Notes
to Consolidated Financial Statements
December
31, 2016 and 2015
NOTE
1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Company:
Surna
Inc. incorporated in Nevada on October 15, 2009. On March 26, 2014, we acquired Safari Resource Group, Inc. (“Safari”),
a Nevada Corporation, whereby we became the sole surviving corporation after the acquisition of Safari. In July 2014, we acquired
100% of the membership interest in Hydro Innovations, LLC, a Colorado limited liability company, (“Hydro”), pursuant
to which Hydro became a wholly-owned subsidiary of the Company. We engineer and manufacture innovative technology and products
that address the energy and resource intensive nature of indoor cultivation. Our focus lies in supplying industrial solutions
to commercial indoor cannabis cultivation facilities. The engineering team is tasked with creating novel energy and resource efficient
solutions, including our signature liquid-cooled climate control platform. Our engineers continuously seek to create technologies
that allow growers to easily meet the highly specific demands of a cannabis cultivation environment through temperature, humidity,
light, and process control. Our objective is to provide intelligent solutions that improve the quality, control and overall yield
and efficiency of indoor cannabis cultivation. We are headquartered in Boulder, Colorado.
The
Company’s operations exclude the production or sale of marijuana.
History:
On
September 1, 2011, Surna Inc. acquired Surna Media, Inc. (“Surna Media”) for 20,000,000 shares of its common stock.
The merger with Surna Media was accounted for as among entities under common control. Surna Media’s predecessor entity,
Surna Hong Kong Limited (“Surna HK”), was formed on June 14, 2010. Surna Media was formed October 29, 2010 by the
same owners and Surna HK became a wholly-owned subsidiary. Flying Cloud Information Technology Co. Ltd. was incorporated in China
in April 2011 as a wholly owned subsidiary of Surna HK (“Flying Cloud”). All of the Surna HK, Surna Media, and Flying
Cloud transactions are consolidated with those of the Company beginning at the formation of Surna HK on June 14, 2010. Surna Networks,
Inc. (“Surna Networks I”) and Surna Networks Ltd. (“Surna Networks II”) are wholly owned subsidiaries
of the Company, formed on July 19, 2011 and August 2, 2011, respectively. On March 27, 2012, the Company sold Surna Networks I
and Surna Networks II to Chan Kam Ming for a total sales price of US$1 and assumption of liability related to those companies.
The Company assumed the liabilities of Surna Networks I and Surna Networks II, which totaled US$9,286. All significant intercompany
transactions are eliminated. We sold Surna Media and its subsidiaries in 2014.
Financial
Statement Presentation:
The
preparation of the consolidated financial statements in conformity with U.S. generally accepted accounting principles (“GAAP”)
requires management to make estimates and assumptions that affect reported amounts and related disclosures. In the opinion of
management, all adjustments (consisting of normal recurring items) considered necessary for a fair presentation have been included.
The
accompanying consolidated financial statements have been prepared on a going-concern basis, which contemplates the realization
of assets and the satisfaction of liabilities in the normal course of business. The Company has not generated sufficient revenue
and has funded its operating losses through the sale of common stock and the issuance of debt. The Company has a limited operating
history and its prospects are subject to risks, expenses and uncertainties frequently encountered by companies in the industry.
(See Note 2.)
Basis
of Consolidation and Reclassifications:
The
consolidated financial statements include the accounts of the Company and its controlled and wholly-owned subsidiaries. Intercompany
transactions, profit, and balances are eliminated in consolidation.
Certain
reclassifications have been made to amounts in prior periods to conform to the current period presentation. All reclassifications
have been applied consistently to the periods presented. The reclassifications had no impact on net loss or total assets and liabilities.
Use
of Estimates:
The
preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect
the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial
statements and that affect the reported amounts of revenue and expenses during the reporting period. We base our estimates on
historical experience and on various other assumptions that we believe to be reasonable under the circumstances, the results of
which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from
other sources. Actual results could differ from those estimates. In addition, any change in these estimates or their related assumptions
could have an adverse effect on our operating results. Key estimates include: valuation of derivative liabilities, valuation of
intangible assets, and valuation of deferred tax assets and liabilities.
Cash
and Cash Equivalents:
All
highly liquid investments with original maturities of three months or less at the date of purchase are considered to be cash equivalents.
The Company may, from time to time, have deposits in one financial institution that exceeds the federally insured amount.
Accounts
Receivable and Allowance for Doubtful Accounts:
Accounts
receivable are recorded at invoiced amount and generally do not bear interest. An allowance for doubtful accounts is established,
as necessary, based on past experience and other factors, which, in management’s judgment, deserve current recognition in
estimating bad debts. Such factors include growth and composition of accounts receivable, the relationship of the allowance for
doubtful accounts to accounts receivable and current economic conditions. The determination of the collectability of amounts due
from customer accounts requires the Company to make judgments regarding future events and trends. Allowances for doubtful accounts
are determined based on assessing the Company’s portfolio on an individual customer and on an overall basis. This process
consists of a review of historical collection experience, current aging status of the customer accounts, and the financial condition
of the Company’s customers. Based on a review of these factors, the Company establishes or adjusts the allowance for specific
customers and the accounts receivable portfolio as a whole. As of December 31, 2016 and 2015 the allowance for doubtful accounts
was $90,839 and $40,873, respectively.
Inventory:
Inventory
is stated at the lower of cost or market. The majority of inventory is valued based on a first-in, first-out (“FIFO”)
basis. Lower of cost or market is evaluated by considering obsolescence, excessive levels of inventory, deterioration and other
factors. Adjustments to reduce the cost of inventory to its net realizable value, if required, are made for estimated excess,
obsolescence or impaired inventory. Excess and obsolete inventory is charged to cost of revenue and a new lower-cost basis for
that inventory is established and subsequent changes in facts and circumstances do not result in the restoration or increase in
that newly established cost basis.
Property
and Equipment:
Property
and equipment are stated at cost. When retired or otherwise disposed, the related carrying value and accumulated depreciation
are removed from the respective accounts and the net difference less any amount realized from disposition, is reflected in earnings.
For financial statement purposes, property and equipment are recorded at cost and depreciated using the straight-line method over
their estimated useful lives, which is generally five years. Leasehold improvements are amortized on a straight-line basis over
the lesser of their useful lives or the life of the lease. Upon sale or retirement of assets, the cost and related accumulated
depreciation and amortization are removed from the balance sheet and the resulting gain or loss is reflected in operations. Maintenance
and repairs are charged to operations as incurred.
Impairment
of Long-Lived Assets:
Long-lived
tangible assets are reviewed for impairment whenever events or changes in business circumstances indicate the carrying value of
the assets may not be recoverable. When such an event occurs, management determines whether there has been impairment by comparing
the anticipated undiscounted future net cash flows to the related asset’s carrying value. If an asset is considered impaired,
the asset is written down to fair value, which is determined based either on discounted cash flows or appraised value, depending
on the nature of the asset. The Company has not identified any such impairment losses to date.
Goodwill
and Other Intangible Assets:
Goodwill
is reviewed for impairment annually or more frequently when events or changes in circumstances indicate that fair value of the
reporting unit has been reduced to less than its carrying value. The Company performs its impairment test annually during the
fourth quarter. First, the Company assesses qualitative factors to determine whether it is more likely than not that the fair
value of a reporting unit is less than its carrying value as a basis for determining whether it is necessary to perform the two-step
goodwill impairment test. If, after assessing qualitative factors, the Company determines it is not more likely than not that
the fair value of a reporting unit is less than its carrying amount, then performing the two-step impairment test is unnecessary.
If deemed necessary, a two-step test is used to identify the potential impairment and to measure the amount of goodwill impairment,
if any. The first step is to compare the fair value of the reporting unit with its carrying amount, including goodwill. If the
fair value of the reporting unit exceeds its carrying amount, goodwill is considered not impaired; otherwise, there is an indication
that goodwill may be impaired and the amount of the loss, if any, is measured by performing step two. Under step two, the impairment
loss, if any, is measured by comparing the implied fair value of the reporting unit goodwill with the carrying amount of goodwill.
We completed this assessment as of December 31, 2016, and concluded that no impairment existed.
Separable
intangible assets that have finite useful lives continue to be amortized over their respective useful lives.
All
of the Company’s identifiable intangible assets are subject to amortization on a straight-line basis over their estimated
useful lives. Identifiable intangibles consist of intellectual property such as patents and trademarks, and capitalized software.
Identifiable intangibles are also subject to evaluation for potential impairment if events or circumstances indicate the carrying
value may not be recoverable.
Fair
Value Measurement:
The
accounting standards regarding fair value of financial instruments and related fair value measurements define fair value, establish
a three-level valuation hierarchy for disclosures of fair value measurement and enhance disclosure requirements for fair value
measures.
ASC
Topic 820 establishes a valuation hierarchy for disclosure of the inputs to valuation used to measure fair value. This hierarchy
prioritizes the inputs into three broad levels as follows:
Level
1 - inputs are quoted prices (unadjusted) in active markets for identical assets or liabilities.
Level
2 - inputs are quoted prices for similar assets and liabilities in active markets or inputs that are observable for the asset
or liability, either directly or indirectly through market corroboration, for substantially the full term of the financial instrument.
Level
3 - inputs are unobservable inputs based on our own assumptions used to measure assets and liabilities at fair value.
On
a Recurring Basis:
A
financial asset or liability’s classification within the hierarchy is determined based on the lowest level of input that
is significant to the fair value measurement. The Company’s assessment of the significance of a particular input to the
fair value measurement in its entirety requires management to make judgments and consider factors specific to the asset or liability.
The Company has determined that the convertible debt instruments outstanding as of the date of these financial statements include
an exercise price “reset” adjustment that qualifies as derivative financial instruments under the provisions of ASC
815-40, Derivatives and Hedging - Contracts in an Entity’s Own Stock (“ASC 815-40”). See Note 10 for discussion
of the impact the derivative financial instruments had on the Company’s consolidated financial statements and results of
operations.
Financial
assets and liabilities carried at fair value, measured on a recurring basis as follows:
|
|
|
December
31, 2016
|
|
|
Description
|
|
Level
1
|
|
|
Level
2
|
|
|
Level
3
|
|
|
Gains
(Losses)
(1)
|
|
|
Derivative
liability on conversion feature
|
|
$
|
-
|
|
|
$
|
-
|
|
|
|
$
|
|
|
|
(200,083
|
)
|
|
Derivative
liability on warrants
|
|
|
-
|
|
|
|
-
|
|
|
|
477,814
|
|
|
|
(338,622
|
)
|
|
Total
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
477,814
|
|
|
$
|
(538,705
|
)
|
|
(1)
|
The
loss on change in derivative liabilities of $538,705 presented in the statement of operations for the year ended December
31, 2016 also includes gains on derivatives associated with convertible promissory note balances outstanding at various dates
during the year ended December 31, 2016, which were converted to common stock prior to December 31, 2016.
|
|
|
|
December
31, 2015
|
|
|
Description
|
|
Level
1
|
|
|
Level
2
|
|
|
Level
3
|
|
|
Gains
(Losses)
(2)
|
|
|
Derivative
liability on conversion feature
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
472,967
|
|
|
$
|
383,049
|
|
|
Derivative
liability on warrants
|
|
|
-
|
|
|
|
-
|
|
|
|
139,192
|
|
|
|
106,829
|
|
|
Total
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
612,159
|
|
|
$
|
489,878
|
|
|
(2)
|
The
gain on change in derivative liabilities of $964,751 presented in the statement of operations for the fiscal year ended December
31, 2015 also includes gains on derivatives associated with convertible promissory note balances outstanding at various dates
during fiscal year 2015, which were converted to common stock prior to December 31, 2015.
|
Our
Level 3 fair value liabilities represent contingent consideration recorded related to the embedded conversion features in the
convertible notes issued in 2014 and 2015. The change in the balance of the conversion feature derivative liabilities and warrant
liabilities during the fiscal years ended December 31, 2016 and 2015 was calculated using the Black-Scholes Model, which is classified
as gain on change in derivative liabilities in the consolidated statement of operations. The Black-Scholes Model does take into
consideration the Company’s stock price, historical volatility, and risk-free interest rate, which do have observable Level
1 or Level 2 inputs.
During
the year ended December 31, 2016, the Company converted all of the Series 3 and 4 convertible promissory notes (see Note 9) issued
in 2015 into common stock, which gave rise to the fair value liabilities for the embedded conversion features. At conversion,
the balance of the derivative liability of, $673,050 has been credited to additional paid in capital in the consolidated balance
sheet.
During
the year ended December 31, 2015, the Company converted all of the Series 1 convertible promissory notes (see Note 9) issued in
2014 into common stock, which gave rise to the fair value liabilities for the embedded conversion features. At conversion, the
balance of the derivative liability of, $791,409 has been credited to additional paid in capital in the consolidated balance sheet.
Additionally, the Series 2 convertible promissory notes derivative liability balance of $119,348 was also credited to additional
paid in capital. The Series 2 notes embedded conversion features were classified as derivative liabilities solely due to “sequencing”
such that, when the Series 1 notes were converted the Series 2 notes are no longer derivatives.
On
a Non-Recurring Basis:
In
accordance with the provisions of ASC Topic 350, Intangibles – Goodwill and Other (“ASC Topic 350”), the Company
estimates the fair value of reporting units, utilizing unobservable Level 3 inputs. Level 3 inputs require significant management
judgment due to the absence of quoted market prices or observable inputs for assets of a similar nature. The Company utilizes
a discounted cash flow analysis to estimate the fair value of reporting units utilizing unobservable inputs. The fair value measurements
for goodwill under the step-one and step-two analysis of the quantitative goodwill impairment test are classified as Level 3 inputs.
Intangible
assets that are amortized are evaluated for recoverability whenever adverse effects or changes in circumstances indicate that
the carrying value may not be recoverable. The recoverability test consists of comparing the undiscounted projected cash flows
with the carrying amount. Should the carrying amount exceed undiscounted projected cash flows, an impairment loss would be recognized
to the extent the carrying amount exceeds fair value. For the Company’s indefinite-lived intangible asset, the impairment
test consists of comparing the fair value, determined using the market value method, with its carrying amount. An impairment loss
would be recognized for the carrying amount in excess of its fair value. As of December 31, 2016, the Company concluded that no
indicators of impairment relating to intangible assets or goodwill existed and an interim test was not performed.
Due
to their short-term nature, the carrying values of cash and equivalents, accounts receivable, accounts payable, and accrued expenses,
approximate fair value. Based on borrowing rates currently available to the Company for loans with similar terms, the carrying
value of the notes payable approximates fair value.
There
were no changes in valuation technique from prior periods.
Derivative
Financial Instruments:
We
evaluate our 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 statements
of operations. For stock-based derivative financial instruments, the Company uses the Black-Scholes Option Pricing Model to value
the derivative instruments. 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.
We
have determined that certain convertible debt instruments outstanding as of the date of these financial statements include an
exercise price “reset” adjustment that qualifies as derivative financial instruments under the provisions of ASC 815-40,
Derivatives and Hedging - Contracts in an Entity’s Own Stock (“ASC 815-40”). Certain of the convertible debentures
have a variable exercise price, thus are convertible into an indeterminate number of shares for which we cannot determine if we
have sufficient authorized shares to settle the transaction with. Accordingly, the embedded conversion option is a derivative
liability and is marked to market through earnings at the end of each reporting period.
We
evaluate the application of ASC 815-40-25 to the warrants to purchase common stock issued with the convertible notes, and determined
that the warrants were required to be accounted for as derivatives due to the provisions in certain convertible notes that result
in our being unable to determine if we have sufficient authorized shares to settle the instrument. See Note 10 for discussion
of the impact the derivative financial instruments had on the Company’s consolidated financial statements and results of
operations.
Accordingly,
the embedded conversion option and the warrants are derivative liabilities and are marked to market through earnings at the end
of each reporting period. Any change in fair value during the period recorded in earnings as “Other income (expense) - gain
(loss) on change in derivative liabilities.”
Revenue
Recognition:
We
recognize revenue from the sale of our products, which we primarily manufacture. Revenue is recognized when products are shipped
or delivered and title passes to the customer, provided that persuasive evidence of an arrangement exists, the price is fixed
or determinable, and collection of the resulting receivable is reasonably assured. Sales of our products are not subject to regulatory
requirements that vary from state to state. We generally do not provide our customers with a contractual right of return. In certain
limited circumstances, revenue could be recognized using the percentage-of-completion method as performance occurs. Management
believes that all relevant criteria and conditions are considered when recognizing revenue.
Sales
arrangements sometimes involve delivering multiple elements, including services such as installation. In these instances, the
revenue assigned to each element is based on vendor-specific objective evidence, third-party evidence or a management estimate
of the relative selling price. Revenue is recognized individually for delivered elements only if they have value to the customer
on a stand-alone basis and the performance of the undelivered items is probable and substantially in our control, or the undelivered
elements are inconsequential or perfunctory and there are no unsatisfied contingencies related to payment. We had no revenue arise
from qualifying sales arrangements that include the delivery of multiple elements in fiscal year 2015 or 2014. The vast majority
of these deliverables are tangible products, with a small portion attributable to installation. We do not provide any separate
maintenance. Generally, contract duration is short term and cancellation, termination or refund provisions apply only in the event
of contract breach, and have historically not been invoked.
The
Company provides climate control equipment and installation services designed for the controlled environment agriculture industry
through construction-type contracts with contract terms typically less than one year. Advance payments received from customers
are included in deferred revenue, a component of current liabilities, until such time that all criteria are met, as noted above,
and revenue is recognized.
Shipping
and handling costs are reported within cost of sales in the consolidated statements of operations.
The
Company accounts for sales taxes and other related taxes on a net basis, excluding such taxes from revenue.
Product
Warranty:
Products
are generally subject to a warranty period of the lesser of 12 months from start-up or 18 months from shipment. Warranty provides
for the repair, rework, or replacement of products (at the Company’s option) that fail to perform within stated specification.
We assessed the historical claims and, in 2015, claims were insignificant. In 2016, product warranty claims were approximately
1% of total annual revenue. We will continue to assess the need to record a warranty accrual at the time of sale going forward.
Accordingly, a provision of $85,000 and $0 was established for 2016 and 2015 respectively.
Concentrations:
Two
customers accounted for 14% and 10% of the Company’s revenue for the year ended December 31, 2016. One customer accounted
for 10% of the Company’s revenue for the year ended December 31, 2015.
The
Company’s accounts receivable from two customers make up 39% and 29% of the total balance as of December 31, 2016. The Company’s
accounts receivable from four customers made up 89% of the total balance as of December 31, 2015.
Product
Development:
The
Company accounts for product development cost in accordance with Accounting Standards Codification subtopic 730-10, Research and
Development (“ASC 730-10”). ASC 730-10 requires such costs be charged to expenses as incurred. Accordingly, internal
product development costs are expensed as incurred. Third-party product developments costs are expensed when the contracted work
has been performed or as milestone results have been achieved. For the years ended December 31, 2016 and 2015, we incurred $349,062
and $705,517, respectively, on product development, which is included in the consolidated statements of operations.
Accounting
for Stock-Based Compensation:
Share-based
compensation cost is measured at grant date, based on the fair value of the award, and is recognized as expense over the employee’s
service period. The Company recognizes compensation expense on a straight-line basis over the requisite service period of the
award.
We
determined that the Black-Scholes Option Pricing Model is the most appropriate method for determining the estimated fair value
for stock options or warrants. The Black-Scholes Model requires the use of highly subjective and complex assumptions that determine
the fair value of share-based awards, including the equity instrument’s expected term and the price volatility of the underlying
stock.
Equity
instruments issued to nonemployees are recorded at their fair value on the measurement date and are subject to periodic adjustment
as the underlying equity instruments vest.
Share-based
payments to employees for compensation and nonemployees for services provided to the Company totaled $4,028 and $127,493 for the
years ended December 31, 2016 and 2015, respectively.
Income
Taxes:
The
provision for income taxes is determined using the asset and liability approach of accounting for income taxes. Under this approach,
deferred taxes represent the future tax consequences expected to occur when the reported amounts of assets and liabilities are
recovered or paid. The provision for income taxes represents income taxes paid or payable for the current year plus the change
in deferred taxes during the year. Deferred taxes result from differences between the financial and tax basis of the Company’s
assets and liabilities and are adjusted for changes in tax rates and tax laws when changes are enacted. A valuation allowance
is recorded to reduce deferred tax assets when it is more likely than not that a tax benefit will not be realized.
We
must assess the likelihood that the Company’s deferred tax assets will be recovered from future taxable income, and to the
extent the Company believes that recovery is not likely, we establish a valuation allowance. Management judgment is required in
determining our provision for income taxes, deferred tax assets and liabilities, and any valuation allowance recorded against
the net deferred tax assets. We recorded a full valuation allowance as of December 31, 2016 and 2015. Based on the available evidence,
the Company believes it is more likely than not that it will not be able to utilize its deferred tax assets in the future. We
intend to maintain valuation allowances until sufficient evidence exists to support the reversal of such valuation allowances.
We make estimates and judgments about its future taxable income that are based on assumptions that are consistent with our plans.
Should the actual amounts differ from our estimates, the carrying value of our deferred tax assets could be materially impacted.
We
recognize in the financial statements the impact of a tax position, if that position is more likely than not of being sustained
on audit, based on the technical merits of the position. The Company’s policy is to recognize interest and penalties accrued
on any unrecognized tax benefits as a component of operating expense. We do not believe there are any tax positions for which
it is reasonably possible that the total amounts of unrecognized tax benefits will significantly increase or decrease within twelve
months of the reporting date. There were no penalties or interest liabilities accrued as of fiscal year end December 31, 2016
or 2015, nor were any penalties or interest costs included in expense for the years ended December 31, 2016 and 2015.
The
years under which we conducted our evaluation coincided with the tax years currently still subject to examination by major federal
and state tax jurisdictions, those being 2010 through 2016 for federal purposes and 2014 through 2016 for state purposes.
Comprehensive
Income (Loss):
Comprehensive
income (loss) represents the change in shareholders’ equity (deficit) of an enterprise, other than those resulting from
shareholder transactions. Accordingly, comprehensive income (loss) may include certain changes in shareholders’ equity (deficit)
that are excluded from net income (loss). For the years ended December 31, 2016 and 2015, the Company’s comprehensive loss
is the same as its net loss.
Basic
and Diluted Net Loss per Common Share:
Basic
net loss per common share is computed by dividing net loss by the weighted-average number of common shares outstanding during
the period. Diluted net loss per common share is determined using the weighted-average number of common shares outstanding during
the period, adjusted for the dilutive effect of common stock equivalents. In periods when losses are reported, the weighted-average
number of common shares outstanding excludes common stock equivalents, because their inclusion would be anti-dilutive. As of December
31, 2016, the Company had approximately 11,400,000 common stock equivalents.
Commitments
and Contingencies:
In
the normal course of business, the Company is subject to loss contingencies, such as legal proceedings and claims arising out
of its business, that cover a wide range of matters, including, among others, government investigations, environment liability
and tax matters. An accrual for a loss contingency is recognized when it is probable that an asset had been impaired or a liability
had been incurred and the amount of loss can be reasonably estimated.
Other
Risks and Uncertainties:
To
achieve profitable operations, the Company must successfully develop, manufacture, and market its products. There can be no assurance
that any such products can be developed or manufactured at an acceptable cost and with appropriate performance characteristics,
or that such products will be successfully marketed. These factors could have a material adverse effect upon the Company’s
financial results, financial position, and future cash flows.
The
Company is subject to risks common to companies who supply the cannabis industry including, but not limited to, new technological
innovations, dependence on key personnel, protection of proprietary technology, compliance with government regulations, uncertainty
of market acceptance of products, product liability, and the need to obtain additional financing. The Company’s ultimate
success is dependent upon its ability to raise additional capital and to successfully develop and market its products.
Segment
Information:
Operating
segments are defined as components of an enterprise about which separate financial information is available that is evaluated
regularly by the chief operating decision maker, or decision-making group, in deciding how to allocate resources and in assessing
performance. The Company’s chief operating decision maker is its senior management team. The Company has one operating segment
that is dedicated to the manufacture and sale of its products.
Recent
Accounting Pronouncements:
In
January 2017, the FASB issued Accounting Standards Update No. 2017-01,
Clarifying the Definition of a Business
(“ASU
2017-01”). The standard clarifies the definition of a business by adding guidance to assist entities in evaluating whether
transactions should be accounted for as acquisitions of assets or businesses. ASU 2017-01 is effective for fiscal years beginning
after December 15, 2017, and interim periods within those fiscal years. Under ASU 2017-01, to be considered a business, the assets
in the transaction need to include an input and a substantive process that together significantly contribute to the ability to
create outputs. Prior to the adoption of the new guidance, an acquisition or disposition would be considered a business if there
were inputs, as well as processes that when applied to those inputs had the ability to create outputs. Early adoption is permitted
for certain transactions. Adoption of ASU 2017-01 may have a material impact on the Company’s consolidated financial statements
if it enters into future business combinations.
In
January 2017, the FASB issued Accounting Standards Update No. 2017-04,
Simplifying the Test for Goodwill Impairment
(“ASU
2017-04”). ASU 2017-04 simplifies the accounting for goodwill impairment by removing Step 2 of the goodwill impairment test,
which requires a hypothetical purchase price allocation. ASU 2017-04 is effective for annual or interim goodwill impairment tests
in fiscal years beginning after December 15, 2019, and should be applied on a prospective basis. Early adoption is permitted for
interim or annual goodwill impairment tests performed on testing dates after January 1, 2017. The Company is currently evaluating
the effect that adopting this new accounting guidance will have on its consolidated results of operations, cash flows and financial
position.
In
August 2016, the FASB issued ASU 2016-15,
Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and
Cash Payments (a consensus of the Emerging Issues Task Force).
This ASU requires changes in the presentation of certain items
in the statement of cash flows including but not limited to debt prepayment or debt extinguishment costs; contingent consideration
payments made after a business combination; proceeds from the settlement of insurance claims; proceeds from the settlement of
corporate-owned life insurance policies and distributions received from equity method investees. This guidance will be effective
for annual periods and interim periods within those annual periods beginning after December 15, 2017, will require adoption on
a retrospective basis and will be effective for the Company on January 1, 2018. The Company is currently evaluating the effect
that adopting this new accounting guidance will have on its consolidated results of operations, cash flows and financial position.
In
June 2016, the FASB issued ASU 2016-13,
Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on
Financial Instruments
. The amendments within this ASU replace the incurred loss impairment methodology in current GAAP with
a methodology that reflects expected credit losses and requires consideration of a broader range of reasonable and supportable
information to inform credit loss estimates. ASU 2016-13 is effective for fiscal years beginning after December 15, 2019, including
interim periods within those fiscal years. Entities may early adopt the amendments within this ASU but not prior to the fiscal
years beginning after December 15, 2018, including the interim periods within those fiscal years. An entity will apply the amendments
in this Update through a cumulative-effect adjustment to retained earnings as of the beginning of the first reporting period in
which the guidance is effective (that is, a modified-retrospective approach). However, a prospective transition approach is required
for debt securities for which an other-than-temporary impairment had been recognized before the effective date. The Company is
currently evaluating the effect that adopting this new accounting guidance will have on its consolidated results of operations,
cash flows and financial position.
In
March 2016, the FASB issued ASU 2016-09,
Compensation - Stock Compensation (Topic 718): Improvements to Employee Share-Based
Payment Accounting
. This ASU is designed to address simplification of several aspects of the accounting for share-based payment
transactions, including the income tax consequences, classification of awards as either equity or liabilities, and classification
on the statement of cash flows. ASU 2016-09 is effective for annual periods beginning after December 15, 2016, and interim periods
within those annual periods. Early adoption of this ASU is permitted and would be applied on a retrospective basis back to the
beginning of fiscal year that included any such interim period in which early adoption was elected. The Company is currently evaluating
the effect that adopting this new accounting guidance will have on its consolidated results of operations, cash flows and financial
position.
In
February 2016, the FASB issued ASU 2016-02,
Leases
(Topic 842) which requires companies leasing assets to recognize on
their balance sheet a liability to make lease payments (the lease liability) and a right-of-use asset representing its right to
use the underlying asset for the lease term on contracts longer than one year. The lessee is permitted to make an accounting policy
election to not recognize lease assets and lease liabilities for short-term leases. How leases are recorded on the balance sheet
represents a significant change from previous GAAP guidance in Topic 840. ASU 2016-02 maintains a distinction between finance
leases and operating leases similar to the distinction under previous lease guidance for capital leases and operating leases.
The Company is currently evaluating the effect that adopting this new accounting guidance will have on its consolidated results
of operations, cash flows and financial position. ASU 2016-02 is effective for fiscal periods beginning after December 15, 2018,
and early adoption is permitted. The Company is currently evaluating the effect that adopting this new accounting guidance will
have on its consolidated results of operations, cash flows and financial position.
In
January 2016, the FASB issued ASU 2016-01,
Financial Instruments - Overall (Subtopic 825-10): Recognition and Measurement of
Financial Assets and Financial Liabilities
. The amendments in this Update address certain aspects of recognition, measurement,
presentation, and disclosure of financial instruments. ASU 2016-01 is effective for fiscal years beginning after December 15,
2017, including interim periods within those fiscal years. The Company is currently evaluating the effect that adopting this new
accounting guidance will have on its consolidated results of operations, cash flows and financial position.
In
July 2015, the FASB issued ASU 2015-11,
Simplifying the Measurement of Inventory
. ASU 2015-11 simplifies the subsequent
measurement of inventory by replacing today’s lower of cost or market test with a lower of cost and net realizable value
test. The guidance applies only to inventories for which cost is determined by methods other than last-in first-out (LIFO) and
the retail inventory method (RIM). Entities that use LIFO or RIM will continue to use existing impairment models (e.g., entities
using LIFO would apply the lower of cost or market test). The guidance is effective for public business entities for fiscal years
beginning after December 15, 2016, and interim periods within those fiscal years. Early adoption is permitted as of the beginning
of an interim or annual reporting period. The Company is currently evaluating the effect that adopting this new accounting guidance
will have on its consolidated results of operations, cash flows and financial position.
In
May 2014, the FASB issued ASU 2014-09,
Revenue from Contracts with Customers
, issued as a new Topic, ASC Topic 606. The
new revenue recognition standard supersedes all existing revenue recognition guidance. Under this ASU, an entity should recognize
revenue when it transfers promised goods or services to customers in an amount that reflects the consideration to which the entity
expects to be entitled in exchange for those goods or services. ASU 2015-14, issued in August 2015, deferred the effective date
of ASU 2014-09 to the first quarter of 2018, with early adoption permitted in the first quarter of 2017. The Company is currently
evaluating the effect that adopting this new accounting guidance will have on its consolidated results of operations, cash flows
and financial position.
In
March, April, May, and December 2016, the FASB issued the following updates, respectively, to provide supplemental adoption guidance
and clarification to ASU 2014-09. These standards must be adopted concurrently upon the adoption of ASU 2014-09. We are currently
evaluating the potential effects of adopting the provisions of these updates.
|
●
|
ASU
No. 2016-08, Revenue from Contracts with Customers: Principal versus Agent Considerations (Reporting Revenue Gross versus
Net)
|
|
|
|
|
●
|
ASU
No. 2016-10, Revenue from Contracts with Customers: Identifying Performance Obligations and Licensing;
|
|
|
|
|
●
|
ASU
No. 2016-12, Revenue from Contracts with Customers: Narrow-Scope Improvements and Practical Expedients; and
|
|
|
|
|
●
|
ASU
No. 2016-19, Technical Corrections and Improvements
|
NOTE
2 - GOING CONCERN
The
accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern.
The Company has experienced recurring losses since its inception. The Company incurred a net loss of approximately $3,300,000
for the year ended December 31, 2016, and had an accumulated deficit of approximately $14,340,000 as of December 31, 2016. Since
inception, the Company has financed its activities principally through debt and equity financing. Management expects to incur
additional losses and cash outflows in the foreseeable future in connection with development of its operating activities.
The
Company’s consolidated financial statements have been presented on a going concern basis, which contemplates the realization
of assets and the satisfaction of liabilities in the normal course of business.
The
Company is subject to a number of risks similar to those of other similar stage companies, including dependence on key individuals,
successful development, marketing and branding of products; uncertainty of product development and generation of revenues; dependence
on outside sources of financing; risks associated with research, development; dependence on third-party content providers, suppliers
and collaborators; protection of intellectual property; and competition with larger, better-capitalized companies. Ultimately,
the attainment of profitable operations is dependent on future events, including obtaining adequate financing to fulfil its development
activities and generating a level of revenues adequate to support the Company’s cost structure. To support the Company’s
financial performance, management has undertaken several initiatives, including the raising of additional financing subsequent
to year end:
In
November and December 2016 and January and February 2017, the Company was successful in negotiating the extinguishing its convertible
promissory notes with the issuance of shares of its common stock (See Note 16 - Subsequent Events.
In
March 2017, the Company raised $2,685,000 through a private placement sale of 16,781,250 shares of the Company’s
common stock to accredited investors (see Note 16 - Subsequent Events).
There
can be no assurance however that such financing will be available in sufficient amounts, when and if needed, on acceptable terms
or at all. If results of operations for 2017 do not meet management’s expectations, or additional capital is not available,
management believes it has the ability to reduce certain expenditures. The precise amount and timing of the funding needs cannot
be determined accurately at this time, and will depend on a number of factors, including the market demand for the Company’s
products and services, the quality of product development efforts, management of working capital, and continuation of normal payment
terms and conditions for purchase of services. The Company is uncertain whether its cash balances and cash flow from operations
will be sufficient to fund its operations for the next twelve months. If the Company is unable to substantially increase revenues,
reduce expenditures, or otherwise generate cash flows for operations, then the Company will need to raise additional funding to
continue as a going concern through its major shareholder(s), or through other avenues.
NOTE
3 - INVENTORY
Inventory
consisted of the following as of December 31,:
|
|
|
2016
|
|
|
2015
|
|
|
Finished
goods
|
|
$
|
591,564
|
|
|
$
|
619,319
|
|
|
Work
in progress
|
|
|
16,518
|
|
|
|
43,466
|
|
|
Raw
materials
|
|
|
187,192
|
|
|
|
599,017
|
|
|
Reserve
for Excess & Obsolete Inventory
|
|
|
(47,369
|
)
|
|
|
-
|
|
|
Total
inventory
|
|
$
|
747,905
|
|
|
$
|
1,261,802
|
|
Overhead
expenses of $26,764 and $73,125 were included in the inventory balance as of December 31, 2016 and 2015, respectively. This includes
depreciation expense of $417 and $5,869 as of December 31, 2016 and 2015, respectively.
NOTE
4 - PROPERTY AND EQUIPMENT
Property
and equipment consists of the following as of December 31,:
|
|
|
2016
|
|
|
2015
|
|
|
Furniture
and equipment
|
|
$
|
171,709
|
|
|
$
|
168,899
|
|
|
Molds
|
|
|
31,063
|
|
|
|
31,063
|
|
|
Vehicles
|
|
|
15,000
|
|
|
|
62,286
|
|
|
Leasehold
Improvements
|
|
|
38,101
|
|
|
|
35,804
|
|
|
|
|
|
255,873
|
|
|
|
298,052
|
|
|
Accumulated
depreciation
|
|
|
(162,308
|
)
|
|
|
(135,522
|
)
|
|
Property
and equipment, net
|
|
$
|
93,565
|
|
|
$
|
162,530
|
|
Depreciation
expense amounted to $55,296 for the year ended December 31, 2016, of which $8,349 was allocated to cost of revenue and inventory.
Depreciation expense amounted to $59,168 for the year ended December 31, 2015, of which $16,322 was allocated to cost of revenue
and inventory.
NOTE
5 - INTANGIBLE ASSETS
Intangible
assets consist of the following as of December 31,:
|
|
|
2016
|
|
|
2015
|
|
|
Intellectual
property
|
|
$
|
48,004
|
|
|
$
|
22,712
|
|
|
Accumulated
amortization
|
|
|
(11,623
|
)
|
|
|
(6,312
|
)
|
|
|
|
|
36,381
|
|
|
|
16,400
|
|
|
Goodwill
|
|
|
631,064
|
|
|
|
631,064
|
|
|
Intangible
assets, net
|
|
$
|
667,445
|
|
|
$
|
647,464
|
|
Goodwill
of an acquired company is neither amortized nor deductible for tax purposes and is primarily related to expected improvements
in sales growth from future product and service offerings, new customers and productivity.
Intangible
assets have an estimated life of 5 years. Amortization expense for the intangible assets was $5,311 and $4,100 for the
years ended December 31, 2016 and 2015, respectively.
Expected
future amortization expense of acquired intangible assets as of December 31, 2016 is as follows:
|
Year
Ended December 31,
|
|
|
|
|
|
2017
|
|
|
$
|
4,757
|
|
|
2018
|
|
|
|
4,757
|
|
|
2019
|
|
|
|
4,757
|
|
|
2020
|
|
|
|
4,757
|
|
|
Total
|
|
|
$
|
19,028
|
|
NOTE
6 - PATENTS AND TRADEMARKS
Surna
relies on a combination of patent and trademark rights, trade secrets, laws that protect intellectual property, confidentiality
procedures, and contractual restrictions with its employees and others to establish and protect its intellectual property rights.
As of December 31, 2016, the Company has eight pending patent applications and four issued patents. The pending patent applications
are a combination of PCT, utility and design patent applications that are directed to certain core Company technology. The Company’s
four issued patents are U.S. design patents related to the Company’s Reflector. The U.S. design patents provide protection
for 14 years from the date of issue. Utility patents provide protection for 20 years from the earliest non-provisional application
filing date. The Company has registered trademarks for its core brand (“Surna”), including the wordmark alone, the
associated logo, and the combined wordmark and logo in the United States. The wordmark is also registered in the European Union
and is pending registration in Canada. Subject to ongoing use and renewal, trademark protection is potentially perpetual.
NOTE
7 - ACCOUNTS PAYABLE AND ACCRUED LIABILITIES
Accounts
payable and accrued liabilities consist of the following as of December 31,:
|
|
|
2016
|
|
|
2015
|
|
|
Accounts
payable
|
|
$
|
1,020,224
|
|
|
$
|
1,849,544
|
|
|
Sales
commissions payable
|
|
|
40,736
|
|
|
|
73,711
|
|
|
Sales
tax payable
|
|
|
23,631
|
|
|
|
65,758
|
|
|
Accrued
payroll liabilities
|
|
|
43,573
|
|
|
|
34,965
|
|
|
Other
accrued expenses
|
|
|
209,689
|
|
|
|
42,825
|
|
|
Total
|
|
$
|
1,337,853
|
|
|
$
|
2,066,803
|
|
NOTE
8 - RELATED PARTY TRANSACTIONS
In
July of 2014 the Company issued a $250,000 promissory note (“Hydro2 Note”) to Stephen and Brandy Keen. Stephen Keen
was the Chief Executive Officer at the time of the note, and is now Director of Technology, and his wife, Brandy, who is Vice
President of Sales as part of the purchase price of Hydro Innovations. On April 15, 2016 (the “Effective Date”) the
parties entered into an amendment to the original agreement (the “Amendment”). In accordance with the terms of the
Amendment, the Company made a payment of $100,000 on or around the Effective Date which resulted in the reduction of the outstanding
balance from $194,514 to $94,514. Additionally, pursuant to the Amendment, the Company was not obligated to make further payments
until July 2016 at which time the Company resumed monthly payments equal to $5,000 per month. The interest rate remained at 6%
per annum. The parties agreed that the note no longer had to be paid in full by July 18, 2016 and no default had occurred. As
of December 31, 2016, the Hydro2 Note had a balance of $69,383 with $57,398 and $11,985 reflected on the balance sheet as current
and long-term respectively.
As
of December 31, 2015, there was a deferred compensation balance of $25,600 due to Stephen and Brandy Keen. This balance was paid
in full during 2016.
During
the year ended December 31, 2015, $194,958 of debt due to the Company’s former Chief Executive Officer, Tom Bollich, was
retired for a one-time, immediate cash payment of $100. The related party extinguishment has been recognized as a credit to additional
paid in capital.
NOTE
9 - CONVERTIBLE PROMISSORY NOTES
The
following table summarizes the convertible promissory notes for the years ended December 31, 2016 and 2015:
|
|
|
Series
1
|
|
|
Series
2
|
|
|
Series
3
|
|
|
Series
4
|
|
|
Total
|
|
|
Balance
January 1, 2015
|
|
$
|
1,336,783
|
|
|
$
|
1,625,000
|
|
|
$
|
|
|
|
$
|
|
|
|
$
|
2,961,783
|
|
|
Additions
|
|
|
|
|
|
|
911,250
|
|
|
|
711,000
|
|
|
|
103,273
|
|
|
|
1,725,523
|
|
|
Conversions
|
|
|
(1,336,783
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1,336,783
|
)
|
|
Balance
December 31, 2015
|
|
|
-
|
|
|
|
2,536,250
|
|
|
|
711,000
|
|
|
|
103,273
|
|
|
|
3,350,523
|
|
|
Discounts
and deferred finance charges
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1,598,940
|
)
|
|
Convertible
notes payable, net
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1,751,583
|
|
|
Less
current portion - December 31, 2015
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1,227,761
|
|
|
Long-term
portion - December 31, 2015
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
523,822
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance January
1, 2016
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
3,350,523
|
|
|
Conversions
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(2,570,523
|
)
|
|
Balance December
31, 2016
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
780,000
|
|
|
Discounts
and deferred finance charges
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(18,560
|
)
|
|
Convertible
notes payable, net
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
761,440
|
|
|
Less
current portion - December 31, 2016
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
761,440
|
|
|
Long-term
portion - December 31, 2016
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
-
|
|
Conversions:
During
the year ended December 31, 2015, the Company issued 25,169,786 shares of its common stock in connection with conversions of the
Series 1 Notes for $1,336,783 principal amount and $216,141 accrued interest. The total of $1,668,267 was allocated to common
stock and additional paid in capital because of the conversion.
During
the year ended December 31, 2016, the Company issued 17,888,828 shares of its common stock in connection with the conversions
of the Series 3 & 4 notes for $814,273 and $74,632 accrued interest. The total of $888,905 was allocated to common stock and
additional paid in capital as a result of the conversion.
The
Company entered into negotiations with certain of the Series 4 noteholders for them to convert principal and interest into shares
of the Company’s common stock. As an incentive for them to convert, the Company agreed to amend the notes and the warrants
During
the year ended December 31, 2016, the Company entered into note conversion and warrant amendment agreements (each, an “Agreement”
and together, the “Agreements”) to: (i) amend the convertible promissory notes – series 2 (Original Notes”)
to reduce the conversion price of such holder’s Original Note and simultaneously cause the conversion of the outstanding
amount under such Original Note into shares of common stock of the Company (“Conversion Shares”); and (ii) reduce
the exercise price of the original warrant (“Original Warrants” and together with an amended notes and the amended
warrants, the “Amendments”). Each Agreement has been privately negotiated so the terms vary. Pursuant to the Agreements,
the Original Notes have been amended to reflect a reduced conversion price per share between $0.09 and $0.22. Additionally, pursuant
to the Agreements
,
the Original Warrants have been amended to reflect a reduced exercise price per share between
$0.30 and $0.35, except for one Original Warrants to reflect a reduced exercise price of $0.15 per share.
Pursuant
to the Agreements, the Company has (i) converted Original Notes with an aggregate outstanding principal amount of approximately
$1,756,250 and accrued interest of $399,063, of the total principal amount under the Original Notes, (ii) issued 14,871,781 shares
of the Company’s common stock in connection with the conversion of such Original Notes and (iii) amended Original Warrants
to reduce their exercise price.
The
Company has accounted for the Amended agreements as debt extinguishment in accordance with ASC 470 - Debt section 470-50-40-2
where by the difference between the reacquisition price of the debt and the net carrying amount of the extinguished debt was recognized
as a loss during for the year ended December 31, 2016. The following details the calculation of the loss on extinguishment of
the notes payable – series 2:
|
Carrying
Amount of debt
|
|
|
|
|
Principal
converted
|
|
$
|
1,756,250
|
|
|
Interest
converted
|
|
|
399,063
|
|
|
Unamortized
debt discount
|
|
|
(51,208
|
)
|
|
|
|
|
2,104,105
|
|
|
Reacquisition
price of debt
|
|
|
|
|
|
Fair
value of shares issued
|
|
|
2,346,
240
|
|
|
Warrant
modification value
|
|
|
96,106
|
|
|
|
|
|
2,442,346
|
|
|
Loss
on Extinguishment
|
|
$
|
(338,241
|
)
|
Convertible
Promissory Notes – Series 1
During
the period ended December 31, 2014, the Company issued Series 1 convertible promissory notes (“Series 1 Notes”) in
the aggregate principal amount of $1,336,783. The Series 1 Notes (i) were unsecured, (ii) bore interest at the rate of 10% per
annum, and (iii) were due two years from the date of issuance. The Series 1 Notes were convertible at any time at the option of
the investor into a number of shares of the Company’s common stock that is determined by dividing the amount to be converted
by the lesser of (i) $1.00 per share or (ii) eighty percent (80%) of the prior thirty-day weighted average market price for the
Company’s common stock. During the fiscal year ended December 31, 2015, all of the Series 1 Notes were converted into 25,169,786
shares of common stock.
Due
to the variable conversion price, the number of shares issuable upon conversion was variable and the fact that there was no cap
on the number of shares that could have been issued in exchange for these convertible promissory notes, the Company determined
that the conversion feature was considered a derivative liability. The accounting treatment of derivative financial instruments
requires that the Company record the fair value of the derivatives as of the inception date of the convertible promissory notes
and to adjust the fair value as of each subsequent balance sheet date. Upon the issuance of the Series 1 Notes, the Company determined
a fair value of $1,324,283 of the embedded derivative. The fair value of the embedded derivative was determined using intrinsic
value up to the face amount of the Series 1 Notes.
The
initial fair value of the embedded debt derivative of $1,324,283 was allocated as a debt discount and a conversion feature derivative
liability. The debt discount was being amortized over the two-year term of the Series 1 Notes. Upon conversion of each Series
1 Note, the unamortized portion of the debt discount was recorded as amortization of debt discount on convertible notes. The Company
recognized a charge of $916,094 for the year ended December 31, 2015 for amortization of this debt discount.
Convertible
Promissory Notes – Series 2
In
October 2014, the Company engaged a placement agent to act on a “best efforts” basis for the Company in connection
with the structuring, issuance, and private placement for the sale of debt and/or equity securities. The Company offered up to
60 investment units (each, a “Unit”) with each Unit sold at a price of $50,000 and consisting of (i) two hundred fifty
thousand (250,000) shares of the Company’s common stock, par value $0.00001; (ii) a $50,000 10% convertible promissory note,
(“Series 2 Note”); and (iii) warrants for the purchase of 50,000 shares of the Company’s common stock. The Series
2 Notes (i) are unsecured, (ii) bear interest at the rate of 10% per annum, and (iii) are due two years from the date of issuance.
The Series 2 Notes are convertible after 360 days from the issuance date at the option of the investor into a number of shares
of the Company’s common stock that is determined by dividing the amount to be converted by the $0.60 conversion price. If
not converted, the debt is payable in full twenty-four months from the issuance date. Additionally, the entire principal amount
due on each Series 2 Note shall be automatically converted into common stock at the automatic conversion price (the greater of
$0.50 per share or 75% of the public offering price per share) without any action of the purchaser on the earlier of: (x) the
date on which the Company closes on a financing transaction involving the sale of the Company’s common stock at a price
of no less than $2.00 per share with gross proceeds to the Company of no less than $5,000,000; or (y) the date which is three
(3) days after the common stock shall have traded at a VWAP of at least $2.00 per share for a period of ten (10) consecutive trading
days. The Company raised $2,536,250 from the sale of these Units.
The
gross proceeds from the sale of the Series 2 Notes are recorded net of a discount related to the conversion feature of the embedded
conversion option. When the fair value of conversion options is in excess of the debt discount the amount has been included as
a component of interest expense in the statement of operations. The fair value of the embedded conversion option and the fair
value of the warrants underlying the Series 2 Note issued at the time of their issuance were calculated pursuant to the Black-Scholes
Model. The fair value was recorded as a reduction to the Series 2 Notes payable and was charged to operations as interest expense
in accordance with the effective interest method within the period of the Series 2 Notes. Transaction costs are apportioned to
Series 2 Notes payable, common stock, warrants and derivative liabilities. The portion of transaction costs attributed to the
conversion feature, warrants and common stock are immediately expensed, because the derivative liabilities are accounted for at
fair value through the statement of operations. Any non-cash issuance costs are accounted for separately and apart from the allocation
of proceeds. However, if the non-cash issuance costs are paid in the form of convertible instruments, the convertible instruments
issued are subject to the same accounting guidance as those sold to investors after first applying the guidance of ASC 505-50
(Stock-Based Compensation Issued to Nonemployees). There were no non-cash issuance costs.
Convertible
Notes – Series 3
Starting
in the third fiscal quarter of 2015, the Company entered into Securities Purchase Agreements (the “SPAs”) with three
accredited investors (each a “Purchaser” and together the “Purchasers”), pursuant to which the Company
sold and the Purchasers purchased convertible notes with a one year term in the aggregate original principal amount of $711,000,
with an aggregate original issue discount of $61,000 (each a “Note” and together the “Notes”), and warrants
to purchase up to an aggregate of 2,625,000 shares of the Company’s common stock, subject to adjustment, for aggregate cash
proceeds of $656,250. The conversion price is equal to 80% of the lowest trading price of our common stock as reported on the
OTCQB for the fifteen prior trading days. These convertible notes and the Amended 2015 Note (see Note 9) have an embedded conversion
option that qualifies for derivative accounting and bifurcation under ASC 815-15 Derivatives and Hedging. Pursuant to ASC 815,
“Derivatives and Hedging”, the Company recognized the fair value of the embedded conversion feature as a derivative
liability upon issuance of the Notes.
The
following table outlines the key terms of the Notes:
|
|
|
Note
1
|
|
|
Note
2
|
|
|
Note
3
|
|
|
Note
4
|
|
|
Note
5
|
|
|
Total
|
|
|
Term
|
|
|
1
year
|
|
|
|
1
year
|
|
|
|
1
year
|
|
|
|
1
year
|
|
|
|
1
year
|
|
|
|
|
|
|
Origination
Date
|
|
|
Jul
2015
|
|
|
|
Jul
2015
|
|
|
|
Sept
2015
|
|
|
|
Sept
2015
|
|
|
|
Sept
2015
|
|
|
|
|
|
|
Cash
Received
|
|
$
|
150,000
|
|
|
$
|
100,000
|
|
|
$
|
200,000
|
|
|
$
|
100,000
|
|
|
$
|
100,000
|
|
|
$
|
650,000
|
|
|
Note Face
Value
|
|
$
|
165,000
|
|
|
$
|
106,000
|
|
|
$
|
220,000
|
|
|
$
|
110,000
|
|
|
$
|
110,000
|
|
|
$
|
711,000
|
|
|
Original
Issue Discount
|
|
$
|
15,000
|
|
|
$
|
6,000
|
|
|
$
|
20,000
|
|
|
$
|
10,000
|
|
|
$
|
10,000
|
|
|
$
|
61,000
|
|
|
Financing
Expense
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
6,000
|
|
|
$
|
3,000
|
|
|
$
|
13,000
|
|
|
$
|
22,000
|
|
|
Interest
Rate
|
|
|
10
|
%
|
|
|
11
|
%
|
|
|
10
|
%
|
|
|
10
|
%
|
|
|
10
|
%
|
|
|
|
|
|
Conversion
% of Stock Value
|
|
|
80
|
%
|
|
|
80
|
%
|
|
|
80
|
%
|
|
|
80
|
%
|
|
|
80
|
%
|
|
|
|
|
|
Share Reserve
Minimum
|
|
|
10,000,000
|
|
|
|
10,000,000
|
|
|
|
10,000,000
|
|
|
|
10,000,000
|
|
|
|
10,000,000
|
|
|
|
50,000,000
|
|
|
Warrants
|
|
|
500,000
|
|
|
|
375,000
|
|
|
|
750,000
|
|
|
|
500,000
|
|
|
|
500,000
|
|
|
|
2,625,000
|
|
|
Warrant Exercise
Price
|
|
$
|
0.25
|
|
|
$
|
0.25
|
|
|
$
|
0.25
|
|
|
$
|
0.25
|
|
|
$
|
0.25
|
|
|
|
|
|
|
Warrant
Term
|
|
|
5
Years
|
|
|
|
5
Years
|
|
|
|
5
Years
|
|
|
|
5
Years
|
|
|
|
5
Years
|
|
|
|
|
|
The
gross proceeds from the sale of the debentures are recorded net of a discount of related to the embedded conversion feature. When
the fair value of conversion options is in excess of the debt discount the amount has been included as a component of interest
expense in the statement of operations. During the year ended December 31, 2015, the Company recorded $373,881 of interest expense
relating to the excess fair value of the conversion option over the face value of the debentures. The fair value of the embedded
conversion option and the warrants associated with the promissory notes at the time of their issuance was calculated pursuant
to the Black-Scholes Model. The fair value was recorded as a reduction to the promissory notes payable and was charged to operations
as interest expense in accordance with effective interest method within the period of the promissory notes. Transaction costs
are apportioned to the debt liability, common stock and derivative liabilities. The portion of transaction costs attributed to
the conversion feature, warrants and common stock are immediately expensed, because the derivative liabilities are accounted for
at fair value through the statement of operations. Any non-cash issuance costs are accounted for separately and apart from the
allocation of proceeds. However, if the non-cash issuance costs are paid in the form of convertible instruments, the convertible
instruments issued are subject to the same accounting guidance as those sold to investors after first applying the guidance of
ASC 505-50 (Stock-Based Compensation Issued to Nonemployees). There were no non-cash issuance costs.
Upon
issuance of the Notes, the Company determined a fair value of $1,023,881 for the derivative liabilities. The fair value of the
warrants was determined to be $246,020 and the fair value of the conversion feature was $777,861. The aggregate debt discount
is being amortized over the one year term of the convertible promissory notes.
Convertible
Note – Series 4
On
December 18, 2015, the July 2015 Secured Note (see Note 9) balance of $103,319 ($100,273 principal and accrued interest of $3,046)
was mutually extended to a new Maturity Date from December 22, 2015 to April 30, 2016 (the “Amended 2015 Note”). In
consideration of the extension the Company amended the terms to include a conversion feature. The Amended 2015 Note is convertible
into shares of our common stock at any time following the Extension and Amendment Agreement date. The conversion price is equal
to 70% of the lowest trading price of our common stock as reported on the OTCQB for the twenty prior trading days.
The
Amended 2015 Note has an embedded conversion option that qualifies for derivative accounting and bifurcation under ASC 815-15
Derivatives and Hedging. Pursuant to ASC 815, “Derivatives and Hedging”, the Company recognized the fair value of
the embedded conversion feature as a derivative liability when the Amended 2015 Note became convertible on December 18, 2015.
The increase in the fair value of the embedded note conversion liability was $78,155, calculated using the Black-Scholes Option
Pricing Model. In accordance with ASC 470, since the present value of the cash flows under the new debt instrument was at least
ten percent different from the present value of the remaining cash flows under the terms of the original debt instrument, the
Company accounted for the amendment as a debt extinguishment. Accordingly, for the year ended December 31, 2015, the Company recorded
a $78,155 loss on extinguishment of debt in the consolidated statement of operations.
For
the year ended December 31, 2016 and 2015, the Company recognized amortization expense for the debt discounts on the convertible
promissory notes of $1,529,219 and $2,220,115, respectively. Also, for the years ended December 31, 2016 and 2015, the
Company recognized interest expense for the convertible promissory notes of approximately $500,000 and $429,561, respectively.
NOTE
10 - DERIVATIVE LIABILITIES
The
Series 1 convertible promissory notes discussed in Note 10 have a variable conversion price, which results in a variable number
of shares needed for settlement that gave rise to a derivative liability for the embedded conversion feature. Due to the variable
conversion price in the Series 1 convertible notes, the warrants to purchase shares of common stock are also classified as a liability.
The fair value of the conversion feature derivative liability is recorded and shown separately under noncurrent liabilities. Changes
in the fair values of the derivative liabilities related to the embedded conversion feature and the warrants are recorded in the
statement of operations under other income (expense).
During
the year ended December 31, 2015, the Company converted all of the Series 1 convertible promissory notes issued in 2014 into common
stock, which gave rise to fair value liabilities for the embedded conversion features. At conversion, the balance of the derivative
liability of $791,409 was credited to additional paid in capital in the consolidated balance sheet.
Additionally,
the Series 2 convertible promissory notes derivative liability balance of $119,348 was also credited to additional paid in capital.
The Series 2 notes embedded conversion features were classified as a derivative liability solely due to “sequencing”
such that, when the Series 1 notes were converted the Series 2 notes are no longer considered a derivative.
Additionally,
the Series 3 and 4 convertible promissory notes discussed in Note 10 have a variable conversion price, which results in a variable
number of shares needed for settlement that gave rise to a derivative liability for the embedded conversion feature. Both the
variable conversion price in the Series 3 convertible notes as well as a “Half Ratchet” or “Down Round Protection”
clause in the warrant agreements require classification of the warrants as a derivative liability. The fair value of the conversion
feature derivative liability and the warrant liability are recorded and shown separately under current liabilities. Changes in
the fair values of the derivative liabilities related to the embedded conversion feature and the warrants are recorded in the
statement of operations under other income (expense). At conversion, the balance of the derivative liability of $673,050 was credited
to additional paid in capital in the consolidated balance sheet.
The
following table sets forth movement in the derivative liability from the initial measurement at issuance date through December
31, 2016:
|
Balance
December 31, 2014
|
|
$
|
1,151,870
|
|
|
Initial
measurement at issuance date of convertible promissory notes
|
|
|
1,335,797
|
|
|
Change
in derivative liability, net
|
|
|
(1,875,508
|
)
|
|
Balance December
31, 2015
|
|
|
612,159
|
|
|
Change
in derivative liability, net
|
|
|
(
134,345
|
)
|
|
Balance
December 31, 2016
|
|
$
|
477,814
|
|
NOTE
11 - VEHICLE LOAN
During
the year ended December 31, 2014, the Company financed a vehicle. The original balance of the loan was $47,286. The balance of
the loan as of December 31, 2015 was $34,115. In January 2016, the Company paid the balance of the loan in full.
NOTE
12 - COMMITMENTS AND CONTINGENCIES
Operating
Leases
The
Company holds a lease agreement for its manufacturing and office space consisting of approximately 18,000 square feet. The lease
term extends through April 1, 2017. The Company is in the process of negotiating a 90-day extension for our expired lease. We
are in the process of evaluating our future office and warehouse needs, so we plan to continue with 90-day extensions under our
expired lease agreement until we determine our office and warehouse requirements.
Rent
expense for office space amounted to $237,552 and $237,617 for the years ended December 31, 2016 and 2015, respectively.
Employment
agreements
The
Company has employment agreements with Brandy Keen as its Vice President of Sales and Stephen Keen as its Director of Technology
to pay each an annual base salary of $96,000. The Company agreed to employ Mr. and Ms. Keen for a period of three years beginning
on July 25, 2014. Notwithstanding the 3-year term, each of the Keens’ employment agreements are at-will and may be terminated
at any time, with or without cause. The committed amount payable over the remaining term of the Keens’ agreements totals
$112,000.
Other
Commitments
In
the ordinary course of business, the Company may provide indemnifications of varying scope and terms to customers, vendors, lessors,
business partners, and other parties with respect to certain matters, including, but not limited to, losses arising out of the
Company’s breach of such agreements, services to be provided by the Company, or from intellectual property infringement
claims made by third parties. In addition, the Company has entered into indemnification agreements with its directors and certain
of its officers and employees that will require the Company to, among other things, indemnify them against certain liabilities
that may arise by reason of their status or service as directors, officers, or employees. The Company has also agreed to indemnify
certain former officers, directors, and employees of acquired companies in connection with the acquisition of such companies.
The Company maintains director and officer insurance, which may cover certain liabilities arising from its obligation to indemnify
its directors and certain of its officers and employees, and former officers, directors, and employees of acquired companies,
in certain circumstances.
It
is not possible to determine the maximum potential amount of exposure under these indemnification agreements due to the limited
history of prior indemnification claims and the unique facts and circumstances involved in each particular agreement. Such indemnification
agreements may not be subject to maximum loss clauses.
Litigation
From
time to time, the Company may become subject to legal proceedings, claims, and litigation arising in the ordinary course of business.
In addition, the Company may receive letters alleging infringement of patent or other intellectual property rights. The Company
is not currently a party to any material legal proceedings, nor is the Company aware of any pending or threatened litigation that
would have a material adverse effect on the Company’s business, operating results, cash flows, or financial condition should
such litigation be resolved unfavorably.
NOTE
13 - PREFERRED AND COMMON STOCK
Preferred
Stock
As
of December 31, 2016 and 2015, there were 77,220,000 shares of Series A Preferred Stock issued and outstanding, respectively.
The Series A Preferred Stock has no conversion rights, liquidation priorities, or other preferences; it only has voting rights
equal to the common stock.
Common
Stock
During
the year ended December 31, 2016, the Company issued shares of its common stock as follows:
A
total of 46,045 shares were issued to any employee for compensation
A
total of 1,493,400 shares were issued for the exercise of stock options
A
total of 33,365,609 shares were issued for the conversion the convertible promissory notes (See Note 9_ - Convertible Promissory
notes).
During
the year ended December 31, 2015, the Company issued shares of its common stock as follows:
A
total of 1,000,000 shares were issued in connection with a consulting agreement. These shares, valued at $330,000, were authorized
in 2014 and deemed issued as of December 31, 2014, however were not issued by the stock transfer agent until January 7, 2015.
The consulting agreement called for the consultant to provide business advisory and related consulting services, including but
not limited to: study and review of the business, operations, and financial performance and development initiatives, and formulating
the optimal strategy to meet working capital needs.
A
total of 4,556,250 shares were issued in connection with the issuance of convertible promissory notes. (See Note 9 – Convertible
Promissory Notes.) $427,448 of the proceeds, which is net of transaction costs of $19,042, was allocated to common stock and additional
paid in capital.
A
total of 25,169,786 shares were issued as a result of conversions of Series 1 convertible promissory notes. (See Note –
9 Convertible Promissory Notes.) $1,668,267 of the proceeds was allocated to common stock and additional paid in capital.
A
total of 21,408,023 shares were transferred to the Company. This transfer was not the result of any agreements between the Company
and the individual. On August 11, 2015, the Company authorized cancellation of the shares.
A
total of 539,028 shares were issued to employees as compensation.
A
total of 866,571 shares were issued for nonemployee services provided to the Company.
A
total of 2,625,000 shares were issued for the exercise of stock options. In December 2015, stock option holders gave the Company
notice of their intent to exercise the options to purchase the Company’s common shares. The issuance was accounted for as
though completed in 2015, however the issuance of those shares was not actually completed until subsequent to December 31, 2015.
NOTE
14 - WARRANTS AND OPTIONS
Warrants
for common stock
Warrant
activity during the years ended December 31, 2016 and 2015 is as follows:
|
|
|
Number
of
Warrants
|
|
|
Weighted-Average
Exercise Price
|
|
|
Aggregate
Intrinsic Value
|
|
|
Outstanding
and exercisable December 31, 2014
|
|
|
1,625,000
|
|
|
$
|
3.00
|
|
|
$
|
515,125
|
|
|
Granted
(with Series 2 convertible notes)
|
|
|
911,250
|
|
|
|
3.00
|
|
|
|
|
|
|
Granted
(with Series 3 convertible notes)
|
|
|
2,625,000
|
|
|
|
0.25
|
|
|
|
|
|
|
Exercised
|
|
|
-
|
|
|
|
-
|
|
|
|
|
|
|
Expired
|
|
|
-
|
|
|
|
-
|
|
|
|
|
|
|
Outstanding
and exercisable December 31, 2015
|
|
|
5,161,250
|
|
|
$
|
0.70
|
|
|
$
|
350,788
|
|
|
Exercised
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
Expired
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
Outstanding
and exercisable December 31, 2016
|
|
|
5,161,250
|
|
|
$
|
0.70
|
|
|
$
|
1,032,250
|
|
As
of December 31, 2016, there were outstanding warrants to purchase an aggregate of 5,161,250 shares of common stock. The warrants
expire between October 2018 and September 2020. Those issued in connection with the Series 2 convertible promissory notes expire
within four years from the date of issue. Those issued in connection with the Series 3 convertible promissory notes expire five
years from the issuance date.
Stock
Option Plan
At
the closing of the merger with Safari Resource Group, Safari had stock options that had previously been granted to its founders
totaling 10,000 shares, and were fully vested. At the date of grant, Safari had no operations and nominal assets. As a result,
the options were deemed to have no value and no charge was made to the income statement. The options were converted at the same
rate as the common shares resulting in 10,296,000 options, with an exercise price of $0.00024. In the years ended 2016 and 2015,
stock option holders exercised 1,493,400 and 2,625,000 stock options respectively. No new options were granted during the year
ended December 31, 2016 or the year ended December 31, 2015.
The
following table summarizes our stock option activity:
|
|
|
Number
of Options
|
|
|
Weighted
Average Grant-Date Fair Value
|
|
|
Outstanding
as of December 31, 2014
|
|
|
10,296,000
|
|
|
$
|
-
|
|
|
Options
granted
|
|
|
-
|
|
|
|
0.00024
|
|
|
Options
exercised
|
|
|
(2,625,000
|
)
|
|
|
-
|
|
|
Options
forfeited
|
|
|
-
|
|
|
|
-
|
|
|
Outstanding
as of December 31, 2015
|
|
|
7,671,000
|
|
|
$
|
0.00024
|
|
|
Options
granted
|
|
|
-
|
|
|
|
-
|
|
|
Options
exercised
|
|
|
(1,493,400
|
)
|
|
|
0.00024
|
|
|
Options
forfeited
|
|
|
-
|
|
|
|
-
|
|
|
Outstanding
as of December 31, 2016
|
|
|
6,177,600
|
|
|
$
|
0.00024
|
|
The
Company’s stock option activity and related information for 2016 and 2015 is summarized as follows:
|
|
|
Year
Ended December 31, 2016
|
|
|
Year
Ended December 31, 2015
|
|
|
|
|
|
|
|
|
|
|
Weighted
|
|
|
|
|
|
|
|
|
|
|
|
Weighted
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Average
|
|
|
|
|
|
|
|
|
|
|
|
Average
|
|
|
|
|
|
|
|
|
|
|
Weighted
|
|
|
Remaining
|
|
|
|
|
|
|
|
|
Weighted
|
|
|
Remaining
|
|
|
|
|
|
|
|
Number
|
|
|
Average
|
|
|
Contractual
|
|
|
Aggregate
|
|
|
Number
|
|
|
Average
|
|
|
Contractual
|
|
|
Aggregate
|
|
|
|
|
of
Options
|
|
|
Exercise
Price
|
|
|
Term
(in years)
|
|
|
Intrinsic
Value
|
|
|
of
Options
|
|
|
Exercise
Price
|
|
|
Term
(in years)
|
|
|
Intrinsic
Value
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Options
outstanding, beginning of year
|
|
|
7,671,000,
|
|
|
$
|
0.00024
|
|
|
|
1.2
|
|
|
$
|
536,970
|
|
|
|
10,296,000
|
|
|
$
|
0.00024
|
|
|
|
2.2
|
|
|
$
|
3,263,832
|
|
|
Options
granted
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
Options
exercised
|
|
|
(1,493,400
|
)
|
|
|
0.00024
|
|
|
|
-
|
|
|
|
119,966
|
|
|
|
(2,625,000
|
)
|
|
|
0.00024
|
|
|
|
-
|
|
|
|
183,750
|
|
|
Options
canceled
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
Options
outstanding, end of year
|
|
|
6,177,600
|
|
|
$
|
0.00024
|
|
|
|
.2
|
|
|
$
|
1,155,211
|
|
|
|
7,671,000
|
|
|
$
|
0.00024
|
|
|
|
1.2
|
|
|
$
|
536,970
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Vested
and exercisable and expected to vest, end of year
|
|
|
6,177,600
|
|
|
$
|
0.00024
|
|
|
|
.2
|
|
|
$
|
1,155,211
|
|
|
|
7,671,000
|
|
|
$
|
0.00024
|
|
|
|
1.2
|
|
|
$
|
536,970
|
|
|
|
(1)
|
The
stock options outstanding were issued under the 2014 Stock Ownership Plan of Safari. Upon the acquisition of Safari on March
26, 2014, the existing stock options in Safari were converted into stock options in Surna. All options were fully vested at
the date of the acquisition. Accordingly, there was no unrecognized compensation. The options expire in March 2017.
|
Stock
options outstanding and exercisable as of December 31, 2016 are as follows:
|
|
|
|
|
|
Options
Outstanding
|
|
|
|
Options
Exercisable
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Average
|
|
|
|
|
|
|
|
Weighted
|
|
|
|
|
|
|
|
|
|
|
|
Weighted
|
|
|
|
Remaining
|
|
|
|
|
|
|
|
Average
|
|
|
|
|
|
|
|
|
|
|
|
Average
|
|
|
|
Contractual
|
|
|
|
|
|
|
|
Weighted
|
|
|
Exercise
|
|
|
|
Number
|
|
|
|
Exercise
|
|
|
|
Term
|
|
|
|
Number
|
|
|
|
Exercise
|
|
|
Price
|
|
|
|
Outstanding
|
|
|
|
Price
|
|
|
|
(in
years)
|
|
|
|
Exercisable
|
|
|
|
Price
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
0.00024
|
|
|
|
6,177,600
|
|
|
$
|
0.00024
|
|
|
|
.2
|
|
|
|
6,177,600
|
|
|
$
|
0.00024
|
|
NOTE
15 - INCOME TAXES
In
2016 and 2015, we recorded net tax provisions of nil.
The
components of the provision for income taxes, net for the fiscal years ended December 31, 2016 and 2015 are:
|
|
|
|
2016
|
|
|
|
2015
|
|
|
Current
taxes:
|
|
|
|
|
|
|
|
|
|
U.S.
Federal
|
|
$
|
-
|
|
|
$
|
-
|
|
|
U.S.
State
|
|
|
-
|
|
|
|
-
|
|
|
International
|
|
|
-
|
|
|
|
-
|
|
|
Current
taxes
|
|
|
-
|
|
|
|
-
|
|
|
Deferred
taxes:
|
|
|
|
|
|
|
|
|
|
U.S.
Federal
|
|
|
-
|
|
|
|
-
|
|
|
U.S.
State
|
|
|
-
|
|
|
|
-
|
|
|
International
|
|
|
-
|
|
|
|
-
|
|
|
Deferred
taxes
|
|
|
-
|
|
|
|
-
|
|
|
Provision
for income taxes, net
|
|
$
|
-
|
|
|
$
|
-
|
|
Differences
between income taxes computed at the federal statutory rate and the provision recorded for income taxes are comprised of the follow
items:
|
|
|
2016
|
|
|
2015
|
|
|
Income
taxes computed at the federal statutory rate
|
|
$
|
(1,021,000
|
)
|
|
$
|
(1,801,000
|
)
|
|
Effect
of:
|
|
|
|
|
|
|
|
|
|
State
taxes, net of federal benefits
|
|
|
(92,000
|
)
|
|
|
(162,000
|
)
|
|
Loss
of net operating losses from discontinued operations
|
|
|
|
|
|
|
-
|
|
|
Loss
of net operating losses due to 382 limitations
|
|
|
|
|
|
|
596,000
|
|
|
Nondeductible
expenses
|
|
|
717,000
|
|
|
|
501,000
|
|
|
Other,
net
|
|
|
122,000
|
|
|
|
114,000
|
|
|
Change
in valuation allowance
|
|
|
274,000
|
|
|
|
752,000
|
|
|
Total
|
|
$
|
-
|
|
|
$
|
-
|
|
As
of December 31, 2016, the Company has approximately $ in net operating losses carried forward for federal and state income tax
purposes, which will expire, if not utilized, in 2035.
As
a result of the Safari acquisition (see Note 1), there was a change of control (greater than 50% ownership change) and a change
in lines of business, thus utilization of prior year net operations losses will be limited.
Deferred
income tax assets as of December 31, 2016 and 2015 are as follows:
|
|
|
2016
|
|
|
2015
|
|
|
Deferred
tax assets:
|
|
|
|
|
|
|
|
|
|
Net
operating losses
|
|
$
|
3,762,000
|
|
|
$
|
2,155,000
|
|
|
Consultant
Expenses
|
|
|
-
|
|
|
|
7,000
|
|
|
Other
items
|
|
|
19,000
|
|
|
|
12,000
|
|
|
Total
deferred tax assets
|
|
|
3,781,000
|
|
|
|
2,052,000
|
|
|
Deferred
tax liabilities
|
|
|
|
|
|
|
|
|
|
Federal
utilization of state benefits
|
|
|
(154,000
|
)
|
|
|
(82,000
|
)
|
|
Fixed
asset basis difference
|
|
|
(14,000
|
)
|
|
|
(41,000
|
)
|
|
Consulting
expense
|
|
|
(25,000
|
)
|
|
|
|
|
|
Total
deferred tax liabilities
|
|
|
(193,000
|
)
|
|
|
(115,000
|
)
|
|
Net
deferred tax assets before valuation allowance
|
|
|
3,588,000
|
|
|
|
|
|
|
Less
valuation allowance
|
|
|
(3,588,000
|
)
|
|
|
(2,052,000
|
)
|
|
Net
Deferred tax assets
|
|
$
|
-
|
|
|
$
|
-
|
|
We
are under examination, or may be subject to examination, by the Internal Revenue Service (“IRS”) for the calendar
year 2009 and thereafter. These examinations may lead to ordinary course adjustments or proposed adjustments to our taxes or our
net operating losses with respect to years under examination as well as subsequent periods. We have filed our past years’
federal corporate income tax returns from 2009 through 2015and may be subject to penalties, as described below, for non-compliance;
however, we believe that we had no taxable income in US or in any foreign jurisdiction. We are in process of completing our US
federal tax return for 2016 and state tax returns for years 2009 through 2016.
The
Company also has net operating loss carryforwards of approximately $9,737,098 included in the deferred tax asset table above for
2016 and 2015, respectively, However, due to limitations of carryover attributes , it is unlikely the company will benefit from
these NOL’s and thus Management has determined a 100% valuation reserved is required. .
For
U.S. purposes, the Company has not completed its evaluation of NOL utilization limitations under Internal Revenue Code, as amended
(the “Code”) Section 382, change of ownership rules. If the Company has had a change in ownership, the NOL’s
would be limited as to the amount that could be utilized each year, based on the Code.
The
Company has been penalized by the Internal Revenue Service for failure to file its Foreign Form 5471, Information Return
of U.S. Persons With Respect To Certain Foreign Corporations for the years 2009 through 2014 on a timely basis . The Penalties
are approximate $120,000. The Company has requested the penalties be abated to the Internal Revenue Service and believes
the Penalties will be abated for reasonable cause, but no assurance can be relied upon until the Internal Revenue Service acts
upon the request.
NOTE
16 - SUBSEQUENT EVENTS
In
accordance with ASC 855, “Subsequent Events”, the Company has evaluated all subsequent events through March 31, 2017,
the date the financial statements were available to be issued. The following events occurred after December 31, 2016
As
described in Note 9 – Convertible Promissory Notes, the Company entered negotiations to extinguish its Convertible Promissory
notes. Subsequent to December 31, 2016, the Company extinguished $761,440 and $161,031 of convertible promissory notes, net and
convertible accrued interest, respectively. The promissory notes and interest were extinguished by the issuance of approximately
3,416,612 shares of the Company’ common stock and cash payments of approximately $314,000.
In
January, 2017, the Company received a payment to settle a note receivable plus accrued interest totaling $100,000 which was included
in our Notes Receivable balance as of December 31, 2016.
March
2017, the Company entered into a Securities Purchase Agreement (the “Agreement”) with certain accredited investors
(the “Investors”). The Company issued an aggregate of 16,781,250 investment units (the “Units”),
for aggregate gross proceeds of $2,685,000. Each Unit consists of one share of the Company’s common stock and one
warrant for the purchase of one share of Common Stock.
In
Mar
ch 2017, the Company issued a two promissory note, with identical terms, in the amount of $268,750,
or $537,200 in total, with an interest rate of 6% per annum. The promissory note and all accrued interest are due and payable
on November 9, 2017.
In
March 2017, the Company’s CEO completed certain milestones as to restricting the Company’s convertible promissory
notes and raised approximately $2,700,000 through a private placement of the Company’s common stock. Upon completion of
these milestones certain shareholders, of the Company, transferred 3,088,800 options to purchase the Company’s common stock,
at $0.00024 per share, to the Company’s CEO as a bonus. In the first quarter of 2017, the Company will record as compensation
expense, the fair value of these options as of the date of transfer.