to remit approximately $250,000
to the Company for credit card sales processed by PayToo from January 2017 to February 2017. On December 11, 2017, the Company
filed a complaint against the other credit card processor, T1 Payments, LLC (“T1”), a Nevada corporation, in District
Court, Clark County, Nevada, asserting breach of contract claims for T1’s failure to remit approximately $500,000 to the
Company for credit card sales processed by T1 from February 2017 to October 2017. The T1 matter was resolved on October 22, 2018
with $450,000 of previously restricted cash being released to the Company by T1 in full settlement of the Company’s complaint.
The Company has been made aware of a series
of complaints and one derivative suit filed by various plaintiffs alleging violations of securities law related to the Company’s
disclosures regarding patent prosecution of its various drug development assets. On August 24, 2018, David Smith filed a purported
class action complaint against the Company in the United States District Court District of Nevada. This complaint and the other
complaints that the Company has been made aware of were filed directly after Citron Research published on Twitter on August 20,
2018 its belief that the Company misled investors by failing to disclose that the Company’s efforts to secure patent protection
had been “finally rejected” by the United States Patent and Trademark Office (USPTO). The Company believes these claims
are without merit, and intends to vigorously defend any claims in the event it is served with a complaint.
In the normal course of business, the Company
is a party to a variety of agreements pursuant to which we may be obligated to indemnify the other party. It is not possible to
predict the maximum potential amount of future payments under these types of agreements due to the conditional nature of our obligations
and the unique facts and circumstances involved in each particular agreement. Historically, payments made by us under these types
of agreements have not had a material effect on our business, consolidated results of operations or financial condition.
The Company operates in two distinct business
segments: a consumer product segment in manufacturing, marketing and selling plant-based CBD products to a range of market sectors;
and, a specialty pharmaceutical segment focused on developing and commercializing novel therapeutics utilizing synthetic CBD. The
Company’s segments maintain separate financial information for which operating results are evaluated on a regular basis by
the Company’s senior management in deciding how to allocate resources and in assessing performance. The Company evaluates
its consumer product segment based on net product sales, gross profit and operating income or loss. The Company currently evaluates
its specialty pharmaceutical segment based on the progress of its clinical development programs.
The following table presents information
by reportable operating segment for the three and nine months ended September 30, 2018 and 2017:
|
|
Consumer Products Segment
|
|
|
Specialty Pharmaceutical Segment
|
|
|
Consolidated Totals
|
|
Three Months Ended
|
|
|
|
|
|
|
|
|
|
|
|
|
September 30, 2018:
|
|
|
|
|
|
|
|
|
|
|
|
|
Product sales, net
|
|
$
|
13,600,881
|
|
|
$
|
–
|
|
|
$
|
13,600,881
|
|
Gross profit
|
|
|
9,945,423
|
|
|
|
–
|
|
|
|
9,945,423
|
|
Selling, general and administrative expense
|
|
|
(5,869,762
|
)
|
|
|
(20,570
|
)
|
|
|
(5,890,332
|
)
|
Research and development expense
|
|
|
(170,466
|
)
|
|
|
(359,096
|
)
|
|
|
(529,562
|
)
|
Operating income (loss)
|
|
$
|
3,905,195
|
|
|
$
|
(379,666
|
)
|
|
$
|
3,525,529
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
|
|
|
|
|
|
|
|
|
|
|
September 30, 2017:
|
|
|
|
|
|
|
|
|
|
|
|
|
Product sales, net
|
|
$
|
5,591,210
|
|
|
$
|
–
|
|
|
$
|
5,591,210
|
|
Gross profit
|
|
|
3,997,649
|
|
|
|
–
|
|
|
|
3,997,649
|
|
Gain on change in derivative liabilities
|
|
|
10,987
|
|
|
|
–
|
|
|
|
10,987
|
|
Selling, general and administrative expense
|
|
|
(4,259,725
|
)
|
|
|
(51,353
|
)
|
|
|
(4,311,078
|
)
|
Research and development expense
|
|
|
(76,520
|
)
|
|
|
(102,818
|
)
|
|
|
(179,338
|
)
|
Operating loss
|
|
$
|
(327,609
|
)
|
|
$
|
(154,171
|
)
|
|
$
|
(481,780
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nine Months Ended
|
|
|
|
|
|
|
|
|
|
|
|
|
September 30, 2018:
|
|
|
|
|
|
|
|
|
|
|
|
|
Product sales, net
|
|
$
|
34,020,341
|
|
|
$
|
–
|
|
|
$
|
34,020,341
|
|
Gross profit
|
|
|
24,567,402
|
|
|
|
–
|
|
|
|
24,567,402
|
|
Selling, general and administrative expense
|
|
|
(15,915,882
|
)
|
|
|
(35,647
|
)
|
|
|
(15,951,529
|
)
|
Research and development expense
|
|
|
(362,933
|
)
|
|
|
(762,337
|
)
|
|
|
(1,125,270
|
)
|
Operating income (loss)
|
|
$
|
8,289,587
|
|
|
$
|
(797,984
|
)
|
|
$
|
7,490,603
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nine Months Ended
|
|
|
|
|
|
|
|
|
|
|
|
|
September 30, 2017:
|
|
|
|
|
|
|
|
|
|
|
|
|
Product sales, net
|
|
$
|
13,437,233
|
|
|
$
|
–
|
|
|
$
|
13,437,233
|
|
Gross profit
|
|
|
9,275,111
|
|
|
|
–
|
|
|
|
9,275,111
|
|
Gain on change in derivative liabilities
|
|
|
248,875
|
|
|
|
–
|
|
|
|
248,875
|
|
Royalty buy-out
|
|
|
–
|
|
|
|
(2,432,000
|
)
|
|
|
(2,432,000
|
)
|
Selling, general and administrative expense
|
|
|
(11,312,687
|
)
|
|
|
(200,873
|
)
|
|
|
(11,513,560
|
)
|
Research and development expense
|
|
|
(181,509
|
)
|
|
|
(392,192
|
)
|
|
|
(573,701
|
)
|
Operating loss
|
|
$
|
(1,970,210
|
)
|
|
$
|
(3,025,065
|
)
|
|
$
|
(4,995,275
|
)
|
On October 22, 2018, the Company
received un-restricted control of $450,000 of restricted cash held at September 30, 2018 in connection with the settlement of a
complaint filed by the Company against a former credit card processor of the Company (Note 11). The Company recognized bad debt
expense of $40,223 in connection with this settlement.