NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
FOR
THE THREE MONTHS ENDED DECEMBER 31, 2019 AND 2018
NOTE
1 – BASIS OF PRESENTATION
Organization
and Operations
Wellness
Center USA, Inc. (“WCUI” or the “Company”) was incorporated in June 2010 under the laws of the State of
Nevada. The Company initially engaged in online sports and nutrition supplements marketing and distribution. The Company subsequently
expanded into additional businesses within the healthcare and medical sectors through acquisitions, including Psoria-Shield Inc.
(“PSI”) and StealthCo Inc. (“SCI”), d/b/a Stealth Mark, Inc.
The
Company currently operates in the following business segments: (i) distribution of targeted Ultra Violet (“UV”) phototherapy
devices for dermatology; and (ii) authentication and encryption products and services. The segments are operated, respectively,
through PSI and SCI.
Basis
of Presentation of Unaudited Financial Information
The
accompanying unaudited condensed consolidated financial statements of Wellness Center USA, Inc. and 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 months ended December 31, 2019 are not necessarily indicative of the results that may be expected for the year ending
September 30, 2020.
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, the Company has not yet generated significant revenues and has incurred recurring
net losses. During the three months ended December 31, 2019, the Company incurred a net loss of $346,596 and used cash in operations
of $195,784, and had a shareholders’ deficit of $1,314,852 as of December 31, 2019. In addition, $102,899 of payroll taxes
are past due. These factors raise substantial doubt about the Company’s ability to continue as a going concern. 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 strategies. 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 September 30,
2019 financial statements, has raised substantial doubt about the Company’s ability to continue as a going concern.
At
December 31, 2019, the Company had cash on hand in the amount of $42,363. The ability to continue as a going concern is dependent
on the Company attaining and maintaining profitable operations in the future and raising additional capital soon to meet its obligations
and repay its liabilities arising from normal business operations when they come due. Since inception, we have funded our operations
primarily through equity and debt financings and we expect to continue to rely on these sources of capital in the future. During
the three months ended December 31, 2019, the Company received $185,000 through short-term loans and contributions of capital
by a joint venture partner.
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 stock holders, in case of equity financing.
NOTE
2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis
of Consolidation
The
Company’s consolidated subsidiaries and/or entities are as follows:
Name
of consolidated
subsidiary
or entity
|
|
State
or other jurisdiction of incorporation or organization
|
|
Date
of incorporation or formation
(date
of acquisition/disposition, if
applicable)
|
|
Attributable
interest
|
|
|
|
|
|
|
|
|
|
Psoria-Shield
Inc. (“PSI”)
|
|
The
State of Florida
|
|
June
17, 2009
(August 24, 2012)
|
|
|
100
|
%
|
|
|
|
|
|
|
|
|
|
StealthCo,
Inc. (“StealthCo”)
|
|
The
State of Illinois
|
|
March
18, 2014
|
|
|
100
|
%
|
|
|
|
|
|
|
|
|
|
Psoria
Development Company LLC. (“PDC”)
|
|
The
State of Illinois
|
|
January
15, 2015/November 15, 2018
|
|
|
50
|
%
|
|
|
|
|
|
|
|
|
|
NEO
Phototherapy LLC (“NEO”)
|
|
The
State of Illinois
|
|
December
2018
|
|
|
51
|
%
|
Through
October 2018, PSI was operated by PDC, a joint venture between PSI and the Medical Alliance, Inc (“TMA”). On November
15, 2018, the Company and TMA entered into a Withdraw and Mutual Release Agreement to terminate their joint venture agreement.
In December 2018, the Company and its wholly-owned subsidiary, Psoria-Shield, Inc. (“PSI”), entered into a Joint Venture
Agreement with PSI Gen 2 Funding, Inc. (“GEN2”), an Illinois corporation, to further development, marketing, licensing
and/or sale of PSI technology and products. The joint venture is conducted through NEO Phototherapy, LLC, a recently formed Illinois
limited liability company (“NEO”), with principal offices and records to be maintained at WCUI’s offices. See
Non-Controlling Interests in Note 2 for more details.
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 the valuation of accounts receivable and allowance for uncollectible amounts, inventory and
obsolescence reserves, accruals for potential liabilities, valuations of stock-based compensation, realization of deferred tax
assets, among others. Actual results could differ from these estimates.
Income
(Loss) Per Share
Basic
loss per share is computed by dividing net loss applicable to common stockholders by the weighted average number of outstanding
common shares during the period. Diluted loss per share is computed by dividing the net loss applicable to common stockholders
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. For the three months ended December 31, 2019 and 2018, the basic and
diluted shares outstanding were the same, as potentially dilutive shares were considered anti-dilutive. At December 31, 2019 and
2018, the dilutive impact of outstanding stock options of 15,037,738 and 17,587,738 shares, respectively, and outstanding warrants
for 66,484,049 and 68,192,442 shares, respectively, have been excluded because their impact on the loss per share is anti-dilutive.
NOTE
2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Revenue
Recognition
In
May 2014, the FASB issued Accounting Standards Update (“ASU”) 2014-09, Revenue from Contracts with Customers (Topic
606). This ASU is a comprehensive new revenue recognition model that requires a company to recognize revenue to depict the
transfer of goods or services to a customer at an amount that reflects the consideration it expects to receive in exchange for
those goods or services. The Company adopted this ASU on October 1, 2018 retrospectively, the cumulative effect of the initial
application on our accumulated deficit on that date was immaterial.
For
trade sales, the Company generates its revenue from sales contracts with customers with revenues being generated upon the shipment
of merchandise, or for consulting services, revenue is recognized in the period services are rendered and earned under
service arrangements with clients.
We
sell our products through two main sales channels: 1) directly to customers who use our products (the “Direct Channel”)
and 2) to distribution partners who resell our products (the “Indirect Channel”).
Under
the Direct Channel, we sell our products to and we receive payment directly from customers who purchase our products. Under our
Indirect Channel, we have entered into distribution agreements that allow the distributors to sell our products and fulfill performance
obligations under the agreements.
We
determine revenue recognition through the following steps:
|
●
|
Identification
of the contract, or contracts, with a customer
|
|
●
|
Identification
of the performance obligations in the contract
|
|
●
|
Determination
of the transaction price
|
|
●
|
Allocation
of the transaction price to the performance obligations in the contract
|
|
●
|
Recognition
of revenue when, or as, we satisfy a performance obligation.
|
Revenue
is generally recognized upon shipment or when a service has been completed, unless we have significant performance obligations
for services still to be completed. We recognize revenue when a material reversal is no longer probable. Payments received before
the relevant criteria for revenue recognition are satisfied are recorded as deferred revenue. There was no deferred revenue at
December 31, 2019 and 2018.
Non-controlling
Interests
Through
November 2018, non-controlling interest represented the non-controlling interest holder’s proportionate share of the equity
of the Company’s majority-owned subsidiary, PDC. Non-controlling interest is adjusted for the non-controlling interest holder’s
proportionate share of the earnings or losses and other comprehensive income (loss), if any, and the non-controlling interest
continues to be attributed its share of losses even if that attribution results in a deficit non-controlling interest balance.
On
November 15, 2018, PSI and TMA entered into a Withdraw and Mutual Release Agreement to terminate their joint venture agreement.
On the date of termination, the non-controlling interest’s share of the accumulated losses of the joint venture totaled
to $405,383. Upon termination, during the three months ended December 31, 2018, the Company wrote-off the non-controlling interest’s
share of the accumulated losses and recorded a loss from the deconsolidation of a non-controlling interest of $405,383.
NOTE
2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Non-controlling
Interests (continued)
In
December 2018, PSI entered into a Joint Venture Agreement with GEN2 to further development, marketing, licensing and/or sale of
PSI technology and products. Pursuant to the Joint Venture Agreement, the venture will be conducted through NEO. PSI and GEN2
will be the members of NEO, owning 50.5% and 36.0%, respectively, of the Units issued in connection with the organization of NEO.
An additional 13.5% of such Units will be reserved for issuance as incentives for key employees and consultants. Until such shares
are distributed, the Company controls 68% of the joint venture and GEN2 the remaining 32%. PSI and GEN2 will manage NEO’s
day-to-day operations. PSI will contribute PSI technology to NEO and GEN2 will contribute $700,000. As of December 31, 2019, NEO’s
operations required additional funding above the $700,000 documented in the agreement, and as of September 30, 2019, GEN2 had
received $925,000 of investments to contribute to NEO. During the three months ended December 30, 2019, an additional $50,000
was contributed by GEN2 to NEO. As of December 31, 2019, GEN2 had received $975,000 of investments to contribute to NEO. As of
December 31, 2019, the Company controlled 51% of the joint venture, GEN2 controlled 39% and another individual controlled the
remaining 10%. The Company recorded its proportionate share of the contributions received of $497,250 to additional paid-in-capital
and $477,750 to non-controlling interest as of that date. During the three months ended December 31, 2019, NEO recorded a loss
of $45,162 relating to its operations.
Repayment
of the investment by GEN2 will begin through and upon the date which NEO has realized and retained cumulative net income/distributable
cash in the amount of $300,000. Distributions thereafter will be made to PSI, GEN2 and other members in proportion to their respective
Unit ownership, at the times and in the manner determined from time to time by the managers, in their sole discretion. GEN2 consists
of accredited investors, and investment participation of $700,000 from several WCUI officers and directors, including Calvin R.
O’Harrow and Roy M. Harsch.
Stock-Based
Compensation
The
Company periodically grants stock options and warrants to employees and non-employees in non-capital raising transactions as compensation
for services rendered. The Company accounts for stock option and stock warrant grants to employees based on the authoritative
guidance provided by the Financial Accounting Standards Board where the value of the award is measured on the date of grant and
recognized over the vesting period. The Company accounts for stock option and stock warrant grants to non-employees in accordance
with the authoritative guidance of the Financial Accounting Standards Board where the value of the stock compensation is determined
based upon the measurement date at either a) the date at which a performance commitment is reached, or b) at the date at which
the necessary performance to earn the equity instruments is complete. Non-employee stock-based compensation charges generally
are amortized over the vesting period on a straight-line basis. In certain circumstances where there are no future performance
requirements by the non-employee, option or warrant grants are immediately vested and the total stock-based compensation charge
is recorded in the period of the measurement date.
The
fair value of the Company’s common stock option and warrant grants are estimated using a Black-Scholes Merton option pricing
model, which uses certain assumptions related to risk-free interest rates, expected volatility, expected life of the common stock
options, estimated forfeitures and future dividends. Compensation expense is recorded based upon the value derived from the Black-Scholes
option pricing model, and based on actual experience. The assumptions used in the Black-Scholes Merton option pricing model could
materially affect compensation expense recorded in future periods.
NOTE
2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Leases
In
February 2016, the FASB issued ASU No. 2016-02, Leases. 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 twelve 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 leases existing at, or entered into after, the beginning of the earliest period presented
in the financial statements.
The
Company adopted ASU 2016-02 effective October 1, 2019. As a result, we recorded right-of-use assets of $27,841, and lease
liabilities of the same amount, as of that date. In accordance with ASU 2016-02, the right-of-use assets are being amortized over
the life of the underlying leases, and monthly lease payments are being recorded as reductions to the lease liability and imputed
interest expense. See Note 4 for additional information.
Recently
Issued Accounting Pronouncements
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. The standard is effective for interim and annual reporting periods beginning after
December 15, 2019. The adoption of ASU 2016-13 is not expected to have a material impact on the Company’s financial position,
results of operations, and cash flows.
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 – LOANS PAYABLE FROM OFFICERS AND SHAREHOLDERS
As
of September 30, 2019, loans payable from officers and shareholders of $399,250 were outstanding. During the three months ended
December 31, 2019, the Company borrowed $135,000 from its officers and shareholders. All of the loans are unsecured, have an interest
rate of eight percent and are due one year from the date of issuance. As of December 31, 2019, loans payable to officers and shareholders
of $534,250 were outstanding.
NOTE
4 – LEASE LIABILITIES
In
February 2019, the Company’s PSI subsidiary entered into a 24-month
non-cancellable lease for its office facilities that requires monthly payments of $1,800 through January 2021. The Company
adopted ASU 2016-02, Leases, effective October 1, 2019, which requires a lessee to record a right-of-use
asset and a corresponding lease liability at the inception of the lease initially measured at the present value of the lease payments.
The Company classified the lease as an operating lease and determined that the value of the lease assets and liability
at the adoption date was $27,841 using a discount rate of 4.00%. During the three months ended December 31, 2019, the Company
made payments of $5,144 towards the lease liability. As of December 31, 2019, lease liability amounted to $22,697.
ASU
2016-02 requires recognition in the statement of operations of a single lease cost, calculated so that the cost of the lease is
allocated over the lease term, generally on a straight-line basis. Rent expense for the three months ended December 31, 2019 was
$5,144. During the three months ended December 31, 2019, the Company reflected amortization of right of use asset of $5,144 related
to this lease, resulting in a net asset balance of $22,697 as of December 31, 2019.
NOTE
5 – SHAREHOLDERS’ EQUITY
Stock
Options
On
December 22, 2010, effective retroactively as of June 30, 2010, the Company’s Board of Directors approved the adoption of
the “2010 Non-Qualified Stock Option Plan” (“2010 Option Plan”) by unanimous consent. The 2010 Option
Plan was initiated to encourage and enable officers, directors, consultants, advisors and key employees of the Company to acquire
and retain a proprietary interest in the Company by ownership of its common stock. A total of 7,500,000 of the authorized shares
of the Company’s common stock may be subject to, or issued pursuant to, the terms of the plan. Effective January 1, 2018,
the Board of Directors approved to increase the number of authorized shares of the Company’s common stock that may be subject
to, or issued pursuant to, the terms of the plan from 7,500,000 to 30,000,000.
The
Company’s policy is to recognize compensation cost for awards with only service conditions and a graded vesting schedule
on a straight-line basis over the requisite service period for the entire award. Additionally, the Company’s policy is to
issue new shares of common stock to satisfy stock option exercises. The Company applied fair value accounting for all share based
payments awards. The fair value of each option granted is estimated on the date of grant using the Black-Scholes option-pricing
model.
During
the three months ended December 31, 2019, the Company granted options to an employee to purchase a total of 62,500 shares of its
common stock with an aggregate fair value of $2,313. The options have an exercise price of $0.04 per share and expire five years
from the date of grant. The shares vested on December 31, 2019. The Company valued the options using a Black-Scholes option pricing
model.
The
assumptions used for the option granted during the three months ended December 31, 2019 are as follows:
Exercise
price
|
|
$
|
0.04
|
|
Expected
dividends
|
|
|
-
|
|
Expected
volatility
|
|
|
157.6
|
%
|
Risk
free interest rate
|
|
|
1.60
|
%
|
Expected
life of options
|
|
|
2.5
|
|
During
the three months ended December 31, 2019, the Company recorded $65,738 of stock compensation for the value of all outstanding
options, and as of December 31, 2019, unvested compensation of $314,812 remained that will be amortized over the remaining vesting
period.
The
table below summarizes the Company’s stock option activities for the three months ended December 31, 2019:
|
|
|
Number of
Option Shares
|
|
|
Exercise
Price Range
Per Share
|
|
|
Weighted
Average
Exercise Price
|
|
|
Fair
Value
at
Date of Grant
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance,
September 30, 2019
|
|
|
|
15,237,738
|
|
|
$
|
0.03
- 2.00
|
|
|
$
|
0.27
|
|
|
$
|
3,255,121
|
|
Granted
|
|
|
|
62,500
|
|
|
|
0.04
|
|
|
|
0.04
|
|
|
|
2,313
|
|
Cancelled
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
Exercised
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
Expired
|
|
|
|
(262,500
|
)
|
|
|
0.11
|
|
|
|
0.11
|
|
|
|
-
|
|
Balance,
December 31, 2019
|
|
|
|
15,037,738
|
|
|
$
|
0.03
– 2.00
|
|
|
$
|
0.27
|
|
|
$
|
3,257,434
|
|
Vested
and exercisable, December 31, 2019
|
|
|
|
12,350,238
|
|
|
$
|
0.03
– 2.00
|
|
|
$
|
0.30
|
|
|
$
|
2,189,047
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Unvested,
December 31, 2019
|
|
|
|
2,687,500
|
|
|
$
|
0.14
|
|
|
$
|
0.14
|
|
|
$
|
1,068,387
|
|
There
was no aggregate intrinsic value for option shares outstanding at December 31, 2019. As of December 31, 2019, there were 14,962,262
shares of stock options remaining available for issuance under the 2010 Plan.
NOTE
5 – SHAREHOLDERS’ EQUITY (CONTINUED)
Stock
Options (continued)
The
following table summarizes information concerning outstanding and exercisable options as of December 31, 2019:
|
|
|
Options
Outstanding
|
|
|
Options
Exercisable
|
|
|
Range
of Exercise Prices
|
|
|
|
Number
Outstanding
|
|
|
|
Average
Remaining Contractual Life (in years)
|
|
|
|
Weighted
Average Exercise Price
|
|
|
|
Number
Exercisable
|
|
|
|
Average
Remaining Contractual Life (in years)
|
|
|
|
Weighted
Average Exercise Price
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
0.06
- 0.39
|
|
|
|
13,575,238
|
|
|
|
2.93
|
|
|
$
|
0.15
|
|
|
|
10,887,738
|
|
|
|
2.85
|
|
|
$
|
0.15
|
|
|
0.40
- 0.99
|
|
|
|
62,500
|
|
|
|
2.25
|
|
|
|
0.40
|
|
|
|
62,500
|
|
|
|
2.25
|
|
|
|
0.40
|
|
|
1.00
- 1.99
|
|
|
|
750,000
|
|
|
|
1.00
|
|
|
|
1.00
|
|
|
|
750,000
|
|
|
|
1.00
|
|
|
|
1.00
|
|
|
2.00
|
|
|
|
650,000
|
|
|
|
1.00
|
|
|
|
2.00
|
|
|
|
650,000
|
|
|
|
1.00
|
|
|
|
2.00
|
|
$
|
0.06
- 2.00
|
|
|
|
15,037,738
|
|
|
|
2.75
|
|
|
$
|
0.27
|
|
|
|
12,350,238
|
|
|
|
2.64
|
|
|
$
|
0.30
|
|
Stock
Warrants
The
table below summarizes the Company’s warrants activities for the three months ended December 31, 2019:
|
|
Number
of
Warrant
Shares
|
|
|
Exercise
Price
Range
Per
Share
|
|
|
Weighted
Average Exercise Price
|
|
|
Fair
Value at Date of Issuance
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance,
September 30, 2019
|
|
|
66,484,049
|
|
|
$
|
0.12
- 0.40
|
|
|
$
|
0.17
|
|
|
$
|
3,434,560
|
|
Granted
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
Cancelled
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
Exercised
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
Expired
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
Balance,
December 31, 2019
|
|
|
66,484,049
|
|
|
$
|
0.12
- 0.40
|
|
|
$
|
0.17
|
|
|
$
|
3,434,560
|
|
Vested
and exercisable, December 31, 2019
|
|
|
66,484,049
|
|
|
$
|
0.12
- 0.40
|
|
|
$
|
0.17
|
|
|
$
|
3,434,560
|
|
There
was no aggregate intrinsic value for warrant shares outstanding at December 31, 2019.
The
following table summarizes information concerning outstanding and exercisable warrants as of December 31, 2019:
|
|
|
Warrants
Outstanding
|
|
Warrants
Exercisable
|
|
Range
of Exercise Prices
|
|
|
Number
Outstanding
|
|
|
|
Average
Remaining Contractual Life (in years)
|
|
|
|
Weighted
Average Exercise Price
|
|
|
Number
Exercisable
|
|
|
|
Average
Remaining Contractual Life (in years)
|
|
|
|
Weighted
Average Exercise Price
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
0.12
– 0.20
|
|
|
59,279,384
|
|
|
|
1.70
|
|
|
$
|
0.15
|
|
|
59,279,384
|
|
|
|
1.70
|
|
|
$
|
0.15
|
|
0.21
– 0.40
|
|
|
7,204,665
|
|
|
|
0.61
|
|
|
|
0.26
|
|
|
7,204,665
|
|
|
|
0.61
|
|
|
|
0.26
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
0.12
– 0.67
|
|
|
66,484,049
|
|
|
|
1.58
|
|
|
$
|
0.17
|
|
|
66,484,049
|
|
|
|
1.58
|
|
|
$
|
0.17
|
NOTE
6 – SEGMENT REPORTING
Reportable
segments are components of an enterprise about which separate financial information is available and that is evaluated regularly
by the chief operating decision maker in deciding how to allocate resources and in assessing performance. The Company’s
reportable segments are based on products and services, geography, legal structure, management structure, or any other manner
in which management disaggregates a company.
The
Company operates in the following business segments:
(i)
Medical Devices: which stems from PSI, its wholly-owned subsidiary acquired on August 24, 2012, a developer, manufacturer,
marketer and distributer of targeted Ultra Violet (“UV”) phototherapy devices for the treatment of skin diseases.
(ii)
Authentication and Encryption Products and Services: which stems from StealthCo, its wholly-owned subsidiary formed on March
18, 2014, which has engaged in the business of selling, licensing or otherwise providing certain authentication and encryption
products and services since acquisition of certain assets from SMI on April 4, 2014.
The
detailed segment information of the Company is as follows:
Assets
By Segment
|
|
December
31, 2019
|
|
|
|
Corporate
|
|
|
Medical
Devices
|
|
|
Authentication
and Encryption
|
|
|
Total
|
|
ASSETS
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Current
Assets
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash
|
|
$
|
2,273
|
|
|
$
|
33,330
|
|
|
$
|
6,760
|
|
|
$
|
42,363
|
|
Prepaid
expenses and other current assets
|
|
|
-
|
|
|
|
55,500
|
|
|
|
-
|
|
|
|
55,500
|
|
Total
current assets
|
|
|
2,273
|
|
|
|
88,830
|
|
|
|
6,760
|
|
|
|
97,863
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Right-of-use
asset
|
|
|
-
|
|
|
|
22,697
|
|
|
|
-
|
|
|
|
22,697
|
|
Total
other assets
|
|
|
-
|
|
|
|
22,697
|
|
|
|
-
|
|
|
|
22,697
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
TOTAL
ASSETS
|
|
$
|
2,273
|
|
|
$
|
111,527
|
|
|
$
|
6,760
|
|
|
$
|
120,560
|
|
Operations
by Segment
|
|
For
the Three Months Ended
|
|
|
|
December
31, 2019
|
|
|
|
Corporate
|
|
|
Medical
Devices
|
|
|
Authentication
and Encryption
|
|
|
Total
|
|
Sales:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Trade
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
-
|
|
Consulting
services
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
Total
Sales
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost
of goods sold
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross
profit
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating
expenses
|
|
|
98,462
|
|
|
|
175,286
|
|
|
|
63,525
|
|
|
|
337,273
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss
from operations
|
|
$
|
(98,462
|
)
|
|
$
|
(175,286
|
)
|
|
$
|
(63,525
|
)
|
|
$
|
(337,273
|
)
|
Operations
by Segment
|
|
For
the Three Months Ended
|
|
|
|
December
31, 2018
|
|
|
|
Corporate
|
|
|
Medical
Devices
|
|
|
Authentication
and Encryption
|
|
|
Total
|
|
Sales:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Trade
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
7,675
|
|
|
$
|
7,675
|
|
Consulting
services
|
|
|
-
|
|
|
|
-
|
|
|
|
5,200
|
|
|
|
5,200
|
|
Total
Sales
|
|
|
-
|
|
|
|
-
|
|
|
|
12,875
|
|
|
|
12,875
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost
of goods sold
|
|
|
-
|
|
|
|
-
|
|
|
|
7,725
|
|
|
|
7,725
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross
profit
|
|
|
-
|
|
|
|
-
|
|
|
|
5,150
|
|
|
|
5,150
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating
expenses
|
|
|
254,429
|
|
|
|
119,720
|
|
|
|
101,715
|
|
|
|
475,864
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss
from operations
|
|
$
|
(254,429
|
)
|
|
$
|
(119,720
|
)
|
|
$
|
(96,565
|
)
|
|
$
|
(470,714
|
)
|
NOTE
7 – LEGAL MATTERS
The
Company is periodically engaged in legal proceedings arising from and relating to its business operations. We currently are not
involved in any litigation that we believe could have a material adverse effect on our financial condition or results of operations.
There is no action, suit, proceeding, inquiry or investigation before or by any court, public board, government agency, self-regulatory
organization or body pending or, to the knowledge of the executive officers of our Company or any of our subsidiaries, threatened
against or affecting our Company, our common stock, any of our subsidiaries or of our Company’s or our subsidiaries’
officers or directors in their capacities as such, in which an adverse decision could have a material adverse effect on our financial
condition or results of operations. However, we recently decided to attempt to preserve revenue and reduce operating expenses
through actions including, but not limited to, facilities consolidation and staff reductions, which we hope to implement through
negotiated transactions with lessors, employees and other third parties. Such actions may result in disputes with and claims by
such parties which, if not resolved through negotiations, may impact negatively the Company’s ability to continue as a going
concern. To date, we have negotiated settlement of all but $89,302 in ex-employee wage and benefits claims, with agreement to
pay such remaining amount, together with interest at the rate of 4% per annum on the principal amount from time to time outstanding,
when and as cash flow permits. One of the employees claims additional amounts due for certain statutory damages under the Illinois
Wage Payment and Collection which currently could exceed $21,600 and would increase at the rate of 2% of the wages due per month
plus attorneys’ fees if the employee elects to file suit for a violation of the Act and is successful in obtaining a judgment
on his claim.
NOTE
8 – COMMITMENTS
Operating
Leases
The
Company leased its corporate office facility in Hoffman Estates, Illinois pursuant to a non-cancellable lease initiated in July
2016 and expiring February 28, 2024. The lease terms require a monthly payment of approximately $11,000. The Company vacated the
facility in April 2019, in favor of its present facilities in Tucson AZ, which are provided by a shareholder on a rent-free basis.
The Company is in negotiations with the owners regarding the settlement of its lease obligations and expects that the property
will be subleased or a settlement with the landlord will be reached at an amount significantly less than the remaining payment
obligations. At the date of abandonment, the Company had a remaining lease obligation of $631,587. During the year ended September
30, 2019, the Company recorded an accrual for the estimated potential settlement and wrote-off its $15,000 security deposit relating
to the lease. During the three months ended December 31, 2019, the Company recorded an additional expense of $37,815 relating
to the lease obligation.
NOTE
9 – PROPOSED SALE OF STEALTHCO, INC.
On
September 3, 2019, the Company’s Board of Directors unanimously approved, subject to stockholder approval: (1) execution
and delivery of a proposed Share Exchange Agreement with DTI Holdings, Inc. (“DTI”) relating to the share exchange
and transfer of certain assets of StealthCo, Inc. (“SCI”) pursuant to the terms and conditions of a Memorandum of
Agreement in substantially the form of the copy presented to the Board (“Agreement”). As of September 18, 2019, holders
of a majority of the outstanding shares of voting capital stock have executed written stockholder consents approving this action.
The
Agreement provides, among other things, that: (1) DTI will pay the Company $500,000 upon the execution of a definitive share exchange
agreement (“Share Exchange Agreement”) which the parties will endeavor to negotiate and execute as quickly as possible,
and not later than October 15, 2019; (2) DTI will pay the Company an additional $500,000 within seven days following the completion
date of the transfer of all assets and/or full ownership of SCI to DTI, with such date to occur within 120 days following execution
of the Share Exchange Agreement; (3) DTI will issue to the Company 3,112,000 shares of DTI common stock and will guaranty that
the value of the 3,112,000 shares of DTI common stock will have a value of at least $4.50 per share ($14,004,000, in the aggregate),
as of December 31, 2021; (4) To the extent that the value of the DTI common shares, as of December 31, 2021, is less than $4.50
per share ($14,004,000, in the aggregate), DTI will issue additional shares of DTI common stock, at the then current fair market
value, in an amount sufficient to cause the resulting aggregate value of all shares of DTI common stock issued to the Company
to be $14,004,000, in the aggregate; (5) DTI will assign the assets transferred by SCI, including trademarks, intellectual properties,
and patents, to its subsidiary, Femtobitz, Inc., a Delaware corporation, and will pay to the Company 1% of annual gross revenue
arising from or relating to operation of Femtobitz, Inc.; and (6) Upon closing of the share exchange, the Company’s Chairman
will be appointed an advisory board member of DTI and a board member of Femtobitz, Inc.
As
of September 18, 2019, stockholders holding a majority of our outstanding common stock approved the share exchange and the Company
began discussions and negotiations with DTI, which are currently on-going as of the date of this filing. There can be no assurance
that the proposed transaction will be concluded successfully on the terms described or any alternate terms that may be proposed
hereafter.
NOTE
10 – SUBSEQUENT EVENTS
Subsequent
to December 31, 2019, the Company borrowed $235,000 from its officers and shareholders. All of the loans are unsecured,
have an interest rate of eight percent and are due one year from the date of issuance.
Commencing
on October 1, 2016, the Company’s wholly-owned subsidiary, StealthCo, entered into a non-cancellable lease agreement to
lease its office facilities in Oak Ridge, Tennessee. The term of the lease is five years and expires September 30, 2021. On January
6, 2020, the Company entered into an agreement with the owners to terminate the agreement effective January 1, 2020. Under the
agreement, the Company agreed to pay $11,000 and abandon certain Company property as documented in the agreement.
Effective
January 1, 2020, the Company’s Board of Directors approved the extension of the Company’s unexpired stock warrants
as of December 31, 2019, by an additional one year period. This change would affect approximately 66 million warrant shares and
approximately 20 million warrant shares that were set to expire by the year ending September 30, 2020. The 20 million warrant
shares that were set to expire by September 30, 2020, had exercise prices ranging from $0.15 per share to $0.25 per share. The
66 million warrant shares had exercise prices ranging from $0.12 per share to $0.40 per share. The incremental fair value of the
warrants resulting from modification is approximately $700,000 that will be recognized as an expense beginning with the period
ending March 31, 2020, as the options vest.
ITEM
2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Forward
Looking Statements
Except
for historical information, the following discussion contains forward-looking statements based upon current expectations that
involve certain risks and uncertainties. Such forward-looking statements include statements regarding, among other things, (a)
our projected sales and profitability, (b) our growth strategies, (c) anticipated trends in our industry, (d) our future financing
plans, (e) our anticipated needs for working capital, (f) our lack of operational experience and (g) the benefits related to ownership
of our common stock. Forward-looking statements, which involve assumptions and describe our future plans, strategies, and expectations,
are generally identifiable by use of the words “may,” “will,” “should,” “expect,”
“anticipate,” “estimate,” “believe,” “intend,” or “project” or the
negative of these words or other variations on these words or comparable terminology. This information may involve known and unknown
risks, uncertainties, and other factors that may cause our actual results, performance, or achievements to be materially different
from the future results, performance, or achievements expressed or implied by any forward-looking statements. These statements
may be found under “Description of Business,” and “Analysis of Financial Condition and Results of Operations”,
as well as in this Report generally. Actual events or results may differ materially from those discussed in forward-looking statements
as a result of various factors, including, without limitation, the risks outlined under “Risk Factors” in our Annual
Report on Form 10-K and in other Reports we have filed with the Securities and Exchange Commission, as well as matters described
in this Report generally. In light of these risks and uncertainties, there can be no assurance that the forward-looking statements
contained in this Report will in fact occur as projected.
The
following discussion and analysis provides information which management believes is relevant to an assessment and understanding
of our results of operations and financial condition. The discussion should be read along with our financial statements and notes
thereto. This section includes a number of forward-looking statements that reflect our current views with respect to future events
and financial performance. You should not place undue certainty on these forward-looking statements. These forward-looking statements
are subject to certain risks and uncertainties that could cause actual results to differ materially from our predictions.
Description
of Business
Background
Wellness
Center USA, Inc. (“WCUI” or the “Company”) was incorporated in June 2010 under the laws of the State of
Nevada. We initially engaged in online sports and nutrition supplements marketing and distribution. We subsequently expanded into
additional businesses within the healthcare and medical sectors through acquisitions, including Psoria-Shield Inc. (“PSI”)
and StealthCo Inc. (“SCI”), d/b/a Stealth Mark, Inc.
The
Company currently operates in two business segments: (i) distribution of targeted Ultra Violet (“UV”) phototherapy
devices for dermatology; and (ii) authentication and encryption products and services. The segments are conducted through our
wholly-owned subsidiaries, PSI and SCI.
PSI
PSI
was incorporated under the laws of the state of Florida on June 17, 2009. We acquired all of the issued and outstanding shares
of stock in PSI on August 24, 2012.
Joint
Ventures
We
conducted PSI operations through Psoria Development Company LLC, an Illinois limited liability company (“PDC”), from
January 15, 2015 through October, 2018. PDC was a joint venture between WCUI/PSI and The Medical Alliance, Inc., a Florida corporation
(“TMA”). On November 15, 2018, PSI and TMA terminated the PDC joint venture. On the termination date, the non-controlling
interest’s share of the accumulated losses of the joint venture totaled $405,383. During the year ended September 30, 2019,
the Company wrote-off the non-controlling interest’s share of the accumulated losses and recorded a loss from deconsolidation
of non-controlling interest of $405,383.
In
December 2018, the Company and PSI entered into a Joint Venture Agreement with PSI GEN2 Funding, Inc., an Illinois corporation
(“GEN2”), to further develop, market, license and/or sell PSI technology and products. The Joint Venture Agreement
provides for the venture to be conducted through NEO Phototherapy, LLC, an Illinois limited liability company (“NEO”),
with PSI and GEN2 to hold membership Units representing 50.5% and 36.0% ownership, respectively. It provides for an additional
13.5% of such Units to be reserved for issuance as incentive awards to key employees and consultants. PSI and GEN2 are to jointly
manage NEO’s day-to-day operations.
According
to the Joint Venture Agreement, PSI would contribute PSI technology to NEO in consideration for its Units and GEN2 would contribute
$700,000 for its Units. Once NEO has realized and retained cumulative net income/distributable cash in the amount of $300,000,
the next $700,000 of realized and retained cumulative net income/distributable cash would be distributed to GEN2. Distributions
thereafter would be made to PSI, GEN2 and other members, if any, in proportion to their respective Unit ownership, at the times
and in the manner determined from time to time by the managers, in their sole discretion.
As
of December 31, 2019, NEO’s operations required funding in excess of the $700,000 initially anticipated by the joint venture.
As of that date, GEN2 had contributed $975,000 to NEO, for which GEN2 received Units representing a cumulative total of 39.0%
ownership of NEO. Additional Units representing a 10% ownership interest in NEO were awarded to one individual as a key staff
incentive from the reserve initially established for such awards, with no further awards currently anticipated. As a result, once
NEO has realized and retained cumulative net income/distributable cash in the amount of $300,000, the next $975,000 of realized
and retained cumulative net income/distributable cash would be distributed to GEN2. Distributions thereafter would be made to
PSI, GEN2 and the other member, in proportion to their respective Unit ownership, at the times and in the manner determined from
time to time by the managers, in their sole discretion.
GEN2
contributions to NEO were derived from its shareholders, which consist of accredited investors, and which include several WCUI
officers and directors, including Calvin R. O’Harrow, Roy M. Harsch, William E. Kingsford, Douglas Samuelson, Paul D. Jones
and Thomas E. Scott. GEN2 shareholders, including said officers and directors of WCUI, will share any realized and retained cumulative
net income/distributable cash that may be distributed to GEN2.
As
of September 30, 2019, the Company interest was adjusted to 51% of the joint venture, GEN2 controlled 39% and another individual
controlled the remaining 10%. As of December 31, 2019, the Company recorded its proportionate share of $497,250 to additional
paid-in-capital and $477,750 to non-controlling interest as of that date. During the three months ended December 31, 2019, NEO
recorded a loss of $45,162 relating to its operations.
Psoria-Light
PSI
designs, develops and markets a targeted ultraviolet (“UV”) phototherapy device called the Psoria-Light. The Psoria-Light
is designated for use in targeted PUVA photochemistry and UVB phototherapy and is designed to treat certain skin conditions including
psoriasis, vitiligo, atopic dermatitis (eczema), seborrheic dermatitis, and leukoderma.
Psoriasis,
eczema, and vitiligo, are common skin conditions that can be challenging to treat, and often cause the client significant psychosocial
stress. Clients may undergo a variety of treatments to address these skin conditions, including routine consumption of systemic
and biologic drug therapies which are highly toxic, reduce systemic immune system function, and come with a host of chemotherapy-like
side effects. Ultraviolet (UV) phototherapy is a clinically validated alternate treatment modality for these disorders.
Traditionally,
“non-targeted” UV phototherapy was administered by lamps that emitted either UVA or UVB light to both diseased and
healthy skin. While sunblocks or other UV barriers may be used to protect healthy skin, the UV administered in this manner must
be low dosage to avoid excessive exposure of healthy tissue. Today, “targeted” UV phototherapy devices administer
much higher dosages of light only to affected tissue, resulting in “clearance” in the case of psoriasis and eczema,
and “repigmentation” in the case of vitiligo, at much faster rates than non-targeted (low dosage) UV treatments.
Targeted
UV treatments are typically administered to smaller total body surface areas, and are therefore used to treat the most intense
parts of a client’s disease. Non-targeted UV treatment is typically used as a follow-up and for maintenance, capable of
treating large surfaces of the body. Excimer laser devices (UVB at 308nm) are expensive and consume dangerous chemicals (Xenon
and Chlorine). Mercury lamp devices (UVB and/or UVA) require expensive lamp replacements regularly and require special disposal
(due to mercury content). Additionally, mercury lamp devices typically deliver wavelengths of light below 300nm. While within
the UVB spectrum, it has been shown that wavelengths below 300nm produce significantly more “sunburn” type side effects
than do wavelengths between 300 and 320nm without improvement in therapeutic benefit.
The
Psoria-Light is a targeted UV phototherapy device that produces UVB light between 300 and 320 nm as well as UVA light between
350 and 395nm. It does not require consumption of dangerous chemicals or require special environmental disposal, and is cost effective
for clinicians, which should result in increased patient access to this type of treatment. It has several unique and advanced
features that we believe will distinguish it from the non-targeted and targeted UV phototherapy devices that are currently being
used by dermatologists and other healthcare providers. These features include the following: the utilization of deep narrow-band
UVB (“NB-UVB”) LEDs as light sources; the ability to produce both UVA or NB-UVB therapeutic wavelengths; an integrated
high resolution digital camera and client record integration capabilities; the ability to export to an external USB memory device
a PDF file of treatment information including a patent pending graph that includes digital images plotted against user tracked
metrics which can be submitted to improve medical reimbursements; an accessory port and ability to update software; ease of placement
and portability; advanced treatment site detection safety sensor; international language support; a warranty which includes the
UV lamp(s); and a non-changeable treatment log (that does not include HIPPA information).
The
Psoria-Light consists of three components: a base console, a color display with touchscreen control, and a hand-held delivery
device with a conduit (or tether) between the handheld device and the base console. PSI requires clearance by the United States
Food and Drug Administration (“FDA”) to market and sell the device in the United States as well as permission from
TUV SUD America Inc., PSI’s Notified Body, to affix the CE mark to the Psoria-Light in order to market and sell the device
in countries of the European Union.
To
obtain FDA clearance and permission to affix the CE mark, PSI was required to conduct EMC and electrical safety testing, which
it completed in the second quarter of 2011. PSI received FDA clearance on February 11, 2011 (no. K103540) and was granted permission
to affix the CE mark on November 10, 2011. In its 510(k) application with the FDA (application number K103540), PSI asserted that
the Psoria-Light was “substantially equivalent” in intended use and technology to two predicate devices, the X -Trac
Excimer Laser, which has wide acceptance in the medical billing literature and has a large installed base in the U.S., and the
Dualight, another competing targeted UV phototherapy device.
PSI
has established an ISO 13485 compliant quality system for the Psoria-Light, which was first audited in the third quarter of 2011.
This system is intended to ensure PSI devices will be manufactured in a controlled and reliable environment and that its resources
follow similar practices and is required for sales in countries requiring a CE mark. PSI has also received Certified Space Technology
designation from the Space Foundation, based on PSI’s incorporation of established NASA-funded LED technology.
PSI
began Psoria-Light Beta deployment in January 2012. It is currently operating at a loss, and there is no assurance that its business
development plans and strategies will ever be successful. PSI’s success depends upon the acceptance by healthcare providers
and clients of Psoria-Light treatment as a preferred method of treatment for psoriasis and other UV-treatable skin conditions.
Psoria-Light treatment appears to have been beneficial to clients, without demonstrable harmful side effects or safety issues,
as evidenced by more than 10,000 treatments completed on more than 1,000 clients, domestically and Mexico, since 2012. In order
for the Company to continue PSI operations, it will need additional capital and it will have to successfully coordinate integration
of PSI operations without materially and adversely affecting continuation and development of other Company operations.
SCI
SCI
was incorporated under the laws of the state of Illinois on March 18, 2014. SCI acquired certain Stealth Mark assets on April
4, 2014 and operates as a wholly-owned subsidiary of the Company. It is a provider of: a) Stealth Mark encryption and authentication
solutions offering advanced technologies within the security and supply chain management vertical sectors (Intelligent Microparticles),
and b) advanced data intelligence services offering proprietary, unprecedented, and actionable technology for industries, companies,
and agencies on a global scale (ActiveDuty™).
Intelligent
Microparticles
SCI
provides clients premiere authentication technology for the protection of a variety of products and brands from illicit counterfeiting
and diversion activities. Its technology is applicable to a wide range of industries affected by counterfeiting, diversion and
theft including, but not limited to, pharmaceuticals, defense/aerospace, automotive, electronics, technology, consumer and personal
care goods, designer products, beverage/spirits, and many others.
SCI
delivers the client a complete, simple to use, easy to implement, and cost effective turnkey system that is extremely difficult
to compromise. SCI’s technology includes a combination of proprietary software and intelligent microparticle marks that
are unduplicatable and undetectable to the human eye. These taggants are created with proprietary materials that create unique
numerical codes that are assigned meaning by the client and are machine readable without the use of rare earth or chemical tracers.
They have been used in covert and overt operations with easy to implement technology and do-it-yourself in-the-field forensic
caliber verification.
In
April 2018, the Company’s subsidiary, SCI, concluded licensing of a patent for technology that is the next generation of
Stealth Mark. Working with researchers at the Oak Ridge National Labs, the patent signifies development of a new technology that
will generate an invisible marking system with attributes currently unavailable in the anti-counterfeit marketplace today. The
formula and techniques have been shown through extensive testing to be resilient to manufacturing processes and can be used on
a wide range of materials from woven and non-woven fabrics, cardboard, metal, concrete, plastics, leather, wood, and paper. In
addition, the complexity of the information that can be encoded with the system makes counterfeiting difficult.
ActiveDuty™
SCI’s
ActiveDuty™ data intelligence services offer unique, unprecedented, actionable technology for industries, companies, and
agencies on a global scale. Comprised of a suite of powerful analytical tools, including artificial intelligence and social-psychology,
the service provides timely and actionable intelligence to clients. ActiveDuty™ is adaptable to a broad spectrum of illicit
activities within both private and public sectors such as, but not limited to, counterfeiting, sex and human trafficking, money
laundering, and a variety of other markets.
The
proprietary algorithmic architecture of ActiveDuty™ creates the first systemic reporting mechanism to deliver strategic
and tactical results supported by an intense worldwide analysis of patterns of human behavior. The ActiveDuty™ global framework
is heuristic in nature, capable of comprehending big data across the digital spectrum and speaks all the major languages. Up until
now, there has not existed a unified system that could actively measure this lifecycle that is a collection of discreet and seemingly
random behaviors of criminals anywhere within the digital domain. Criminals change their identities but not their basic behaviors.
SCI
was managed initially by Ricky Howard, who brought over thirty years of experience in operations management and executive positions
in a variety of industries ranging from entrepreneurial startups to Fortune 500 companies. He played an integral role in bringing
the company’s capabilities to its present status including design and creation of its manufacturing capabilities, implementation
of its ERP inventory controls system, software and hardware development, marketing and sales materials processes and day-to-day
operational procedures and processes. In November 2018, Mr. Howard passed away suddenly and Mr. O’Harrow took over operations
of SCI’s business on an interim basis.
Proposed
Share Exchange
On
September 3, 2019, our Board unanimously approved, subject to stockholder approval, the execution and delivery of a proposed Share
Exchange Agreement relating to the share exchange and transfer of certain assets of SCI to DTI Holdings, Inc. (“DTI”)
pursuant to the terms and conditions of a Memorandum of Agreement providing, among other things, as follows:
●
DTI will pay the Company $500,000 upon execution of a definitive share exchange agreement (“Share Exchange Agreement”)
which the parties will endeavor to negotiate and execute as quickly as possible, and not later than October 15, 2019.
●
DTI will pay the Company an additional $500,000 within seven days following the completion date of the transfer of all assets
and/or full ownership of SCI to DTI, with such date to occur within 120 days following execution of the Share Exchange Agreement.
●
DTI will issue to the Company 3,112,000 shares of DTI common stock and will guaranty that the value of the 3,112,000 shares of
DTI common stock will have a value of at least $4.50 per share ($14,004,000, in the aggregate), as of December 31, 2021.
●
To the extent that the value of the DTI common shares, as of December 31, 2021, is less than $4.50 per share ($14,004,000, in
the aggregate), DTI will issue additional shares of DTI common stock, at the then current fair market value, in an amount sufficient
to cause the resulting aggregate value of all shares of DTI common stock issued to the Company to be $14,004,000, in the aggregate.
●
DTI will assign the assets transferred by SCI, including trademarks, intellectual properties, and patents, to its subsidiary,
Femtobitz, Inc., a Delaware corporation, and will pay to the Company 1% of annual gross revenue arising from or relating to operation
of Femtobitz, Inc.
●
Upon closing of the share exchange, the Company’s Chairman will be appointed an advisory board member of DTI and a board
member of Femtobitz, Inc.
The
3,112,000 shares of DTI common stock to be issued to us in exchange for all of our shares of SCI common stock will represent a
minority of the issued and outstanding shares of DTI common stock as of the date of issuance. The DTI shares will be issued in
reliance upon the exemption from registration requirements under the Securities Act of 1933, as amended (the “Securities
Act”), pursuant to Section 4(2) thereof and Regulation D thereunder. As such, such shares may not be offered or sold by
us unless they are registered under the Securities Act or qualify for an exemption from the registration requirements under the
Securities Act.
As
of September 18, 2019, stockholders holding a majority of our outstanding common stock approved the share exchange and the Company
began discussions and negotiations with DTI, which are currently on-going as of the date of this filing. There can be no assurance
that the proposed transaction will be concluded successfully on the terms described or any alternate terms that may be proposed
hereafter.
Analysis
of Financial Condition and Results of Operations
Results
of Operations for the three months ended December 31, 2019 compared to the three months ended December 31, 2018.
Revenue
and Cost of Goods Sold
Revenue
for the three months ended December 31, 2018 was $12,875. There was no revenue, cost of sales or gross profit for the three months
ended December 31, 2019. The decrease in 2019 was due to the decrease in revenues at SCI, as there was no revenue at PSI for each
period. Cost of sales for the three months ended December 31, 2018 was $7,725. Gross profit for the three months ended December
31, 2018 was $5,150.
Operating
Expenses
Operating
expenses for the three months ended December 31, 2019 and 2018 were $337,273 and $475,864, respectively. The decrease in operating
expenses of $138,591 was due primarily to the decrease in consulting fees and stock compensation during the three months ended
December 31, 2019.
Other
Expenses
Other
expenses during the three months ended December 31, 2019 consisted of $9,323 of interest expense. Other expenses during the three
months ended December 31, 2018 consisted of $50,689 of amortization of debt discount, $51,434 of financing costs and $4,851 of
interest expense, totaling to $106,974.
Net
Loss
Our
net loss for the three months ended December 31, 2019 was $346,596, compared to a net loss of $577,688 for the three months ended
December 31, 2018. The decrease in the net loss of $231,091 was primarily due to the decrease in operating and other expenses.
Results
of Operations by Segment
The
Company currently maintains two business segments:
|
(i)
|
Medical
Devices: which it provided through PSI, its wholly-owned subsidiary acquired on August 24, 2012, a developer, manufacturer,
marketer and distributer of targeted Ultra Violet (“UV”) phototherapy devices for the treatment of skin diseases;
and
|
|
|
|
|
(ii)
|
Authentication
and Encryption Products and Services: which it provided through SCI, its wholly-owned subsidiary that on April 4, 2014
acquired certain assets of SMI Holdings, Inc. d/b/a Stealth Mark, Inc., including Stealth Mark tradenames and marks, and related
encryption and authentication solutions offering advanced product security technologies within the security and supply chain
management vertical sectors.
|
The
detailed segment information of the Company is as follows:
Operations
by Segment
|
|
For
the Three Months Ended
|
|
|
|
December
31, 2019
|
|
|
|
Corporate
|
|
|
Medical
Devices
|
|
|
Authentication
and Encryption
|
|
|
Total
|
|
Sales:
|
|
|
|
|
|
|
|
|
|
|
|
|
Trade
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
-
|
|
Consulting
services
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
Total
Sales
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost
of goods sold
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross
profit
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating
expenses
|
|
|
98,462
|
|
|
|
175,286
|
|
|
|
63,525
|
|
|
|
337,273
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss
from operations
|
|
$
|
(98,462
|
)
|
|
$
|
(175,286
|
)
|
|
$
|
(63,525
|
)
|
|
$
|
(337,273
|
)
|
Operations
by Segment
|
|
For
the Three Months Ended
|
|
|
|
December
31, 2018
|
|
|
|
Corporate
|
|
|
Medical
Devices
|
|
|
Authentication
and Encryption
|
|
|
Total
|
|
Sales:
|
|
|
|
|
|
|
|
|
|
|
|
|
Trade
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
7,675
|
|
|
$
|
7,675
|
|
Consulting
services
|
|
|
-
|
|
|
|
-
|
|
|
|
5,200
|
|
|
|
5,200
|
|
Total
Sales
|
|
|
-
|
|
|
|
-
|
|
|
|
12,875
|
|
|
|
12,875
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost
of goods sold
|
|
|
-
|
|
|
|
-
|
|
|
|
7,725
|
|
|
|
7,725
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross
profit
|
|
|
-
|
|
|
|
-
|
|
|
|
5,150
|
|
|
|
5,150
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating
expenses
|
|
|
254,429
|
|
|
|
119,720
|
|
|
|
101,715
|
|
|
|
475,864
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss
from operations
|
|
$
|
(254,429
|
)
|
|
$
|
(119,720
|
)
|
|
$
|
(96,565
|
)
|
|
$
|
(470,714
|
)
|
There
was no revenue or cost of goods sold for the Medical Devices segment for the three months ended December 31, 2019 and 2018. Operating
expenses for the three months ended December 31, 2019 and 2018 was $175,286 and $119,720, respectively. The increase in operating
expenses of $55,566 in 2019 was due primarily to the increase in contract labor. The loss from operations for the three months
ended December 31, 2019 and 2018 was $175,286 and $119,720, respectively.
Revenue
for the Authentication and Encryption segment for the three months ended December 31, 2018 was $12,875. There was no revenue or
cost of sales for the Authentication and Encryption segment for the three months ended December 31, 2019. The decrease in 2019
was due to the decrease in trade sales and consulting services. Cost of goods sold for the three months ended December 31, 2018
was $7,725 and the gross profit was $5,150. The gross profit decrease in 2019 was primarily due to the decrease in sales. Operating
expenses for the three months ended December 31, 2019 and 2018 was $63,525 and $101,715, respectively. The decrease in operating
expenses of $38,190 in 2019 was due primarily to the decrease in stock compensation costs and salaries and wages. The loss from
operations for the three months ended December 31, 2019 and 2018 was $63,525 and $96,565, respectively.
The
Corporate segment primarily provides executive management services for the Company. Operating expenses for the three months ended
December 31, 2019 and 2018 was $60,647 and $254,429, respectively. The decrease in operating expenses of $193,782 in 2019 was
due primarily to the decrease in professional fees and stock compensation. The loss from operations for the three months ended
December 31, 2019 and 2018 was $60,647 and $254,429, respectively.
Liquidity
and Capital Resources
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, the Company has not yet generated significant revenues and has incurred recurring
net losses. During the three months ended December 31, 2019, the Company incurred a net loss of $346,596 and used cash in operations
of $195,784, and had a shareholders’ deficit of $1,314,852 as of December 31, 2019. These factors raise substantial doubt
about the Company’s ability to continue as a going concern. 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 strategies. 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 September 30,
2019 financial statements, has raised substantial doubt about the Company’s ability to continue as a going concern.
At
December 31, 2019, the Company had cash on hand in the amount of $42,363. The ability to continue as a going concern is dependent
on the Company attaining and maintaining profitable operations in the future and raising additional capital soon to meet its obligations
and repay its liabilities arising from normal business operations when they come due. Since inception, we have funded our operations
primarily through equity and debt financings and we expect to continue to rely on these sources of capital in the future. During
the three months ended December 31, 2019, the Company received $185,000 through short-term loans and contributions of capital
by a joint venture partner. As of December 31, 2019, loans payable to officers and shareholders of $534,250 were outstanding.
All of the loans are unsecured, have an interest rate of eight percent and are due one year from the date of issuance.
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 stock holders, in case of equity financing.
Comparison
of three months ended December 31, 2019 and 2018
As
of December 31, 2019, we had $42,363 in cash, negative working capital of $1,337,549 and an accumulated deficit of $25,686,754.
As
of December 31, 2018, we had $134,750 in cash, negative working capital of $716,195 and an accumulated deficit of $23,954,052.
Cash
flows used in operating activities
During
the three months ended December 31, 2019, the Company used cash flows in operating activities of $195,784, compared to $314,460
used in the three months ended December 31, 2018. During the three months ended December 31, 2019, the Company incurred a net
loss of $346,596 and $67,300 of non-cash expenses, compared to a net loss of $577,688 and $197,938 of non-cash expenses during
the three months ended December 31, 2018.
Cash
flows used in investing activities
During
the three months ended December 31, 2019 and 2018, the Company had no cash flows from investing activities.
Cash
flows provided by financing activities
During
the three months ended December 31, 2019, the Company had proceeds from loans payable from officers and shareholders of $135,000
and proceeds of $50,000 from contributions of capital by its joint venture partner. During the three months ended December 31,
2018, the Company had proceeds from loans payable from officers and shareholders of $60,000, from the sale of common stock of
$10,000 and from contributions of capital by its joint venture partner of $375,000.
Off-Balance
Sheet Arrangements
We
have no off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial
condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital
resources.
Summary
of Critical Accounting Policies.
The
Company has identified critical accounting policies that, as a result of the judgments, uncertainties, uniqueness and complexities
of the underlying accounting standards and operations involved could result in material changes to its financial condition or
results of operations under different conditions or using different assumptions. The Company’s most critical accounting
policies include, but are not limited to, those related to fair value of financial instruments, revenue recognition, stock based
compensation for obtaining employee services, and equity instruments issued to parties other than employees for acquiring goods
or services. Details regarding the Company’s use of these policies and the related estimates are described in the Company’s
Annual Report on Form 10-K for the fiscal year ended September 30, 2019, filed with the Securities and Exchange Commission on
January 28, 2020. There have been no material changes to the Company’s critical accounting policies that impact the Company’s
financial condition, results of operations or cash flows for the three months ended December 31, 2019.
Recently
Issued Accounting Pronouncements
See
Management’s discussion of recent accounting policies included in footnote 2 to the condensed consolidated financial statements.
Item
4. Controls and Procedures
Evaluation
of Disclosure Controls and Procedures
Regulations
under the Securities Exchange Act of 1934 (the “Exchange Act”) require public companies to maintain “disclosure
controls and procedures,” which are defined as controls and other procedures that are designed to ensure that information
required to be disclosed by the issuer in the reports that it files or submits under the Exchange Act is recorded, processed,
summarized and reported, within the time periods specified in the Securities and Exchange Commission’s rules and forms.
Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required
to be disclosed by an issuer in the reports that it files or submits under the Exchange Act is accumulated and communicated to
the issuer’s management, including its principal executive and principal financial officers, or persons performing similar
functions, as appropriate to allow timely decisions regarding required disclosure. A material weakness is a control deficiency
(within the meaning of the Public Company Accounting Oversight Board (PCAOB) Auditing Standard No. 2) or combination of control
deficiencies that result in more than a remote likelihood that a material misstatement of the annual or interim financial statements
will not be prevented or detected.
The
Company carried out an evaluation, with the participation of the Company’s management, including the Company’s Chief
Executive Officer (“CEO”), of the effectiveness of the Company’s disclosure controls and procedures (as defined
under Rule 13a-15(e) under the Exchange Act) as of December 31, 2019, the end of the period covered by this report. Based upon
that evaluation, the Company’s CEO concluded that the Company’s disclosure controls and procedures are not effective
at the reasonable assurance level due to the material weaknesses described below:
1.
The lack of an independent audit committee and the lack of internal personnel necessary to provide accurate and timely regulatory
filings.
2.
The Company does not have written documentation of its internal control policies and procedures. Written documentation of key
internal controls over financial reporting is a requirement of Section 404 of the Sarbanes-Oxley Act which is applicable to the
Company. Management evaluated the impact of its failure to have written documentation of its internal controls and procedures
on its assessment of its disclosure controls and procedures and has concluded that the control deficiency that resulted represented
a material weakness.
3.
The Company does not have sufficient segregation of duties within its accounting functions, which is a basic internal control.
Due to its size and nature, segregation of all conflicting duties may not always be possible and may not be economically feasible.
However, to the extent possible, the initiation of transactions, the custody of assets and the recording of transactions should
be performed by separate individuals. Management evaluated the impact of its failure to have segregation of duties on its assessment
of its disclosure controls and procedures and has concluded that the control deficiency that resulted represented a material weakness.
4.
The Company does not have sufficient segregation of duties so that one person can initiate, authorize and execute transactions.
In
light of the material weaknesses, the management of the Company performed additional analysis and other post-closing procedures
to ensure our consolidated financial statements were prepared in accordance with the accounting principles generally accepted
in the United States of America. Accordingly, we believe that our consolidated financial statements included herein fairly present,
in all material respects, our consolidated financial condition, consolidated results of operations and cash flows as of and for
the reporting periods then ended.
Management’s
Report on Internal Control over Financial Reporting
Our
management is responsible for establishing and maintaining adequate internal control over financial reporting. Internal control
over financial reporting is defined in Rule 13a-15(f) or 15d-15(f) promulgated under the Exchange Act as a process designed by,
or under the supervision of, the issuer’s principal executive and principal financial officer and effected by the issuer’s
board of directors, management and other personnel, to provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance with accounting principles generally accepted
in the United States of America and includes those policies and procedures that:
●
Pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions
of the assets of the issuer;
●
Only in accordance with authorizations of management and directors of the issuer; and provide reasonable assurance that transactions
are recorded as necessary to permit preparation of financial statements in accordance with accounting principles generally accepted
in the United States of America and that receipts and expenditures of the Company are being made;
●
Provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the issuer’s
assets that could have a material effect on the financial statements.
Because
of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Projections of
any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes
in conditions, or that the degree of compliance with the policies or procedures may deteriorate. All internal control systems,
no matter how well designed, have inherent limitations. Therefore, even those systems determined to be effective can provide only
reasonable assurance with respect to financial statement preparation and presentation. Because of the inherent limitations of
internal control, there is a risk that material misstatements may not be prevented or detected on a timely basis by internal control
over financial reporting. However, these inherent limitations are known features of the financial reporting process. Therefore,
it is possible to design into the process safeguards to reduce, though not eliminate, this risk.
Because
of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Projections of
any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes
in conditions, or that the degree of compliance with the policies or procedures may deteriorate. All internal control systems,
no matter how well designed, have inherent limitations. Therefore, even those systems determined to be effective can provide only
reasonable assurance with respect to financial statement preparation and presentation. Because of the inherent limitations of
internal control, there is a risk that material misstatements may not be prevented or detected on a timely basis by internal control
over financial reporting. However, these inherent limitations are known features of the financial reporting process. Therefore,
it is possible to design into the process safeguards to reduce, though not eliminate, this risk.
As
of the end of our most recent fiscal year, management assessed the effectiveness of our internal control over financial reporting
based on the criteria for effective internal control over financial reporting established in Internal Control—Integrated
Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”) and SEC guidance
on conducting such assessments. Based on that evaluation, they concluded that, as of September 30, 2019, such internal control
over financial reporting was not effective. This was due to deficiencies that existed in the design or operation of our internal
control over financial reporting that adversely affected our internal controls and that may be considered to be material weaknesses.
The
matters involving internal control over financial reporting that our management considered to be material weaknesses under the
standards of the Public Company Accounting Oversight Board were: (1) lack of a functioning audit committee due to a lack of a
majority of independent members and a lack of a majority of outside directors on our board of directors, resulting in ineffective
oversight in the establishment and monitoring of required internal controls and procedures; and (2) inadequate segregation of
duties consistent with control objectives of having segregation of the initiation of transactions, the recording of transactions
and the custody of assets. The aforementioned material weaknesses were identified by our Chief Executive Officer in connection
with the review of our financial statements as of December 31, 2019.
To
address the material weaknesses set forth in items (2) and (3) discussed above, management performed additional analyses and other
procedures to ensure that the financial statements included herein fairly present, in all material respects, our financial position,
results of operations and cash flows for the periods presented.
This
Report does not include an attestation report of the Company’s independent registered public accounting firm regarding internal
control over financial reporting. Management’s report was not subject to attestation by the Company’s independent
registered public accounting firm pursuant to the rules of the SEC that permit the Company to provide only the management’s
report in this Report.
Management’s
Remediation Initiatives
In
response to the above identified weaknesses in our internal control over financial reporting, we plan to work on documenting in
writing our internal control policies and procedures and implement sufficient segregation of duties within our accounting functions,
so that one person cannot initiate, authorize and execute transactions, and so that one person cannot record transactions in the
accounting records without sufficient review by a separate person. We do not have a specific timeline within which we expect to
conclude these remediation initiatives but do expect it to be an on-going process for the foreseeable future. We continue to evaluate
testing of our internal control policies and procedures, including assessing internal and external resources that may be available
to complete these tasks, but do not know when these tasks will be completed.
Our
CEO and CFO, along with other Board members, are and will be active participants in these remediation processes. We believe the
steps taken to date have improved the effectiveness of our internal control over financial reporting.
Changes
in internal control over financial reporting.
There
have been no changes in our internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15 (f)
under the Exchange Act) during the fourth quarter of our fiscal year 2019 that have materially affected, or are reasonably likely
to materially affect, our internal control over financial reporting.