NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER
30, 2018 AND 2017 (UNAUDITED)
NOTE
1 – BASIS OF PRESENTATION
The
accompanying unaudited condensed consolidated financial statements of Generation Alpha, Inc. and its subsidiaries (the “Company”)
have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial
information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the
information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion
of management, all normal recurring adjustments considered necessary for a fair presentation have been included. Operating results
for the three and nine months ended September 30, 2018 are not necessarily indicative of the results that may be expected for
the year ending December 31, 2018.
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. 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.
Name
Change and Merger Agreement
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.
As
permitted by Chapter 92A.180 of Nevada Revised Statutes, the purpose of the Merger was to effect a change of the Company’s
name from “Solis Tek Inc.” to “Generation Alpha, Inc.” On September 24, 2018, the Company filed articles
of merger with the Secretary of State of Nevada, which were effective September 25, 2018, to effect the Merger, and the Company’s
Articles of Incorporation were deemed amended to reflect the change in the Company’s corporate name (the “Name Change”).
In
connection with the foregoing, the Company filed an Issuer Company-Related Action Notification Form with the Financial Industry
Regulatory Authority (“FINRA”), requesting confirmation of the Name Change and also to request the change of the Company’s
ticker symbol from “SLTK” to “GNAL” (the “Symbol Change”).
The
Name Change and Symbol Change do not affect the rights of the Company’s security holders. The Company’s securities
will continue to be quoted on the OTC Markets. Following the Name Change, the stock certificates, which reflect the former name
of the Company, will continue to be valid. Certificates reflecting the Name Change will be issued in due course as old stock certificates
are tendered for exchange or transfer to the Company’s transfer agent.
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. For nearly a decade, growers have used the Company’s lighting solutions to increase yield, lower costs and
grow better to maximize their return on investment. More recently, the Company’s Zelda Horticulture nutrient division has
provided an expanding product mix to the Company’s offerings. The Company’s lighting and nutrient customers include
retail stores, distributors and commercial growers in the United States and abroad. In early 2018, the Company announced its expansion
into the “touch-the-plant” side of the cannabis business with its present build-out of an existing facility in Phoenix,
Arizona to be utilized as both a cultivation site and processing platform. This operation is under a contract with an Arizona
licensee and is expected to be revenue generating in early 2019.
Going
Concern
The
accompanying condensed 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
condensed consolidated financial statements, during the nine months ended September 30, 2018, the Company incurred an operating
loss of $14,087,704, used cash in operations of $2,719,100 and had a shareholders’ deficit of $4,483,160 as of September
30, 2018. 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. In addition, the Company’s
independent registered public accounting firm, in its report on the Company’s December 31, 2017 consolidated financial statements,
raised substantial doubt about the Company’s ability to continue as a going concern.
At
September 30, 2018, the Company had cash on hand in the amount of $2,053,399. On April 16, 2018, the Company entered in a Standby
Equity Distribution Agreement (“SEDA”) that may provide it with additional funds (See Note 12). Management estimates
that the current funds on hand will be sufficient to continue operations through December 2018. 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 its operations, in the case of debt financing or cause substantial dilution for the Company’s
shareholders, in case of 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”),
and entity incorporated under the laws of the State of California, and YLK Partners NV, LLC (“YLK”), an entity formed
under the laws of Nevada. Intercompany transactions and balances have been eliminated in consolidation.
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.
For
the nine months ended September 30, 2018, options to acquire 7,784,391 shares of common stock and warrants to acquire 13,783,140
shares of common stock have been excluded from the calculation of weighted average common shares outstanding at September 30,
2018, as their effect would have been anti-dilutive. For the nine months ended September 30, 2017, options to acquire 3,000,000
shares of common stock have been excluded from the calculation of weighted average common shares outstanding at September 30,
2017, 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, impairment
testing of long lived assets, valuing equity instruments issued for services and valuation allowance for deferred tax assets,
among others. Actual results could differ from these estimates.
Revenue
Recognition
In
September 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”)
No. 2014-09 regarding revenue recognition. The new 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. The ASU
became effective January 1, 2018. Due to the nature of the products sold by the Company, the adoption of the new standard has
had no quantitative effect on the financial statements. However, the guidance requires additional disclosures to help users of
financial statements better understand the nature, amount, timing, and uncertainty of revenue that is recognized.
The
Company recognizes revenue upon shipment of the Company’s products to its customers, provided that evidence of an arrangement
exists, title and risk of loss have passed to the customer, fees are fixed or determinable, and collection of the related receivable
is reasonably assured. Title to the Company’s products primarily is transferred to the customer once the product is shipped
from the Company’s warehouses. Products are not shipped until there is a written agreement with the customer with a specified
payment arrangement. Any discounts that are offered are done as a reduction of the invoiced amount at the time of billing. Payments
received before all of the relevant criteria for revenue recognition are satisfied are recorded as customer deposits.
Under
the new 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.
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 September 30, 2018 and December 31, 2017, the Company recorded reserves for returned
product in the amounts of $116,857 and $114,119, respectively, which reduced the accounts receivable balances as of those periods.
Concentration
Risks
The
Company maintains the majority of its cash balances with one financial institution, in the form of demand deposits. At September
30, 2018 and December 31, 2017, 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 nine months ended September 30, 2018 and 2017,
its ballasts, lamps and reflectors, which comprised the majority of the Company’s purchases during those periods, were each
only purchased from one separate vendor. The ballast vendor is a former related party (see Note 5).
The
Company performs a regular review of customer activity and associated credit risks and does not require collateral or other arrangements.
Two customers accounted for 19.0% and 13.0%, respectively, of the Company’s revenue for the three months ended September
30, 2018, and for the three months ended September 30, 2017, no customer accounted for more than 10% of the Company’s revenue.
Shipments to customers outside the United States comprised 3.3% and 0.1% for the three months ended September 30, 2018 and 2017,
respectively. One customer accounted for 12.1% of the Company’s revenue for the nine months ended September 30, 2018, and
for the nine months ended September 30, 2017, no customer accounted for more than 10% of the Company’s revenue. Shipments
to customers outside the United States comprised 4.7% and 2.6% for the nine months ended September 30, 2018 and 2017, respectively.
As
of September 30, 2018, one customer accounted for 12.9% of the Company’s trade accounts receivable balance, and as of December
31, 2017, four customers accounted for 17.1%, 14.8%, 14.5% and 14.3%, respectively, 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
fair value of the derivative liabilities of $6,617,284 and $7,415,000 at September 30, 2018 and December 31, 2017, 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
September 30, 2018, the Company had intangible assets of $1,382,941 (see Note 4) that consist of a license right. Management believes
there were no indications of impairment based on management’s assessment of these assets at that date. Factors the Company
considers important that could trigger an impairment review include significant underperformance relative to historical or projected
future operating results, significant changes in the manner of the use of its assets or the strategy for the Company’s overall
business, and significant negative industry or economic trends. If current economic conditions worsen causing a decrease in anticipated
revenues and/or increased costs, the Company may have to record an impairment to its intangible assets.
Recently
Issued Accounting Pronouncements
In
February 2016, the FASB issued ASU No. 2016-02, Leases (“ASU 2016-02”). ASU 2016-02 requires a lessee to record a
right of use asset and a corresponding lease liability on the balance sheet for all leases with terms longer than 12 months. ASU
2016-02 is effective for all interim and annual reporting periods beginning after December 15, 2018. Early adoption is permitted.
A modified retrospective transition approach is required for lessees for capital and operating leases existing at, or entered
into after, the beginning of the earliest comparative period presented in the financial statements, with certain practical expedients
available. The Company is in the process of evaluating the impact of ASU 2016-02 on the Company’s financial statements and
disclosures.
In
July 2017, the FASB issued ASU No. 2017-11, “Earnings Per Share (Topic 260); Distinguishing Liabilities from Equity (Topic
480); Derivatives and Hedging (Topic 815): (Part I) Accounting for Certain Financial Instruments with Down Round Features; (Part
II) Replacement of the Indefinite Deferral for Mandatorily Redeemable Financial Instruments of Certain Nonpublic Entities and
Certain Mandatorily Redeemable Noncontrolling Interests with a Scope Exception” (“ASU 2017-11”). ASU 2017-11
allows companies to exclude a down round feature when determining whether a financial instrument (or embedded conversion feature)
is considered indexed to the entity’s own stock. As a result, financial instruments (or embedded conversion features) with
down round features may no longer be required to be accounted for as derivative liabilities. A company will recognize the value
of a down round feature only when it is triggered, and the strike price has been adjusted downward. For equity-classified freestanding
financial instruments, an entity will treat the value of the effect of the down round as a dividend and a reduction of income
available to common shareholders in computing basic earnings per share. For convertible instruments with embedded conversion features
containing down round provisions, entities will recognize the value of the down round as a beneficial conversion discount to be
amortized to earnings. ASU 2017-11 is effective for fiscal years beginning after December 15, 2018, and interim periods within
those fiscal years. Early adoption is permitted. The guidance in ASU 2017-11 can be applied using a full or modified retrospective
approach. The Company is currently evaluating the impact of the adoption of ASU 2017-11 on the Company’s financial statement
presentation and disclosures.
Other
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 did not or 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 consists of the following September 30, 2018 and December 31, 2017:
|
|
|
September
30, 2018
|
|
|
December
31, 2017
|
|
|
|
|
|
|
|
|
|
|
Machinery and equipment
|
|
$
|
198,455
|
|
|
$
|
234,706
|
|
|
Computer equipment
|
|
|
12,448
|
|
|
|
12,448
|
|
|
Furniture and fixtures
|
|
|
82,779
|
|
|
|
97,451
|
|
|
Leasehold improvements
|
|
|
431,819
|
|
|
|
7,000
|
|
|
|
|
|
725,501
|
|
|
|
351,605
|
|
|
Less: accumulated
depreciation
|
|
|
(215,532
|
)
|
|
|
(213,362
|
)
|
|
Property and
equipment, net
|
|
$
|
509,969
|
|
|
$
|
138,243
|
|
Depreciation
expense for the three and nine months ended September 30, 2018 was $13,066 and $44,134, respectively, and depreciation expense
for the three and nine months ended September 30, 2017 was $17,480 and $53,111, respectively. During the nine months ended September
30, 2018, the Company sold certain of its property and equipment for $28,500. The book value of the property and equipment was
$26,100, resulting in a gain on the sale of property and equipment of $2,400.
Property
and equipment include assets acquired under capital leases of $64,632 and $64,632 at September 30, 2018 and December 31, 2017,
respectively.
NOTE
4 – LICENSE AGREEMENT ACQUIRED FROM RELATED PARTIES
License
agreement acquired from related parties as of September 30, 2018 and December 31, 2017, consisted of the following:
|
|
|
As
of
|
|
|
|
|
September
30, 2018
|
|
|
December
31, 2017
|
|
|
License agreement
|
|
$
|
1,518,523
|
|
|
$
|
-
|
|
|
Accumulated amortization
|
|
|
(135,582
|
)
|
|
|
-
|
|
|
Intangible assets,
net
|
|
$
|
1,382,941
|
|
|
$
|
-
|
|
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 one of the YLK investors.
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 amount of these payments of $1,518,523 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 both the three and nine months ended September 30, 2018 was $54,235 and $135,584, 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 condensed consolidated statements of operations. The $250,000 receivable was received by the Company during the nine
month period ended September 30, 2018.
As
of September 30, 2018, the remaining Management Agreement obligation was $777,113 (net of discount of $72,887), for which $331,818
was reflected as current and $445,295 was reflected as long term in the accompanying condensed consolidated balance sheet.
NOTE
5 - RELATED PARTY TRANSACTIONS
Supplier
(Former Related Party)
A
family member of an officer/shareholder owned a minority interest in a company in China, which is the sole supplier of ballasts
to the Company. Purchases from the supplier for the three and nine months ended September 30, 2018 totaled approximately $381,000
and $1,478,000, and $1,411,000 and $2,913,000, respectively, for the three and nine months ended September 30, 2017. The Company
believes purchase prices from this vendor approximated what the Company would have to pay from an independent third party vendor.
In 2017, the Company determined that due to a change in relationship status, this vendor that was formerly considered a related
party, was deemed to no longer be a related party. At September 30, 2018 and December 31, 2017, the Company owed the former related
party $0 and $381,457, respectively. At September 30, 2018 and December 31, 2017, the Company had made advanced deposit payments
to this vendor for $540,090 and $735,730, respectively, which will be applied to purchase inventory upon delivery.
Due
to Related Parties
As
of September 30, 2018 and December 31, 2017, the Company owed related parties $124,117 and $146,534, respectively. The balances
are interest owed on notes payable to related parties (see Note 6). During the nine months ended September 30, 2018, the Company
added $52,889 of additional accrued interest and made interest payments of $75,306.
NOTE
6 – NOTES PAYABLE TO RELATED PARTIES
Notes
payable to related parties consists of the following at September 30, 2018 and December 31, 2017:
|
|
|
September
30, 2018
|
|
|
December
31, 2017
|
|
|
|
|
|
|
|
|
|
|
Notes payable to officers/shareholders
(a)
|
|
$
|
-
|
|
|
$
|
195,000
|
|
|
Notes payable to officers/shareholders
(b)
|
|
|
600,000
|
|
|
|
600,000
|
|
|
Notes payable to related parties (c)
|
|
|
-
|
|
|
|
300,000
|
|
|
Notes payable
to related parties (d)
|
|
|
40,000
|
|
|
|
50,000
|
|
|
Total
|
|
$
|
640,000
|
|
|
$
|
1,145,000
|
|
|
|
a.
|
On
July 1, 2012, the Company entered into a notes payable agreement with Lydia Hao, who is the mother of Alvin Hao, the Company’s
executive vice president and a director. The maximum borrowings allowed under the note are $200,000. Through December 31,
2013, the note bore interest at 20% per annum. Beginning on January 1, 2014, the interest rate on the note was reduced to
8% per annum. The note is due 30 days after demand. Amounts owed on the note balance were $195,000 at December 31, 2017. During
the nine months ended September 30, 2018, the Company made payments of $195,000 and the notes were retired.
|
|
|
|
|
|
|
b.
|
On
May 9, 2016, the Company entered into note payable agreements with Alan Lien and Alvin Hao, each an 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 September 30,
2018 and December 31, 2017, respectively.
|
|
|
|
|
|
|
c.
|
In
February 2017, the Company executed two separate promissory notes and borrowed $300,000 from the relatives of Alan Lien, the
Company’s Chief Executive Officer and one of its directors. The notes are unsecured, payable on demand and carry an
interest rate of 14% per annum. A total of $300,000 was outstanding on the combined notes at December 31, 2017. During the
nine months ended September 30, 2018, the Company made payments of $300,000 and the notes were retired.
|
|
|
|
|
|
|
d.
|
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. A total
of $50,000 was due on the loans as of each of December 31, 2017 and 2016. During the nine months ended September 30, 2018,
the Company made payments of $10,000, leaving a balance due of $40,000 as of September 30, 2018. The loans are currently past
due.
|
NOTE
7 – LOANS PAYABLE
Loans
payable consist of the following as of September 30, 2018 and December 31, 2017:
|
|
|
September
30, 2018
|
|
|
December
31, 2017
|
|
|
|
|
|
|
|
|
|
|
Automobile loans
|
|
$
|
3,383
|
|
|
$
|
25,957
|
|
|
Less: current
portion
|
|
|
(3,383
|
)
|
|
|
(8,476
|
)
|
|
Non-current portion
|
|
$
|
-
|
|
|
$
|
17,481
|
|
In
2015, the Company entered into two loan agreements to purchase automobiles. The combined principal amount of the loans was $44,093
and they mature by November 2021. During the nine months ended September 30, 2018, the Company made payments of $22,574, which
included payment in full on one of its automobile loans, leaving one remaining loan. A total of $3,383 and $25,957 was owed on
the loans as of September 30, 2018 and December 31, 2017, respectively.
NOTE
8 – SECURED NOTE PAYABLE TO RELATED PARTY
Secured
note payable to related party consists of the following as of September 30, 2018 and December 31, 2017:
|
|
|
September
30, 2018
|
|
|
December
31, 2017
|
|
|
|
|
|
|
|
|
|
|
YA II PN, Ltd.
|
|
$
|
1,500,000
|
|
|
$
|
-
|
|
|
Less debt discount
|
|
|
(747,032
|
)
|
|
|
-
|
|
|
Secured note
payable, net
|
|
$
|
752,968
|
|
|
$
|
-
|
|
On
May 10, 2018, the Company issued a secured debenture (the “2018 Note”) to 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 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 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 nine months ended September 30, 2018.
During
the nine months ended September 30, 2018, amortization of debt discount was $752,968 and was recorded as an interest cost. The
unamortized balance of the debt discount was $747,032 as of September 30, 2018.
NOTE
9 – CONVERTIBLE NOTE PAYABLE TO RELATED PARTY
Convertible
note payable to related party consist of the following as of September 30, 2018 and December 31, 2017:
|
|
|
September
30, 2018
|
|
|
December
31, 2017
|
|
|
|
|
|
|
|
|
|
|
YA II PN, Ltd.
|
|
$
|
-
|
|
|
$
|
1,750,000
|
|
|
Less debt discount
|
|
|
-
|
|
|
|
(1,555,556
|
)
|
|
Convertible note
payable, net
|
|
$
|
-
|
|
|
$
|
194,444
|
|
On
November 8, 2017, the Company issued a secured convertible debenture (the “2017 Note”) to YA II PN in the principal
amount of $1,750,000 with interest at 5% per annum (15% on default) and due 18 months from closing. The 2017 Note is secured by
all the assets of the Company and its subsidiaries. The 2017 Note is convertible into common stock of the Company at $1.00 per
share (the “Conversion Price”), subject to adjustment based on upon the Company’s trading price. As part of
the issuance, the Company also granted YA II PN a 5-year warrant to purchase 1,137,500 shares of the Company at $1.10 per share
The
Company paid 5% of aggregate funding as a commitment fee to YA II PN and $15,000 towards due diligence and structuring fee. The
Company netted $1,647,500 after fees and expenses of $102,500.
The
Company determined that since the adjustment to the Conversion Price of the 2017 Note had no floor, the Company could no longer
determine if it had enough authorized shares to fulfil the conversion obligation. Furthermore, 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 such, the Company determined that the conversion feature and the warrants created a derivative
with a fair value of $3,767,724 at the date of issuance. The Company accounted for the fair value of the derivative up to the
face amount of the 2017 Note of $1,750,000 as a valuation discount to be amortized over the life of the 2017 Note, and the excess
of $2,017,724 being recorded as a finance cost during the year ended December 31, 2017.
The
unamortized balance of the debt discount was $1,555,556 as of December 31, 2017. In April 2018, YA II PN notified the Company
in writing that it elected to convert all remaining outstanding principal and interest accrued and otherwise payable under the
2017 Note, which included the conversion of $1,750,000 of principal and $38,082 of interest. Upon the conversion of the 2017 Note,
the Company issued an aggregate of 1,788,082 shares of its common stock to YA II PN and the 2017 Note and the security agreement
were both terminated and all security interest and liens under the security agreement were released and terminated. The balance
of the debt discount of $1,555,556 was recorded as an interest cost during the period ended September 30, 2018.
NOTE
10 – SERIES-A CONVERTIBLE PREFERRED STOCK AND WARRANTS
Series-A
Convertible Preferred Shares consisted of the following as of September 30, 2018 and December 31, 2017:
|
|
|
September
30, 2018
|
|
|
December
31, 2017
|
|
|
|
|
|
|
|
|
|
|
5% Series-A preferred stock, $0.0001 par value,
none and 351,000 shares issued and outstanding as of September 30, 2018 and December 31, 2017
|
|
$
|
-
|
|
|
$
|
351,000
|
|
|
Discount relating
to fair value of conversion feature and warrants granted upon issuance
|
|
|
-
|
|
|
|
(351,000
|
)
|
|
Preferred stock
|
|
$
|
-
|
|
|
$
|
-
|
|
In
October 2017, the Company conducted a private offering to raise up to $3,000,000 in convertible Preferred Series-A stock. Each
unit consisted of (i) three shares of Series-A Convertible Preferred Stock of the Company (the “Series-A”) and (ii)
a warrant to purchase 1,936 shares of the Company’s common stock at $1.25 per share (the “Series-A Warrants”).
Each Series-A share is convertible into such number of share of common stock of the Company equal to the stated value of $1,050
divided by the conversion price. The conversion price is the lesser of $1.00 per share or 80% of the VWAP of the 10 trading days
prior to conversion. The Series A shares also contained a number of automatic conversion features based on achievement of market
and other conditions. On October 24, 2017 FirstFire Global Opportunities Fund LLC (“FirstFire”) purchased 117 Units,
which consisted of 351,000 Series-A shares and Series-A Warrants to purchase 283,140 shares of common stock for $351,000. The
Company received a total of $295,410 after fees and expenses. The Series-A offering was terminated after this issuance.
As
part of the issuance, the Company initially granted Series-A Warrants to purchase 226,512 shares of common stock to FirstFire.
The Company subsequently issued 56,628 additional Series-A Warrants to FirstFire as part of the offering, bringing the total Series-A
Warrants issued to them to 283,140. The Series-A Warrants are exercisable at $1.25 per share and will expire in five years. The
exercise price, and the number of warrants to be issued, are subject to adjustment. The exercise price of the Series-A Warrants
is subject to a reset provision (down round protection) in the event the Company issues similar debt or equity instruments with
a price lower than $1.25 per share. The number of Series-A Warrants shall also be increased upon the occurrence of certain events.
The
Company considered the accounting guidance and determined the appropriate treatment is to account the Series-A conversion feature
as a liability since the instrument is convertible into a variable number of shares (i.e. the conversion price continuously reset)
and that the Company could no longer determine if it had enough authorized shares to fulfil the conversion obligation. Furthermore,
the Company determined that the exercise price of the Series A Warrants were not a fixed amount because they were subject to an
adjustment based on the occurrence of future offerings or events. As such, the Company determined that the conversion feature
of the Series-A preferred stock had a fair value of $564,000 at issuance, and the fair value of 283,140 Series-A Warrants had
a fair value of $338,358 at issuance, which created a derivative with an aggregate fair value of $902,358 at the date of issuance.
The Company accounted for the fair value of the derivative up to the face amount of the preferred as a reduction of the fair value
of the preferred stock of $295,410, and the excess of $606,948 was recorded as a deemed dividend and a charge to paid in capital
during the year ended December 31, 2017.
In
November 2017, FirstFire informed the Company that it was exercising its right to participate in the YA II PN debt offering described
in Note 7. However, YA II PN refused and threatened to back out of the offering if FirstFire was included in it. The YA II PN
debt offering was consummated without FirstFire. In December 2017, as a settlement with FirstFire for not to exercising its right
to participate in the YA II PN debt offering, the Company granted FirstFire warrants to purchase 166,860 shares of common stock
at $1.00 per share. The warrant contained “down-round/reset” provisions (both exercise price and number of shares)
in the event the Company issues similar instrument at a price lower than $1.25 per shares, and as such, is subject to derivative
liability accounting. The Company determined that the issuance of these additional warrants was part of a negotiated settlement
with FirstFire, and recorded the fair value of the warrants of $199,000 as a liability and as a financing cost during the year
ended December 31, 2017.
The
Company also considered the guidance of ASC 480-10-S99-3A, and determined that as redemption is outside control of the issuer
as the conversion price not fixed, such preferred shares should be recognized outside of permanent equity.
During
the nine months ended September 30, 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 September 30, 2018. Upon conversion,
the unamortized discount of $351,000 was reflected as an interest cost.
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 September 30, 2018, and December 31, 2017, 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:
|
|
|
September
30, 2018
|
|
|
Issued
During 2018
|
|
|
December
31, 2017
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Exercise Price
|
|
$
|
0.49
– 1.50
|
|
|
$
|
1.50
|
|
|
$
|
1.10
– 1.25
|
|
|
Stock Price
|
|
$
|
0.95
|
|
|
$
|
1.09
|
|
|
$
|
2.23
|
|
|
Risk-free interest rate
|
|
|
2.91-2.94
|
%
|
|
|
2.83
|
%
|
|
|
1.76-2.20
|
%
|
|
Expected volatility
|
|
|
126
– 138
|
%
|
|
|
171
|
%
|
|
|
172
|
%
|
|
Expected life (in years)
|
|
|
4.06
– 4.61
|
|
|
|
5.0
|
|
|
|
1.30
– 5.00
|
|
|
Expected dividend yield
|
|
|
0
|
%
|
|
|
0
|
%
|
|
|
0
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Warrants
|
|
$
|
6,617,284
|
|
|
$
|
7,677,406
|
|
|
$
|
3,000,000
|
|
|
Convertible debt
|
|
|
-
|
|
|
|
-
|
|
|
|
3,633,000
|
|
|
Series-A Preferred
Stock
|
|
|
-
|
|
|
|
-
|
|
|
|
782,000
|
|
|
Fair Value:
|
|
$
|
6,617,284
|
|
|
$
|
7,677,406
|
|
|
$
|
7,415,000
|
|
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 nine months ended September 30, 2018, the Company recognized $4,286,692 as other income, which represented the change in the
fair value of the derivative from the respective prior period. In addition, during the nine months ended September 30, 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 was recorded to additional paid-in-capital. In addition, the Company recognized
derivative liabilities of $7,677,406 upon issuance of warrants (see Note 8).
NOTE
12 – SHAREHOLDERS’ EQUITY
Common
shares issued for cash
During
the nine months ended September 30, 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 nine months ended September 30, 2018, the Company issued an aggregate of 1,310,000 shares of
common stock to these consultants with a fair value of $1,636,000 at date of grant, which was recognized as compensation cost.
Common
shares issued to directors and employees for services
Board
of Directors Appointments
On
August 22, 2018, the Board of Directors (the “Board”) of the Company appointed Mr. Peter Najarian and Ms. Tiffany
Davis as directors of the Company, effective immediately. In connection with the appointments, the Company issued an aggregate
of 200,000 shares of common stock valued at $148,000, or $0.74 per share, and recorded to stock based compensation expense during
the period ended September 30, 2018.
Executive
Employment Agreements
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 nine months
ended September 30, 2018. As discussed in Note 13 below, on August 22, 2018, Ms. Davis entered into an employment agreement that
superseded and replaced this employment agreement.
Former
Chief Compliance Officer
On
December 27, 2017, the Company entered into a four-year employment agreement with Stanley L. Teeple as the Company’s Chief
Compliance Officer. As part of the Employment Agreement, Mr. Teeple 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 $1,710,000, of which $427,500
was recorded as stock-based compensation during the year ended December 31, 2017, and $285,000 was recorded as stock-based compensation
during the nine months ended September 30, 2018. Stanley Teeple resigned as the Company’s Chief Compliance Officer, Secretary
and Senior Vice President, effective August 31, 2018, and the obligation to issue the remaining 750,000 shares and corresponding
remaining future amortization of stock-based compensation ceased.
Former
Chief Executive Officer
On
January 6, 2017, the Company extended an offer to Dennis G. Forchic to become the Company’s Chief Executive Officer. Mr.
Forchic accepted the offer and contracts were executed on March 27, 2017. As part of the Employment Agreement, the Company issued
a total of 5,411,765 shares valued at $2,760,000. In addition, Mr. Forchic purchased an additional 784,314 shares valued at $400,000
for a consideration of $100,000. The fair value of the shares on the date of grant over consideration received was $300,000, which
was recorded as stock compensation expense during the nine months ended September 30, 2017. In addition, Mr. Forchic was granted
an option to purchase 3,000,000 shares at $0.60 per share, with 33.3% of these shares vesting on the one year anniversary of the
date of grant and the remainder vesting in equal installments at the end of each month over the next three years. The options
were valued at $835,767 using a Black Scholes options pricing model and was being amortized as an expense over the vesting period.
The unamortized portion of this award as of December 31, 2017 was $561,671.
On
February 5, 2018, the Company terminated its employment agreement with Mr. Dennis G. Forchic, its Chief Executive Officer and
a member of the Company’s Board of Directors. In accordance with the severance terms of his Employment Agreement: (i) all
3,000,000 Options previously granted to Mr. Forchic were terminated as they had not vested; (ii) the Company will pay Mr. Forchic
at the annual rate of $162,000 per annum, from February 5, 2018 through the fourth anniversary date of the Employment Agreement;
and, (iii) the Company will reimburse Mr. Forchic for each month until the fourth anniversary of January 6, 2017, an amount equal
to 50% of Employee’s health care coverage, to the extent such coverage was in place as at February 5, 2018.
During
the nine months ended September 30, 2018, the Company recorded a charge of $561,671 of stock-based compensation related to the
immediate vesting of 2,000,000 previously unvested stock options, and $449,000 related to Mr. Forchic’s remaining salary
obligation. The total charge of $1,010,671 is included in selling, general and administrative expenses in the accompanying condensed
consolidated financial statements.
Employee
Employment Agreement
In
November 2015, the Company entered into a four-year employment agreement with one of its employees, in which the employee was
granted 500,000 shares of the Company’s common stock. The shares vest equally in six-month periods over the four years.
The fair value of the shares on the date of grant was $400,000, which was being amortized ratably over the four-year service period.
This employee was terminated February 27, 2018, and the remaining 250,000 share obligation ceased. The amount amortized as stock-based
compensation expense during the nine months ended September 30, 2018 was $16,667.
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 Condensed Consolidated Statements of Operations
for the nine months ended September 30, 2018. Subsequent to September 30, 2018, the Fee Warrant was exercised (see Note 14).
The
Company cannot sell shares of common stock to YA II PN under the SEDA until a registration statement is declared effective by
the Securities and Exchange Commission.
Summary
of Stock Options
A
summary of stock options for the nine months ended September 30, 2018, is as follows:
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Weighted
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Number
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|
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Average
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|
|
|
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of
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|
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Exercise
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|
|
|
|
Options
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Price
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Balance outstanding,
December 31, 2017
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3,000,000
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|
|
$
|
0.60
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|
|
Options granted
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|
|
4,784,391
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|
|
|
0.77
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|
|
Options exercised
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|
-
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|
|
|
-
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Options expired
or forfeited
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-
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|
|
-
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Balance outstanding,
September 30, 2018
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|
|
7,784,391
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|
|
$
|
0.71
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|
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Balance exercisable,
September 30, 2018
|
|
|
7,784,391
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|
|
$
|
0.71
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|
Information
relating to outstanding options at September 30, 2018, summarized by exercise price, is as follows:
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Outstanding
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Exercisable
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|
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|
|
|
|
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Weighted
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|
|
|
|
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Weighted
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|
|
|
|
|
|
|
|
|
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Average
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|
|
|
|
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Average
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Exercise
Price Per Share
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|
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Shares
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|
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Life
(Years)
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|
|
Exercise
Price
|
|
|
Shares
|
|
|
Exercise
Price
|
|
|
$
|
0.60
|
|
|
|
3,000,000
|
|
|
|
4.36
|
|
|
$
|
0.60
|
|
|
|
3,000,000
|
|
|
$
|
0.60
|
|
|
$
|
0.74
|
|
|
|
4,034,391
|
|
|
|
4.89
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|
|
$
|
0.74
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|
|
|
4,034,391
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|
|
$
|
0.74
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|
|
$
|
0.94
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|
|
|
750,000
|
|
|
|
4.91
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|
|
$
|
0.94
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|
|
|
750,000
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|
|
$
|
0.94
|
|
|
|
|
|
|
|
7,784,391
|
|
|
|
4.72
|
|
|
$
|
0.71
|
|
|
|
7,784,391
|
|
|
$
|
0.71
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|
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 (see Note 13
Executive Agreements
). 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 nine month period ended September 30,
2018. The stock options immediately vested on the date of issuance. The fair value of the stock options was calculated using the
Black-Scholes option pricing model using the following assumptions – stock price of $0.74; exercise price of $0.74; expected
life of 3 years; volatility of 123.1%; dividend rate of 0.0% and discount rate of 2.7%. 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
February 5, 2018, the Company terminated its employment agreement with Mr. Forchic, and per the terms of the employment agreement,
2,000,000 unvested option immediately vested, resulting in a stock-based compensation charge of $561,671 during the nine month
period ended September 30, 2018.
As
of September 30, 2018, the Company had no outstanding unvested options with future compensation costs. However, there will be
future compensation related to the options to be awarded to Lien and Davis under their employment agreements discussed above.
The weighted-average remaining contractual life of options outstanding and exercisable at September 30, 2018 was 4.72 years. The
intrinsic value of both outstanding and exercisable options at September 30, 2018 was $1,889,000.
Summary
of Warrants
A
summary of warrants for the nine months ended September 30, 2018, is as follows:
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Weighted
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|
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Number
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|
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Average
|
|
|
|
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of
|
|
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Exercise
|
|
|
|
|
Warrants
|
|
|
Price
|
|
|
Balance outstanding,
December 31, 2017
|
|
|
1,589,500
|
|
|
$
|
1.10
|
|
|
Warrants granted
|
|
|
13,500,000
|
|
|
|
0.84
|
|
|
Warrants exercised
|
|
|
(1,306,360
|
)
|
|
|
1.10
|
|
|
Warrants expired
or forfeited
|
|
|
-
|
|
|
|
-
|
|
|
Balance outstanding,
September 30, 2018
|
|
|
13,783,140
|
|
|
$
|
0.84
|
|
|
Balance exercisable,
September 30, 2018
|
|
|
13,783,140
|
|
|
$
|
0.84
|
|
Information
relating to outstanding warrants at September 30, 2018, summarized by exercise price, is as follows:
|
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Outstanding
|
|
|
Exercisable
|
|
|
|
|
|
|
|
|
|
|
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Weighted
|
|
|
|
|
|
Weighted
|
|
|
|
|
|
|
|
|
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Average
|
|
|
|
|
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Average
|
|
|
Exercise
Price Per Share
|
|
|
Shares
|
|
|
Life
(Years)
|
|
|
Exercise
Price
|
|
|
Shares
|
|
|
Exercise
Price
|
|
|
$
|
0.01
|
|
|
|
6,000,000
|
|
|
|
4.61
|
|
|
$
|
0.01
|
|
|
|
6,000,000
|
|
|
$
|
0.01
|
|
|
$
|
1.10
|
|
|
|
283,140
|
|
|
|
4.06
|
|
|
$
|
1.10
|
|
|
|
283,140
|
|
|
$
|
1.10
|
|
|
$
|
1.50
|
|
|
|
7,500,000
|
|
|
|
4.61
|
|
|
$
|
1.50
|
|
|
|
7,500,000
|
|
|
$
|
1.50
|
|
|
|
|
|
|
|
13,783,140
|
|
|
|
4.59
|
|
|
$
|
0.84
|
|
|
|
13,783,140
|
|
|
$
|
0.84
|
|
During
the nine month period ended September 30, 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 8). 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 nine months ended September 30, 2018, the Company issued 1,306,360 shares of its common stock on the conversion of warrants,
at $1.10 per share, resulting in proceeds of $1,436,996.
The
weighted-average remaining contractual life of warrants outstanding and exercisable at September 30, 2018 was 4.59 years. The
intrinsic value of both outstanding and exercisable warrants at September 30, 2018 was $5,628,000.
NOTE
13- COMMITMENTS
Operating
Leases
California
Facility (West Coast Facility)
The
Company’s principal executive offices and warehouse are located at 853 Sandhill Avenue, Carson, California, 90746. The Company
occupies a 17,640 square foot facility pursuant to a five-year lease with an independent party ending on September 30, 2023, with
an unaffiliated party, pursuant to which it pays $15,000 per month in rental charges.
Closure
of New Jersey Facility (East Coast Facility)
On
October 1, 2014, STE executed a lease with an independent party for 10,160 square feet of offices and warehouse facilities
located at 89 Leuning Street, Unit D2, South Hackensack, New Jersey. The lease, with an unaffiliated party, is for the five year
period ending on December 31, 2019, pursuant to which STE pays $8,818 per month in rental charges. The Company guaranteed STE’s
performance under the lease.
On
May 7, 2018 the Company signed a sublease with Atlas Company for subletting its east coast facility in South Hackensack, NJ. The
decision to close the east coast operations was a consolidation move to better serve the customer base with all shipments coming
out of the west coast facility in Carson, CA. With this move, the serviceability and supply chain fulfillment has eliminated multiple
shipping destinations out of China, and split shipment to customers from both east and west in the USA. The sublease has been
executed and provides a zero out-of-pocket cost to the Company for the remainder of the lease.
Arizona
Property
On
April 19, 2018, the Company entered into an Option Agreement, or the Option, with MSCP, LLC, a non-affiliated Arizona limited
liability company, or the Lessor, pursuant to which, the Company’s subsidiary was granted an option to enter into a certain
Lease Agreement, or the Lease, for the real property, including the structure and all improvements, identified in the Option,
or the Premises. The Premises consists of 70,000 square feet of space and is to be used for the sole purpose of providing services
related to the management, administration and operation of a cultivation and processing facility, or the Facility, on behalf of
an Arizona limited liability company operating as a nonprofit organization, or the Arizona Licensee, which has been allocated
a Medical Marijuana Dispensary Registration Certificate by the Arizona Department of Health Services. The activities within the
Facility shall be limited to the cultivation, processing, production and packaging of medical marijuana and manufactured and derivative
products which contain medical marijuana, with no right to sell or dispense any such plants or products. The Lease is for a 5-year
initial term, or the Term, with an option to renew for an additional 5 year term. The base rent for the initial year of the Term
is $101,500 per month with additional pro-rata net-lease charges.
As consideration for the
Option, the Company paid to Lessor, $160,000, or the Deposit.
On
May 19, 2018, the Company exercised the Option and YLK executed the Lease, and the Deposit was treated a security deposit and
rent advance, in accordance with the terms and conditions of the Lease. The Company is a guarantor of YLK’s obligations
under the Lease, on behalf of Arizona Licensee.
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 three and nine months ended September 30, 2018 and 2017, $25,000
and $75,000, respectively, was recorded as research and development expense under the agreement on the Condensed Consolidated
Statements of Operations related to the minimum annual fee. For the three and nine months ended September 30, 2018 and 2017, $0
and $0, and $4,126 and $25,160, respectively, was recorded as cost of goods sold on the Condensed Consolidated Statements of Operations
related to the royalty. A total of $140,713 and $165,553 was owed under the amended agreement at September 30, 2018 and December
31, 2017, respectively.
Executive
Employment Agreements
On
August 22, 2018, the Company entered into an employment agreement (the “Lien Agreement”) with Alan Lien (“Lien”)
to continue to serve as the Company’s President, Chief Executive Officer and Chief Financial Officer. On August 22, 2018,
and subsequently amended on August 27, 2018, the Company entered into an employment agreement (the “Davis Agreement”
and together with the Lien Agreement, the “Agreements”) with Tiffany Davis (“Davis” and together with
Lien, the “Executives”) to continue to serve as our Chief Operating Officer. The Davis Agreement supersedes and replaces
the employment agreement entered into between the Company and Davis on February 14, 2018, which was terminated on August 22, 2018.
The
base salary for Lien under the Lien Agreement is $280,000 per annum and the base salary for Davis under the Davis Agreement is
$230,000 per annum. The base salaries increase by 10% and 8% per annum for Lien and Davis, respectively. The Lien Agreement has
an initial term of four years and the Davis Agreement has an initial term of three years and the Agreements automatically renew
for successive one year terms unless either party delivers written notice not to renew at least 60 days prior to the end of the
current term. Lien and Davis will receive signing bonuses of $46,500 and $55,000, respectively, within 30 days. The Executives
are entitled to receive performance-based bonuses based on increases in the Company’s total gross, top-line revenue compared
to the prior year. These performance-based bonuses are a percentage of their total salary and options to purchase the Company’s
common stock.
Pursuant
to the Agreements, Lien and Davis received options to purchase shares of common stock equal to 6% and 3%, respectively, of the
Company’s total number of shares of common stock outstanding. These options are immediately exercisable, expire five years
from issuance, and are exercisable at $0.74 per share. In addition, 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.
Pursuant
to the Agreements, if the Company terminates Executive’s employment without Cause (as defined in the Agreements) or Executive
resigns for Good Reason (as defined in the Agreement), the Executive is entitled to the following payments and benefits: (1) Executive’s
fully earned but unpaid base salary through the date of termination at the rate then in effect, plus all other benefits, if any,
under any group retirement plan, nonqualified deferred compensation plan, equity award plan or agreement, health benefits plan
or other group benefit plan to which Executive may be entitled to under the terms of such plans or agreements; (2) a lump sum
cash payment in an amount equal to 12 months of Executive’s base salary as in effect immediately prior to the date of termination;
(3) continuation of health benefits for Executive and Executive’s eligible dependents for a period of 12 months following
the date of termination; and (4) the automatic acceleration of the vesting and exercisability of outstanding unvested stock awards
as to the number of stock awards that would have vested over the 12-month period following termination had such Executive remained
continuously employed by the Company during such period.
Pursuant to the Agreements, if Executive’s
employment is terminated as a result of death or permanent disability, Executive or Executive’s estate, as applicable, is
entitled to Executive’s fully earned but unpaid base salary through the end of the month in which termination occurs at
the rate then in effect.
NOTE
14 – SUBSEQUENT EVENTS
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 (see Note 12). YA Global paid the Company $10,000, or $0.01 per share, in full settlement
of the exercise price.