NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
FOR
THE YEARS ENDED DECEMBER 31, 2019 AND 2018
NOTE
1 – BASIS OF PRESENTATION
History
and Organization
Generation
Alpha, Inc. (the “Company”) was originally incorporated under the laws of the State of Nevada on March 2, 2007 as
Cinjet, Inc. (“Cinjet”). Effective September 1, 2015, Cinjet changed its corporate name to Solis Tek Inc. (“Solis
Tek”). Effective September 25, 2018, Solis Tek changed its corporate name to Generation Alpha, Inc. Effective September
25, 2018, Generation Alpha, Inc. (f/k/a Solis Tek Inc.) (the “Company”) entered into an agreement and plan of merger
(the “Merger Agreement”), whereby a wholly-owned subsidiary of the Company (the “Merger Sub”) was merged
into the Company (the “Merger”). Upon consummation of the Merger, the separate existence of Merger Sub ceased. On
June 23, 2015, the Company entered into an Agreement of Merger and Plan of Reorganization (the “Agreement”) with Solis
Tek Inc., a California corporation (“STI”), and CJA Acquisition Corp., a California corporation and a wholly owned
subsidiary of the Company (“Merger Sub”), providing for the merger of Merger Sub with and into STI (the “Merger”),
with STI surviving the Merger as a wholly-owned subsidiary of the Company. The Merger was accounted for as a recapitalization
of the Company with STI being deemed the accounting acquirer.
Overview
of Business
The
Company is a vertically integrated technology innovator, developer, manufacturer and distributor focused on bringing products
and solutions to commercial and retail cannabis growers in both the medical and adult use recreational space in legal markets
across the U.S. The Company’s lighting and nutrient customers include retail stores, distributors and commercial growers
in the United States and abroad.
Going
Concern
The
accompanying consolidated financial statements have been prepared on a going concern basis, which contemplates the realization
of assets and the settlement of liabilities and commitments in the normal course of business. As reflected in the accompanying
consolidated financial statements, during the year ended December 31, 2019, the Company incurred a net loss of $7,893,656 and
used cash in operations of $1,009,931 and had a shareholders’ deficit of $8,624,232 as of December 31, 2019. In addition,
$790,000 of notes payable to related parties, $351,439 of accrued interest to related parties, and $798,589 of contract obligations
are past due. These factors raise substantial doubt about the Company’s ability to continue as a going concern within one
year after the date of the financial statements being issued. The ability of the Company to continue as a going concern is dependent
upon the Company’s ability to raise additional funds and implement its business plan. The financial statements do not include
any adjustments that might be necessary if the Company is unable to continue as a going concern.
At
December 31, 2019, the Company had cash on hand in the amount of $103,637. On February 21, 2020, the Company received proceeds
of $150,000 on the issuance of a secured convertible note payable (see Note 15). Management estimates that the current funds on
hand will be sufficient to continue operations through June 30, 2020. The continuation of the Company as a going concern is dependent
upon its ability to obtain necessary debt or equity financing to continue operations until it begins generating positive cash
flow. No assurance can be given that any future financing will be available or, if available, that it will be on terms that are
satisfactory to the Company. Even if the Company is able to obtain additional financing, it may contain undue restrictions on
our operations, in the case of debt financing or cause substantial dilution for our stockholders, in case or equity financing.
NOTE
2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis
of Consolidation
The
consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries: STI; Solis Tek East,
Corporation (“STE”), an entity incorporated under the laws of the State of New Jersey, Zelda Horticulture, Inc. (“Zelda”),
an entity incorporated under the laws of the State of California, and YLK Partners NV, LLC (“YLK”), Generation Alpha
Brands, Inc., Trilogy Dispensaries, Inc., Extracting Point, LLC (“Extracting Point”), and GrowPro Solutions, Inc.,
all entities formed under the laws of Nevada. Intercompany transactions and balances have been eliminated in consolidation.
Leases
Prior
to January 1, 2019, the Company accounted for leases under ASC 840, Accounting for Leases. Effective January 1, 2019, the
Company adopted the guidance of ASC 842, Leases (“ASC 842”), which requires an entity to recognize a ROU asset
and a lease liability for virtually all leases. The Company adopted ASC 842 using a modified retrospective approach. As a
result, the comparative financial information has not been updated and the required disclosures prior to the date of adoption
have not been updated and continue to be reported under the accounting standards in effect for those periods. The adoption of
ASC 842 on January 1, 2019 resulted in the recognition of operating lease ROU assets and lease liabilities for operating
leases of $645,025. There was no cumulative-effect adjustment to accumulated deficit.
Loss
per Share Calculations
Basic
earnings per share are computed by dividing net income (loss) available to common shareholders by the weighted-average number
of common shares available. Diluted earnings per share is computed by dividing the net income applicable to common shareholders
by the weighted average number of common shares outstanding plus the number of additional common shares that would have been outstanding
if all dilutive potential common shares had been issued using the treasury stock method. Potential common shares are excluded
from the computation when their effect is antidilutive. The dilutive effect of potentially dilutive securities is reflected in
diluted net income per share if the exercise prices were lower than the average fair market value of common shares during the
reporting period.
Options
to acquire 1,948,300 shares of common stock, warrants to acquire 18,283,140 shares of common stock, and 37,994,931 shares
of common stock issuable under convertible note agreements, have been excluded from the calculation of weighted average common
shares outstanding at December 31, 2019, as their effect would have been anti-dilutive. Options to acquire 8,394,391 shares of
common stock and warrants to acquire 12,783,140 shares of common stock have been excluded from the calculation of weighted average
common shares outstanding at December 31, 2018, as their effect would have been anti-dilutive.
Use
of Estimates
The
preparation of the consolidated financial statements in conformity with accounting principles generally accepted in the U.S requires
management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent
assets and liabilities at the financial statement date, and reported amounts of revenue and expenses during the reporting period.
Significant estimates are used in valuing our allowances for doubtful accounts, reserves for inventory obsolescence, valuing derivative
liabilities, valuing equity instruments issued for services, and valuation allowance for deferred tax assets, among others. Actual
results could differ from these estimates.
Segment
Reporting
The
Company operates in one segment for the manufacture and distribution of our products. In accordance with the “Segment Reporting”
Topic of the ASC, the Company’s chief operating decision maker has been identified as the Chief Executive Officer and President,
who reviews operating results to make decisions about allocating resources and assessing performance for the entire Company. Existing
guidance, which is based on a management approach to segment reporting, establishes requirements to report selected segment information
quarterly and to report annually entity-wide disclosures about products and services, major customers, and the countries in which
the entity holds material assets and reports revenue. All material operating units qualify for aggregation under “Segment
Reporting” due to their similar customer base and similarities in: economic characteristics; nature of products and services;
and procurement, manufacturing and distribution processes. Since the Company operates in one segment, all financial information
required by “Segment Reporting” can be found in the accompanying consolidated financial statements.
Revenue
Recognition
The
Company recognizes revenue in accordance with Accounting Standard Update (“ASU”) No. 2014-09. This standard provides
authoritative guidance clarifying the principles for recognizing revenue and developing a common revenue standard for U.S. generally
accepted accounting principles. The core principle of the guidance is that an entity should recognize revenue to depict the transfer
of promised goods and services to customers in an amount that reflects the consideration to which the entity expects to be entitled
in the exchange for those goods or services.
Under
this guidance, revenue is recognized when control of promised goods or services is transferred to the Company’s customers,
in an amount that reflects the consideration the Company expects to be entitled to in exchange for those goods or services. The
Company reviews its sales transactions to identify contractual rights, performance obligations, and transaction prices, including
the allocation of prices to separate performance obligations, if applicable. Revenue and costs of sales are recognized once products
are delivered to the customer’s control and performance obligations are satisfied.
In the following table, revenue is disaggregated
by major product line for the year ended 2019:
Sales Channels
|
|
Lighting
|
|
|
Plant
Nutrients and Fertilizers
|
|
|
Total
|
|
|
|
|
|
|
|
|
|
|
|
Hydroponic resellers/retail
|
|
$
|
1,411,086
|
|
|
$
|
495,772
|
|
|
$
|
1,906,858
|
|
Direct to consumer/online
|
|
|
58,305
|
|
|
|
-
|
|
|
|
58,305
|
|
Total
|
|
$
|
1,469,391
|
|
|
$
|
495,772
|
|
|
$
|
1,965,163
|
|
In the following table, revenue is disaggregated
by major product line for the year ended 2018:
Sales Channels
|
|
Lighting
|
|
|
Plant
Nutrients and Fertilizers
|
|
|
Total
|
|
|
|
|
|
|
|
|
|
|
|
Hydroponic resellers/retail
|
|
$
|
2,654,520
|
|
|
$
|
654,067
|
|
|
$
|
3,308,587
|
|
Direct to consumer/online
|
|
|
39,701
|
|
|
|
-
|
|
|
|
39,701
|
|
Total
|
|
$
|
2,694,221
|
|
|
$
|
654,067
|
|
|
$
|
3,348,288
|
|
All
products sold by the Company are distinct individual products and consist of advanced energy efficient indoor horticulture
lighting, plant nutrient products, and ancillary equipment. The products are offered for sale as finished goods only, and
there are no performance obligations required post-shipment for customers to derive the expected value from them. Contracts
with customers contain no incentives or discounts that could cause revenue to be allocated or adjusted over time.
The
Company does not offer a general right of return on any of its sales and considers all sales as final. The Company generally provides
a three-year warranty on its ballasts. However, the Company does not maintain a warranty reserve as the Company is able to chargeback
its vendors for all warranty claims. As of December 31, 2019, and 2018, the Company recorded reserves for returned product in
the amounts of $59,804 and $143,947, respectively, which reduced the accounts receivable balances as of those periods .
Accounts
Receivable
The
Company evaluates the collectability of its trade accounts receivable based on a number of factors. In circumstances where the
Company becomes aware of a specific customer’s inability to meet its financial obligations to the Company, a specific reserve
for bad debts is estimated and recorded, which reduces the recognized receivable to the estimated amount the Company believes
will ultimately be collected. In addition to specific customer identification of potential bad debts, bad debt charges are recorded
based on the Company’s historical losses and an overall assessment of past due trade accounts receivable outstanding.
The
allowance for doubtful accounts and returns is established through a provision reducing the carrying value of receivables. At
December 31, 2019, and December 31, 2018, the allowance for doubtful accounts was $52,115 and $720, respectively.
Inventories
Inventories
are stated at the lower of cost or net realizable value. Cost is computed on a first-in, first-out basis. The Company’s
inventories consist almost entirely of finished goods as of December 31, 2019 and 2018.
The
Company provides inventory reserves based on excess and obsolete inventories determined primarily by future demand forecasts.
The write down amount is measured as the difference between the cost of the inventory and market based upon assumptions about
future demand and charged to the provision for inventory, which is a component of cost of sales. At the point of the loss recognition,
a new, lower cost basis for that inventory is established, and subsequent changes in facts and circumstances do not result in
the restoration or increase in that newly established cost basis. At December 31, 2019 and December 31, 2018, the reserve for
excess and obsolete inventory was $125,262 and $910,778, respectively. During the year ended December 31, 2019, the Company disposed
of approximately $827,000 of inventory that was previously reserved in prior years.
Property
and Equipment
Property
and equipment are carried at cost less accumulated depreciation and amortization. Depreciation is calculated using the straight-line
method over the estimated useful lives of the assets. The Company has determined the estimated useful lives of its property and
equipment, as follows:
Leasehold
improvements
|
5
years
|
|
Machinery
and equipment
|
5
years
|
|
Computer
equipment
|
3
years
|
|
Furniture
and fixtures
|
7
years
|
|
Maintenance
and repairs are charged to expense as incurred. The cost and accumulated depreciation of assets sold or otherwise disposed of
are removed from the related accounts and the resulting gain or loss is reflected in the statements of operations.
Management
assesses the carrying value of property and equipment whenever events or changes in circumstances indicate that the carrying value
may not be recoverable. If there is an indication of impairment, management prepares an estimate of future cash flows expected
to result from the use of the asset and its eventual disposition. If these cash flows are less than the carrying amount of the
asset, an impairment loss is recognized to write down the asset to its estimated fair value. The Company did not record an impairment
loss for the years ended December 31, 2019 and 2018.
Research
and Development
Research
and development costs are expensed in the period incurred. The costs primarily consist of personnel and supplies.
Shipping
and Handling Costs
The
Company’s shipping and handling costs relating to inbound freight are reported as cost of goods sold in the consolidated
Statements of Operations, while shipping and handling costs relating to outbound freight are reported as selling, general and
administrative expenses in the consolidated Statements of Operations. The Company classifies amounts billed to customers for shipping
fees as revenues.
Income
Taxes
Income
tax expense is based on pretax financial accounting income. Deferred tax assets and liabilities are recognized for the expected
tax consequences of temporary differences between the tax bases of assets and liabilities and their reported amounts. Valuation
allowances are recorded to reduce deferred tax assets to the amount that will more likely than not be realized. The Company has
recorded a valuation allowance against its deferred tax assets as of December 31, 2019 and 2018.
The
Company accounts for uncertainty in income taxes using a two-step approach to recognizing and measuring uncertain tax positions.
The first step is to evaluate the tax position for recognition by determining if the weight of available evidence indicates that
it is more likely than not that the position will be sustained on audit, including resolution of related appeals or litigation
processes, if any. The second step is to measure the tax benefit as the largest amount that is more than 50 percent likely of
being realized upon settlement. The Company classifies the liability for unrecognized tax benefits as current to the extent that
the Company anticipates payment (or receipt) of cash within one year. Interest and penalties related to uncertain tax positions
are recognized in the provision for income taxes.
Concentration
Risks
The
Company maintains the majority of its cash balances with one financial institution, in the form of demand deposits. During
the years ended December 31, 2019 and 2018, the Company had cash deposits that exceeded the federally insured limit of $250,000.
The Company believes that no significant concentration of credit risk exists with respect to these cash balances because of its
assessment of the creditworthiness and financial viability of the financial institution.
The
Company operates in markets that are highly competitive and rapidly changing. Significant technological changes, shifting customer
needs, the emergence of competitive products or services with new capabilities, and other factors could negatively impact the
Company’s operating results. State and federal government laws could have a material adverse impact on the Company’s
future revenues and results of operations.
The
Company’s products require specific components that currently are available from a limited number of sources. The Company
purchases some of its key products and components from single vendors. During the years ended December 31, 2019 and 2018, its
ballasts, lamps and reflectors, which comprised the clear majority of the Company’s purchases during those periods, were
each only purchased from one separate vendor.
The
Company performs a regular review of customer activity and associated credit risks and does not require collateral or other arrangements.
There were no customers that accounted for more than 10% of the Company’s revenue for the years ended December 31, 2019
and 2018. Shipments to customers outside the United States comprised less than 5.0% of our sales for the years ended December
31, 2019 and 2018, respectively.
As
of December 31, 2019, two customers accounted for 23.6% and 10.1% of the Company’s trade accounts receivable balance, and
as of December 31, 2018, four customers accounted for 37.4%, 14.4%, 12.9% and 12.1% of the Company’s trade accounts receivable
balance.
Fair
Value measurements
The
Company determines the fair value of its assets and liabilities based on the exchange price in U.S. dollars 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 uses a fair value hierarchy with
three levels of inputs, of which the first two are considered observable and the last unobservable, to measure fair value:
|
●
|
Level
1 — Quoted prices in active markets for identical assets or liabilities.
|
|
●
|
Level
2 — Inputs, other than Level 1, that are observable, either directly or indirectly, such as quoted prices for similar
assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated
by observable market data for substantially the full term of the assets or liabilities.
|
|
|
|
|
●
|
Level
3 — Unobservable inputs that are supported by little or no market activity and that are significant to the fair value
of the assets or liabilities.
|
The
carrying amounts of financial instruments such as cash, accounts receivable, inventories, and accounts payable and accrued liabilities,
approximate the related fair values due to the short-term maturities of these instruments. The carrying values of notes payable
approximate their fair values due to the fact that the interest rates on these obligations are based on prevailing market interest
rates.
The
fair value of the derivative liabilities of $1,332,000 and $2,160,806 at December 31, 2019 and 2018, respectively, was valued
using Level 2 inputs.
Derivative
Financial Instruments
The
Company evaluates its financial instruments to determine if such instruments are derivatives or contain features that qualify
as embedded derivatives. For derivative financial instruments that are accounted for as liabilities, the derivative instrument
is initially recorded at its fair value and is then re-valued at each reporting date, with changes in the fair value reported
in the consolidated statements of operations. The classification of derivative instruments, including whether such instruments
should be recorded as liabilities or as equity, is evaluated at the end of each reporting period. Derivative instrument liabilities
are classified in the balance sheet as current or non-current based on whether or not net-cash settlement of the derivative instrument
could be required within 12 months of the balance sheet date.
Intangible
Assets
The
Company accounts for intangible assets in accordance with the authoritative guidance issued by the FASB. Intangibles are valued
at their fair market value and are amortized taking into account the character of the acquired intangible asset and the expected
period of benefit. The Company evaluates intangible assets for impairment, at a minimum, on an annual basis and whenever events
or changes in circumstances indicate that the carrying value may not be recoverable from its estimated undiscounted future cash
flows. Recoverability of intangible assets is measured by comparing their net book value to the related projected undiscounted
cash flows from these assets, considering a number of factors, including past operating results, budgets, economic projections,
market trends and product development cycles. If the net book value of the asset exceeds the related undiscounted cash flows,
the asset is considered impaired, and a second test is performed to measure the amount of impairment loss.
At
December 31, 2018, the Company had intangible assets of $1,301,591 that consisted of a license right. In June 2019, and based
on management’s assessment, it was determined that the intangible asset was impaired, and an impairment charge was recorded
for $1,138,892 during the twelve month period ended December 31, 2019 (see Note 4).
Recently
Issued Accounting Pronouncements
In
July 2017, the FASB issued ASU No. 2017-11, Earnings Per Share (Topic 260); Distinguishing Liabilities from Equity (Topic 480):
Accounting for Certain Financial Instruments with Down Round Features. This ASU addresses the complexity and reporting burden
associated with the accounting for freestanding and embedded instruments with down round features as liabilities subject to fair
value measurement. The Company has elected to apply ASU 2017-11 using a modified-retrospective approach by means of a cumulative-effect
adjustment to its financial statements as allowed under ASU 2017-11. Upon adoption on January 1, 2019, the Company recorded
an increase paid in capital and decreased the derivative liability by $2,160,806.
In
June 2016, the FASB issued ASU No. 2016-13, Credit Losses - Measurement of Credit Losses on Financial Instruments (“ASC 326”).
The standard significantly changes how entities will measure credit losses for most financial assets, including accounts and notes
receivables. The standard will replace today’s “incurred loss” approach with an “expected loss”
model, under which companies will recognize allowances based on expected rather than incurred losses. Entities will apply the
standard’s provisions as a cumulative-effect adjustment to retained earnings as of the beginning of the first reporting
period in which the guidance is effective. As small business filer, the standard will be effective for us for interim and annual
reporting periods beginning after December 15, 2022. The Company is currently assessing the impact of adopting this standard on
the Company’s financial statements and related disclosures.
Recent
accounting pronouncements issued by the FASB, including its Emerging Issues Task Force, the American Institute of Certified Public
Accountants, and the Securities and Exchange Commission are not believed by management to have a material impact on the Company’s
present or future consolidated financial statements.
NOTE
3 - PROPERTY AND EQUIPMENT
Property
and equipment consist of the following at December 31, 2019 and 2018:
|
|
2019
|
|
|
2018
|
|
|
|
|
|
|
|
|
Leasehold improvements
|
|
$
|
-
|
|
|
$
|
7,000
|
|
Machinery and equipment
|
|
|
81,045
|
|
|
|
178,455
|
|
Computer equipment
|
|
|
10,908
|
|
|
|
10,908
|
|
Furniture and fixtures
|
|
|
39,560
|
|
|
|
39,560
|
|
|
|
|
131,513
|
|
|
|
235,923
|
|
Less: accumulated depreciation and amortization
|
|
|
(109,474
|
)
|
|
|
(179,162
|
)
|
Property and equipment, net
|
|
$
|
22,039
|
|
|
$
|
56,761
|
|
Depreciation
expense for the years ended December 31, 2019 and 2018 was $33,106 and $54,081, respectively.
During
the year ended December 31, 2019, the Company disposed of property and equipment with a book value of $6,506, resulting in a loss
on the disposal of property and equipment of $6,506. During the year ended December 31, 2018, the Company sold certain of its
property and equipment for $28,500. The book value of the property and equipment was $44,543, resulting in a loss on the sale
of property and equipment of $16,043.
In
February 2019, the Company terminated its Arizona facility lease thereby abandoning $856,760 of leasehold improvements. The Company
recorded the abandonment of leasehold improvements of $217,562 and $639,198 during the year ended December 31, 2019 and 2018,
respectively, as a component of operating expense in the consolidated statement of operations (see Note 7).
NOTE
4 – LICENSE AGREEMENT ACQUIRED FROM RELATED PARTIES
License
agreement acquired from related parties as of December 31, 2019 and December 31, 2018, consisted of the following:
|
|
As of
|
|
|
|
December 31, 2019
|
|
|
December 31, 2018
|
|
License agreement
|
|
$
|
1,518,523
|
|
|
$
|
1,518,523
|
|
Accumulated amortization
|
|
|
(379,631
|
)
|
|
|
(216,932
|
)
|
Impairment charge
|
|
|
(1,138,892
|
)
|
|
|
-
|
|
Intangible assets, net
|
|
$
|
-
|
|
|
$
|
1,301,591
|
|
On
May 10, 2018, the Company entered into an acquisition agreement (the “Acquisition Agreement”) with the members (the
“Sellers”), which in the aggregate, owned 100% of the membership interests in YLK. Pursuant to the Acquisition Agreement,
in consideration of the Company acquiring all of the outstanding membership interests of YLK, the Company issued to the Sellers,
a total of 5,000,000 warrants (the “Warrants”) to purchase 5,000,000 common shares, at an exercise price of $0.01
per share. The Warrants are exercisable until May 9, 2023. The aggregate fair value of the Warrants issued as consideration for
the acquisition was determined to be $5,450,000.
The
Sellers were the following, who were determined to be related parties:
|
(a)
|
LK
Ventures, LLC a Nevada limited liability company. One-half of the membership interests of LK Ventures, LLC is owned by Alan
Lien, Chief Executive Officer, President and a director of the Company, and the remaining one-half is owned by a non-affiliated
party. LK Ventures, LLC received 2,250,000 Warrants under the Acquisition Agreement for the 45% membership interests held
in YLK.
|
|
|
|
|
(b)
|
MDM
Cultivation LLC, a Delaware limited liability company. The members of MDM Cultivation are affiliates of YA II PN, Ltd. (“YA
II PN”) and D-Beta One EQ, Ltd., which presently hold (i) 2,258,382 shares of the Company’s common stock, (ii)
warrants to purchase 11,200,000 shares of the Company’s common stock and (iii) a secured promissory note issued by the
Company with an outstanding principal amount of $1.5 million. In addition, YA II PN and the Company are parties to that SEDA,
pursuant to which YA II PN has agreed to purchase up to $25.0 million of the Company’s common stock, subject to the
terms and conditions thereof. MDM Cultivation owned 45% of the outstanding membership interests of YLK. MDM Cultivation was
issued 2,250,000 Warrants under the Acquisition Agreement. As affiliates of MDM Cultivation, YA II PN and D-Beta One EQ, Ltd.
will be deemed to be the beneficial owners of the 2,250,000 Warrants in addition to the other shares and warrants presently
held by them.
|
|
(c)
|
Future
Farm Technologies Inc. of Vancouver British Columbia, Canada. Future Farm Technologies, Inc. was issued 500,000 Warrants under
the Acquisition Agreement for the 10% membership interests held in YLK.
|
The
major asset of YLK is a Cultivation Management Services Agreement (the “Management Agreement”) with an Arizona licensee
(the “Arizona Licensee”) that was entered into on January 5, 2018. No operating activity existed prior to the acquisition.
The Arizona Licensee is authorized to operate a medical marijuana dispensary, one (1) onsite facility and one (1) offsite facility,
to produce, sell and dispense medical marijuana and manufactured and derivative products that contain marijuana pursuant to Title
9; Chapter 17 of the Arizona Department of Health Services (“AZDHS”) Medical Marijuana Program and Arizona Revised
Statute § 36-2801 et seq., as amended from time to time. Pursuant to the Management Agreement, YLK will provide the management
services for the offsite facility, on behalf of the Arizona Licensee. The assets acquired also included a $250,000 receivable
from Future Farm Technologies.
As
consideration for the exclusive right of YLK to manage the Arizona Licensee’s facility pursuant to the Management Agreement;
(i) YLK paid $750,000 to the Arizona Licensee; (ii) YLK agreed to pay an additional $250,000 within 10 days after receipt of the
AZDHS approval to operate the facility; and (iii) YLK agreed to pay a total of $600,000, payable in 44 equal monthly installments
commencing on April 1, 2019 (the “Installment Payments”). The term of the Management Agreement is five years. YLK
has the option to extend the term for an additional five years with the payment of $1,000,000 at the commencement of the additional
term and a total of $1,000,000 payable in equal monthly installments over the extended term of the Management Agreement. Before
the acquisition, the Sellers paid $750,000 per the terms of the Management Agreement.
Through
the acquisition, the Sellers’ rights and obligations under the CMSA transferred to the Company, including the payment of
an additional $250,000 within 10 days after receipt of the AZDHS approval to operate the facility; and the Installment Payments.
As the Installment Payments totaling $600,000 are noninterest bearing, the Company calculated the net present value of the Installment
Payments to be $518,523 (or a discount of $81,477) based on an 8% cost of capital (which is consistent with borrowing rate of
the Company’s other notes). The Company recorded the aggregate present value of these payments of $518,523 as part of the
acquisition cost of the Management Agreement, which will be amortized over five years, the length of the Management Agreement.
Amortization expense for twelve months ended December 31, 2019 and 2018, was $379,631 and $216,932, respectively.
Since
the assets, including a $250,000 balance due from Future Farm Technologies, was acquired from related parties, the assets were
recorded at their historical acquisition cost of $1,000,000. The Company issued 5,000,000 Warrants to the Sellers with an exercise
price of $0.01 and an expiration date of May 9, 2023. Based on a Black-Sholes Merton model, the Warrants were valued at $5,450,000.
Since the assets acquired were acquired from related parties, the difference of $4,450,000 between the fair value of the Warrants
granted of $5,450,000 and the historical acquisition cost of $1,000,000 was recorded as related party compensation cost in the
accompanying consolidated statements of operations. The $250,000 receivable was received by the Company during the year ended
December 31, 2018.
In
the first quarter of 2019, the Company recorded $162,699 of amortization expense. In June 2019, the Company determined that its
intangible assets were impaired after assessing the impact of the Company’s current lack of liquidity, the recent lease
abandonment of its planned Arizona cultivation facility (Note 7), and the recent Deed in Lieu of Foreclosure Release and Settlement
Agreement with its Lender of a facility in Arizona (Note 10). The Company based on its assessment, recorded an impairment charge
of $1,138,892, which is reflected in the year ended December 31, 2019.
As
of December 31, 2018, the remaining Management Agreement obligation was $781,408 (net of discount of $68,592) for which $372,727
is reflected as current and $408,681 was reflected as long term in the accompanying consolidated balance sheet. As of December
31, 2019, the remaining Management Agreement obligation was $798,589 (net of discount of $51,411) and is reflected as a current
liability in the accompanying consolidated balance sheet. As of December 31, 2019, the Company is past due on its Installment
Payments obligations under the Management Agreement .
NOTE
5 – NOTES PAYABLE TO RELATED PARTIES – PAST DUE
Notes
payable to related parties consists of the following at December 31, 2019 and 2018:
|
|
December 31, 2019
|
|
|
December 31, 2018
|
|
|
|
|
|
|
|
|
Notes payable to officers/shareholders – past due (a)
|
|
|
600,000
|
|
|
|
600,000
|
|
Notes payable to related party – past due (b)
|
|
|
150,000
|
|
|
|
-
|
|
Notes payable to related parties – past due (c)
|
|
|
40,000
|
|
|
|
40,000
|
|
Total
|
|
$
|
790,000
|
|
|
$
|
640,000
|
|
|
a.
|
On
May 9, 2016, the Company entered into note payable agreements with Alan Lien and Alvin Hao, each a former officer and director,
to borrow $300,000 under each individual note. Pursuant to the terms of each of these agreements, the Company borrowed $300,000
from each of Alan Lien and Alvin Hao. The notes accrue interest at a rate of 8% per annum, are unsecured and were due on or
before May 31, 2018. The loans are currently past due. A total of $600,000 was due on the combined notes at December
31, 2019 and 2018, respectively.
|
|
|
|
|
b.
|
On
May 8, 2019, the Company entered into a note agreement with the sister of Alvin Hao, a former officer and director, to borrow
$150,000. The loan accrues interest at 8% per annum (12% on default), is unsecured and is due on November
8, 2019. The note is currently past due.
|
|
|
|
|
c.
|
The
Company entered into note agreements with the parents of Alan Lien, the Company’s Chief Executive Officer and one of
its directors. The loans accrue interest at 10% per annum, are unsecured and were due on or before December 31,
2016. The loans are currently past due. A total of $40,000 is due on the loans as of each of December 31,
2019 and 2018.
|
At
December 31, 2018, accrued interest on the notes payable to related parties was $125,039. During the twelve months ended December
31, 2019, the Company added $61,740 of additional accrued interest, and made interest payments of $37,347, leaving an accrued
interest on the notes payable to related parties balance of $149,432 at December 31, 2019.
NOTE
6 – LEASE PAYABLE
Our
principal executive offices and warehouse is located at 853 Sandhill Avenue, Carson, California, 90746. We occupy a 17,640 square
foot facility pursuant to a five-year lease with an independent party ending on June 30, 2023, pursuant to which we pay $15,000
per month in rental charges. Effective January 1, 2020, we relocated our principal executive offices and warehouse to Upland,
California (see Note 15), and abandoned our Carson, California lease. The Company remains obligated under its Carson, California
lease, until such time the landlord releases us from our lease agreement. As of the date of this report, we have not been released
from the lease agreement.
The
lease agreement above has a weighted average remaining lease term of 3.50 years as of December 31, 2019. Leases with an
initial term of 12 months or less are not recorded on the balance sheet. The Company accounts for the lease and non-lease components
of its leases as a single lease component. Rent expense is recognized on a straight-line basis over the lease term.
On
December 31, 2019, the Company abandoned its operating lease in Carson, California. Based on the abandonment, the Company determined
its ROU asset was impaired and recorded an impairment charge of $100,000 during the year ended December 31, 2019.
Prior
to January 1, 2019, the Company accounted for leases under ASC 840, Accounting for Leases. Effective January 1, 2019, the Company
adopted the guidance of ASC 842, Leases (“ASC 842”), which requires an entity to recognize a ROU asset and a lease
liability for virtually all leases. The Company adopted ASC 842 using a modified retrospective approach. As a result, the comparative
financial information has not been updated and the required disclosures prior to the date of adoption have not been updated and
continue to be reported under the accounting standards in effect for those periods. The adoption of ASC 842 on January 1, 2019
resulted in the recognition of operating lease ROU assets and lease liabilities for operating leases of $645,025. There was no
cumulative-effect adjustment to accumulated deficit.
Operating
lease ROU assets and liabilities are recognized at commencement date based on the present value of lease payments over the lease
term. ROU assets represent our right to use an underlying asset for the lease term and lease liabilities represent our obligation
to make lease payments arising from the lease. Generally, the implicit rate of interest in arrangements is not readily determinable
and the Company utilizes its incremental borrowing rate in determining the present value of lease payments. The Company’s
incremental borrowing rate is a hypothetical rate based on its understanding of what its credit rating would be. The operating
lease ROU asset includes any lease payments made and excludes lease incentives.
The
components of rent expense and supplemental cash flow information related to leases for the period are as follows:
|
|
Year ended
December 31, 2019
|
|
Lease Cost
|
|
|
|
|
Operating lease cost (included in general and administration in the Company’s statement of operations)
|
|
$
|
180,000
|
|
|
|
|
|
|
Other Information
|
|
|
|
|
Cash
paid for amounts included in the measurement of lease liabilities during the year ended December 31, 2019
|
|
$
|
-
|
|
Weighted
average remaining lease term – operating leases (in years)
|
|
|
3.50
|
|
Average
discount rate – operating leases
|
|
|
10.0
|
%
|
The
supplemental balance sheet information related to leases for the period is as follows:
|
|
At December 31, 2019
|
|
Operating leases
|
|
|
|
|
ROU assets, net of accumulated amortization of $117,618 and an impairment charge of $100,000
|
|
$
|
427,407
|
|
|
|
|
|
|
Current operating lease liabilities
|
|
$
|
133,188
|
|
Long-term operating lease liabilities
|
|
|
422,525
|
|
Total operating lease liabilities
|
|
$
|
555,713
|
|
Maturities
of the Company’s lease liabilities are as follows:
Year Ending
|
|
Operating Leases
|
|
2020
|
|
$
|
182,250
|
|
2021
|
|
|
189,000
|
|
2022
|
|
|
189,000
|
|
2023
|
|
|
94,500
|
|
2024
|
|
|
-
|
|
Total lease payments
|
|
|
654,750
|
|
Less: Imputed interest/present value discount
|
|
|
(99,037
|
)
|
Present value of lease liabilities
|
|
$
|
555,713
|
|
Rent
expense for the twelve months ended December 31, 2019 and 2018 was $495,670 and $361,868, respectively.
NOTE
7 – LEGAL SETTLEMENTS PAYABLE
Lease
Abandonment Settlement
On
February 15, 2019, MSCP, L.L.C (“MSCP”), filed suit in the Superior Court of Arizona, County of Maricopa, Case No.
CV2019-001613 against the Company and YLK. The case arises from YLK’s alleged breach of a certain lease agreement dated
May 19, 2018 (the “Lease”), for the lease of certain real property located at 4301 W. Buckeye Road, Phoenix, Arizona
85043 (the “Premises”), between MSCP and YLK, which the Company guaranteed. MSCP filed the lawsuit after YLK provided
a notice of termination for, amongst other reasons, MSCP’s failure to disclose various material information regarding code,
safety, structural and other issues in the Premises that rendered the Premises unsuitable for use, unless the Company undertook
significant and extraneous costs that were not contemplated under the Lease to remedy said issues in and outside of the Premises.
MSCP’s complaint alleged counts for breach of lease and waste and breach of guaranty. MSCP is seeking compensatory damages,
rents and other charges due under the lease, and attorney’s fees and costs. The Company just recently filed its answer denying
the allegations as well as having filed counterclaims for fraud in the inducement, negligent misrepresentation, breach of the
implied covenant of good faith and fair dealing, rescission of contract, unjust enrichment and punitive damages. On December 12,
2019, MSCP was awarded a default judgement against the Company in the amount of $1,487,000, which is recorded as a charge to operating
expenses in the consolidated statements of operations for the twelve months ended December 31, 2019. No
payments were made during the twelve months ended December 31, 2019.
Employment
Matter Judgement
On
September 27, 2019, Dennis Forchic (the “Plaintiff”) filed a breach of contract case against the Company in the Los
Angeles Superior Court of Los Angeles, California, under case number 19STCV34592, alleging that the Company wrongfully terminated
the Plaintiff’s employment agreement on February 5, 2018. The Plaintiff claims damages of $646,000 for unpaid severance,
unpaid reimbursed expenses, and unpaid health benefits. In addition, the Plaintiff claims damages for failing to compensate Plaintiff
for 3,000,000 stock options which vested on termination. As of December 31, 2018, the Company had recorded $558,469 related to
this matter as $448,718 Due to former officer and $139,751 as Accounts payable and accrued expenses. On March 3, 2020, the Plaintiff
was awarded a judgement against the Company in the amount of $646,000, plus post judgment interest, as well as the vesting
of options to purchase 1,000,000 shares of the Company’s common stock. During the year ended December 31, 2019, the
previous year recording of $448,718 Due to former officer and $139,751 as Accounts payable and accrued expenses, was reclassified
to Legal Settlement Payable on the Consolidated Balance Sheet. During the year ended December 31, 2019, the Company recorded an
additional $57,531 of legal expenses, leaving a total balance due to Plaintiff of $646,000 at December 31, 2019. No
payments were made during the twelve months ended December 31, 2019.
Breach
of Contract
On September 12, 2019, DPA, Inc., or DPA, filed suit in the Superior
Court of Arizona, County of Maricopa, Case No. CV2019-008265 against us. The plaintiff alleges
the Company breached an agreement to pay DPA for architectural design services related to a facility in Arizona and has requested
a judgment for $251,923 plus interest. On September 18, 2019, the DPA was awarded judgement against the Company for $251,923 plus
interest at 18% per annum from June 6, 2019 until paid. No payments were made during the twelve months ended December 31, 2019.
On
August 7, 2019, Rose Law Group PC (“RLG”) filed a breach of contract case against the Company in the Superior Court
of the State of Arizona, County of Maricopa, Case No. CV2019-008484 against the Company. RLG alleges breach of a contract to pay
RLG for legal representation, and requested a judgment for $143,836. On October 17, 2019, RLG was awarded judgment against the
Company for $150,256 plus interest at 12% per annum until paid.
NOTE 8 – LOANS PAYABLE
Loan
payable consisted of the following as of December 31, 2019 and 2018:
|
|
December 31, 2019
|
|
|
December 31, 2018
|
|
|
|
|
|
|
|
|
Term loan (a)
|
|
$
|
64,375
|
|
|
$
|
-
|
|
Automobile loan (b)
|
|
|
-
|
|
|
|
2,548
|
|
Loans payable
|
|
$
|
64,375
|
|
|
$
|
2,548
|
|
|
a.
|
On
May 21, 2019, the Company entered into a loan agreement with Celtic Bank in the principal amount of $150,000 with interest
at 40.44% per annum and due on May 21, 2020. The loan was guaranteed by Alvin Hao, a former officer of the Company. During
the twelve months ended December 31, 2019, the Company made principal payments of $85,625, leaving a total of $64,375 owed
on the loan as of December 31, 2019.
|
|
b.
|
At
December 31, 2018, $2,548 was due on a loan agreement for a purchased automobile. During the twelve months ended December
31, 2019, the Company made payments of $2,548, and the loan was retired.
|
NOTE
9 – CONVERTIBLE SECURED NOTE PAYABLE TO RELATED PARTY
Secured
note payable to related party consists of the following as of December 31, 2019 and 2018:
|
|
December 31, 2019
|
|
|
December 31, 2018
|
|
|
|
|
|
|
|
|
YA II PN, Ltd.
|
|
$
|
1,750,000
|
|
|
$
|
1,500,000
|
|
Less debt discount
|
|
|
(153,470
|
)
|
|
|
(247,032
|
)
|
Secured note payable, net
|
|
$
|
1,596,530
|
|
|
$
|
1,252,968
|
|
YA
II PN Ltd May 2018 Convertible Note
On
May 10, 2018, the Company issued a secured debenture (the “2018 Note”) to YA II PN Ltd. (“YA II PN”) in
the principal amount of $1,500,000 with interest at 8% per annum (18% on default) and due on February 9, 2019. The 2018 Note was
amended effective February 9, 2019 (see below). The 2018 Note is secured by all the assets of the Company and its subsidiaries.
As part of the issuance, the Company also granted YA II PN 5-year warrants to purchase a total of 7,500,000 shares of the Company
per the following terms.
|
(a)
|
A
warrant, or Warrant #1, to purchase 1,000,000 Warrant Shares at an exercise price of $1.50 per share for a term expiring on
May 10, 2023;
|
|
(b)
|
A
warrant, or Warrant #2, purchase 2,250,000 shares of common stock at an exercise price of $1.50 per share for a term expiring
on May 10, 2023. At any time, the Company has the right and option to purchase any unexercised shares of common stock
underlying Warrant #2 for a purchase price of $0.03 per share so purchased if and only if the average volume weighted
average price, or VWAP (as reported by Bloomberg, LP) of the Company’s common stock is greater than $1.75 per share
for the five (5) consecutive trading days immediately preceding the Company’s delivery of a notice of exercise.
The
Company has the right and option to compel YA II PN to exercise and purchase shares of common stock underlying Warrant
#2 on the terms set forth in Warrant #2 if and only if the average VWAP of the Company’s common stock is greater
than $1.75 per share for the five (5) consecutive trading days immediately preceding the Company’s delivery of a
notice of exercise.
|
|
(c)
|
A
warrant, or Warrant #3, to purchase 2,250,000 shares of common stock at an exercise price of $1.50 per share for a term expiring
on May 10, 2023. At any time, the Company has the right and option to purchase any unexercised shares of common stock underlying
Warrant #3 for a purchase price of $0.03 per share so purchased if and only if the average VWAP (as reported by Bloomberg,
LP) of the Company’s common stock is greater than $2.00 per share for the five (5) consecutive trading days immediately
preceding the Company’s delivery of a notice of exercise.
|
|
|
|
|
|
The
Company has the right and option to compel YA II PN to exercise and purchase shares of common stock underlying Warrant #3
on the terms set forth in Warrant #3 if and only if the average VWAP of the Company’s common stock is greater than $2.00
per share for the five (5) consecutive trading days immediately preceding the Company’s delivery of a notice of exercise.
|
|
|
|
|
(d)
|
A
warrant, or Warrant #4, to purchase 2,000,000 shares of common stock at an exercise price of $1.50 per share for a term expiring
on May 10, 2023. At any time, the Company has the right and option to purchase any unexercised shares of common stock underlying
Warrant #4 for a purchase price of $0.03 per share so purchased if and only if the average VWAP (as reported by Bloomberg,
LP) of the Company’s common stock is greater than $1.50 per share for the five (5) consecutive trading days immediately
preceding the Company’s delivery of a notice of exercise.
|
|
|
|
|
|
The
Company has the right and option to compel YA II PN to exercise and purchase the shares of common stock underlying Warrant
#4 on the terms set forth in Warrant #4 if and only if the average VWAP of the Company’s common stock is greater than
$2.50 per share for the five (5) consecutive trading days immediately preceding the Company’s delivery of a notice of
exercise.
|
The
Company determined that the exercises prices of the warrants were not a fixed amount because they were subject to an adjustment
based on the occurrence of future events. As such, the Company determined that the conversion feature and the warrants created
a derivative with a fair value of $7,677,406 at the date of issuance. The Company accounted for the fair value of the derivative
up to the face amount of the 2018 Note of $1,500,000 as a valuation discount to be amortized over the life of the 2018 Note, and
the excess of $6,177,406 was recorded as a finance cost for the twelve months ended December 31, 2018. During the twelve months
ended December 31, 2019 and 2018, amortization of valuation discount was $247,032 and $1,252,968 was recorded as an interest cost,
leaving no remaining unamortized balance of the valuation discount at December 31, 2019.
Amendment
to Secured Note Payable to Related Party
On
February 25, 2019, the Company entered into an amendment agreement (the “Amendment”) with YA II PN, which amended
(i) the secured promissory note in the principal face amount of $1.5 million issued on May 10, 2018 (the “Note”),
(ii) a warrant, dated May 10, 2018 for 1,000,000 shares of the Company’s common stock at an exercise price of $1.50 (“Warrant
#1”), (iii) a warrant, dated May 10, 2018 for 2,250,000 shares of the Company’s common stock at an exercise price
of $1.50 (“Warrant #2”), (iv) a warrant, dated May 10, 2018 for 2,250,000 shares of the Company’s common stock
at an exercise price of $1.50 (“Warrant #3”), and (v) a warrant, dated May 10, 2018 for 2,000,000 shares of the Company’s
common stock at an exercise price of $1.50 (“Warrant #4”, and together with Warrant #1, Warrant #2 and Warrant #3,
the “Warrants”).
Pursuant
to the Amendment, the Note was amended to (i) extend the maturity date of the Note from February 9, 2019 to August 9, 2019 and
(ii) provide a conversion right, in which the principal amount of the Note, together with any accrued but unpaid interest, could
be converted into the Company’s common stock at a conversion price of $0.50 a share. The Note was not convertible previously.
In
addition, pursuant to the Amendment, the Warrants were amended to (i) reduce the exercise price from $1.50 per share to $0.50,
$0.75, $1.00 and $1.25 per share for Warrant #1, Warrant #2, Warrant #3 and Warrant #4, respectively, and (ii) remove in Warrant
#2, Warrant #3 and Warrant #4, the Company’s right of redemption and right to compel exercise of such Warrants. The Company
calculated the fair market value of the Warrants before and after the modifications above, and recorded the difference of $129,384
as a financing cost included in other expenses during the twelve months ended December 31, 2019.
Second
Amendment to Secured Note Payable to Related Party
On
October 29, 2019, the Company entered into a second amendment agreement (the “Second Amendment”) with YA II PN, which
amended (i) the secured promissory note in the principal face amount of $1.5 million issued on May 10, 2018. Pursuant to the Amendment,
the Note was amended to (i) extend the maturity date of the Note from August 9, 2019 to June 30, 2020 and (ii) provide a conversion
right, in which the principal amount of the Note, together with any accrued but unpaid interest, could be converted into the Company’s
common stock at a conversion price at 75% of the lowest volume weighted average price (VWAP) of the Company Common Stock during
the 10 trading days immediately preceding the conversion date. The Note was convertible previously at $0.50 per share. The Company
concluded that the modification was a significant change in the conversion feature and treated the change as a debt extinguishment
cost. The Company calculated the fair market value of the Secured Note Payable before and after the modifications above, and recorded
the difference of $962,000 as a debt extinguishment cost and included in other expenses during the twelve months ended December
31, 2019.
In
addition, pursuant to the Second Amendment, the Warrants were amended to (i) reduce the exercise price from $0.50, $0.75, $1.00
and $1.25 per share for Warrant #1, Warrant #2, Warrant #3 and Warrant #4, respectively, to $0.05 per share for all four warrants.
The Company calculated the fair market value of the Warrants before and after the modifications above, and recorded the difference
of $64,485 as a financing cost included in other expenses during the twelve months ended December 31, 2019.
YA
II PN Ltd October 2019 Convertible Note
On
October 29, 2019, the Company issued a convertible secured debenture (the “2019 Note”) to YA II PN Ltd. (“YA
II PN”) in the principal amount of $275,000 with interest at 10% per annum (15% on default) and due on April 29, 2020. The
Company received net proceeds of $237,500, net of closing costs of $37,500. The 2019 Note is secured by all the assets of the
Company and its subsidiaries. The 2019 Note provides a conversion right, in which the principal amount of the Note, together with
any accrued but unpaid interest, could be converted into the Company’s common stock at a conversion price at 75% of the
lowest volume weighted average price (VWAP) of the Company Common Stock during the 10 trading days immediately preceding the conversion
date. As such, the Company determined that the conversion feature created a derivative with a fair value of $167,000 at the date
of issuance. The Company also granted YA II PN 5-year warrants to purchase a total of 5,500,000 shares of the Company at an exercise
price of $0.05 per common share. The fair value of the warrants was determined to be $63,205. The aggregate amount of the closing
costs, fair value of the derivative liability, and the fair value of the warrant, of $267,705 was recorded as a valuation discount
to be amortized over the life of the 2019 Note.
During
the twelve months ended December 31, 2019, amortization of valuation discount was $89,235 and was recorded as an interest cost,
leaving a $178,470 remaining unamortized balance of the valuation discount at December 31, 2019.
NOTE
10 – ACQUISITION OF FACILITY, LOAN AGREEMENT, AND SUBSEQUENT SETTLEMENT
Acquisition
of Facility
On
April 2, 2019, the Company, through its newly formed wholly-owned subsidiary Extracting Point, entered into an agreement to purchase
real property located at 2601 West Holly Street in Phoenix, Arizona (the “Property”) for $3,500,000. The Property
holds the approval and authorization for a Conditional Use Permit, which allows the Property to be used for the operation of a
cultivation and infusion facility, allowing for the cultivation, harvesting, preparation, packaging and storing of medical cannabis,
as well as extraction, refinement, infusion, production, preparation, packaging, and storage of manufactured and derivative oils,
waxes, concentrates, edible and non-edible products that contain cannabis.
Loan
Agreement
On
April 2, 2019, Extracting Point entered into a loan agreement (the “Loan Agreement”) with Michael Cannon and Jennifer
Cannon, Trustees of the Core 4 Trust Dated February 29, 2016 (the “Lender”), pursuant to which Extracting Point borrowed
$3,500,000 from the Lender (the “Loan”). The Loan is evidenced by an installment note – interest included (the
“Note”), guaranteed by the Company pursuant to a corporate guaranty (the “Guaranty”) and is secured by
a first priority lien on the Property pursuant to a deed of trust and assignment of rents between Extracting Point and Thomas
Title & Escrow, for the benefit of the Lender (the “Deed of Trust”). Extracting Point used the net proceeds from
the Loan to acquire the Property.
The
Note, together with accrued and unpaid interest, was due and payable on March 31, 2024 (the “Maturity Date”). Interest
on the Note was to accrue at the rate of 10% per annum. For the first 12 months, Extracting Point was to pay the Lender interest
only of $29,167 per month. After the first 12 months, Extracting Point was to pay the Lender principal and interest of $88,769
per month. Extracting Point had the right to prepay the Note at any time, however, Extracting Point agreed to pay the first 36
months of interest, even if the Note was repaid prior to that date.
As
additional consideration for the issuance of the Loan, Extracting Point and the Company agreed to pay the Lender an amount
equal to five percent (5%) of the management fees (the “Management Royalty”) received relating to the services
rendered on the Property, for a period of three years from the date an “Approval to Operate” is granted by the
Arizona Department of Health Services (such date, the “Commencement Date”). In the event that the Commencement
Date has not occurred on or prior to April 2, 2021, then Extracting Point and the Company agreed to pay the Lender an amount
equal to five percent (5%) of the fair market value of the rent of the Property as if the Property was fully occupied (the
“Rental Royalty”), such payments to be made each month for a period of thirty-nine months, provided, that, if the
Commencement Date occurs after the Rental Royalty has commenced, the Rental Royalty payments shall cease and the Management
Royalty payments shall commence, and any amounts paid as a Rental Royalty shall be credited against any Management Royalty
owed.
In
connection with the Loan, the Company issued to the Lender a warrant (the “Warrant”) to purchase 1,000,000 shares
of the Company’s common stock, exercisable for five years from issuance at an exercise price of $1.00 per share. The Warrant
exercise price is subject to adjustment only in the event of a stock dividend or split.
Settlement
Agreement
On
May 24, 2019, the Company and Extracting Point entered into a Deed in Lieu of Foreclosure Release and Settlement Agreement (the
“Settlement Agreement”) with the Lender. Pursuant to the Settlement Agreement, Extracting Point executed a Deed in
Lieu of Foreclosure (the “Deed”), conveying the real property located at 2601 West Holly Street in Phoenix, Arizona
to the Lender.
In
exchange, the Lender agreed to release the Company and Extracting Point from all their obligations under the Loan Agreement, the
Note, the Deed of Trust and the Guaranty. Pursuant to the Settlement Agreement, the Loan Agreement, the Note, the Deed of Trust
and the Guaranty were terminated. In addition, the Warrant was returned to the Company and canceled.
Extracting
Point was delinquent in payment under the Note, and the Lender informed Extracting Point and the Company that unless payment was
made current or an agreement reached between the parties, the Lender would declare Extracting Point in default, call the entire
Note due and payable, record a notice of default of the Deed of Trust, and take any other actions it deemed necessary or appropriate
against the Company and Extracting Point.
NOTE
11 – DERIVATIVE LIABILITY
The
FASB has issued authoritative guidance whereby instruments which do not have fixed settlement provisions are deemed to be derivative
instruments. The conversion prices and the exercise prices of the notes, Series-A preferred stock, and warrants described in Notes
8, 9 and 10 were not a fixed amount because they were either subject to an adjustment based on the occurrence of future offerings
or events or they were variable. Since the number of shares is not explicitly limited, the Company is unable to conclude that
enough authorized and unissued shares are available to settle the conversion option. In accordance with the FASB authoritative
guidance, the conversion features have been characterized as derivative liabilities to be re-measured at the end of every reporting
period with the change in value reported in the statement of operations.
As
of December 31, 2019, and December 31, 2018, the derivative liabilities were valued using either a probability weighted average
Monte Carlo pricing model or the Black Scholes pricing model with the following assumptions:
|
|
December 31, 2019
|
|
|
Issued During 2019
|
|
|
December 31, 2018
|
|
|
Issued During 2018
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Exercise Price
|
|
$
|
0.05
|
|
|
$
|
0.05
|
|
|
|
$ 0.22 – 1.50
|
|
|
$
|
1.50
|
|
Stock Price
|
|
$
|
0.01
|
|
|
$
|
0.02
|
|
|
$
|
0.34
|
|
|
$
|
1.09
|
|
Risk-free interest rate
|
|
|
1.55 – 1.60
|
%
|
|
|
1.64
|
%
|
|
|
2.50
|
%
|
|
|
2.83
|
%
|
Expected volatility
|
|
|
201-203
|
%
|
|
|
147-165
|
%
|
|
|
137 – 147
|
%
|
|
|
171
|
%
|
Expected life (in years)
|
|
|
0.33-0.50
|
|
|
|
0.50-0.67
|
|
|
|
3.96 – 4.36
|
|
|
|
5.0
|
%
|
Expected dividend yield
|
|
|
0
|
%
|
|
|
0
|
%
|
|
|
0
|
%
|
|
|
0
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Convertible Note
|
|
$
|
1,332,000
|
|
|
$
|
1,129,000
|
|
|
$
|
-
|
|
|
|
-
|
|
Warrants
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
2,160,806
|
|
|
$
|
7,677,406
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fair Value:
|
|
$
|
1,332,000
|
|
|
$
|
1,129,000
|
|
|
$
|
2,160,806
|
|
|
$
|
7,677,406
|
|
The
risk-free interest rate was based on rates established by the Federal Reserve Bank. The Company uses the historical volatility
of its common stock to estimate the future volatility for its common stock. The expected life of the conversion feature of the
notes was based on the remaining term of the notes. The expected dividend yield was based on the fact that the Company has not
customarily paid dividends in the past and does not expect to pay dividends in the future.
During
the prior years, the Company issued 7,950,000 warrants as part of its Convertible Notes and Series A preferred stock financings.
The Company determined that the exercises prices of the warrants were not a fixed amount because they were subject to an adjustment
based on the occurrence of future offerings or events. As a result, the Company had determined at issuance that the warrants should
be classified as liabilities due to variability in shares to be issued and changes in exercise price due to down round protection.
The fair value of these liabilities at December 31, 2018 was $2,160,806. During the year ended December 31, 2019, the Company
adopted ASU 2017-11, which simplified the accounting for financial instruments with down round features. The adoption resulted
in the reclassification of the Company’s derivative liability to equity of $2,160,806. The Company recognized derivative
liabilities of $167,000 upon issuance of a secured convertible note (see Note 9), and recognized $203,000 as other expense, which
represented the change in the fair value of the derivative from the respective prior period. In addition, the Company recognized
$962,000, which represented a change in the terms of two convertible notes, and recorded as a financing cost and included in other
expense.
During
the year ended December 31, 2018, the Company recognized $8,743,170, as change in the fair value of the derivative from the respective
prior period. In addition, during the year ended December 31, 2018, the Company recognized $4,188,430, which represented the extinguishment
of derivative liabilities, of which $2,389,437, was included in other income, and the remaining $1,799,003, respectively, was
recorded to additional paid-in-capital. In addition, the Company recognized derivative liabilities of $7,677,406 upon issuance
of warrants (see Note 9).
NOTE
12 – SHAREHOLDERS’ EQUITY
Common
shares issued for cash
During
the year ended December 31, 2018, the Company received proceeds of $1,068,000 from the issuance of 821,538 shares of common stock,
at $1.30 per share, as part of a Regulation D offering, and the Company received proceeds
of $500,000 from YA II PN from the sale of 500,000 shares of common stock at $1.00 per share.
Common
shares issued for services
The
Company entered into various consulting agreements with third parties (“Consultants”) pursuant to which these Consultants
provided business development, sales promotion, introduction to new business opportunities, strategic analysis and, sales and
marketing activities. During the year ended December 31, 2019 and 2018, the Company issued an aggregate of 426,000 and 1,388,000
shares of common stock to these consultants, with a fair value of $177,750 and $1,676,557 at date of grant, respectively, which
was recognized as compensation cost.
Common
shares issued to directors and employees
The
Company appointed certain directors and issued shares as part of new executive employment agreements. During the year ended December
31, 2019 and 2018, the Company issued an aggregate of 600,000 and 100,000 shares of common stock, with a fair value of $78,000
and $74,000 at date of grant, respectively, which was recognized as compensation cost.
On
October 31, 2019, the Board of the Company appointed Mr. George O’Leary as a director and Executive Chairman of the Company.
In connection with the appointment of Mr. O’Leary, the Company granted him 500,000 shares of common stock, included in the
common shares issued to directors and employees above, and which vested immediately, and he is entitled to receive equity compensation
of $15,000 of shares per quarter thereafter as well as $5,000 per month as determined by the Board.
Shares
issued on exercise of warrants
During
the year ended December 31, 2018, we received $1,446,996 in proceeds on the exercise of 2,306,360 warrants.
Common
shares issued on conversion of convertible note payable
During
the year ended December 31, 2018, the Company was notified in writing that the Note holder elected to convert all remaining outstanding
principal and interest accrued, which included the conversion of $1,750,000 of principal and $38,082 of interest. Upon the conversion
of the Note, the Company issued an aggregate of 1,788,082 shares of its common stock. The balance of the debt discount of $1,555,556
was recorded as an interest cost during the twelve months ended December 31, 2018.
Common
shares issued on conversion of Series-A convertible preferred shares
During
the year ended December 31, 2018, the Company received notices of conversion from FirstFire, pursuant to which FirstFire elected
to convert all of the outstanding Series-A into common shares of the Company. Upon the conversion of the balance of the Series-A,
the Company issued 368,550 shares of common stock and no Series-A were outstanding as of December 31, 2018. Upon conversion, the
unamortized discount of $351,000 was reflected as an interest cost for the twelve months ended December 31, 2018.
Standby
Equity Distribution Agreement
On
April 16, 2018, the Company entered into a SEDA with YA II PN. The
SEDA establishes what is sometimes termed an equity line of credit or an equity draw-down facility. The $25,000,000 facility may
be drawn-down upon by the Company in installments, the maximum amount of each of which is limited to $1,000,000. For each share
of common stock purchased under the SEDA, YA II PN will pay 90% of the lowest VWAP of the Company’s shares during the five
trading days following the Company’s draw-down notice to YA II PN. The VWAP that will be used in the calculation will be
that reported by Bloomberg, LLC, a third-party reporting service. In general, the VWAP represents the sum of the value of all
the sales of the Company’s common stock for a given day (the total shares sold in each trade times the sales price per share
of the common stock for that trade), divided by the total number of shares sold on that day.
In
connection with the SEDA, the Company issued to YA II PN, a five-year Commitment Fee Warrant (the “Fee Warrant”) to
purchase 1,000,000 shares of the Company’s common stock at $0.01 per share. The aggregate fair value of the Fee Warrant
granted was determined to be $1,140,000 and recorded as a financing costs in the consolidated statements of operations for the
year ended December 31, 2018. On October 12, 2018, the Company issued 1,000,000 shares of common stock to YA Global II SPV LLC
(“YA Global”), which shares were issued upon YA Global exercising the warrants issued on April 15, 2018, as a commitment
fee in connection with the Standby Equity Distribution Agreement. YA Global paid the Company $10,000, or $0.01 per share, in full
settlement of the exercise price.
2018
Stock Incentive Plan
On
November 30, 2018, the 2018 Stock Incentive Plan (the “Plan”) for officers, employees, non-employee members of the
Board of Directors, and consultants of the Company was approved pursuant to a Joint Written Consent of the Board of Directors
and Majority Stockholders of the Company. The Plan authorized the granting of not more than 10,000,000 restricted shares, stock
appreciation rights (“SAR’s”), and incentive and non-qualified stock options to purchase shares of the Company’s
common stock. The Plan provided that stock options or SAR’s granted can be exercisable immediately as of the effective date
of the applicable agreement, or in accordance with a schedule or performance criteria as may be set in the applicable agreement.
The exercise price for non-qualified stock options or SAR’s would be the amount specified in the agreement, but shall not
be less than the fair value of the Company’s common stock at the date of the grant. The maximum term of options and SARs
granted under the plan is ten years. During the years ended December 31, 2019 and 2018, the Company issued 833,300 and 5,394,391
options to purchase shares of its common stock under the Plan, and 245,000 and no options were forfeited, respectively. As of
December 31, 2019, options to purchase 4,017,309 shares of common stock remain reserved for issuance under the Plan.
Summary
of Stock Options
A
summary of stock options for the year ended December 31, 2019 and 2018, is as follows:
|
|
|
|
|
Weighted
|
|
|
|
Number
|
|
|
Average
|
|
|
|
of
|
|
|
Exercise
|
|
|
|
Options
|
|
|
Price
|
|
Balance outstanding, December 31, 2017
|
|
|
3,000,000
|
|
|
|
0.60
|
|
Options granted
|
|
|
10,178,782
|
|
|
|
0.69
|
|
Option exercised
|
|
|
-
|
|
|
|
-
|
|
Options expired or forfeited
|
|
|
(4,784,391
|
)
|
|
|
(0.77
|
)
|
Balance outstanding, December 31, 2018
|
|
|
8,394,391
|
|
|
|
0.66
|
|
Options granted
|
|
|
833,300
|
|
|
|
0.03
|
|
Options exercised
|
|
|
-
|
|
|
|
-
|
|
Options expired or forfeited
|
|
|
(7,279,391
|
)
|
|
|
(0.67
|
)
|
Balance outstanding, December 31, 2019
|
|
|
1,948,300
|
|
|
$
|
0.35
|
|
Balance exercisable, December 31, 2019
|
|
|
1,938,707
|
|
|
$
|
0.35
|
|
Executive
Employment Agreements
Chief
Executive Officer
On
February 14, 2018, the Company entered into a three-year employment agreement with Tiffany Davis as the Company’s Chief
Operating Officer. As part of the employment agreement, Ms. Davis was granted 1,000,000 shares of the Company’s common stock,
of which 250,000 shares vested and were issued on the signing of the employment agreement and 250,000 shares vest annually on
the anniversary of the employment agreement. The fair value of the shares on the date of grant was $1,340,000, of which $335,000
was recorded as stock-based compensation expense on the date of grant, and the remaining $1,005,000 was to be amortized ratably
over the three-year vesting period, of which $173,353 was recorded as stock-based compensation expense during the year ended December
31, 2018. On August 22, 2018, Ms. Davis entered into an employment agreement that superseded and replaced this employment agreement.
On November 30, 2018, in exchange for the cancellation of 250,000 shares of common stock issued to Tiffany Davis above, the Board
authorized 250,000 non-statutory stock option awards be granted to Ms. Tiffany Davis pursuant to the terms of the Company’s
2018 Stock Incentive Plan, expiring five years from date of issuance and having an exercise price per share equal to $0.69, the
closing price of the Company’s common stock on the date of Board approval. On September 12, 2019, Ms. Tiffany Davis resigned
from the Company. On October 31, 2019, the Board of Directors of the Company reappointed Ms. Tiffany Davis as Chief Executive
Officer, Chief Financial Officer and as a director, effective immediately. In connection with the appointment of Ms. Davis, the
Company granted her options to purchase 833,333 shares of common stock, which vested immediately, expire five years from the date
of issuance, and are exercisable at a price of $0.03 per share. The fair value of the stock options granted was determined to
be $25,261, which was recorded to stock-based compensation expense during the year ended December 31, 2019. Mr. Davis is entitled
to receive stock options of $25,000 of shares per quarter at the then closing market price on the last trading day at the end
of each calendar quarter.
In
August 2018, the Company granted to its executives, Lien and Davis, stock options to purchase an aggregate of 4,034,391 shares
of Common Stock. The fair value of the stock options granted was determined to be $2,164,755, which was recorded to stock-based
compensation expense during the year ended December 31, 2018. The stock options immediately vested on the date of issuance. In
addition, pursuant to the agreements, on the first, second and third anniversaries, (i) Lien shall receive options to purchase
3% of the total number of shares of common stock then outstanding and (ii) Davis shall receive options to purchase 2%, 2% and
3%, respectively, of the total number of shares of common stock then outstanding, with all such options having an exercise price
equal to the closing price of the Company’s common stock on the trading day prior to such anniversary and exercisable for
five years from issuance. In addition, Davis received fully vested options to purchase 750,000 shares of Common Stock, exercisable
for five years at $0.94 per share with a fair value of $516,356. On November 30, 2018, in exchange for the cancellation of the
fully vested stock options to purchase an aggregate of 4,734,891 shares of Common Stock (stock options of 4,034,391 and 750,000
reference above), the Board authorized 4,734,891 fully vested non-statutory stock option awards be granted in aggregate to Lien
and Davis, pursuant to the terms of the Company’s 2018 Stock Incentive Plan, expiring five years from date of issuance and
having an exercise price per share equal to $0.69 the closing price of the Company’s common stock on the date of Board approval.
The
fair value of each option on the date of grant was estimated using the Black-Scholes option pricing model with the following weighted
average assumptions:
|
|
2019
|
|
|
2018
|
|
|
|
|
|
|
|
|
Exercise Price
|
|
$
|
0.03
|
|
|
$
|
0.73
|
|
Stock Price
|
|
$
|
0.03
|
|
|
$
|
0.73
|
|
Risk-free interest rate
|
|
|
1.51
|
%
|
|
|
2.78
|
%
|
Expected volatility
|
|
|
155
|
%
|
|
|
125
|
%
|
Expected life (in years)
|
|
|
5.0
|
|
|
|
3.0
|
|
Expected dividend yield
|
|
|
0
|
%
|
|
|
0
|
%
|
Information
relating to outstanding options at December 31, 2019, summarized by exercise price, is as follows:
|
|
|
Outstanding
|
|
|
Exercisable
|
|
|
|
|
|
|
|
|
|
|
Weighted
|
|
|
|
|
|
Weighted
|
|
|
|
|
|
|
|
|
|
|
Average
|
|
|
|
|
|
Average
|
|
Exercise Price
Per
Share
|
|
|
Shares
|
|
|
Life
(Years)
|
|
|
Exercise
Price
|
|
|
Shares
|
|
|
Exercise
Price
|
|
$
|
0.03
|
|
|
|
833,300
|
|
|
|
4.84
|
|
|
$
|
0.03
|
|
|
|
833,300
|
|
|
$
|
0.03
|
|
$
|
0.46
|
|
|
|
100,000
|
|
|
|
3.95
|
|
|
$
|
0.46
|
|
|
|
100,000
|
|
|
$
|
0.46
|
|
$
|
0.60
|
|
|
|
3,000,000
|
|
|
|
3.11
|
|
|
$
|
0.60
|
|
|
|
3,000,000
|
|
|
$
|
0.60
|
|
$
|
0.69
|
|
|
|
15,000
|
|
|
|
3.92
|
|
|
$
|
0.69
|
|
|
|
5,417
|
|
|
$
|
0.69
|
|
|
|
|
|
|
3,948,300
|
|
|
|
3.16
|
|
|
$
|
0.60
|
|
|
|
3,938,717
|
|
|
$
|
0.48
|
|
As
of December 31, 2019, the Company has outstanding unvested options with future compensation costs of $5,417, which will be recorded
as compensation cost as the options vest over their remaining average vesting period of 2.0 years. In addition, there will be
future compensation related to the options to be awarded to Davis under her employment agreement discussed above. The weighted-average
remaining contractual life of options outstanding and exercisable at December 31, 2019 was 3.1 years. Both the outstanding and
exercisable stock options had no intrinsic value at December 31, 2019.
Summary
of Warrants
A
summary of warrants for the year ended December 31, 2019, is as follows:
|
|
|
|
|
Weighted
|
|
|
|
Number
|
|
|
Average
|
|
|
|
of
|
|
|
Exercise
|
|
|
|
Warrants
|
|
|
Price
|
|
Balance outstanding, December 31, 2017
|
|
|
1,589,500
|
|
|
|
1.10
|
|
Warrants granted
|
|
|
13,500,000
|
|
|
|
0.84
|
|
Warrants exercised
|
|
|
(2,306,360
|
)
|
|
|
0.63
|
|
Warrants expired or forfeited
|
|
|
-
|
|
|
|
-
|
|
Balance outstanding, December 31, 2018
|
|
|
12,783,140
|
|
|
|
0.91
|
|
Warrants granted
|
|
|
5,500,000
|
|
|
|
0.05
|
|
Warrants exercised
|
|
|
-
|
|
|
|
-
|
|
Warrants expired or forfeited
|
|
|
-
|
|
|
|
-
|
|
Balance outstanding, December 31, 2019
|
|
|
18,283,140
|
|
|
$
|
0.06
|
|
Balance exercisable, December 31, 2019
|
|
|
18,283,140
|
|
|
$
|
0.06
|
|
Information
relating to outstanding warrants at December 31, 2019, summarized by exercise price, is as follows:
|
|
|
Outstanding
|
|
|
Exercisable
|
|
|
|
|
|
|
|
|
|
|
Weighted
|
|
|
|
|
|
Weighted
|
|
|
|
|
|
|
|
|
|
|
Average
|
|
|
|
|
|
Average
|
|
Exercise Price Per Share
|
|
|
Shares
|
|
|
Life
(Years)
|
|
|
Exercise
Price
|
|
|
Shares
|
|
|
Exercise
Price
|
|
$
|
0.01
|
|
|
|
5,000,000
|
|
|
|
4.36
|
|
|
$
|
0.01
|
|
|
|
5,000,000
|
|
|
$
|
0.01
|
|
$
|
0.05
|
|
|
|
13,000,000
|
|
|
|
4.45
|
|
|
$
|
0.05
|
|
|
|
13,000,000
|
|
|
$
|
0.05
|
|
$
|
1.10
|
|
|
|
283,000
|
|
|
|
2.81
|
|
|
$
|
1.10
|
|
|
|
283,000
|
|
|
$
|
1.10
|
|
|
|
|
|
|
18,283,140
|
|
|
|
4.20
|
|
|
$
|
0.91
|
|
|
|
12,783,140
|
|
|
$
|
0.06
|
|
During
the year ended December 31, 2019, the Company issued five-year warrants to purchase 5,500,000 shares of common stock at an exercise
price of $0.05 as part of a secured convertible promissory note (see Note 9). The fair value of each option on the date of grant
was estimated using the Black-Scholes option pricing model with the following weighted average assumptions: stock price of $0.02,
risk-free interest rate of 1.65%, expected volatility of 171%, and an expected life of 3.0 years.
During
the year ended December 31, 2018, the Company issued five-year warrants to purchase 5,000,000 shares of common stock at an exercise
price of $0.01 as consideration for an acquisition (see Note 4). The Company also issued five-year warrants to purchase 7,500,000
shares of common stock at an exercise price of $1.50 as part of a secured promissory note (see Note 9). Lastly, in connection
with the SEDA discussed above, the Company issued five-year warrants to YA II PN to purchase 1,000,000 shares of common stock
at an exercise price of $0.01 per share as a commitment fee.
During
the year ended December 31, 2018, the Company issued 2,306,360 shares of its common stock on the conversion of warrants, at $1.10
per share, resulting in proceeds of $1,446,996.
The
weighted-average remaining contractual life of warrants outstanding and exercisable at December 31, 2019 was 4.20 years. The intrinsic
value of both outstanding and exercisable warrants at December 31, 2019 was $20,500.
NOTE
13 – COMMITMENTS AND CONTINGENCIES
Technology
License Agreement
The
Company entered into a Technology License Agreement with a third-party vendor for consulting services. Under the agreement, the
Company will pay the vendor a minimum consulting amount of $100,000 per year, plus a royalty of 7% of all net sales of the vendor’s
products above $1,428,571 per calendar year. For each of the years ended December 31, 2019 and 2018, $100,000 was recorded as
research and development expense under the agreement on the consolidated Statements of Operations related to the minimum annual
fee. For each of years ended December 31 2019 and 2018, no royalty was recorded as cost of goods sold on the Consolidated Statements
of Operations. A total of $190,713 and $190,713 was owed under the amended agreement at December 31, 2019 and 2018, respectively.
Litigation
On
September 25, 2018, Matthew Geschke (the “Plaintiff”) filed a breach of contract case against the Company in the San
Diego Superior Court of San Diego, California, under case number 37-2018-00031350-CU-OE-NC. The Plaintiff claims damages of $335,000
for breach of an employment contract when the Company terminated the Plaintiff’s employment agreement on February 22, 2018.
The case is in the early discovery phase of litigation and no trial date has been set yet. The Company believes the case is without
merit and intends to vigorously define this case.
NOTE
14 – INCOME TAXES
At
December 31, 2019, the Company had available Federal and state net operating loss carryforwards to reduce future taxable income.
The amounts available were approximately $10,075,000 for Federal and state purposes. The carryforwards expire in various amounts
through 2037. Given the Company’s history of net operating losses, management has determined that it is more likely than
not that the Company will not be able to realize the tax benefit of the carryforwards. Accordingly, the Company has not recognized
a deferred tax asset for this benefit. Section 382 generally limits the use of NOLs and credits following an ownership change,
which occurs when one or more 5 percent shareholders increase their ownership, in aggregate, by more than 50 percentage points
over the lowest percentage of stock owned by such shareholders at any time during the “testing period” (generally
three years).
Effective
January 1, 2007, the Company adopted FASB guidelines that address the determination of whether tax benefits claimed or expected
to be claimed on a tax return should be recorded in the financial statements. Under this guidance, we may recognize the tax benefit
from an uncertain tax position only if it is more likely than not that the tax position will be sustained on examination by the
taxing authorities, based on the technical merits of the position. The tax benefits recognized in the financial statements from
such a position should be measured based on the largest benefit that has a greater than fifty percent likelihood of being realized
upon ultimate settlement. This guidance also provides guidance on de-recognition, classification, interest and penalties on income
taxes, accounting in interim periods and requires increased disclosures. At the date of adoption, and as of December 31, 2019
and 2018, the Company did not have a liability for unrecognized tax benefits, and no adjustment was required at adoption.
The
Company’s policy is to record interest and penalties on uncertain tax provisions as income tax expense. As of December 31,
2019, and 2018, the Company has not accrued interest or penalties related to uncertain tax positions. Additionally, tax years
2016 through 2019 remain open to examination by the major taxing jurisdictions to which the Company is subject.
Upon
the attainment of taxable income by the Company, management will assess the likelihood of realizing the tax benefit associated
with the use of the carryforwards and will recognize the appropriate deferred tax asset at that time.
The
Company’s effective income tax rate differs from the amount computed by applying the federal statutory income tax rate to
loss before income taxes as follows:
|
|
December 31, 2019
|
|
|
December 31, 2018
|
|
|
|
|
|
|
|
|
Income tax benefit at federal statutory rate
|
|
|
(21.0
|
)%
|
|
|
(21.0
|
)%
|
State income tax benefit, net of federal benefit
|
|
|
(6.0
|
)%
|
|
|
(6.0
|
)%
|
Change in valuation allowance
|
|
|
27.00
|
%
|
|
|
27.00
|
%
|
|
|
|
|
|
|
|
|
|
Income taxes at effective tax rate
|
|
|
-
|
|
|
|
-
|
%
|
The
components of deferred taxes consist of the following at December 31, 2019 and 2018:
|
|
December 31, 2019
|
|
|
December 31, 2018
|
|
|
|
|
|
|
|
|
Inventory reserves
|
|
$
|
212,000
|
|
|
$
|
798,000
|
|
Allowance for doubtful accounts and returns
|
|
|
9,000
|
|
|
|
(297,000
|
)
|
Depreciation and amortization
|
|
|
(53,000
|
)
|
|
|
(271,000
|
)
|
Net operating loss carryforwards
|
|
|
2,721,000
|
|
|
|
1,430,000
|
|
Less: Valuation allowance
|
|
|
(2,889,000
|
)
|
|
|
(1,600,000
|
)
|
|
|
|
|
|
|
|
|
|
Net deferred tax assets
|
|
$
|
-
|
|
|
$
|
-
|
|
NOTE
15 – SUBSEQUENT EVENTS
Relocation
of Principal Executive Offices and Warehouse
Effective
January 1, 2020, our principal executive offices and warehouse are located at 1689-A Arrow Rt., Upland, CA 91786. We occupy a
2,974 square foot facility pursuant to a four-year lease with an independent party ending on January 31, 2023, with an unaffiliated
party, pursuant to which we pay $2,825 per month in rental charges.
Secured
Convertible Note Payable
On
February 13, 2020, the Company issued a secured convertible debenture (the “2020 Note”) in the amount of $150,000.
The Note bears interest at a rate of 10% per annum (15% on default) and has a maturity date of August 10, 2021. The 2020 Note
is secured by all the assets of the Company and its subsidiaries. The 2020 Note provides a conversion right, in which any portion
of the principal amount of the 2020 Note, together with any accrued but unpaid interest, may be converted into the Company’s
common stock at a conversion price equal to 75% of the lowest VWAP of the Company’s common stock during the ten (10) trading
days immediately preceding the date of conversion, subject to adjustment. As part of the issuance, the Company also granted YA
II PN 5-year warrants to purchase a total of 3,000,000 shares of the Company at an exercise price of $0.05 per common share. The
Warrant expires on February 13, 2025.
Common
Shares Issued
On
April 6, 2020, the Company issued 166,667 shares of common stock to a director, with a fair value of $1,667.
Subsequent
to December 31, 2019, YA II PN (see Note 9) elected to convert $29,000 of outstanding interest into 2,287,066 shares of the Company’s
common at $0.0127 per share.
COVID-19
The
outbreak of communicable diseases, such as a new virus known as the Coronavirus (COVID-19), could result in a widespread health
crisis that could adversely affect general commercial activity and our business. An outbreak of communicable diseases in the region
that we operate or regions from which our customers travel from or through, or the perception that such an outbreak could occur,
and the measures taken by the governments of countries affected, including restricting air travel and other means of transportation,
imposing quarantines and curfews and requiring the closure of our offices or other businesses, including office buildings, theatres,
retail stores and other commercial venues, could adversely affect our business, financial condition or results of operations.