Item 1. Financial Statements
The accompanying footnotes are in integral
part of these unaudited condensed consolidated financial statements.
The accompanying footnotes are in integral
part of these unaudited condensed consolidated financial statements.
NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
FOR
THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2018
(Unaudited)
NOTE
1 – NATURE OF THE ORGANIZATION AND BUSINESS
Nature of Business
Conversion Labs,
Inc. (“Conversion Labs,” “we,” “us,” “our,” the “Company”) is an internet-based
direct response marketing company that in-licenses, acquires and creates innovative and proprietary products that are sold to
consumers around the world via our technology infrastructure and relationships with agencies, third party marketers, and online
advertising platforms such as Facebook, Google and Amazon. We currently have three commercial stage products including Shapiro
MD, a patented shampoo, conditioner, and leave-in foamer for thicker, fuller hair, iNR Wellness MD, a nutritional supplement for
immune support, and PDF Simpli, a PDF conversion software, which was acquired through the purchase of 51% of the membership interests
of LegalSimpli Software, LLC, a Puerto Rico limited liability company, which operates a marketing-driven software solutions business.
We
launched our online direct marketing business in the fourth quarter of 2015 with the establishment of a partnership with Inate
Skincare, LLC (“Inate”). Our initial intention was to launch a skin care line containing our proprietary ingredients
and to market such products directly to consumers. We entered into a limited liability company operating agreement with our joint
venture partners with respect to Inate under the legal name Immudyne PR LLC (“Immudyne PR”). On April 1, 2016, the
original operating agreement of Immudyne PR was amended and restated and we increased our ownership and voting interest in Immudyne
PR to 78.2%.
During
2016, we utilized third party entities to provide and increase credit card processing capacity and optimize corresponding rates
and fees through one or more merchant bank accounts held by such entities. Some of the entities contracted to provide these services
had been determined to be variable interest entities (“VIEs”) and were consolidated in the Company’s financial
statements. The one (1%) percent fee received by these VIEs was eliminated in consolidation of the net revenues processed and
collected by such contractors from sales initiated by the Company. The remaining entities provided such services as independent
contractors, the majority of which were considered related parties and no fee was paid. Upon receipt of funds by such contractors
from their respective merchant banks, the Company required the prompt transfer of funds to Company controlled accounts. The Company
reimbursed and/or advanced funds to such contractors for any deficit or charge related to returns, chargeback and other fees charged
by such merchant bank. By our year ended December 31, 2017, we ceased processing credit card charges through all VIE merchant
accounts. At December 31, 2017, we recorded the merchant reserves from these VIE merchant accounts on our balance sheet as accounts
receivable.
As
used in these financial statements and unless otherwise indicated, the terms “Company,” “we,” “us,”
and “our” refer to Conversion Labs, Inc. (formerly known as Immudyne, Inc.) and our majority-owned subsidiaries LegalSimpli
Software, LLC, a Puerto Rico limited liability company (“LegalSimpli”), Conversion Labs PR, LLC (formerly Immudyne
PR LLC), a Puerto Rico limited liability company (“Conversion Labs PR”), and Conversion Labs Asia Limited, a Hong
Kong company (“Conversion Labs Asia”). Unless otherwise specified, all dollar amounts are expressed in United States
dollars.
Acquisition
of Membership Interest Purchase Agreement
On
May 29, 2018, Immudyne PR acquired 51% of the membership interests (the “Membership Interests”) of LegalSimpli Software,
LLC, a Puerto Rico limited liability company (“LegalSimpli”), which operates a marketing-driven software solutions
business. In consideration for Immudyne PR’s purchase of the Membership Interests, Immudyne PR paid $150,000 (the “Initial
Payment”) to the sellers upon execution of the purchase agreement. Additionally, Immudyne PR agreed to pay up to an additional
$200,000 for such Membership Interests.
Going
Concern
The
Company has funded operations in the past through the sales of its products, issuance of common stock and through loans and advances
from officers and directors. The Company’s continued operations are dependent upon obtaining an increase in its sales volume
and the continued financial support from officers and directors or the sale of additional shares of common stock or debt securities.
The accompanying financial statements have been prepared on the basis that the Company will continue as a going concern, which
assumes the realization of assets and the satisfaction of liabilities in the normal course of business. At September 30, 2018,
the Company had an accumulated deficit of approximating $11.1 million and has incurred negative cash flows from operations. These
conditions raise substantial doubt about the Company’s ability to continue as a going concern. The accompanying financial
statements do not include any adjustments that might result from the outcome of this uncertainty.
Based
on the Company’s cash balance at September 30, 2018, and projected cash needs for 2018, management estimates that it will
need to increase sales revenue and/or raise additional capital to cover operating and capital requirements for the 2018 fiscal
year. Management will need to raise the additional needed funds through increased sales volume, issuing additional shares of common
stock or other equity securities, or obtaining debt financing. Although management has been successful to date in raising necessary
funding, there can be no assurance that sales revenue will substantially increase or that any required future financing can be
successfully completed on a timely basis, or on terms acceptable to the Company.
NOTE
2 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles
of Consolidation
The
Company evaluates the need to consolidate affiliates based on standards set forth in ASC 810 Consolidation (“ASC 810”).
The consolidated financial statements include the accounts of the Company and its majority owned subsidiary, Conversion Labs PR,
its 51% owned LegalSimpli and variable interest entities (VIE’s) in which the Company has been determined to be the primary
beneficiary. The non-controlling interest in Conversion Labs PR represents the 21.833% equity interest held by other members of
the joint venture. All significant consolidated transactions and balances have been eliminated in consolidation.
Management’s
Representation of Interim Financial Statements
The
accompanying unaudited consolidated financial statements have been prepared by the Company without audit pursuant to the rules
and regulations of the Securities and Exchange Commission (“SEC”). Certain information and disclosures normally included
in financial statements prepared in accordance with accounting principles generally accepted in the United States (“GAAP”)
have been condensed or omitted as allowed by such rules and regulations, and management believes that the disclosures are adequate
to make the information presented not misleading. These consolidated financial statements include all of the adjustments, which
in the opinion of management are necessary to a fair presentation of financial position and results of operations. All such adjustments
are of a normal and recurring nature. Interim results are not necessarily indicative of results for a full year. These consolidated
financial statements should be read in conjunction with the audited consolidated financial statements at December 31, 2017 and
2016 filed in the Company’s Annual Report on Form 10-K with the SEC on April 2, 2018.
Variable
Interest Entities
The
Company follows ASC 810-10-15 guidance with respect to accounting for variable interest entities (each, a “VIE”).
These entities do not have sufficient equity at risk to finance their activities without additional subordinated financial support
from other parties or whose equity investors lack any of the characteristics of a controlling financial interest. A variable interest
is an investment or other interest that will absorb portions of a VIE’s expected losses or receive portions of its expected
residual returns and are contractual, ownership, or pecuniary in nature and that change with changes in the fair value of the
entity’s net assets. A reporting entity is the primary beneficiary of a VIE and must consolidate it when that party has
a variable interest, or combination of variable interests, that provides it with a controlling financial interest. A party is
deemed to have a controlling financial interest if it meets both of the power and losses/benefits criteria. The power criterion
is the ability to direct the activities of the VIE that most significantly impact its economic performance. The losses/benefits
criterion is the obligation to absorb losses from, or right to receive benefits from, the VIE that could potentially be significant
to the VIE. The VIE model requires an ongoing reconsideration of whether a reporting entity is the primary beneficiary of a VIE
due to changes in facts and circumstances.
By
our fiscal year ending December 31, 2017, we ceased processing credit card charges through all VIE merchant accounts. At September
30, 2018 and December 31, 2017, we recorded the merchant reserves from these VIE merchant accounts on our balance sheet as accounts
receivable.
Conversion
Labs PR is the primary beneficiary of Innerwell Skincare LLC, Spurs 5, LLC, and Salus LLC, which are qualified as VIEs. The assets
and liabilities and revenues and expenses of these VIEs included in the financial statements of Conversion Labs PR and further
included in the consolidated financial statements. The assets and liabilities include balances due from and due to the subsidiaries
of Conversion Labs PR. These inter-company receivables and payables are eliminated upon consolidation of the VIE with Conversion
Labs PR and the Company. No assets were pledged or given as collateral against any borrowings.
The
Company utilizes third party entities to provide and increase credit card processing capacity and optimize corresponding rates
and fees. A majority of these entities provide this service as independent contractors in exchange for a one (1%) percent fee
of the net revenues processed and collected by such contractors from sales initiated by the Company. The VIEs consolidated in
the Company’s financial statements are primarily contracted to credit card processing through one or more merchant banks
contracted by each VIE. Upon receipt of funds by each VIE, the collection of receipts less any returns, chargeback and other fees
charged by such merchant bank is transferred to Conversion Labs PR.
Use of
Estimates
The
Company prepares its consolidated financial statements in conformity with accounting principles generally accepted in the United
States of America which requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities
at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Some of
the more significant estimates required to be made by management include the determination of reserves for accounts receivable,
returns and allowances, the accounting for derivatives, the valuation of inventory and stockholders’ equity based transactions.
Actual results could differ from those estimates.
Derivative
Liabilities
Under
ASC 815-40-05, Accounting for Derivative Financial Instruments Indexed to and Potentially Settled in a Company’s Own Stock,
in the event the Company does not have a sufficient number of authorized and unissued shares of common stock to satisfy obligations
for stock options, warrants and other instruments potentially convertible into common stock, the fair value of these instruments
should be reported as a derivative liability. Pursuant to the outstanding option, warrant and convertible debt agreements, there
is currently no effective registration statement covering the shares of common stock underlying these agreements, which are currently
subject to a cashless exercise whereby the holders, at their option, may surrender their options and warrants to the company in
exchange for shares of common stock. The number of shares of common stock into which an option or a warrant would be exchangeable
in such a cashless exercise depends on both the exercise price of the options or warrant and the market price of the common stock,
each at or near the time of exercise. Because the market price is variable, it is possible that the Company could have insufficient
authorized shares to satisfy a cashless exercise. In this scenario, if the Company were unable to obtain shareholder approval
to increase the number of authorized shares, the Company could be obligated to settle such a cashless exercise with cash rather
than by issuing shares of common stock. Further, ASC 815-40-05 requires that the Company record the potential settlement obligation
at each reporting date using the current estimated fair value of these contracts, with any changes in fair value being recorded
through our statement of operations. The Company had reported the potential settlement obligation as a derivative liability. In
the third quarter of 2017, the Company obtained a majority of shareholders’ approval and amended its Articles of Incorporation
to increase the number of shares of its authorized common stock, therefore the derivative liability is no longer applicable.
Inventory
At
September 30, 2018 and December 31, 2017, inventory consisted primarily of finished cosmetic products. Inventory is maintained
in a third-party warehouse in Pennsylvania.
Inventory
is valued at the lower of cost or net realizable value with cost determined on a first-in, first-out (“FIFO”) basis.
Management compares the cost of inventory with the net realizable value and an allowance is made for writing down inventory to
net realizable, if lower. At September 30, 2018 and December 31, 2017, the Company recorded an inventory reserve in the amount
of $12,500 and $12,500, respectively. As of September 30, 2018 and December 31, 2017, the inventory balances were $507,211 and
681,258, respectively.
Revenue
Recognition
The
Company records revenue under the adoption of ASC 606 by analyzing exchanges with its customers using a five-step analysis such
as identifying performance obligations in the contract, estimating the amount of variable consideration to include in the transaction
price and allocating the transaction price to each separate performance obligation. The Company’s policy is to record revenue
as earned when a firm commitment, indicating sales quantity and price exists, delivery has taken place and collectability is reasonably
assured. The Company generally records sales of finished cosmetic products once the customer places the order and the product
is simultaneously shipped, but in limited cases if title does not pass until the product reaches the customer’s delivery
site, then recognition of revenue should be deferred until that time, however the Company does not have a process to properly
record the recognition of revenue if orders are not immediately shipped. Delivery is considered to have occurred when title and
risk of loss have transferred to the customer. Provisions for discounts, returns, allowances, customer rebates and other adjustments
are netted with gross sales. The Company accounts for such provisions during the same period in which the related revenues are
earned. Customer discounts, returns and rebates for the three and nine months ended September 30, 2018, was approximately $133,000
and $353,000, respectively. Customer discounts, returns and rebates for the three and nine months ended September 30, 2017, was
approximately $99,000 and $149,000, respectively.
There
are no formal sales incentives offered to any of the Company’s customers. Volume discounts may be offered from time to time
to customers purchasing large quantities on a per transaction basis.
Accounts
receivable
Accounts
receivable are carried at original invoice amount less an estimate made for holdbacks and doubtful receivables based on a review
of all outstanding amounts. Management determines the allowance for doubtful accounts by regularly evaluating individual customer
receivables and considering a customer’s financial condition, credit history and current economic conditions and sets up
an allowance for doubtful accounts when collection is uncertain. Customers’ accounts are written off when all attempts to
collect have been exhausted. Recoveries of accounts receivable previously written off are recorded as income when received. At
September 30, 2018 and December 31, 2017, the accounts receivable reserve was approximately $0 and $0, respectively. At September
30, 2018 and December 31, 2017, the reserve for sales returns and allowances was approximately $33,754 and $23,200, respectively.
Income
Taxes
The
Company files Corporate Federal and State tax returns, while Conversion Labs PR and LegalSimpli, which were formed as limited
liability companies, file separate tax returns with any tax liabilities or benefits passing through to its members.
The
Company records current and deferred taxes in accordance with Accounting Standards Codification (ASC) 740, “Accounting for
Income Taxes.” This ASC requires recognition of deferred tax assets and liabilities for temporary differences between tax
basis of assets and liabilities and the amounts at which they are carried in the financial statements, based upon the enacted
rates in effect for the year in which the differences are expected to reverse. The Company establishes a valuation allowance when
necessary to reduce deferred tax assets to the amount expected to be realized. The Company periodically assesses the value of
its deferred tax asset, a majority of which has been generated by a history of net operating losses and determines the necessity
for a valuation allowance. ASC 740 also provides a recognition threshold and measurement attribute for the financial statement
recognition of a tax position taken or expected to be taken in a tax return. Using this guidance, a company may recognize the
tax benefit from an uncertain tax position in its financial statements only if it is more likely-than-not (i.e., a likelihood
of more than 50%) that the tax position will be sustained on examination by the taxing authorities, based on the technical merits
of the position.
The
Company’s tax returns for all years since December 31, 2014, remain open to federal and state taxing authorities.
Stock-Based
Compensation
The
Company follows the provisions of ASC 718, “Share-Based Payment”. Under this guidance compensation cost generally
is recognized at fair value on the date of the grant and amortized over the respective vesting periods. The fair value of options
at the date of grant is estimated using the Black-Scholes option pricing model. The expected option life is derived from assumed
exercise rates based upon historical exercise patterns and represents the period of time that options granted are expected to
be outstanding. The expected volatility is based upon historical volatility of the Company’s shares using weekly price observations
over an observation period that approximates the expected life of the options. The risk-free rate approximates the U.S. Treasury
yield curve rate in effect at the time of grant for periods similar to the expected option life. Due to limited history of forfeitures,
the estimated forfeiture rate included in the option valuation was zero.
Many
of the assumptions require significant judgment and any changes could have a material impact in the determination of stock-based
compensation expense.
Earnings (Loss) Per Share
Basic
earnings (loss) per common share is based on the weighted average number of shares outstanding during each period presented. Warrants
and options to purchase common stock are included as common stock equivalents only when dilutive. Potential common stock equivalents
are excluded from dilutive earnings per share when the effects would be antidilutive.
Common
stock equivalents comprising shares underlying 1,886,454 options and warrants for the three and nine months ended September 30,
2018, respectively, have not been included in the income per share calculations as the effects are anti-dilutive.
Common
stock equivalents comprising shares underlying 9,335,800 options and warrants for the three and nine months ended September 30,
2017, have not been included in the loss per share calculation as the effects are anti-dilutive.
Recent
Accounting Pronouncements
In
May 2017, the FASB issued ASU 2017-09, Compensation - Stock Compensation (Topic 718): Scope of Modification Accounting. The new
standard provides guidance about which changes to the terms or conditions of a share-based payment award require an entity to
apply modification accounting in Topic 718. This pronouncement is effective for annual reporting periods beginning after December
15, 2017 but early adoption is permitted. The Company is currently evaluating the impact of adopting this guidance.
In
August 2016, the FASB issued ASU No. 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and
Cash Payments (“ASU 2016-15”). ASU 2016-15 addresses eight specific cash flow issues with the objective of reducing
diversity in practice regarding how certain cash receipts and cash payments are presented in the statement of cash flows. The
standard provides guidance on the classification of the following items: (1) debt prepayment or debt extinguishment costs, (2)
settlement of zero-coupon debt instruments, (3) contingent consideration payments made after a business combination, (4) proceeds
from the settlement of insurance claims, (5) proceeds from the settlement of corporate-owned life insurance policies, (6) distributions
received from equity method investments, (7) beneficial interests in securitization transactions, and (8) separately identifiable
cash flows. The Company is required to adopt ASU 2016-15 for fiscal years, and for interim periods within those fiscal years,
beginning after December 15, 2017 on a retrospective basis. Early adoption is permitted, including adoption in an interim period.
We have reviewed ASU 2016-15 and have determined that it will not have any material effect on our financial statements and related
disclosures.
In
February 2016, the FASB issued ASU 2016-02, Leases (Topic 842), which supersedes all existing guidance on accounting for leases
in ASC Topic 840. ASU 2016-02 is intended to provide enhanced transparency and comparability by requiring lessees to record right-of-use
assets and corresponding lease liabilities on the balance sheet. ASU 2016-02 will continue to classify leases as either finance
or operating, with classification affecting the pattern of expense recognition in the statement of income. ASU 2016-02 is effective
for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. Early adoption is permitted.
ASU 2016-02 is required to be applied with a modified retrospective approach to each prior reporting period presented with various
optional practical expedients. We have reviewed ASC 842 and have determined that it will not have any material effect on our financial
statements and related disclosures.
Recent
Accounting Pronouncements (continued)
All
other accounting standards that have been issued or proposed by the FASB that do not require adoption until a future date are
not expected to have a material impact on the consolidated financial statements upon adoption.
Fair
Value of Financial Instruments
The
carrying value of the Company’s financial instruments, including cash, trade accounts receivable, accounts payable and accrued
expenses and the face amount of notes payable approximate fair value for all periods.
Noncontrolling Interests
The
Company accounts for its less than 100% interests in Conversion Labs PR and LegalSimpli in accordance with ASC Topic 810, Consolidation,
and accordingly the Company presents noncontrolling interests as a component of equity on its consolidated balance sheet and reports
the noncontrolling interest’s share of the Conversion Labs PR, and LegalSimpli’s net loss attributable to noncontrolling
interests in the consolidated statement of operations.
Consolidation of Variable
Interest Entities
In
accordance with ASC 810-10-25-37 and as amended by ASU 2009-17, the Company determines whether any legal entity in which the Company
becomes involved is a VIE and subject to consolidation. The Company conducts an assessment on an ongoing basis for each VIE including
(1) the power to direct activities of the VIE that most significantly impact the VIE’s economic performance, and (2) the
obligation to absorb losses or right to receive benefits from the VIE that could potentially be significant to the VIE. As a result,
the Company determined that six entities were VIEs and subject to consolidation.
Concentration
of Credit Risk
The
Company grants credit in the normal course of business to its customers. The Company periodically performs credit analysis and
monitors the financial condition of its customers to reduce credit risk.
The
Company monitors its positions with, and the credit quality of, the financial institutions with which it invests. The Company,
at times, maintains balances in various operating accounts in excess of federally insured limits.
Although
the Company does have some wholesale customers, over 90% of the Company’s sales are to unique customers. Since the Company
sells its products to thousands of customers, there is no accounts receivable concentration from customers. However, the Company
uses merchant processors to charge customer credit cards and does contain concentration risk between credit card processors.
As
of September 30, 2018, the Company’s accounts receivable had no significant concentration from any one customer.
As
of September 30, 2018, three credit card processors accounted for 56%, 22% and 20% of accounts receivable.
NOTE
3 – DISCONTINUED OPERATIONS AND ASSETS AND LIABILITIES HELD FOR SALE
On
January 29, 2018, the Company entered into a Legacy Asset Sale Agreement (the “Asset Sale Agreement”) with Mark McLaughlin
(the Company’s former President and Chief Executive Officer) whereby the Company sold the assets of the legacy beta glucan
business for $850,000. On February 7, 2018, the Company and Mr. McLaughlin entered into an amendment to the Asset Sale Agreement
(the “Asset Sale Agreement Amendment”) to amend the purchase price of the assets, whereby Mr. McLaughlin agreed, through
a newly formed entity, to purchase the assets and liabilities of the yeast beta glucan manufacturing business, for the following:
(i) 2,000,000 shares of the Company’s common stock (valued at $0.23 per share or $460,000), payable on February 12, 2018,
(the “Closing Date”), (ii) $190,000 payable on the Closing Date, (iii) $200,000 payable within 120 days following
the Closing Date, and (iv) the waiver of all rights to any severance payment in the amount of $150,000. The total purchase price
per the Asset Sale Agreement Amendment was $1,000,000. The total assets and liabilities transferred in the sale was $255,248,
resulting in a gain on sale of $744,752.
Operating
results for the three months and nine months ended September 30, 2018, and 2017 for the yeast beta glucan manufacturing business
are presented as discontinued operations and the assets and liabilities classified as held for sale are presented separately in
the balance sheet.
A
breakdown of the discontinued operations is presented as follows:
|
|
Three
Months Ended
September 30,
|
|
|
Nine
Months Ended
September
30,
|
|
|
|
2018
|
|
|
2017
|
|
|
2018
|
|
|
2017
|
|
Net
Sales
|
|
$
|
-
|
|
|
$
|
447,331
|
|
|
$
|
363,613
|
|
|
$
|
703,894
|
|
Cost of Sales
|
|
|
-
|
|
|
|
144,148
|
|
|
|
56,666
|
|
|
|
259,331
|
|
Gross Profit
|
|
|
-
|
|
|
|
303,183
|
|
|
|
306,947
|
|
|
|
444,563
|
|
Operating
expenses
|
|
|
-
|
|
|
|
148,358
|
|
|
|
125,960
|
|
|
|
262,931
|
|
Income from
discontinued operations
|
|
|
-
|
|
|
|
154,825
|
|
|
|
180,987
|
|
|
|
181,632
|
|
Gain
on sale
|
|
|
-
|
|
|
|
-
|
|
|
|
744,752
|
|
|
|
-
|
|
Net
income from discontinued operations
|
|
$
|
-
|
|
|
$
|
154,825
|
|
|
$
|
925,739
|
|
|
$
|
181,632
|
|
Assets
and liabilities of discontinued operations held for sale included the following:
|
|
September 30,
|
|
|
December 31,
|
|
|
|
2018
|
|
|
2017
|
|
Current assets:
|
|
|
|
|
|
|
Trade
accounts receivable, net
|
|
$
|
-
|
|
|
$
|
270,580
|
|
Inventory,
net
|
|
|
-
|
|
|
|
25,903
|
|
|
|
$
|
-
|
|
|
$
|
296,483
|
|
|
|
|
|
|
|
|
|
|
Current
liabilities:
|
|
|
|
|
|
|
|
|
Accounts
payable and accrued expenses
|
|
$
|
-
|
|
|
$
|
81,733
|
|
|
|
$
|
-
|
|
|
$
|
81,733
|
|
NOTE 4 – BUSINESS COMBINATION
Acquisition
of Membership Interest Purchase Agreement
On
May 29, 2018 (the “Closing Date”), Immudyne, PR entered into a Membership Interest Purchase Agreement (the “Purchase
Agreement”) by and among nine individuals, as sellers and Conversion Labs PR, as buyer (“Buyer”), pursuant to
which Buyer acquired from Sellers all of Sellers’ right, title and interest in and to 51% of the membership interests (the
“Membership Interests”) of LegalSimpli Software, LLC, a Puerto Rico limited liability company (“LegalSimpli”),
which operates a marketing-driven software solutions business.
In
consideration for Buyer’s purchase of the Membership Interests the Buyer paid $150,000 (the “Initial Payment”)
to the Sellers upon execution of the Purchase Agreement. Additionally, Buyer may be obligated to pay up to an additional $200,000
in accordance with the following milestones (the “Milestones”): (i) $100,000 to the Sellers on the 90-day anniversary
of the Purchase Agreement, so long LegalSimpli’s gross revenue for the preceding 30-day period is equal to or greater than
$75,000; and (ii) $100,000 to the Sellers on the 180-day anniversary of the Purchase Agreement, so long as LegalSimpli’s
gross revenue for the preceding 30-day period is equal to or greater than $150,000, with a minimum net profit margin of 25% in
each instance.
Regardless
of whether LegalSimpli achieves either or both of the Milestones, Buyer will retain full ownership of the Membership Interests.
Fair Value of Consideration
Transferred and Recording of Assets Acquired
The
following table summarizes the acquisition date fair value of the consideration paid, identifiable assets acquired, and liabilities
assumed including an amount for intangible assets:
Consideration Paid:
|
|
|
|
Cash and cash equivalents
|
|
$
|
150,000
|
|
Fair value of total consideration
|
|
$
|
150,000
|
|
|
|
|
|
|
Recognized amount of identifiable assets
acquired, and liabilities assumed:
|
|
|
|
|
Financial assets:
|
|
|
|
|
Cash and cash equivalents
|
|
$
|
1,445
|
|
Financial liabilities:
|
|
|
|
|
Accounts payable and accrued liabilities
|
|
|
(84,349
|
)
|
Non-controlling interest
|
|
|
(144,118
|
)
|
Total identifiable net assets
|
|
|
(227,022
|
|
Intangible assets
|
|
|
377,022
|
|
|
|
$
|
150,000
|
|
NOTE
5 – NOTES PAYABLE
In
the third quarter of 2016 the Company commenced an offering pursuant to which it offered 11% subordinated promissory notes in
fifty thousand ($50,000) dollar increments combined with 62,500 shares of the Company’s Common Stock for a maximum offering
amount of $200,000 (the “Offering”). In August and September 2016, the Company sold promissory notes totaling $150,000
to three unrelated individuals. Two of the promissory notes totaling $100,000 were payable in February 2017 and one promissory
note for $50,000 was payable in March 2017. In October 2016, the Company sold promissory notes totaling $50,000 to two unrelated
individuals. These promissory notes were payable in October 2017. In connection with these promissory notes sold, pursuant to
the Offering, the Company issued 250,000 shares of common stock valued at $58,750 which was recorded as a debt discount and were
amortized over the term of these notes. Amortization of the debt discounts for the year ended December 31, 2017 and 2016 was $25,035
and $33,715, respectively. During 2016, the Company repaid $68,600 of the principal balance; and as a result, the outstanding
balances of these notes as of December 31, 2016, were $131,400. The balance of debt discount related to the subordinated promissory
notes is $25,035 at December 31, 2016. During 2017, the Company repaid $81,420 of the principal balance and converted the remaining
balance of $49,980 into 196,000 shares of common stock and 98,000 warrants, which satisfied the notes in full. The fair market
value of the shares and warrants issued upon conversion was determined to be $179,384, of which $129,404 was included in loss
on extinguishment of debt. Interest expense related to these notes for the nine months ended September 30, 2018 and 2017, amounted
to $0 and $131,117, respectively.
In
January 2017, the Company borrowed $200,000 and issued a promissory note with a 5% original issue discount for a total principal
amount of $210,000. The loan incurred 11% interest per annum and matured in various tranches from February 2017 through April
2017. In addition, the Company issued 217,391 shares of common stock related to this note. In February 2017, the Company repaid
$70,000 of the principal balance of this note. In March 2017, the Company converted the remaining $140,000 of the principal balance
of this note and accrued interest of $2,212 in exchange for 559,179 shares of common stock and 304,348 warrants which satisfied
the note in full. The fair market value of the shares and warrants issued upon conversion was determined to be $566,030, of which
$423,818 was included in loss on extinguishment of debt.
In
February 2017, the Company borrowed $25,000 from an American Express working capital line with 60 days maturity. The interest
for this loan is a flat fee of $250. On April 17, 2017, the Company repaid this loan. In June 2017, the Company borrowed $74,043
from an American Express working capital line with 90 days maturity. The interest for this loan is a flat fee of $1,111. On August
30, 2017, the Company repaid this loan. In September 2017, the Company borrowed $77,333 from an American Express working capital
line with 90 days maturity. The interest for this loan is a flat fee of $1,160. In November 2017, $42,479 was drawn from the line
of credit and $78,493 was paid back in December 2017. In the first quarter of 2018 the Company repaid this loan. As of September
30, 2018 and December 31, 2017, there was $0 and $42,479 outstanding, respectively.
In
December 2017, Conversion Labs PR received two working capital loans from related parties for in the amounts of $50,000 and $75,000,
respectively. The loans accrue at 2% interest per month and mature in February 2018. In February 2018, the Company repaid these
loans including all outstanding accrued interest.
In May 2018, the Company
borrowed $550,000 and issued convertible notes in connection therewith. These notes have a maturity date of May 28, 2019 and accrue
interest at a rate of 12% compounded annually. The conversion price for these notes is $0.23 per share of common stock, subject
to adjustment. In the event the average VWAP (as defined) for the consecutive five trading days preceding but not including the
six month anniversary of the original issue date of the note is less than the then conversion price in effect on such six month
anniversary date, then the conversion price shall be reduced to 80% of the VWAP for the ten trading days following (but not including)
such six month anniversary date, subject to further reduction. In addition, the Company issued warrants to purchase up to 2,391,305
shares of common stock with an exercise price of $0.28 per share. The fair value of the warrants was determined to be $533,691
and was recorded as a debt discount to be amortized over the life of the note. For the nine months ended September 30, 2018, amortization
of debt discount was $181,309.
Interest
expense related to loans from officers, directors and other related individuals amounted to $4,383 and $1,713 for the nine months
ended September 30, 2018 and 2017, respectively. There was no interest expense for the three months ended September 30, 2017 and
2016 related to loans from officers, directors and other related individuals.
Total
interest expense on notes payable, inclusive of amortization of debt discount of $181,309 and $81,558, amounted to $205,192 and
$650,718 for the nine months ended September 30, 2018 and 2017, respectively.
Total
interest expense on notes payable, inclusive of amortization of debt discount of $134,519 and $0, amounted to $147,664 and $1,111
for the three months ended September 30, 2018 and 2017, respectively.
NOTE
6 – INCOME TAXES
At
September 30, 2018, the Company has approximately $3,193,000 of operating loss carryforwards for federal that may be applied against
future taxable income. The net operating loss carryforwards will begin to expire in the year 2021 if not utilized prior to that
date, expiring during various years through 2037. There is no provision for income taxes because the Company has historically
incurred operating losses and maintains a full valuation allowance against its net deferred tax assets.
The
Tax Cuts and Jobs Act (the “Act”) was enacted on December 22, 2017. The Act reduces the US federal corporate tax rate
from 34% to 21%. The most significant impact of the legislation for the Company was a $242,000 reduction of the value of net deferred
tax assets (which represent future tax benefits) as a result of lowering the U.S. corporate income tax rate from statutory rate
of 34% to 21%.
The
valuation allowance overall decreased by approximately $419,209 during the nine months ended September 30, 2018. The Company has
fully reserved the deferred tax asset resulting from available net operating loss carryforwards.
The
tax effect of temporary differences that gave rise to significant portion of the deferred tax assets were as follows:
Net operating loss
|
|
$
|
1,197,251
|
|
Accounts receivable reserves
|
|
|
-
|
|
Inventory reserves
|
|
|
-
|
|
Stock compensation
|
|
|
378,958
|
|
Net deferred tax asset
|
|
|
1,576,209
|
|
Valuation allowance
|
|
|
(1,576,209
|
)
|
Total
|
|
$
|
-
|
|
The
net operating loss carryforwards could be subject to limitation in any given year in the event of a change in ownership as defined
by IRC Section 382.
NOTE
7 – STOCKHOLDERS’ EQUITY
Common Stock
In
January 2017, the Company issued 1,183,490 shares of common stock pursuant to a conversion of Conversion Labs PR equity contributions
of $272,203 into equity of the Company by the noncontrolling interest.
In
January 2017, the Company issued 217,391 shares of common stock in relation to issuance of a $210,000 note payable.
In
the first quarter of 2017, the Company commenced an offering to sell up to 4,000,000 shares of common stock at a price of $0.23
per share and warrants to purchase up to 2,000,000 shares of common stock exercisable any time prior to the second anniversary
of the issuance. The warrants are paired with the common stock on the basis of one warrant for every two shares of common stock
purchased. During 2017, the Company received subscriptions for 2,927,156 shares and issued 1,463,578 warrants to purchase shares
of common stock for an aggregate purchase price of $673,246.
In
March 2017, the Company issued an aggregate of 755,179 shares of common stock for the conversion of the outstanding balance of
three notes payable totaling $499,802 (see Note 4).
On
April 24, 2017, the Company, issued 217,390 shares of common stock pursuant to a stock subscription agreement and the Company
issued 108,696 warrants with an exercise price of $0.40 per share for the stated consideration and satisfaction of obligation
to pay $50,000 on the 180-day anniversary of the execution of the Sole and Exclusive License, Royalty, and Advisory Agreement
dated September 1, 2016 with Pilaris Laboratories, LLC.
During
the second quarter of 2017 the Company received subscriptions for the purchase of 110,000 shares and issued 55,000 warrants in
connection therewith for an aggregate purchase price of $25,300.
On
June 1, 2017, the Company entered into an agreement with a consultant to provide services over the course of six months and issued
125,000 shares of common stock as compensation. The shares were valued at $45,000 and the Company is recognizing the expense over
the term of the agreement. For the year ending December 31, 2017, $45,000 has been expensed and included in compensation and related
expenses on the consolidated statement of operations.
In July 2017, the Company
and JLS Ventures, an entity owned by the Company’s current Chief Executive Officer, entered into a second amendment to a
Service Agreement effective July 1, 2017. As compensation, the Company issued 900,000 shares of common stock valued at $432,000.
The Company is recognizing the expense over the term of the agreement. For the nine months ending September 30, 2018 and 2017,
$108,000 and $0, respectively, has been expensed and included in compensation and related expenses on the consolidated statement
of operations.
In
July 2017, Mark McLaughlin, the Company’s former President and Chief Executive Officer, exercised 1,500,000 warrants, at
an exercise price of $0.12 per share, on a cashless basis and was issued 1,140,000 shares of common stock.
In
July 2017, Mark McLaughlin exercised 1,339,473 options, at an exercise price of $0.10 per share, on a cashless basis and was issued
800,000 shares of common stock.
In
July 2017, Mark McLaughlin exercised 339,473 options on a cashless basis and was issued 271,579 shares of common stock.
In
August 2017, the Company issued 100,000 shares of common stock valued at $40,000 to Acorn Management Partners L.L.C. (“Acorn”)
for financial advisory, strategic business planning and other investor relation services. The Company is recognizing the expense
over the term of the agreement. For the year ending December 31, 2017, $40,000 has been expensed and included in compensation
and related expenses on the consolidated statement of operations.
In
August 2017, the Company issued 50,000 shares of common stock valued at $20,000 to BV Global Fulfillment, LLC (“BV Global”)
for fulfillment services.
In
November 2017, the Company issued 100,000 shares of common stock valued at $44,000 to an employee as a bonus.
In
November 2017, the Company issued 135,721 shares of common stock pursuant to a conversion of Conversion Labs PR equity contributions
of $31,216 into equity of the Company by the noncontrolling interest.
In
February 2018, pursuant to the sale of the Company’s legacy yeast beta glucan assets to the Company’s former CEO,
Mr. McLaughlin, 2,000,000 shares of common stock of Mr. McLaughlin’s shares were cancelled.
In
March 2018, the Company issued 500,000 shares of common stock valued at $120,000 to a consultant. In May 2018, the Company amended
the agreement with the consultant whereby the Company rescinded the 500,000 shares of common stock and reissued 250,000 shares
of common stock. The 250,000 shares of common stock issued on May 14, 2018, were valued at $62,500. The Company is recognizing
the expense at the time of issuance.
In May 2018, the
Company issued 1,000,000 shares of common stock valued at $230,000 to JLS Ventures, LLC, a company controlled by our CEO, Justin
Schreiber, for services. The Company also committed to issue an additional 1,000,000 shares of common stock on January 1, 2019
valued in the aggregate amount of $230,000 if JLS Ventures met the service requirement specified in the agreement. These 2,000,000
shares serve as the compensation for Mr. Schreiber for his services as CEO of the Company. The Company is recognizing the expense
for the issuances over the twenty-four month term of the agreement. For the nine months ending September 30, 2018, $172,500 has
been expensed and included in compensation and related expenses on the consolidated statement of operations.
In
May 2018, the Company issued 200,000 shares of common stock valued at $56,000 to a consultant for services over a three month
term. The Company is recognizing the expense at the time of issuance. For the nine months ending September 30, 2018, $56,000 has
been expensed and included in compensation and related expenses on the consolidated statement of operations.
Noncontrolling
Interest
During
2017, the Company issued a total of 1,319,211 shares of common stock and 659,606 warrants to purchase shares of common stock pursuant
to a conversion of Conversion Labs PR equity contributions of $303,418 into equity of the Company by the noncontrolling interest.
For the nine months
ended September 30, 2018 and 2017, the net loss of Conversion Labs PR attributed to the Company amounted to $23,145 and $68,924,
respectively.
For the three months
ended September 30, 2018 and 2017, the net loss of Conversion Labs PR attributed to the Company amounted to $35,842 and $41,194,
respectively.
On
May 29, 2018, Conversion Labs PR acquired a 51% interest in LegalSimpli, which operates a marketing-driven software solutions
business. For the month of June 2018, the net loss of LegalSimpli was $48,613, of which $5,200 was attributed to the Company.
During June 2018, contributions by other members of LegalSimpli resulted an increase in noncontrolling interests of $154,000
During
the quarter end September 30, 2018, the Company had convertible note holders convert 1,351,094 shares at a conversion price of
$0.23 per share, resulting in a decrease to convertible notes of approximately $310,752 during the quarter.
Service-Based
Stock Options
In
January 2017, the Company issued 100,000 service-based options valued at $24,109 to Brunilda McLaughlin, the wife of our CEO during
this period, as additional compensation pursuant to an employment agreement. These options have an exercise price of $0.40 per
shares, are fully vested, and expire in 10 years from date of grant.
In
February 2017, the Company issued 500,000 service-based options valued at $113,522 to a director with an exercise price of $0.20
per share. These options are fully vested and expire in 10 years from date of grant.
In
July 2017, the Company issued 75,000 service-based options valued at $20,985 to Brunilda McLaughlin, the wife of our CEO during
this period, as additional compensation in an employment agreement. These options have an exercise price of $0.35 per shares,
are fully vested, and expire in 10 years from date of grant.
In
July 2017, the Company issued a total of 300,000 service-based options valued at $83,939 to three directors at 100,000 shares
each, with an exercise price of $0.35 per share. These options are fully vested and expire in 10 years from date of grant.
In
July 2017, the Company issued 125,000 service-based options valued at $49,219 to a consultant with an exercise price of $0.40
per share. These options are fully vested and expire in 5 years from date of grant.
In
July 2017, the Company issued Mark McLaughlin, the Company’s CEO at the time, a ten year option to purchase 750,000 shares
of common stock at a price of $0.35 per share, vesting one-third or 250,000 shares upon signing and 250,000 shares on July 1,
2018 and 250,000 shares on July 1, 2019. Once these options are fully vested, they expire in 10 years from date of grant. The
options vested at December 31, 2017 are valued at $69,949. In February 2018, Mr. McLaughlin resigned as CEO, therefore no further
options will be vested.
On October 1, 2017,
Michael Borenstein was appointed to our Board of Directors. In connection with his appointment, Mr. Borenstein received a ten-year,
fully-vested option to purchase 100,000 shares of our common stock at a price of $0.35 per share. In addition, Mr. Borenstein
received four, ten-year options, each to purchase 75,000 shares of our common stock at prices of $0.25, $0.25, $0.35, and $0.35
per share, which vest upon the Company reaching $4,000,000, $5,000,000, $6,000,000 and $7,000,000 in earnings before income taxes,
respectively.
In October 2017, the
Company entered into a consulting agreement with Mr. Robert Kalkstein, the Company’s Chief Financial Officer, and issued
him a ten-year option to purchase 500,000 shares of common stock at a price of $0.40 per share, vesting 30% upon signing, 35%
vesting on the two-year anniversary of the agreement and 35% vesting on the three year anniversary of the agreement. The fair
value of the options upon issuance was $199,897 to be recognized as an expense over the three-year term of the agreement. For
the nine months ended September 30, 2018 and 2017, $49,974 and $0, respectively, has been recognized as expense. For the three
months ended September 30, 2018 and 2017, $16,658 and $0, respectively, has been recognized as expense.
Accordingly,
stock-based compensation for the nine months ended September 30, 2018 and 2017 included $204,750 and $406,247, respectively, related
to such service-based stock options.
Accordingly,
stock-based compensation for the three months ended September 30, 2018 and 2017 included $0 and $292,725, respectively, related
to such service-based stock options.
A
Summary of the outstanding service-based options are as follows:
|
|
Number of
|
|
|
|
Options
|
|
Balance at December 31, 2016
|
|
|
10,700,273
|
|
Issued
|
|
|
1,600,000
|
|
Exercised
|
|
|
(1,339,473
|
)
|
|
|
|
|
|
Balance at December 31, 2017
|
|
|
10,960,800
|
|
Issued
|
|
|
600,000
|
|
Expired
|
|
|
(500,000
|
)
|
Exercised
|
|
|
(40,800
|
)
|
Balance at September 30, 2018
|
|
|
11,020,000
|
|
All
outstanding options are exercisable and have a cashless exercise provision, and certain options provide for accelerated vesting
provisions and modifications, as defined therein. The intrinsic value of options outstanding and exercisable at September 30,
2018 and December 31, 2017 amounted to $160,796 and $1,210,342, respectively.
The significant
assumptions used to determine the fair values of options issued, using a Black-Scholes option-pricing model are as follows:
Significant assumptions:
|
|
|
|
|
Risk-free interest rate at grant date
|
|
|
0.65%
- 2.84
|
%
|
Expected stock price volatility
|
|
|
96.56%
-180.45
|
%
|
Expected dividend payout
|
|
|
-
|
|
Expected option life-years
|
|
|
3
years
|
|
Weighted average grant date fair value
|
|
$
|
0.02
- 0.32
|
|
Forfeiture rate
|
|
|
0.01
|
%
|
The
following is a summary of outstanding service-based options at September 30, 2018:
Exercise Price
|
|
|
Number
of
Options
|
|
|
Weighted
Average
Remaining Contractual Life
|
$
|
0.20
- $0.25
|
|
|
|
8,720,000
|
|
|
4 years
|
$
|
0.35
|
|
|
|
725,000
|
|
|
9 years
|
$
|
0.40
|
|
|
|
1,575,000
|
|
|
4 years
|
|
Total
|
|
|
|
11,020,000
|
|
|
|
Performance-Based
Stock Options
Vested
In
February 2017, the Company granted performance-based options to purchase 250,000 shares of common stock at an exercise price of
$0.40 per share. These options expire in 2027 and are exercisable upon the Company achieving annual sales revenue of $5,000,000.
These options are valued at $55,439. During 2017, the Company met the performance criteria.
Unvested
The
Company granted performance-based options to purchase 900,000 shares of common stock at an exercise price of $0.80 per share.
The options expire at various dates between 2021 and 2027 and are exercisable upon the Company achieving annual sales revenue
of $10,000,000. During 2017, these unvested options were cancelled.
In
July 2017, the Company granted performance-based options to purchase 6,000,000 shares of common stock with an exercise prices
of $0.35 per share. These options expire in 10 years and are exercisable upon cash received by the Company from Conversion Labs
PR between $4,000,000 and $7,000,000. The aggregate fair value of these performance-based options is $1,688,212.
In
the third quarter of 2017, the Company granted performance-based options to purchase 1,575,000 shares of common stock with an
exercise prices of $0.25 and an additional 1,575,000 shares of common stock with an exercise price of $0.35 per share. The options
expire 10 years from date of grant and are exercisable upon the company achieving pre-tax earnings benchmarks between $4,000,000
and $7,000,000. The aggregate fair value of these performance-based options is $910,146.
In
the fourth quarter of 2017, the Company granted performance-based options to purchase 300,000 shares of common stock with an exercise
prices of $0.25 and an additional 300,000 shares of common stock with an exercise price of $0.35 per share. The options expire
in 10 years and are exercisable upon the company achieving pre-tax earnings benchmarks between $4,000,000 and $7,000,000. The
aggregate fair value of these performance-based options is $242,709.
Warrants
The
following is a summary of outstanding and exercisable warrants:
|
|
Number
of
|
|
|
Weighted
Average Exercise
|
|
|
Year of
|
|
|
Shares
|
|
|
Price
|
|
|
Expiration
|
|
|
|
|
|
|
|
|
|
Balance
at December 31, 2016
|
|
|
1,954,981
|
|
|
$
|
0.19
|
|
|
2017 -
2019
|
Issued
|
|
|
2,634,228
|
|
|
|
0.4
0
|
|
|
2018 - 2020
|
Exercised
|
|
|
(1,500,000
|
)
|
|
|
0.12
|
|
|
2017
|
|
|
|
|
|
|
|
|
|
|
|
Balance
at December 31, 2017
|
|
|
3,089,119
|
|
|
|
0.4
0
|
|
|
2018 - 2020
|
Issued
|
|
|
2,491,305
|
|
|
|
0.29
|
|
|
2023 - 2028
|
Exercised
|
|
|
-
|
|
|
|
|
|
|
|
Balance
at September 30, 2018
|
|
|
5,580,424
|
|
|
$
|
0.35
|
|
|
2018 - 2028
|
In
January 2017, the Company issued 591,745 warrants to purchase shares of common stock with an exercise price of $0.40 per share,
in relation to an issuance of common stock for the conversion of an equity contribution into Conversion Labs PR by the noncontrolling
interest. These warrants are fully vested and expire in two years.
In
March 2017, the Company issued 402,348 warrants to purchase shares of common stock with an exercise price of $0.40 per share,
in relation to an issuance of common stock for the conversion of debt. These warrants are fully vested and expire in two years.
In
the first quarter of 2017, the Company issued 1,408,578 warrants to purchase shares of common stock with an exercise price of
$0.40 per share, in relation to a sale of common stock. These warrants are fully vested and expire in two years.
In
April 2017, the Company issued 55,000 warrants to purchase shares of common stock with an exercise price of $0.40 per share, in
relation to a sale of common stock. These warrants are fully vested and expire in two years.
In
April 2017, the Company issued 108,696 warrants to purchase shares of common stock with an exercise price of $0.40 per share,
in relation to an issuance of common stock for conversion of a payable. These warrants are fully vested and expire in three years.
In
November 2017, the Company issued 67,861 warrants to purchase shares of common stock with an exercise price of $0.40 per share,
in relation to an issuance of common stock for conversion of an equity contribution into Conversion Labs PR by the noncontrolling
interest. These warrants are fully vested and expire in three years.
In
March 2018, the Company issued 100,000 warrants to purchase shares of common stock with an exercise price of $0.50 per share,
in relation to royalty license agreement. These warrants are fully vested and expire in ten years.
In
May 2018, the Company issued 2,391,305 warrants to purchase shares of common stock with an exercise price of $0.28 per share,
in relation to an issuance of convertible notes payable. These warrants are fully vested and expire in five years.
Warrants
outstanding and exercisable amounted to 5,580,424 and 3,089,119 at September 30, 2018 and December 31, 2017, respectively. The
weighted average exercise price of warrants outstanding at September 30, 2018 and December 31, 2017 is $0.35 and $0.40, respectively.
The warrants expire at various times between September 2018 and March 2028.
The
fair value of options and warrants granted (or extended) during the nine months ended September 30, 2018 and 2017, was estimated
on the date of grant (or extension) using the Black-Scholes option-pricing model with the following weighted-average assumptions:
|
|
2018
|
|
2017
|
|
|
|
|
|
Expected
volatility
|
|
191%
- 196%
|
|
125%
- 214%
|
Risk
free interest rate
|
|
2.44%
- 2.58%
|
|
1.31%
- 2.57%
|
Expected
dividend yield
|
|
-
|
|
-
|
Expected
option term (in years)
|
|
3-5
|
|
0.9
- 8.1
|
Weighted
average grant date fair value
|
|
$0.21
– 0.22
|
|
$0.12
- 0.45
|
Under
ASC 815-40-05, Accounting for Derivative Financial Instruments Indexed to and Potentially Settled in a Company’s Own Stock,
in the event the Company does not have a sufficient number of authorized and unissued shares of common stock to satisfy obligations
for stock options, warrants and other instruments potentially convertible into common stock, the fair value of these instruments
should be reported as a liability. Pursuant to the outstanding option, warrant and convertible debt agreements, there is currently
no effective registration statement covering the shares of common stock underlying these agreements, which are currently subject
to a cashless exercise whereby the holders, at their option, may surrender their options and warrants to the company in exchange
for shares of common stock. The number of shares of common stock into which an option or a warrant would be exchangeable in such
a cashless exercise depends on both the exercise price of the options or warrant and the market price of the common stock, each
at or near the time of exercise. Because the market price is variable, it is possible that we could have insufficient authorized
shares to satisfy a cashless exercise. In this scenario, if we were unable to obtain shareholder approval to increase the number
of authorized shares, we could be obligated to settle such a cashless exercise with cash rather than by issuing shares of common
stock. Further, ASC 815-40-05 requires that we record the potential settlement obligation at each reporting date using the current
estimated fair value of these contracts, with any changes in fair value being recorded through our statement of operations. We
reported the potential settlement obligation as a liability until such time as these contracts are exercised or expire or we are
otherwise able to modify the agreements to remove the provisions which require this treatment. On September 21, 2017, the Company
filed an amendment to its Certificate of Incorporation with the Delaware Secretary of State increasing the number of authorized
shares of the Company’s common stock from 50,000,000 to 100,000,000, which enabled the Company to reclassify the derivative
liability.
Stock
Based Compensation
The total stock-based
compensation expense related to Service-Based Stock Options, Performance-Based Stock Options and Warrants issued for service amounted
to $383,470 and $142,045 for the nine months ended September 30, 2018 and 2017, respectively. Performance-Based Stock Options
and Warrants issued for service amounted to $127,388 and $28,523 for the three months ended September 30, 2018 and 2017, respectively.
Such amounts are included in compensation and related expenses in the consolidated statement of operations.
NOTE
8 – ROYALTIES
The Company is subject
to a royalty agreement based upon sales of certain hair care products. For the nine months ended September 30, 2018 and 2017,
the Company recognized $12,036 and $65,318, respectively, in royalty expense related to this agreement. As of September 30, 2018,
$26,357 was included in other current assets and as of December 31, 2017, $14,039 was included in accounts payable and accrued
expenses in regard to this agreement. In addition, the Company shall pay a performance fee in relation to this agreement. In April
2017, the Company issued 217,390 shares of common stock and 108,696 warrants, pursuant to a subscription agreement, for the stated
consideration and satisfaction of obligation to pay $50,000 of the performance fee (see Note 8).
On
March 26, 2018, the Company entered into a license agreement (the “Agreement”) with M.ALPHABET, LLC (“Alphabet”),
pursuant to which Alphabet agreed to license its PURPUREX business which consists of methods and compositions developed by Licensor
for the treatment of purpura, bruising, post-procedural bruising and traumatic bruising (the “Product Line”). Pursuant
to the license granted under the Agreement, Conversion Labs PR obtains an exclusive license to incorporate (i) any intellectual
property rights related to the Product Line and (ii) all designs, drawings, formulas, chemical compositions and specifications
used or useable in the Product Line into one or more products manufactured, sold, and/or distributed by Alphabet for the treatment
of purpura, bruising, post-procedural bruising and traumatic bruising and for all other fields of use or purposes (the “Licensed
Product(s)”), and to make, have made, advertise, promote, market, sell, import, export, use, offer to sell and distribute
the Licensed Product(s) throughout the world with the exception of China, Hong Kong, Japan, and Australia (the “License”).
The
Company shall pay Alphabet a royalty equal to 13% of Gross Receipts (as defined in the Agreement) realized from the sales of Licensed
Products. Further, so long as the Agreement is not previously terminated, the Company, also agreed to pay Alphabet $50,000 on
the 120-day anniversary of the Agreement and an additional $50,000 on the 360-day anniversary of the Agreement.
Upon
execution of the Agreement, Alphabet will be granted a 10-year option to purchase 100,000 shares of the Company’s common
stock at an exercise price of $0.50. Further, if Licensed Products have gross receipts of $7,500,000 in any calendar year, the
Company will grant Alphabet an option to purchase 100,000 shares of the Company’s common stock at an exercise price of $0.50;
(ii) if Licensed Products have gross receipts of $10,000,000 in any calendar year, the Company will grant Alphabet an additional
option to purchase 100,000 shares of the Company’s common stock at an exercise price of $0.50 and (iii) If Licensed Products
have gross receipts of $20,000,000 in any calendar year, the Company will grant Alphabet an option to purchase 200,000 shares
of the Company’s common stock at an exercise price of $0.75.
NOTE
9 – COMMITMENTS AND CONTINGENCIES
Leases
Conversion
Labs PR utilizes office space in Puerto Rico which is subleased from Mr. Schreiber (the Company’s President and CEO) and
incurs expense of approximately $4,000 a month for this office space. Rent expense for the nine months ended September 30, 2018
and 2017, was $36,000 and $36,000, respectively.
The
Company started paying $95 per month to WeWork for a mailing address and the ability to lease conference space on-demand at their
locations worldwide. The Company incurred $570 of expenses for the nine month period ended September 30, 2018.
In February 2018,
the Company entered into a 3-year agreement to lease office space in Huntington Beach, CA beginning on March 2, 2018. The rent
is payable on a monthly basis in the amount of $2,106 for the first twelve months, $2,149 for the second twelve months and $2,235
for the third twelve months. A security deposit of $2,235 was paid for this lease. Rent expense for the nine months ended September
30, 2018 and 2017, was $16,848 and $0, respectively.
Consulting
Agreements
In
August 2017, the Company entered into a Professional Service Agreement with Acorn Management Partners L.L.C. (“Acorn”)
for financial advisory, strategic business planning and other investor relation services for one year effective August 8, 2017.
During the term of the Agreement, Acorn shall receive $7,500 cash monthly. As additional compensation, the Company shall issue
within five (5) days of signing 100,000 shares of the Company’s common stock and upon each three (3) month period thereafter
during the term of the Agreement an additional 100,000 shares of the Company’s common stock for a total of 400,000 shares
of the Company’s common stock.
In
July 2017, the Company and JLS Ventures, an entity owned by the Company’s current Chief Executive Officer, entered into
a second amendment to a Service Agreement effective July 1, 2017. As compensation, the Company issued 900,000 shares of common
stock valued at $432,000. The Company is recognizing the expense over the term of the agreement. For the nine months ending September
30, 2018 and 2017, $72,000 and $0, respectively, has been expensed and included in compensation and related expenses on the consolidated
statement of operations. In May 2018, the Company issued 1,000,000 shares of common stock valued at $230,000 to JLS Ventures,
LLC, a company controlled by our CEO, Justin Schreiber, for services. The Company also committed to issue an additional 1,000,000
shares of common stock on January 1, 2019 valued in the aggregate amount of $230,000 if JLS Ventures met the service requirement
specified in the agreement. These 2,000,000 shares serve as the compensation for Mr. Schreiber for his services as CEO of the
Company. The Company is recognizing the expense for the issuances over the twenty-four month term of the agreement. For the nine
months ending September 30, 2018, $172,500 has been expensed and included in compensation and related expenses on the consolidated
statement of operations.
Restricted
Stock and Options
The
Company has entered into two agreements on April 1, 2016 with two consultants of Conversion Labs PR for business development,
marketing and sales related services (the “Consultant Agreements”). The consultants are treated as employees for accounting
purposes. Upon signing, each consultant was issued 1,000,000 restricted shares of the Company’s common stock. In addition,
each consultant shall receive an additional 150,000 restricted shares of the Company’s common stock for each $500,000 distributed
by Conversion Labs PR to the Company. For each consultant, the amount of shares of common stock to be issued by the Company to
the consultants shall be capped at 1,500,000 restricted shares of common stock when Conversion Labs PR has transferred $5,000,000
to the Company, for a combined capped total of 3,000,000 restricted shares of common stock. For the year ended December 31, 2016,
2,300,000 restricted shares of common stock have been issued related to the Consultant. The Company valued the shares of common
stock at their grant date for a value of $0.30 per share for a total of $690,000 to be expensed over the estimated service period.
In addition, the Consultant
Agreements provided that each consultant shall receive a bonus of an additional 750,000 restricted shares of the Company’s
common stock, plus an option to buy 1,000,000 shares of the Company’s common stock at a price of $0.20 per share (including
a cashless exercise feature) when Conversion Labs PR has transferred to the Company at each of the following three (3) thresholds:
$1,250,000, $2,000,000 and $3,000,000 for a total of 2,250,000 of restricted shares of the Company’s common stock and options
to purchase up to 3,000,000 shares of the Company’s common stock at a price of $0.20 per share. As of September 30, 2018
no bonus shares have been issued, and no options have been granted under the Consultant Agreement.
Sole
and Exclusive License, Royalty, and Advisory Agreement
On
September 1, 2016 Conversion Labs PR entered into a sole and exclusive license, royalty and advisory agreement with Pilaris Laboratories,
LLC (“Pilaris”) relating to Pilaris’ PilarisMax shampoo formulation and conditioner. The term of the agreement
will be the life of the US Patent held by Pilaris. As consideration for granting Conversion Labs PR this license, Pilaris will
receive on quarterly basis, 10% of the net income collected by the licensed products based on the following formula: Net Income
= total income – cost of goods sold – advertising and operating expenses directly related to the marketing of the
licensed products. In addition, Conversion Labs PR shall pay Pilaris a performance fee of $50,000 on the 180-day anniversary of
the agreement and an additional $50,000 performance fee on the 365-day anniversary of the agreement. For the year ended December
31, 2017, the Company recognized expenses related to the performance fee in the amount of $100,000. In April 2017, the Company
issued 217,390 shares of common stock and 108,696 warrants, pursuant to a subscription agreement, for the stated consideration
and satisfaction of obligation to pay $50,000 on the 180-day anniversary of the execution of this agreement. As of September 30,
2018, $26,357 was included in other current assets and as of December 31, 2017, $14,039 was included in accounts payable and accrued
expenses in regard to this agreement.
Legal
Matters
In
the normal course of business operations, the Company may become involved in various legal matters. At September 30, 2018, the
Company’s management does not believe that there are any potential legal matters that could have a material adverse effect
on the Company’s financial position.
NOTE
10 – PRODUCT DEPOSIT
Many
of our vendors require deposits when a purchase order is placed for goods. Our vendors issue a credit memo when sending their
final invoice, reducing the amount the Company owes for the deposit amount on file with the vendors. As of September 30, 2018,
the Company has $106,700 of products deposit with multiple vendors for the purchase of raw materials for products we sell online.
NOTE
11 – RELATED PARTY TRANSACTIONS
Certain
related party transactions were incurred by the legacy business that was sold in February 2018, including reimbursement of home
office expenditures to the Company’s former President and CEO, employment of the Company’s former President and CEO’s
wife, and legal and business advisory services provided by one of the Company’s directors.
Conversion
Labs PR utilizes BV Global Fulfillment, owned by the father of Mr. Schreiber, the Company’s current Chief Executive Officer,
and incurred $93,045 and $181,244 for the nine months ended September 30, 2018 and 2017, respectively, for services. For the three
months ended September 30, 2018, the Company has incurred $32,582 and $138,687, respectively, for these services.
Taggart
International Trust (“Taggart”), a shareholder of the Company, provides credit card processing services through one
or more merchant banks. Taggart did not receive any compensation for these services.
JLS
Ventures LLC, owned by our current CEO, provides credit card processing services through one or more merchant banks. JLS Ventures
LLC did not receive any compensation for these services. In July 2017, the Company and JLS Ventures, an entity owned by the
Company’s current Chief Executive Officer, entered into a second amendment to a Service Agreement effective July 1, 2017.
As compensation, the Company issued 900,000 shares of common stock valued at $432,000. The Company is recognizing the expense
over the term of the agreement. For the nine months ending September 30, 2018 and 2017, $72,000 and $0, respectively, has been
expensed and included in compensation and related expenses on the consolidated statement of operations. In May 2018, the Company
issued 1,000,000 shares of common stock valued at $230,000 to JLS Ventures, LLC, a company controlled by our CEO, Justin Schreiber,
for services. The Company also committed to issue an additional 1,000,000 shares of common stock on January 1, 2019 valued in
the aggregate amount of $230,000 if JLS Ventures met the service requirement specified in the agreement. These 2,000,000 shares
serve as the compensation for Mr. Schreiber for his services as CEO of the Company. The Company is recognizing the expense for
the issuances over the twenty-four month term of the agreement. For the nine months ending September 30, 2018, $172,500 has been
expensed and included in compensation and related expenses on the consolidated statement of operations.
JSDC,
Inc., owned by our current CEO, provides credit card processing services through one or more merchant banks. JSDC, Inc. did not
receive any compensation for these services.
Conversion
Labs PR utilizes office space in Puerto Rico which is subleased from Mr. Schreiber, our current CEO, and incurs expense of approximately
$4,000 a month for this office space.
In
December 2017, Conversion Labs PR received two working capital loans from Robert Kalkstein, the Company’s CFO, and from
Mr. Schreiber, the Company’s CEO, for $50,000 and $75,000, respectively. These loans accrue at 2% interest per month and
mature in February 2018. Accrued interest relating to the loans were $1,867 as of December 31, 2017. In February 2018, these loans
were repaid in full.
During
2017, the Company issued a total of 1,319,211 shares of common stock to Mr. Schreiber pursuant to a conversion of Conversion Labs
PR equity contributions of $303,419 into equity of the Company.
On
November 20, 2017, the Company entered into an agreement (the “Agreement”) with JOJ Holdings, LLC (“JOJ”).
Pursuant to the terms of the Agreement, the Company purchased 2,000,000 shares (post-split from a 2:1 forward split on January
16, 2018) of Blockchain Industries, Inc. (“BCII”) from JOJ. The Agreement was amended on December 8, 2017 and again
on March 9, 2018. In consideration for the purchase, the Company agreed to issue one (1) share of the Company’s common stock
to JOJ for every dollar the Company realizes from gross proceeds on the sale of shares of BCII purchased pursuant to the Agreement,
up to a total maximum aggregate amount of 5,000,000 shares. The Company has 3 years to sell the shares of BCII and has agreed
not to sell more than 20% of the 30-day average daily trading volume of BCII. Justin Schreiber, the Company’s President
and CEO, is the President and owner of JOJ. The transaction was determined not to meet the criteria for recognition as an exchange
transaction, therefore no asset or liability has been recorded in the financial statements.
NOTE
12 – SUBSEQUENT EVENTS
The
Company has evaluated subsequent events through the date these financial statements were issued.
On
October 25, 2018, the Company’s board of directors unanimously decided to amend warrants with a two-year term issued to
warrant holders issued between January 2017 and March 2017 with an exercise price of $0.40 per share. The Company amended the
warrants to provide for an additional three-year term to warrant holders as consideration for them entering into a call agreement
with the Company, so that when the Company’s common stock trades above or over $0.75 per share for at least ten consecutive
days. The Company has repriced the grant date fair value as of September 30, 2018 and recognized additional expense as stock-based
compensation of approximately $128,000.
On
October 31, 2018, the Company entered into a loan agreement with a private lender for $200,000. The Loan agreement requires the
one-time fee of $30,000 which is due on the maturity date of April 1, 2019.