NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
1. ORGANIZATION AND LINE OF BUSINESS
Organization
CleanSpark, Inc.
(“CleanSpark”, “we”, “our”, the "Company") was incorporated in the state of Nevada
on October 15, 1987 as SmartData Corporation. SmartData conducted a 504-public offering in the State of Nevada in December 1987
and began trading publicly in January 1988. Due to a series of unfortunate events, including the untimely death of the founding
CEO, SmartData discontinued active business operations in 1992.
On March 25, 2014,
we began operations in the alternative energy sector.
In December 2014,
the Company changed its name to Stratean Inc. through a short-form merger in order to better reflect its new business plan.
On July 1, 2016,
the Company entered into an Asset Purchase Agreement, as amended (the “Purchase Agreement”), with CleanSpark Holdings
LLC, CleanSpark LLC, CleanSpark Technologies LLC and Specialized Energy Solutions, Inc. (together, the “Seller”).
Pursuant to the Purchase Agreement, the Company acquired CleanSpark, LLC and all the assets related to the Seller and its line
of business and assumed $200,000 in liabilities.
In October 2016,
the Company changed its name to CleanSpark, Inc. through a short-form merger in order to better reflect the brand identity.
On January 22,
2019, CleanSpark entered into an Agreement with Pioneer Critical Power, Inc., whereby it acquired certain intellectual property
assets and a customer list. As consideration the Company issued to its sole shareholder (i) 175,000 of the common stock of CleanSpark,
(ii) a five-year warrant to purchase 50,000 shares of CleanSpark common stock at an exercise price of $16.00 per share, and (iii)
a five-year warrant to purchase 50,000 shares of CleanSpark common stock at an exercise price of $20.00 per share. As a result
of the transaction Pioneer Critical Power Inc. became a wholly owned subsidiary of CleanSpark Inc. On February 1, 2019, Pioneer
Critical Power, Inc. was renamed to CleanSpark Critical Power Systems, Inc.
On December 10,
2019, the Financial Industry Regulatory Authority (“FINRA”) approved the Company’s 1:10 reverse stock split
of the Company’s common stock. The reverse stock split took effect on December 11, 2019. Unless otherwise noted, impacted
amounts and share information in this report and included in the financial statements and notes thereto as of and for the period
ended December 31, 2019 and September 30, 2019, have been adjusted for the stock split as if such stock split occurred on the
first day of the first period presented.
Line of Business
Through
CleanSpark, LLC, the Company provides microgrid solutions to military, commercial and residential properties.
The
services offered consist of, microgrid design and engineering, project development consulting services. The work is performed
under fixed price bid contracts and negotiated price contracts.
Through
CleanSpark Critical Power Systems, Inc., the Company provides custom hardware solutions for distributed energy systems that serve
military and commercial residential properties. The equipment is generally sold under negotiated fixed price contracts.
2. SUMMARY OF SIGNIFICANT
POLICIES
Basis of Presentation
and Liquidity
The accompanying
unaudited interim financial statements of the Company have been prepared in accordance with accounting principles generally accepted
in the United States of America and the rules of the Securities and Exchange Commission, and should be read in conjunction with
the audited financial statements and notes thereto contained in the Company’s most recent Annual Financial Statements filed
with the SEC on Form 10-K. In the opinion of management, all adjustments, consisting of normal recurring adjustments, necessary
for a fair presentation of financial position and the results of operations for the interim period presented have been reflected
herein. The results of operations for the interim period are not necessarily indicative of the results to be expected for the
full year. Notes to the financial statements which would substantially duplicate the disclosures contained in the audited financial
statements for the most recent fiscal period, as reported in the Form 10-K, have been omitted.
The Company has
incurred losses for the past several years while developing infrastructure and its software platforms. As shown in the accompanying
unaudited consolidated financial statements, the Company incurred net losses of $1,916,254 during the three months ended December
31, 2019. In response to these conditions and to ensure the Company has sufficient capital for ongoing operations for a minimum
of 12 months we have raised additional capital through the sale of debt and
equity securities pursuant to a registration statement on Form S-3. (See Note 8 for additional details.) As of December 31, 2019,
the Company had working capital of approximately $8,571,806.
Principles
of Consolidation
The accompanying
consolidated financial statements include the accounts of CleanSpark, Inc., and its wholly owned operating subsidiaries, CleanSpark,
LLC, CleanSpark, II, LLC and CleanSpark Critical Power Systems Inc. All material intercompany transactions have been eliminated
upon consolidation of these entities.
Use of estimates
– The preparation of consolidated financial statements in conformity with accounting principles generally accepted in
the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets
and liabilities, disclosure of contingent assets and liabilities at the date of the consolidated financial statements, and the
reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Significant
estimates include estimates used to review the Company’s goodwill impairment, impairments and estimations of long-lived
assets, revenue recognition on percentage of completion type contracts, allowances for uncollectible accounts, and the valuations
of non-cash capital stock issuances. The Company bases its estimates on historical experience and on various other assumptions
that are believed to be reasonable in 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.
Revenue Recognition
– Upon adoption of ASC Topic 606, the Company revised its accounting policy on revenue recognition from the policy provided
in the Notes to Consolidated Financial Statements included in our September 30, 2019 10-K. The revised accounting policy on revenue
recognition is provided below. The Company accounts for revenue contracts with customers through the following steps:
|
•
|
Identification
of the contract, or contracts, with a customer
|
|
•
|
Identification
of the performance obligations in the contract
|
|
•
|
Determination
of the transaction price
|
|
•
|
Allocation
of the transaction price to the performance obligations in the contract
|
|
•
|
Recognition
of revenue when, or as, the Company satisfies a performance obligation
|
Engineering
& Construction Contracts and Service Contracts
The Company
recognizes engineering and construction contract revenue over time, as performance obligations are satisfied, due to the continuous
transfer of control to the customer. Engineering and construction contracts are generally accounted for as a single unit of account
(a single performance obligation) and are not segmented between types of services. The Company recognizes revenue based primarily
on contract cost incurred to date compared to total estimated contract cost (an input method). The input method is the most faithful
depiction of the Company’s performance because it directly measures the value of the services transferred to the customer.
Customer-furnished materials, labor and equipment and, in certain cases, subcontractor materials, labor and equipment, are included
in revenue and cost of revenue when management believes that the company is acting as a principal rather than as an agent (i.e.,
the company integrates the materials, labor and equipment into the deliverables promised to the customer). Customer-furnished
materials are only included in revenue and cost when the contract includes construction activity and the Company has visibility
into the amount the customer is paying for the materials or there is a reasonable basis for estimating the amount. The Company
recognizes revenue, but not profit, on certain uninstalled materials that are not specifically produced, fabricated, or constructed
for a project. Revenue on these uninstalled materials is recognized when the cost is incurred (when control is transferred). Changes
to total estimated contract cost or losses, if any, are recognized in the period in which they are determined as assessed at the
contract level. Pre-contract costs are expensed as incurred unless they are expected to be recovered from the client. Project
mobilization costs are generally charged to project costs as incurred when they are an integrated part of the performance obligation
being transferred to the client. Customer payments on engineering and construction contracts are typically due within 30 to 45
days of billing, depending on the contract.
For service
contracts (including maintenance contracts) in which the Company has the right to consideration from the customer in an amount
that corresponds directly with the value to the customer of the Company’s performance completed to date, revenue is recognized
when services are performed and contractually billable. Service contracts that include multiple performance obligations are segmented
between types of services. For contracts with multiple performance obligations, the Company allocates the transaction price to
each performance obligation using an estimate of the stand-alone selling price of each distinct service in the contract. Revenue
recognized on service contracts that have not been billed to clients is classified as a current asset under contract assets on
the Consolidated Balance Sheets. Amounts billed to clients in excess of revenue recognized on service contracts to date are classified
as a current liability under contract liabilities. Customer payments on service contracts are typically due within 30 days of
billing, depending on the contract.
Revenues
from Sale of Equipment
Performance
Obligations Satisfied at a point in time.
We recognize
revenue on agreements for non-customized equipment we sell on a standardized basis to the market at a point in time. We recognize
revenue at the point in time that the customer obtains control of the good, which is generally upon shipment or when the customer
has physical possession of the product depending on contract terms. We use proof of delivery for certain large equipment with
more complex logistics, whereas the delivery of other equipment is estimated based on historical averages of in-transit periods
(i.e., time between shipment and delivery).
In situations
where arrangements include customer acceptance provisions based on seller or customer-specified objective criteria, we recognize
revenue when we have concluded that the customer has control of the goods and that acceptance is likely to occur. We generally
do not provide for anticipated losses on point in time transactions prior to transferring control of the equipment to the customer.
Our billing
terms for these point in time equipment contracts vary and generally coincide with shipment to the customer; however, within certain
businesses, we receive progress payments from customers for large equipment purchases, which is generally to reserve production
slots with our manufacturing partners, which are recorded as contract liabilities.
Service
Performance obligations satisfied over time.
We enter
into long-term product service agreements with our customers primarily within our microgrid segment. These agreements require
us to provide preventative maintenance, and standby support services that include certain levels of assurance regarding system
performance throughout the contract periods, these contracts will generally range from 1 to 10 years. We account for items that
are integral to the maintenance of the equipment as part of our service-related performance obligation, unless the customer has
a substantive right to make a separate purchasing decision (e.g., equipment upgrade). Contract modifications that extend or revise
contract terms are not uncommon and generally result in our recognizing the impact of the revised terms prospectively over the
remaining life of the modified contract (i.e., effectively like a new contract). Revenues are recognized for these arrangements
on a straight-line basis consistent with the nature, timing and extent of our services, which primarily relate to routine maintenance
and as needed product repairs. Our billing terms for these contracts vary, but we generally invoice periodically as services are
provided.
Contract
assets represent revenue recognized in excess of amounts billed and include unbilled receivables (typically for cost reimbursable
contracts) of $0 and contract work in progress (typically for fixed-price contracts) of $28,517 and $57,077 as of December 31,
2019 and September 30, 2019, respectively. Unbilled receivables, which represent an unconditional right to payment subject only
to the passage of time, are reclassified to accounts receivable when they are billed under the terms of the contract. Advances
that are payments on account of contract assets of $0 and $0 as of December 31, 2019 and September 30, 2019, respectively, have
been deducted from contract assets. Contract liabilities represent amounts billed to clients in excess of revenue recognized to
date. The Company recorded $610,834 and $499,401 in contract liabilities as of December 31, 2019 and September 30, 2019, respectively.
Revenues
from software
The
Company derives its revenue from subscription fees from customers for access to its mVSO platform. The Company’s policy
is to exclude sales and other indirect taxes when measuring the transaction price of its subscription agreements.
The Company’s
subscription agreements generally have monthly or annual contractual terms. Revenue is recognized ratably over the related contractual
term beginning on the date that the platform is made available to a customer. Access to the platform represents a series of distinct
services as the Company continually provides access to, and fulfills its obligation to the end customer over the subscription
term. The series of distinct services represents a single performance obligation that is satisfied over time.
Variable
Consideration
The nature
of the Company’s contracts gives rise to several types of variable consideration, including claims and unpriced change orders;
awards and incentive fees; and liquidated damages and penalties. The Company recognizes revenue for variable consideration when
it is probable that a significant reversal in the amount of cumulative revenue recognized will not occur. The Company estimates
the amount of revenue to be recognized on variable consideration using the expected value (i.e., the sum of a probability-weighted
amount) or the most likely amount method, whichever is expected to better predict the amount. Factors considered in determining
whether revenue associated with claims (including change orders in dispute and unapproved change orders in regard to both scope
and price) should be recognized include the following: (a) the contract or other evidence provides a legal basis for the claim,
(b) additional costs were caused by circumstances that were unforeseen at the contract date and not the result of deficiencies
in the company’s performance, (c) claim-related costs are identifiable and considered reasonable in view of the work performed,
and (d) evidence supporting the claim is objective and verifiable. If the requirements for recognizing revenue for claims or unapproved
change orders are met, revenue is recorded only when the costs associated with the claims or unapproved change orders have been
incurred. Back charges to suppliers or subcontractors are recognized as a reduction of cost when it is determined that recovery
of such cost is probable and the amounts can be reliably estimated. Disputed back charges are recognized when the same requirements
described above for claims accounting have been satisfied.
The Company
generally provides limited warranties for work performed under its engineering and construction contracts. The warranty periods
typically extend for a limited duration following substantial completion of the Company’s work on a project. Historically,
warranty claims have not resulted in material costs incurred.
Practical Expedients
If the company
has a right to consideration from a customer in an amount that corresponds directly with the value of the company’s performance
completed to date (a service contract in which the company bills a fixed amount for each hour of service provided), the company
recognizes revenue in the amount to which it has a right to invoice for services performed.
The company does
not adjust the contract price for the effects of a significant financing component if the company expects, at contract inception,
that the period between when the company transfers a service to a customer and when the customer pays for that service will be
one year or less.
The company has
made an accounting policy election to exclude from the measurement of the transaction price all taxes assessed by governmental
authorities that are collected by the company from its customers (use taxes, value added taxes, some excise taxes).
For the three months
ended December 31, 2019 and 2018, the Company reported revenues of $976,824 and $262,907, respectively.
Cash and cash
equivalents – For purposes of the statements of cash flows, the Company considers all highly liquid investments and
short-term debt instruments with original maturities of three months or less to be cash equivalents. There was $6,376,557 and
$7,838,857 in cash and no cash equivalents as of December 31, 2019 and September 30, 2019, respectively.
Accounts
receivable - is comprised of uncollateralized customer obligations due under normal trade terms. The Company performs ongoing
credit evaluation of its customers and management closely monitors outstanding receivables based on factors surrounding the credit
risk of specific customers, historical trends, and other information. The carrying amount of accounts receivable is reviewed periodically
for collectability. If management determines that collection is unlikely, an allowance that reflects management’s best estimate
of the amounts that will not be collected is recorded. Accounts receivable are presented net of an allowance for doubtful accounts
of $254,570 and $254,570 at
December 30, 2019, and September 30, 2019, respectively.
Retention
receivable is the amount withheld by a customer until a contract is completed. Retention receivables of $102,206 and
$159,989 were included in the balance of trade accounts receivable as of December 31, 2019 and September 30, 2019, respectively.
Inventory –
All inventory consists of finished goods and are valued based upon first-in first-out ("FIFO") cost, not in excess of
net realizable value. The determination of whether the carrying amount of inventory requires a write-down is based on an evaluation
of inventory for slow moving and obsolete items.
Investment
securities - Investment securities include debt securities and equity securities. Debt securities are classified as
available for sale (“AFS”) and are reported as an asset in the Consolidated Balance Sheet at their estimated fair
value. As the fair values of AFS debt securities change, the changes are reported net of income tax as an element of OCI, except
for other-than-temporarily-impaired securities. When AFS debt securities are sold, the unrealized gains or losses are reclassified
from OCI to non-interest income. Securities classified as AFS are securities that the Company intends to hold for an indefinite
period of time, but not necessarily to maturity. Any decision to sell a security classified as AFS would be based on various factors,
including significant movements in interest rates, changes in the maturity mix of the Company’s assets and liabilities,
liquidity needs, decline in credit quality, and regulatory capital considerations.
Interest income
is recognized based on the coupon rate and increased by accretion of discounts earned or decreased by the amortization of premiums
paid over the contractual life of the security.
For individual
debt securities where the Company either intends to sell the security or more likely than not will not recover all of its amortized
cost, the OTTI is recognized in earnings equal to the entire difference between the security's cost basis and its fair value at
the balance sheet date. For individual debt securities for which a credit loss has been recognized in earnings, interest accruals
and amortization and accretion of premiums and discounts are suspended when the credit loss is recognized. Interest received after
accruals have been suspended is recognized in income on a cash basis.
Our
accounting for our investment in equity securities is based on fair value accounting with unrealized gains or losses resulting
from changes in fair value reflected as investment gains or losses in our consolidated statement of operations.
Concentration
Risk
At times throughout
the year, the Company may maintain cash balances in certain bank accounts in excess of FDIC limits. As of December 31, 2019, the
cash balance in excess of the FDIC limits was $6,126,557. The Company has not experienced any losses in such accounts and believes
it is not exposed to any significant credit risk in these accounts. The Company had certain customers whose revenue individually
represented 10% or more of the Company’s total revenue. (See Note 14 for details.)
Warranty Liability – The
Company establishes warranty liability reserves to provide for estimated future expenses as a result of installation and product
defects, product recalls and litigation incidental to the Company’s business. Liability estimates are determined based on
management’s judgment, considering such factors as historical experience, the likely current cost of corrective action, manufacturers’
and subcontractors’ participation in sharing the cost of corrective action, consultations with third party experts such as
engineers, and discussions with the Company’s general counsel and outside counsel retained to handle specific product liability
cases. The Company’s manufacturers and service providers currently provide substantial warranties between ten to twenty-five
years with full reimbursement to replace and install replacement parts. Warranty costs and associated liabilities were $0 and $0
at December 31, 2019 and September 30, 2019, respectively.
Stock-based
compensation – The Company follows the guidelines in FASB Codification Topic ASC 718-10 “Compensation-Stock
Compensation,” which requires companies to measure the cost of employee and non-employee services
received in exchange for an award of an equity instrument
based on the grant-date fair value of the award. Stock-based compensation expense is recognized on a straight-line basis over the
requisite service period. The Company may issue compensatory shares for services including, but not limited to, executive, management,
accounting, operations, corporate communication, financial and administrative consulting services.
Earnings (loss)
per share – The Company reports earnings (loss) per share in accordance with Financial Accounting Standards Board’s
(“FASB”) Accounting Standards Codification (“ASC”) 260-10 “Earnings Per Share,” which
provides for calculation of “basic” and “diluted” earnings per share. Basic earnings per share includes
no dilution and is computed by dividing net income or loss available to common stockholders by the weighted average common shares
outstanding the period. Diluted earnings per share reflect the potential dilution of securities that could share in the earnings
of an entity. The calculation of diluted net loss per share gives effect to common stock equivalents; however, potential common
shares are excluded if their effect is anti-dilutive. As of December 31, 2019, there are 5,645,096 shares issuable upon exercise
of outstanding options, warrants and convertible debt which have been excluded as anti-dilutive.
Fair value of financial instruments and
derivative asset –The carrying value of cash, accounts payable and accrued expenses, and debt (See Notes 8 & 9) approximate
their fair values because of the short-term nature of these instruments. Management believes the Company is not exposed to significant
interest or credit risks arising from these financial instruments. The carrying amount of the Company’s long-term convertible
debt is also stated at fair value of $10,900,000 since the stated rate of interest approximates market rates.
Fair value is defined
as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or
most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date.
Valuation techniques used to measure fair value maximize the use of observable inputs and minimize the use of unobservable inputs.
The Company utilizes a fair value hierarchy based on three levels of inputs, of which the first two are considered observable
and the last unobservable.
|
•
|
Level
1 Quoted prices in active markets for identical assets or liabilities. These are typically obtained from real-time quotes
for transactions in active exchange markets involving identical assets.
|
|
•
|
Level
2 Quoted prices for similar assets and liabilities in active markets; quoted prices included for identical or similar assets
and liabilities that are not active; and model-derived valuations in which all significant inputs and significant value drivers
are observable in active markets. These are typically obtained from readily-available pricing sources for comparable instruments.
|
|
•
|
Level
3 Unobservable inputs, where there is little or no market activity for the asset or liability. These inputs reflect the reporting
entity’s own beliefs about the assumptions that market participants would use in pricing the asset or liability, based
on the best information available in the circumstances.
|
The following table
presents the Company’s financial instruments that are measured and recorded at fair value on the Company’s balance
sheets on a recurring basis, and their level within the fair value hierarchy as of December 31, 2019:
|
|
Amount
|
|
Level
1
|
|
Level
2
|
|
Level
3
|
Derivative
asset
|
|
$
|
2,266,654
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
2,266,654
|
Investment in equity
security
|
|
|
462,000
|
|
|
|
462,000
|
|
|
|
|
|
|
|
|
Investment debt security
|
|
|
425,700
|
|
|
|
425,700
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
3,154,354
|
|
|
$
|
887,700
|
|
|
$
|
—
|
|
|
$
|
2,266,654
|
Reclassifications
– Certain prior year amounts have been reclassified for consistency with the current year presentation. These reclassifications
had no effect on the reported results of operations or net assets of the Company.
Recently issued
accounting pronouncements
In
June 2018, the FASB issued ASU 2018-07, "Compensation-Stock Compensation (Topic 718): Improvements to Nonemployee Share-Based
Payment Accounting," which modifies the accounting for share-based payment awards issued to nonemployees to largely align
it with the accounting for share-based payment awards issued to employees. ASU 2018-07 is effective for us for annual periods
beginning October 1, 2019.
The new standard did not have a material impact on the Company’s results of operations or cash flows.
In August 2018,
the FASB issued ASU 2018-15, "Intangibles-Goodwill and Other-Internal-Use Software (Subtopic 350-40): Customer’s Accounting
for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract," which allows for the capitalization
of certain implementation costs incurred in a hosting arrangement that is a service contract. ASU 2018-15 allows for either retrospective
adoption or prospective adoption to all implementation costs incurred after the date of adoption. ASU 2018-15 is effective for
fiscal years beginning after December 15, 2019. We are currently evaluating the impact the adoption of this new standard will
have on our financial position and results of operations.
In February 2016,
the FASB issued guidance within ASU 2016-02, Leases. The amendments in ASU 2016-02 to Topic 842, Leases,
require lessees to recognize the lease assets and lease liabilities arising from operating leases in the statement of financial
position. The accounting applied by a lessor is largely unchanged from that applied under previous GAAP. The Company adopted the
amendments to Topic 842 on October 1, 2019 using the modified retrospective approach. The Company elected the transition option
issued under ASU 2018-11, Leases (Topic 842) Targeted Improvements, which allows entities to continue to apply the
legacy guidance in ASC 840, Leases, to prior periods, including disclosure requirements. Accordingly, prior period
financial results and disclosures have not been adjusted. The Company also elected to apply the package of practical expedients permitting
entities to forgo reassessment of: 1) expired or existing contracts that may contain leases;
2) lease classification of expired
or existing leases; and 3) initial direct costs for any existing leases. The Company has also elected to apply the short term
lease measurement and recognition exemption to leases with an initial term of 12 months or less. The most significant impact of
the new standard on the Company’s Consolidated Financial Statements was the recognition of a right of use asset and lease
liability for operating leases for which the Company is the lessee. Upon adoption of this guidance, on October 1, 2019, the Company
recorded a Right of use asset and corresponding lease liability of $85,280 and $85,280, respectively, on the Consolidated Balance
Sheet. No cumulative effect adjustment to retained earnings resulted from adoption of this guidance. The new standard did not
have a material impact on the Company’s results of operations or cash flows.
The Company has
evaluated all other recent accounting pronouncements, and believes that none of them will have a material effect on the Company's
financial position, results of operations or cash flows.
3. INVESTMENT IN
INTERNATIONAL LAND ALLIANCE
International
Land Alliance, Inc.
On November 5,
2019, CleanSpark entered into a binding Memorandum of Understanding (the “MOU”) with International Land Alliance,
Inc., a Wyoming corporation (“ILAL”), in order to lay a foundational framework where the Company will deploy its energy
solutions products and services to ILAL, its energy projects, and its customers.
Pursuant to the
terms of the MOU, the parties will work in good faith and pursue the following priorities over the next twelve (12) months:
|
1)
|
The Company will perform feasibility
studies to outline the details and scope of developing microgrid energy solutions to support ILAL projects.
|
|
2)
|
ILAL will (a) exclusively sell
the Company’s products and services as part of ILAL’s power solution for its offering of off-grid properties,
and (b) include the Company’s mPulse DER Energy Manager within the off-grid energy project bids;
|
|
3)
|
The Company will provide on-site
testing, training, and support services to ILAL’s projects and operations
|
In connection with
the MOU, and in order to support the power and energy needs of ILAL’s development and construction of certain projects,
the Company entered into a Securities Purchase Agreement, dated as of November 6, 2019, with ILAL (the “SPA”).
Pursuant to the
terms of the SPA, ILAL sold, and the Company purchased 1,000 shares of Series B Preferred Stock (the “Preferred Stock”)
of ILAL for an aggregate purchase price of US $500,000 (the “Stock Transaction”), less certain expenses and fees.
The Series B Preferred Stock will accrue cumulative in kind accruals at a rate of 12% per annum and shall increase by 10% per
annum upon the occurrence of any trigger event. ILAL may redeem by paying in cash within 9 months from the issuance date. The
Preferred Stock becomes convertible into common stock after 9 months or when certain triggering events occur. In the event of
a conversion of any shares of the Preferred Stock, the number of conversion shares is equal to the face value of the Preferred
Stock divided by the applicable Conversion Price (defined at 65% of the 5 lowest individual daily volume weighted average prices
of the Common Stock from issuance to conversion less $0.05 per share, but no less than the Floor Price ($0.01). While the Preferred
Stock is outstanding if triggering events occur, the Conversion Pate may be decreased by 10% and the accrual rate increased by
10% for each triggering event.
The Preferred Stock
is recorded as an AFS debt security and is reported at its estimated fair value as of December 31, 2019. As of December 31, 2019,
the Company has identified a derivative instrument in accordance with ASC Topic No. 815 due to the variable conversion feature
upon certain triggering events that occurred during the period. Topic No. 815 requires the Company to account for the conversion
feature on its balance sheet at fair value and account for changes in fair value as a derivative gain or loss.
The Black-Scholes
model utilized the following inputs to value the derivative asset at the date in which the derivative asset was determined through
December 31, 2019.
Fair value assumptions:
|
|
December 31, 2019
|
Risk free interest rate
|
|
|
1.58%
|
Expected term (months)
|
|
|
7
|
Expected volatility
|
|
|
190%
|
Expected dividends
|
|
|
0%
|
In
connection with the Stock Transaction, ILAL was issued 350,000 shares of its common stock to the Company as commitment shares.
The commitment shares are recorded
at fair value as of December 31, 2019.
4. INVENTORY
Inventory consists
of the following as of December 31, 2019 and September 30, 2019:
|
|
December 31, 2019
|
|
September 30, 2019
|
Finished Goods
|
|
$
|
145,932
|
|
|
$
|
—
|
Total
|
|
$
|
145,932
|
|
|
$
|
—
|
5.
CAPITALIZED SOFTWARE
Capitalized software
consists of the following as of December 31, 2019 and September 30, 2019:
|
|
December 31, 2019
|
|
September 30, 2019
|
mVSO software
|
|
$
|
352,211
|
|
|
$
|
352,211
|
mPulse software
|
|
|
741,846
|
|
|
|
741,846
|
Capitalized Software:
|
|
|
1,094,057
|
|
|
|
1,094,057
|
Less: accumulated amortization
|
|
|
(78,146
|
)
|
|
|
(38,860)
|
Capitalized Software, net
|
|
$
|
1,015,911
|
|
|
$
|
1,055,197
|
Capitalized
software amortization recorded as cost of revenues and product development expense for the three months ended December 31, 2019
and 2018 was $39,286 and $348,660, respectively.
6. INTANGIBLE ASSETS
Intangible assets
consist of the following as of December 31, 2019 and September 30, 2019:
|
|
December 31, 2019
|
|
September 30, 2019
|
Patents
|
|
$
|
74,112
|
|
|
$
|
74,112
|
Websites
|
|
|
16,482
|
|
|
|
16,482
|
Customer list and non-compete agreement
|
|
|
5,722,024
|
|
|
|
5,722,024
|
Trademarks
|
|
|
5,928
|
|
|
|
5,928
|
Engineering trade secrets
|
|
|
4,370,269
|
|
|
|
4,370,269
|
Intangible assets:
|
|
|
10,188,815
|
|
|
|
10,188,815
|
Less: accumulated amortization
|
|
|
(3,371,848
|
)
|
|
|
(2,758,733)
|
Intangible assets, net
|
|
$
|
6,816,967
|
|
|
$
|
7,430,082
|
Amortization expense
for the three months ended December 31, 2019 and 2018 was $613,115 and $146,799, respectively.
7. FIXED ASSETS
Fixed assets consist
of the following as of December 31, 2019 and September 30, 2019:
|
|
December 31, 2019
|
|
September 30, 2019
|
Machinery and equipment
|
|
$
|
213,728
|
|
|
$
|
212,082
|
Leasehold improvements
|
|
|
7,801
|
|
|
|
—
|
Furniture and fixtures
|
|
|
75,121
|
|
|
|
75,121
|
Total
|
|
|
296,650
|
|
|
|
287,203
|
Less: accumulated depreciation
|
|
|
(155,795
|
)
|
|
|
(142,133)
|
Fixed assets, net
|
|
$
|
140,855
|
|
|
$
|
145,070
|
Depreciation expense
for the three months ended December 31, 2019 and 2018 was $13,662 and $10,684, respectively.
8. LOANS
Long term
Long-term loans payable consist of the following:
|
|
December 31, 2019
|
|
September 30, 2019
|
|
|
|
|
|
Promissory notes
|
|
$
|
150,000
|
|
|
$
|
150,000
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
150,000
|
|
|
$
|
150,000
|
Current
Current loans payable consist of the following:
|
|
December 31, 2019
|
|
September 30, 2019
|
|
|
|
|
|
Promissory notes
|
|
$
|
—
|
|
|
$
|
50,000
|
Insurance financing loans
|
|
|
—
|
|
|
|
17,467
|
Current loans payable:
|
|
|
—
|
|
|
|
67,467
|
Unamortized debt discount
|
|
|
—
|
|
|
|
—
|
|
|
|
|
|
|
|
|
Total, net of unamortized discount
|
|
$
|
—
|
|
|
$
|
67,467
|
Promissory Notes
On September 5,
2017, the Company executed a 9% secured promissory note with a face value of $150,000 with an investor. Under the terms of the
promissory note, the Company received $150,000 and agreed to make monthly interest payments and repay the note principal 24 months
from the date of issuance. On September 5, 2019, the investor extended the maturity date to September 5, 2021 and the modification
was not deemed substantial. The note is secured by 15,000 shares which are held in escrow and would be issued to the note holder
only in the case of an uncured default. As of December 31, 2019, the Company owed $150,000 in principal and $0 in accrued interest
under the terms of the agreement and recorded interest expense of $3,402 and $3,402 during the three months ended December 31,
2019 and 2018, respectively.
On November 11, 2017, the Company executed
a 10% secured promissory note with a face value of $100,000 with an investor. Under the terms of the promissory note the Company
received $100,000 and agreed to make monthly interest payments and repay the note principal 24 months from the date of issuance.
The note is secured by 10,000 shares which would be issued to the note holder only in the case of an uncured default. The Company
repaid all principal and outstanding interest on August 13, 2019 and the 10,000 shares of common stock held as collateral were
returned to treasury and cancelled on August 26, 2019. The Company recorded interest expense of $0 and $2,520 for the three months
ended December 31, 2019 and 2018, respectively.
On
December 5, 2017, the Company executed a 9% secured promissory note with a face value of $50,000 with an investor. Under the terms
of the promissory note the Company received $50,000 and agreed to make monthly interest payments and repay the note principal 24
months from the date of issuance. The note is secured by 5,000 shares which
would be issued to the note holder only in the case of an uncured default. The Company repaid all principal and outstanding interest
on December 5, 2019 and the 5,000 shares of common stock held as collateral were returned to treasury and cancelled on January
13, 2020. The Company recorded interest expense of $802 and $1,135 for the three months ended December 31, 2019 and 2018, respectively.
Insurance financing
loans
On February
11, 2019, the Company executed an unsecured 5.6% installment loan with a total face value of $78,603 with a financial institutional
to finance its insurance policies. Under the terms of the installment notes the Company received $76,800 and agreed to make equal
payments and repay the note 10 months from the date of issuance. As of September 30, 2019, $17,467 in principal
remained outstanding. The Company repaid all principal and outstanding interest on November 4th, 2019.
9.
CONVERTIBLE NOTES PAYABLE
Short-Term convertible
notes
Securities
Purchase Agreement – December 31, 2018
On December
31, 2018, the Company entered into a Securities Purchase Agreement (the “SPA”) with an otherwise unaffiliated third-party
institutional investor (the “Investor”), pursuant to which the Company issued to the Investor a Senior Secured Redeemable
Convertible Debenture (the “Debenture”) in the aggregate face value of $5,250,000. The note is secured by all assets
of the Company. The Debenture has a maturity date of two years from the issuance
date and the Company has agreed to pay compounded interest on the unpaid principal balance of the Debenture at the rate equal
7.5% per annum. Interest is payable on the date the applicable principal is converted or on maturity. The interest must be paid
in cash and, in certain circumstances, may be paid in shares of common stock.
The transactions
described above closed on December 31, 2018. In connection with the issuance of the Debenture and pursuant to the terms of the
SPA, the Company issued to the Investor 10,000 shares of common stock and a Common Stock Purchase Warrant to acquire up to 308,333
shares of common stock for a term of three years (the “Warrant”) on a cash-only basis at an exercise price of $20.00
per share with respect to 125,000 Warrant Shares, $25.00 with respect to 100,000 Warrant Shares, $50.00 with respect to 50,000
Warrant Shares and $75.00 with respect to 33,333 Warrant Shares. The warrants and shares issued were fair valued and a debt discount
of $4,995,000 was recorded as a result of the issuance of the warrants and shares and the recognition of a beneficial conversion
feature on the Debenture. The Company also paid a $5,000 due diligence fee prior to receiving the funding which was also recorded
as a debt discount.
Pursuant
to the terms of the SPA, the Investor agreed to tender to the Company the sum of $5,000,000, of which the Company received the
full amount as of the closing.
Prior to
the maturity date, provided that no trigger event has occurred, the Company will have the right at any time upon 30 trading days’
prior written notice, in its sole and absolute discretion, to redeem all or any portion of the Debenture then outstanding by paying
to the Investor an amount equal to 140% of the of the portion of the Debenture being redeemed.
The Investor
may convert the Debenture into shares of the Company’s common stock at a conversion price equal to 95% of the mathematical
average of the 5 lowest individual daily volume weighted average prices of the common stock, less $0.50 per share, during the
period beginning on the issuance date and ending on the maturity date subject to certain floor price restrictions. In the event
certain equity conditions exist, the Company may require that the Investor convert the Debenture. In no event shall the Debenture
be allowed to affect a conversion if such conversion, along with all other shares of Company common stock beneficially owned by
the Investor and its affiliates would exceed 4.99% of the outstanding shares of the common stock of the Company.
While the
note is outstanding if Triggering Events occur the conversion rate may be decreased by 10% and the interest rate increased by
10% for each Triggering Event.
On January
7, 2019, the investor converted $2,500,000 in principal and $875,000 in interest as a conversion premium, for 178,473 shares of
the Company common stock at an effective conversion price of $18.90, due to a trigger event for the Company not filing its annual
report on Form 10-K for the fiscal year ended September 30, 2018 on or before December 31, 2018.
On March
6, 2019, the investor converted $1,000,000 in principal and $350,000 in interest as a conversion premium, for 71,389 shares of
the Company common stock at an effective conversion price of $18.90, due to a trigger event for the Company not filing its annual
report on Form 10-K for the fiscal year ended September 30, 2018 on or before December 31, 2018.
On July
9, 2019, in accordance with the terms of the agreement the investor was issued an additional 45,614 shares of common stock due
to the decrease in stock price resulting in an effective conversion price of $15.06.
On July
16, 2019, in accordance with the terms of the agreement the investor was issued an additional 18,246 shares of common stock due
to the decrease in stock price resulting in an effective conversion price of $15.06.
On July
19, 2019, an investor converted $500,000 in principal and $175,000 in interest as a conversion premium, for 45,109 shares of the
Company common stock at an effective conversion price of $15.00.
On August
23, 2019, in accordance with the terms of the agreement the investor was issued an additional 43,721 shares of common stock due
to the decrease in stock price resulting in an effective conversion price of $7.60.
On September
16, 2019, in accordance with the terms of the agreement the investor was issued an additional 61,500 shares of common stock due
to the decrease in stock price resulting in an effective conversion price of $7.30.
On October 17, 2019, in accordance
with the terms of the agreement the investor was issued an additional 90,000 shares of common stock due to the decrease in stock
price resulting in an effective conversion price of $3.74.
On December 5, 2019, in accordance
with the terms of the agreement the investor was issued an additional 97,100 shares of common stock due to the decrease in stock
price resulting in an effective conversion price of $3.15.
The aggregate
debt discount has been accreted and charged to interest expenses as a financing expense in the amount of $157,379 during the three
months ended December 31, 2019.
The Debenture at
December 31, 2019 consists of:
Principal
|
|
$
|
1,250,000
|
Unamortized debt discount
|
|
|
(626,095)
|
Total, net of unamortized discount
|
|
|
623,905
|
Long-Term convertible
notes
Securities
Purchase Agreement – April 17, 2019
On
April 17, 2019, the Company entered into a Securities Purchase Agreement (the “Agreement”) with an otherwise unaffiliated
third-party institutional investor (the “Investor”), pursuant to which the Company agreed to issue to the Investor
a $10,750,000 face value Senior Secured Redeemable Convertible Promissory Note (the “Debenture”) with a 7.5% original
issue discount, 215 shares of our Series B Preferred Stock with a 7.5% original issue discount, a Common Stock Purchase Warrant
(the “Warrant”) on a cash-only basis to acquire up to 230,000 shares (the “Warrant Shares”) of our common
stock and 125,000 shares of our Common Stock. The aggregate purchase price for the Debenture, the Series B Preferred Stock the
Warrant and the Common Stock is $20,000,000. (See Notes 12 and 13 for
additional details.) The Debenture is secured by all assets of the Company.
Pursuant
to the first closing of the agreement, which occurred on April 18, 2019, the Investor agreed to tender to the Company the sum
of $10,000,000, for the Debenture, the Common Stock and the Warrant. No additional closings to sell the preferred stock had occurred
as of September 30, 2019.
The Debenture
has a maturity date of two years from the issuance date and the Company has agreed
to pay compounded interest on the unpaid principal balance of the Debenture at the rate equal 7.5% per annum. Interest is payable
on the date the applicable principal is converted or on maturity. The interest must be paid in cash and, in certain circumstances,
may be paid in shares of common stock.
Prior to
the maturity date, provided that no trigger event has occurred, the Company will have the right at any time upon 30 trading days’
prior written notice, in its sole and absolute discretion, to redeem all or any portion of the Debenture then outstanding by paying
to the Investor an amount equal to 145% of the of the portion of the Debenture being redeemed.
The Investor
may convert the Debenture into shares of the Company’s common stock at a conversion price equal to 90% of the mathematical
average of the 5 lowest individual daily volume weighted average prices of the common stock, less $0.75 per share, during the
period beginning on the issuance date and ending on the maturity date subject to certain floor price restrictions. In the event
certain equity conditions exist, the Company may require that the Investor convert the Debenture. In no event shall the Debenture
be allowed to effect a conversion if such conversion, along with all other shares of Company common stock beneficially owned by
the Investor and its affiliates would exceed 4.99% of the outstanding shares of the common stock of the Company.
While the
note is outstanding if Triggering Events occur the conversion rate may be decreased by 10% and the interest rate increased by
10% for each Triggering Event.
The Debenture
at December 31, 2019 consists of:
Principal
|
|
$
|
10,750,000
|
Unamortized debt discount
|
|
|
(6,965,410)
|
Total, net of unamortized discount
|
|
$
|
3,784,590
|
The aggregate
debt discount has been accreted and charged to interest expenses as a financing expense in the amount of $1,354,795 during the
three months ended December 31, 2019.
10. LEASES
On October
1, 2019, the Company adopted the amendments to ASC 842, Leases, which requires lessees to recognize lease assets and
liabilities arising from operating leases on the balance sheet. The Company adopted the new lease guidance using the modified
retrospective approach and elected the transition option issued under ASU 2018-11, Leases (Topic 842) Targeted Improvements,
allowing entities to continue to apply the legacy guidance in ASC 840, Leases, to prior periods, including disclosure
requirements. Accordingly, prior period financial results and disclosures have not been adjusted.
The
Company has operating leases under which it leases its branch offices and corporate headquarters, one of which is with a related
party. Upon adoption of the new lease guidance, on October 1, 2019, the Company recorded a right of use asset and corresponding
lease liability of $85,280 and $85,280, respectively, on the consolidated balance sheet. As of December 31, 2019, the Company's
operating lease right of use asset and operating lease liability totaled $74,549 and $74,789, respectively. A weighted
average discount rate of 10% was used in the measurement of the right of use asset and lease liability as of October
1, 2019 .
As the rate implicit in the lease is not readily determinable, the Company's incremental collateralized borrowing rate is used
to determine the present value of lease payments. This rate gives consideration to the applicable Company collateralized borrowing
rates and is based on the information available at the commencement date. The Company has elected to apply the short-term lease
measurement and recognition exemption to leases with an initial term of 12 months or less; therefore, these leases are not recorded
on the Company’s Consolidated Balance Sheet, but rather, lease expense is recognized over the lease term on a straight-line
basis.
The
Company's leases has remaining lease terms between one to two years, with a weighted average lease term of 1.2 years
at December 31, 2019. Some leases include multiple year renewal options.
The Company’s decision to
exercise these renewal options is based on an assessment of its current business needs and market factors at the time of the renewal.
Currently, the Company has no leases for which the option to renew is reasonably certain and therefore, options to renew were
not factored into the calculation of its right of use asset and lease liability as of October 1, 2019.
The following
is a schedule of the Company's operating lease liabilities by contractual maturity as of September 30, 2019:
Fiscal year ending September 30, 2020
|
|
$
|
37,984
|
Fiscal year ending September 30, 2021
|
|
|
43,170
|
Total Lease Payments
|
|
|
81,154
|
Less: imputed interest
|
|
|
(6,365)
|
Total present value of lease liabilities
|
|
$
|
74,789
|
Total operating
lease costs of $21,318 and $19,404 the three months ended December 31, 2019 and 2018, respectively, were included
as part of administrative expense.
11. RELATED PARTY TRANSACTIONS
Zachary
Bradford – Chief Executive Officer, Director and Former Chief Financial Officer
During the quarter ended December 31,
2018, The Company had a consulting agreement with ZRB Holdings, Inc, an entity wholly owned by Zachary Bradford, our Chief Executive
Officer and director, for management services. In accordance with this agreement, as amended, Mr. Bradford $48,000, during the
three months ended December 31, 2018. The agreement was terminated in October 2019 when Mr. Bradford stepped down as the CFO and
took the position of CEO and accepted the associated employment agreement.
Bryan
Huber – Chief Innovation Officer and Former Chief Operations Officer and Director
On August
28, 2018, the Company executed an agreement with Zero Positive, LLC an entity controlled by Mr. Huber. In accordance with the
agreement with Zero Positive, LLC, Mr. Huber earned $46,538 and $41,500, during the three months ended September 30, 2019 and
2018.
Under the
agreement Mr. Huber was also granted a one-time bonus of $50,000 on August 28, 2018, payment of which will be deferred until certain
conditions are met. As of December 31, 2019, the bonus had not been paid. The term of the agreement is one year and automatically
renews until cancelled by either party.
On September
28, 2018, in connection with the consulting agreement executed with Zero Positive, LLC Company issued warrants to purchase 90,000
shares of common stock at an exercise price of $8.00 per share to Zero Positive. The warrants were valued at $2,607,096 using
the Black Scholes option pricing model based upon the following assumptions: term of 10 years, risk free interest rate of 3.05%,
a dividend yield of 0% and volatility rate of 191%. The warrants vest as follows: 30,000 vested immediately, the balance vest
evenly on the last day of each month over forty-two months beginning August 31, 2018. As of December 31, 2019, 54,286 warrants
had vested, and the Company recorded an expense of $124,147 and 124,147 during the three months ended December 31, 2019 and 2018.
Matthew
Schultz- Former Chief Executive Officer and Director
The Company
has a consulting agreement with Matthew Schultz, our former Chief Executive Officer, for management services. In accordance with
this agreement, as amended, Mr. Schultz earned $0 and $48,000, respectively during the three months ended December 31, 2019 and
2018. The agreement was terminated on October 7, 2019 when Mr. Schultz stepped down as the CEO and took the position of Chairman
of the Board.
Larry McNeill
–Director
Effective January
1, 2019, the Company agreed to pay non-executive board members $2,500 per month. Mr. McNeil earned $7,500 and $0 in Board compensation
during the three months ended December 31, 2019 and 2018.
12. STOCKHOLDERS
EQUITY
Overview
The Company’s
authorized capital stock consists of 20,000,000 shares of common stock and 10,000,000 shares of preferred stock, par value $0.001
per share. As of December 31, 2019, there were 4,868,911 shares of common stock issued and outstanding and 1,750,000 shares of
preferred stock issued and outstanding.
On December
10, 2019, the Financial Industry Regulatory Authority (“FINRA”) approved the Company’s 1:10 reverse stock split
of the Company’s common stock. The reverse stock split took effect on December 11, 2019. Unless otherwise noted, impacted
amounts and share information in the consolidated financial statements and notes thereto as of and for the periods ended December
31, 2019 and September 30, 2019, have been adjusted for the stock split as if such stock split occurred on the first day of the
first period presented.
Amendment
to Articles of Incorporation
On August
9, 2019, the Company filed a Certificate of Amendment to its Articles of Incorporation to increase its authorized shares of common
stock from 100,000,000 to 200,000,000. The amendment was previously approved by written consent of the Company’s Board and
more than a majority of the voting power of its stockholders and delivered to stockholders of record as of the close of business
July 2, 2019 pursuant to a Definitive Information Statement on Schedule 14C. As a result, of the reverse split mentioned above,
the effect of the filed amendment reduced the authorized shares to 20,000,000.
On October 4, 2019,
pursuant to Article IV of our Articles of Incorporation, our Board of Directors voted to increase the number of shares of preferred
stock designated as Series A Preferred Stock from one million (1,000,000) shares to two million (2,000,000) shares, par value
$0.001.
Under
the Certificate of Designation, holders of Series A Preferred Stock will be entitled to quarterly dividends on 2% of our earnings
before interest, taxes and amortization. The dividends are payable in cash or common stock. The holders
will also have a liquidation preference on the state value of $0.02 per share plus any accumulated but unpaid dividends. The holders
are further entitled to have us redeem their Series A Preferred Stock for three shares of common stock in the event of a change
of control and they are entitled to vote together with the holders of our common stock on all matters submitted to shareholders
at a rate of forty-five (45) votes for each share held.
The rights of the
holders of Series A Preferred Stock are defined in the relevant Amendment to the Certificate of Designation filed with the Nevada
Secretary of State on October 9, 2019, attached hereto as Exhibit 3.11, and is incorporated by reference herein.
Certificate
of Preferred Stock Designation
On April
16, 2019, pursuant to Article IV of our Articles of Incorporation, the Company’s Board of Directors voted to designate a
class of preferred stock entitled Series B Preferred Stock, consisting of up to one hundred thousand (100,000) shares, par value
$0.001. Under the Certificate of Designation, the holders of Series B Preferred Stock are entitled to the following powers, designations,
preferences and relative participating, optional and other special rights, and the following qualifications, limitations and restrictions,
among others as set forth in the Certificate of Designation:
|
§
|
The holders of shares of Series
B Preferred Stock will have no right to vote on any matters, questions or proceedings of the Company including, without limitation,
the election of directors;
|
|
|
|
|
§
|
Commencing on the date of issuance,
the Series B Preferred Stock will accrue cumulative in kind accruals (“the Accruals”) at the rate of 7.5% per
annum;
|
|
|
|
|
§
|
Upon any liquidation, dissolution
or winding up of the Company, the holders of the Series B Preferred Stock will be entitled to be paid out of the assets of
the Company available for distribution to its stockholders an amount with respect to each share of Series B Preferred Stock
equal to $5,000.00 (the “Face Value”), plus an amount equal to any accrued but unpaid Accruals thereon (the “Liquidation
Value”);
|
|
|
|
|
§
|
On maturity, the Company may redeem
the Series B Preferred Stock by paying the holder the Liquidation Value;
|
|
|
|
|
§
|
Before maturity, the Company may
redeem the Series B Preferred stock on 30 days’ notice by paying 145% of the outstanding Face Value per share;
|
|
|
|
|
§
|
If the Company determines to liquidate,
dissolve or wind-up its business and affairs, the Company will, within three trading days of such determination and prior
to effectuating any such action, redeem all outstanding shares of Series B Preferred Stock;
|
|
|
|
|
§
|
In the event of a conversion of
any shares of Series B Preferred Stock, the Company will (a) satisfy the payment of the Conversion Premium, which is defined
as the Face Value of the shares converted multiplied by the product of 7.5% and the number of whole years between issuance
and maturity, and (b) issue to the holder of the shares of Series B Preferred Stock a number of conversion shares equal to
the Face Value divided by the applicable Conversion Price (defined as 90% of the of the 5 lowest individual daily volume weighted
average prices of the Common Stock from issuance to conversion less $0.75 per share, but no less than the Floor Price ($3.50)
with respect to the number of shares converted; While the note is outstanding if Triggering Events occur the conversion rate
may be decreased by 10% and the interest rate increased by 10% for each Triggering Event. In the event of certain defaults,
conversion price may not be subject to a floor.
|
|
§
|
if at any time the Company grants,
issues or sells any options, convertible securities or rights to purchase stock, warrants, securities or other property pro
rata to the record holders of any class of shares of Common Stock (the “Purchase Rights”), then holder will be
entitled to acquire, upon the terms applicable to such Purchase Rights, the aggregate Purchase Rights which holder could have
acquired if holder had held the number of shares of Common Stock acquirable upon conversion of Series B Preferred Stock;
|
|
|
|
|
§
|
At maturity (2 years from issuance),
all outstanding shares of Series B Preferred Stock shall automatically convert into common stock at the Conversion Price;
and
|
|
|
|
|
§
|
At no time may the holders of
Series B Preferred Stock own more than 4.99% of the outstanding common stock in the Company.
|
Common Stock
issuances during the three months ended December 31, 2019
The Company
issued 187,100 shares in accordance with the terms of the convertible debt agreement due to the decrease in stock price. (See
Note 9 for additional details.)
The Company
issued 2,000 shares for services rendered to an independent consultant.
The Company
issued 793 shares for stock split true up.
Series
A Preferred Stock issuances during the three months ended December 31, 2019
On
October 4, 2019, the Company authorized the issuance of a total of seven hundred and fifty thousand (750,000) shares of its designated
Series A Preferred Stock to members of its board of directors for services rendered.
A fair value of $0.02 per share was determined
by the Company. Director fees of $15,000 was recorded as a result of the stock issued.
Common Stock
issuances during the three months ended December 31, 2018
During
the period commencing October 1, 2018 through December 31, 2018, the Company received $361,800 from 14 investors pursuant to private
placement agreements with the investors to purchase 45,225 shares of the Company’s $0.001 par value common stock at a purchase
price equal to $8.00 for each share of common stock.
On September
11, 2018, the Company entered into an agreement with Regal Consulting, LLC for investor relations services. Under this agreement
the Company agreed to issue 3,000 shares of the Company’s common stock per month as compensation for services plus additional
cash compensation. During the year ended September 30, 2019, the Company issued a total of 36,000 shares of its common stock in
accordance with the agreement. Stock compensation of $897,870 was recorded as a result of the stock issued under the agreement.
On October
15, 2018, the Company entered into an agreement with a consultant for services. Under this agreement the Company agreed to issue
3,000 shares of the Company’s common stock which vest evenly over a six-month period from the agreement date. During the
year ended September 30, 2019, the Company recorded stock compensation of $68,818 was recorded as a result of the stock issued
under the agreement.
On October
2, 2018, an investor exercised warrants to purchase 300 shares of the Company’s $0.001 par value common stock at a purchase
price equal to $3.63 for each share of Common stock. The Company receive $1,088 as a result of this exercise.
The Company
issued 10,000 shares in relation to a Securities purchase agreement executed on December 31, 2018. (See Note 8 for additional
details.)
On
December 31, 2018, the Company settled $25,000 of a promissory note through
the issuance of 2,500 shares of the Company’s common stock. The shares were valued at $51,225 and a $26,225 loss on settlement
of debt was recorded as a result of the issuance.
Common stock
returned during the three months ended December 31, 2018
As a result
of a conversion of a note on September 21, 2018, 13,750 returnable shares were returned to treasury and cancelled on December
21, 2018.
13. STOCK WARRANTS
The following is
a summary of stock warrant activity during the three months ended December 31, 2019.
|
|
Number of Warrant Shares
|
|
Weighted Average Exercise Price
|
Balance, September 30, 2019
|
|
|
1,314,063
|
|
|
$
|
21.62
|
Warrants granted
|
|
|
—
|
|
|
$
|
—
|
Warrants expired
|
|
|
—
|
|
|
|
—
|
Warrants canceled
|
|
|
—
|
|
|
|
—
|
Warrants exercised
|
|
|
—
|
|
|
|
—
|
Balance, December 31, 2019
|
|
|
1,314,063
|
|
|
$
|
21.62
|
As of December
31, 2019, the outstanding warrants have a weighted average remaining term of was 2.63 years and an intrinsic value of $467,824.
As of
December 31, 2019, there are warrants exercisable to purchase 1,278,351 shares of common stock
in the Company and 35,714 unvested
warrants outstanding that cannot be exercised until vesting conditions are met. 996,198 of
the warrants require a cash investment to exercise as follows, 5,000 required a cash investment of $8.00 per share, 449,865 require
a cash investment of $15.00 per share, 125,000 require a cash investment of $20.00 per share, 103,000 require a cash investment
of $25.00 per share, 200,000 require an investment of $35.00 per share, 10,000 require an investment of $40.00 per share, 60,000
require an investment of $50.00 per share, 38,333 require a cash investment of $75.00 per share and 5,000 require a cash investment
of $100.00 per share. 317,865 of the outstanding warrants contain provisions allowing a cashless exercise at their respective exercise
prices.
Warrant activity
for the three months ended December 31, 2018
On October 15,
2018, the Company entered into an agreement with a consultant for services. Under this agreement the Company agreed to issue 3,000
warrants to purchase shares of the Company’s common stock at an exercise price of $25.00 for a period of five years which
vest evenly over a six-month period from the agreement date. During the three months ended December 31, 2019 and 2018, the Company
recorded stock compensation of $0 and $31,650 as a result of the stock issued under the agreement. The warrants were valued using
the black-Scholes valuation model.
On December 31,
2018, in connection with a Securities purchase agreement (see Note 9 for additional details) the Company issued Common Stock Purchase
Warrants to acquire up to 308,333 shares of common stock for a term of three years on a cash-only basis at an exercise price of
$20.00 per share with respect to 125,000 Warrant Shares, $25.00 with respect to 100,000 Warrant Shares, $50.00 with respect to
50,000 Warrant Shares and $75.00 with respect to 33,333 Warrant Shares.
On August 28, 2018,
in connection with the Consulting agreement executed with Zero Positive, LLC the Company issued warrants to purchase 90,000 shares
of common stock at an exercise price of $8.00 per share to Zero Positive. The warrants were valued at $2,607,096 using the Black
Scholes option pricing model. The warrants vest as follows: 30,000 warrants vested immediately, the balance vest evenly on the
last day of each month over the forty-two months beginning August 31, 2018. As of December 31, 2019, 54,286 warrants had vested,
and the Company recorded an expense of $124,147 and 124,147 during the three months ended December 31, 2019 and 2018. (See Note
9 for additional details.)
As of December
31, 2019, the Company expects to recognize $1,034,562 of stock-based compensation for the non-vested outstanding warrants over
a weighted-average period of 2 years.
14. STOCK OPTIONS
The Company sponsors
a stock-based incentive compensation plan known as the 2017 Incentive Plan (the “Plan”), which was established by
the Board of Directors of the Company on June 19, 2017. A total of 300,000 shares were initially reserved for issuance under the
Plan. As of December 31, 2019, there were 82,049 shares available for issuance under the plan.
The Plan allows
the Company to grant incentive stock options, non-qualified stock options, stock appreciation right, or restricted stock. The
incentive stock options are exercisable for up to ten years, at an option price per share not less than the fair market value
on the date the option is granted. The incentive stock options are limited to persons who
are regular full-time employees of the Company at the date of the grant of the option. Non-qualified options may be granted
to any person, including, but not limited to, employees, independent agents, consultants and attorneys, who
the Company’s Board believes have contributed, or will contribute, to the success of the Company. Non-qualified options
may be issued at option prices of less than fair market value on the date of grant and may be exercisable for up to ten years
from date of grant. The option vesting schedule for options granted is determined by the Board of Directors at the time of the
grant. The Plan provides for accelerated vesting of unvested options if there is a change in control, as defined in the Plan.
The following is
a summary of stock option activity during the three months ended December 31, 2019.
|
|
Number of Option Shares
|
|
Weighted Average Exercise Price
|
Balance, September 30, 2019
|
|
|
81,254
|
|
|
$
|
11.82
|
Options granted
|
|
|
136,697
|
|
|
$
|
5.62
|
Options expired
|
|
|
—
|
|
|
|
—
|
Options canceled
|
|
|
—
|
|
|
|
—
|
Options exercised
|
|
|
—
|
|
|
|
—
|
Balance, December 31, 2019
|
|
|
217,951
|
|
|
$
|
7.93
|
As of December 31, 2019, there are options
exercisable to purchase 193,265 shares of common stock in the Company. As of December 31, 2019, the outstanding options have a
weighted average remaining term of was 2.60 years and an intrinsic value of $26,382.
Option activity
for the three months ended December 31, 2019
During the three
months ended December 31, 2019, the Company issued 136,697 options to purchase shares of common stock to employees, the shares
were granted at quoted market prices ranging from $4.50 to $8.50. The options were valued at issuance using the Black Scholes
model and stock compensation expense of $478,022 was recorded as a result of the issuances.
The Black-Scholes
model utilized the following inputs to value the options granted during the three months ended December 31, 2019:
Fair value assumptions – Options:
|
|
December 31, 2019
|
Risk free interest rate
|
|
|
1.52-1.73%
|
Expected term (years)
|
|
|
3-5
|
Expected volatility
|
|
|
124%-144%
|
Expected dividends
|
|
|
0%
|
As of December
31, 2019, the Company expects to recognize $271,478 of stock-based compensation for the non-vested outstanding options over a
weighted-average period of 2.62 years.
Option activity
for the three months ended December 31, 2018
During the three
months ended December 31, 2018, the Company issued 5,779 options to purchase shares of common stock to employees, the shares were
granted at quoted market prices ranging from $15.10 to $59.00. The options were valued at issuance using the Black Scholes model
and stock compensation expense of $95,000 was recorded as a result of the issuances.
On March 10, 2018
the Company issued a total of 25,000 options to four consultants for advisory services. The options vest evenly 12 months from
issuance. The options expire 24 months after issuance and require a cash investment to exercise. The options were valued at issuance
using the Black Scholes model at $342,500 and amortized of the term of the agreement. During the three months ended December 31,
2018, $126,678 was expensed as stock-based compensation.
The Black-Scholes
model utilized the following inputs to value the options granted during the three months ended December 31, 2018:
Fair value assumptions – Options:
|
|
December 31, 2018
|
Risk free interest rate
|
|
|
2.84-2.90%
|
Expected term (years)
|
|
|
3
|
Expected volatility
|
|
|
266%-271%
|
Expected dividends
|
|
|
0%
|
15. COMMITMENTS AND CONTINGENCIES
Office leases
The Company’s corporate offices are located at 70
North Main Street, Suite 105, Bountiful, Utah 84010. The Company occupies the leased space on a month to month basis at a rate
of $850 per month. Future minimum lease payments under the operating leases for the
facilities as of September 30, 2019, are $0. On November 22, 2019, the company entered into a lease to relocate the corporate office
to 1185 South 1800 West, Woods Cross UT 84047. The lease term is on an annual basis beginning on March 1, 2020.
On May 15, 2018, the Company executed
a 37-month lease agreement, which commenced on July 1, 2018 at 4360 Viewridge Avenue, Suite C, San Diego, California. The agreement
calls for the Company to make payments of $4,057 in base rent per month through July 31, 2021 subject to an annual 3% rent escalation.
Future minimum lease payments under the operating leases for the facilities as of
December 31, 2019, are as follows:
Fiscal
year ending September 30, 2020
|
$37,984
|
Fiscal
year ending September 30, 2021
|
$43,170
|
Legal
contingencies
From time
to time we may be subject to litigation. Risks associated with legal liability are difficult to assess and quantify, and their
existence and magnitude can remain unknown for significant periods of time. We have acquired liability insurance to reduce such
risk exposure to the Company. Despite the measures taken, such policies may not cover future litigation, or the damages claimed
may exceed our coverage which could result in continent liabilities.
16. MAJOR CUSTOMERS AND VENDORS
For the three months
ended December 31, 2019 and 2018, the Company had the following customers that represented more than 10% of sales.
|
|
December 31, 2019
|
|
December 31, 2018
|
Customer A
|
|
|
91.2
|
%
|
|
|
—
|
Customer B
|
|
|
—
|
|
|
|
51.4%
|
Customer C
|
|
|
—
|
|
|
|
45.9%
|
|
|
|
|
|
|
|
|
For the three months
ended December 31, 2019 and 2018, the Company had the following suppliers that represented more than 10% of direct material costs.
|
|
December 31, 2019
|
|
December 31, 2018
|
Vendor A
|
|
|
—
|
|
|
|
22.9%
|
Vendor B
|
|
|
—
|
|
|
|
19.0%
|
Vendor C
|
|
|
—
|
|
|
|
37.4%
|
Vendor D
|
|
|
—
|
|
|
|
17.1%
|
Vendor E
|
|
|
93.0
|
%
|
|
|
—
|
17. SUBSEQUENT EVENTS
Acquisition of p2k Labs Inc.
On January 31, 2020, the Company entered into
a Stock Purchase Agreement (the “Agreement”) with p2klabs, Inc. (“p2k”), a Nevada corporation, and its
sole stockholder, Amer Tadayon (“Seller”), whereby the Company purchased all of the issued and outstanding shares of
p2k from the Seller (the “Transaction”) in exchange for an aggregate purchase price of cash and stock of $1,600,000
(the “Purchase Price”). The Transaction closed simultaneously with execution on January 31, 2020. As a result of the
Transaction, p2k, a design and innovation consulting firm that specializes in applying design, technology, and business process
methodologies to create intuitive digital experiences and journeys that help transform and grow businesses, is now a wholly-owned
subsidiary of the Company. Pursuant to the terms of the Agreement, the Purchase Price was as follows:
|
a)
|
$1,039,500 in cash was paid to the Seller;
|
|
b)
|
31,183 restricted shares of the Company’s common stock, valued at $145,000,
were issued to the Seller (the “Shares”). The Shares are subject to certain lock-up and leak-out provisions
whereby the Seller may sell an amount of Shares equal to ten percent (10%) of the daily dollar trading volume of the
Company’s common stock on its principal market for the prior 30 days (the “Leak-Out Terms”);
|
|
c)
|
$115,500 in cash was paid to an independent third-party escrow where such cash is subject to offset for adjustments to the Purchase
Price and indemnification purposes; and
|
|
d)
|
64,516
restricted shares of the Company’s common stock, valued at $300,000, were issued to an independent third-party
escrow (the “Holdback Shares”). The Holdback Shares will be released to Seller once p2k achieves certain revenue
milestones for the future performance of p2k. The Holdback Shares will also be subject to the Leak-Out Terms once they are
released from escrow 12 months from closing. The Shares and Holdback Shares were issued at a fair market value of $4.65 which
was the closing price on January 31, 2020.
|
Sub-lease agreement
On January 2, 2020, the Company entered into
a sub-lease agreement for office space with an entity 50% owned by the Company’s CEO for $1,525 per month. The term of the
lease is one year with a month to month option thereafter.