THE ACCOMPANYING NOTES ARE AN INTEGRAL PART
OF THESE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS.
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART
OF THESE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS.
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS
NINE MONTHS ENDED FEBRUARY 28, 2017 and 2016
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1.
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DESCRIPTION OF BUSINESS
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Arkados Group, Inc. (the “Parent”) conducts business
activities principally through its two wholly-owned subsidiaries, Arkados, Inc. (“Arkados”) and Arkados Energy Solutions,
LLC (“AES”) (collectively, the “Company”).
The Company underwent a significant restructuring following December
23, 2010, during which substantially all of its assets were acquired by STMicroelectronics, Inc. (sometimes referred to hereinafter
as the “Asset Sale”). Settlements reached in connection with the Asset Sale and the fulfillment of obligations in connection
therewith, have been substantially completed.
Following the Asset Sale, the Company shifted its focus towards
the following businesses:
Arkados - Software and hardware design and development of solutions
that enable machine to machine communications for the Internet of Things (“IoT”). Arkados’ solutions are primarily
focused on industrial and commercial applications such as building automation, energy management and predictive maintenance and
are uniquely designed to drive a wide variety of full-featured, cutting edge solutions.
AES - Energy conservation services for commercial and industrial
facilities owners and managers. AES’ services include implementing energy conservation measures such as LED lighting retrofits,
oil to natural gas boiler conversions, co-generation system installation and solar PV system installations. In addition, AES sells
technology solutions designed by Arkados, Inc. and others that serve to improve the effectiveness of the measures and increases
return on investment for the customer.
Effective March 18, 2015, the Company implemented a reverse stock
split of its outstanding common stock at a ratio of 1-for-30 shares. All share figures and results are reflected on a post-split
basis.
The accompanying condensed consolidated financial statements
as of February 28, 2017 (unaudited) and May 31, 2016 and for the three and nine months ended February 28, 2017 and February
29, 2016 (unaudited) have been prepared by the Company pursuant to the rules and regulations of the Securities and Exchange
Commission including Form 10-Q and Regulation S-X. The information furnished herein reflects all adjustments (consisting of
normal recurring accruals and adjustments) which are, in the opinion of management, necessary to fairly present the operating
results for the respective periods. Certain information and footnote disclosures normally present in annual financial
statements prepared in accordance with accounting principles generally accepted in the United States of America have been
omitted pursuant to such rules and regulations. These financial statements and the information included under the heading
“Management’s Discussion and Analysis of Financial Condition and Results of Operations” should be read in
conjunction with the audited financial statements and explanatory notes for the year ended May 31, 2016 as disclosed in our
annual report on Form 10-K for that year. The results of the three and nine months ended February 28, 2017 (unaudited) are
not necessarily indicative of the results to be expected for the pending full year ending May 31, 2017.
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2.
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SUMMARY OF SIGNIFICANT ACCOUNTING
POLICIES
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a.
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Basis of Presentation - The
accompanying condensed consolidated financial statements have been prepared assuming that the Company will continue as a going
concern. The Company has incurred net losses of approximately $44 million since inception, including a net loss of $1,067,675 for
the nine months ended February 28, 2017. Additionally, the Company still had both working capital and stockholders’ deficiencies
at February 28, 2017 and May 31, 2016 and negative cash flow from operations since inception. These conditions raise substantial
doubt about the Company’s ability to continue as a going concern. Management expects to incur additional losses in the foreseeable
future and recognizes the need to raise capital to remain viable. The accompanying unaudited condensed consolidated financial
statements do not include any adjustments that might be necessary should the Company be unable to continue as a going concern.
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The Company’s plan, through potential acquisitions
and the continued promotion of its services to existing and potential customers, is to generate sufficient revenues to cover our
anticipated expenses. The Company is currently exploring several options to meet its short-term cash requirements, including an
equity raise or loan funding from third parties. Although no assurances can be given as to the Company’s ability to deliver
on its revenue plans, or that unforeseen expenses may arise, the management of the Company believes that the revenue to be generated
from operations together with potential bridge note funding, additional issuances of equity or other potential financing will provide
the necessary funding for the Company to continue as a going concern.
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b.
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Principles of Consolidation
- The consolidated financial statements include the accounts of the Parent, and its wholly-owned subsidiaries, which include AES
and Arkados. Intercompany accounts and transactions have been eliminated in consolidation.
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Arkados
The Company enters into arrangements with end users for
items which may include software license fees, services, maintenance and royalties or various combinations thereof. For each
arrangement, revenues will be recognized when evidence of an agreement has been documented, the fees are fixed or determinable,
collection of fees is probable, delivery of the product has occurred and no other significant obligations remain.
Revenues from software licensing are recognized in accordance
with Accounting Standards Codification (“ASC”) 985-605, “Software Revenue Recognition.” Accordingly, revenue
from software licensing is recognized when all of the following criteria are met: persuasive evidence of an arrangement exists,
delivery has occurred, the fee is fixed or determinable, and collectability is probable.
License revenues are recognized at the time of delivery
of the software and all other revenue recognition criteria discussed above have been met. Deferred revenue represents license revenues
billed but not yet earned. Sales of products are recognized when the products are shipped and the customer takes risk of ownership
and assumes the risk of loss. Royalty income is recognized as it is earned and recorded when reported by the customer.
AES
Sales of products are recognized when the products are
shipped and the customer takes risk of ownership and assumes the risk of loss. Service revenue is recognized when the service is
completed. Deferred revenue represents revenues billed but not yet earned.
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d.
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Cash and Cash Equivalents
- The Company considers investments in highly liquid instruments with a maturity of three months or less to be cash equivalents.
The Company did not have any cash equivalents at both February 28, 2017 and May 31, 2016.
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e.
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Accounts Receivable - Accounts receivable are reported at their outstanding unpaid principal balances net of allowances for uncollectible accounts. The Company provides for allowances for uncollectible receivables based on management’s estimate of uncollectible amounts considering age, collection history, and any other factors considered appropriate. The Company writes off accounts receivable against the allowance for doubtful accounts when a balance is determined to be uncollectible. At February 28, 2017 and May 31, 2016, the Company determined that an allowance for doubtful accounts was not needed.
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f.
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Fair Value of Financial Instruments - The carrying value of cash, accounts receivable, other receivables, accounts payable and accrued expenses approximate their fair values based on the short-term maturity of these instruments. The carrying amounts of debt were also estimated to approximate fair value. As defined in ASC 820, "Fair Value Measurements and Disclosures," fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (exit price). The Company utilizes market data or assumptions that market participants would use in pricing the asset or liability, including assumptions about risk and the risks inherent in the inputs to the valuation technique. These inputs can be readily observable, market corroborated, or generally unobservable. ASC 820 establishes a fair value hierarchy that prioritizes the inputs used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (level 1 measurement) and the lowest priority to unobservable inputs (level 3 measurement). This fair value measurement framework applies at both initial and subsequent measurement.
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The three levels of the fair value
hierarchy defined by ASC 820 are as follows:
Level 1 – Quoted prices are available in active
markets for identical assets or liabilities as of the reporting date. Active markets are those in which transactions for the asset
or liability occur in sufficient frequency and volume to provide pricing information on an ongoing basis. Level 1 primarily consists
of financial instruments such as exchange-traded derivatives, marketable securities and listed equities.
Level 2 – Pricing inputs are other than quoted prices
in active markets included in Level 1, which are either directly or indirectly observable as of the reported date. Level 2 includes
those financial instruments that are valued using models or other valuation methodologies. These models are primarily industry-standard
models that consider various assumptions, including quoted forward prices for commodities, time value, volatility factors and current
market and contractual prices for the underlying instruments, as well as other relevant economic measures. Substantially all of
these assumptions are observable in the marketplace throughout the full term of the instrument, can be derived from observable
data or are supported by observable levels at which transactions are executed in the marketplace. Instruments in this category
generally include non-exchange-traded derivatives such as commodity swaps, interest rate swaps, options and collars.
Level 3 – Pricing inputs include significant inputs
that are generally less observable from objective sources. These inputs may be used with internally developed methodologies that
result in management’s best estimate of fair value.
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g.
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Earnings (Loss) Per Share (“EPS”) - Basic EPS is computed by dividing net income (loss) by the weighted average number of shares of common stock outstanding. Diluted EPS includes the effect from potential issuance of common stock, such as stock issuable pursuant to the exercise of stock options and warrants and the assumed conversion of convertible notes.
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The following table summarizes the securities that were
excluded from the diluted per share calculation because the effect of including these potential shares was antidilutive even though
the exercise price could be less than the average market price of the common shares.
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Three and nine months ended
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February 28,/29
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2017
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2016
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|
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Convertible notes
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470,319
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84,059
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Stock options
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5,112,500
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3,012,500
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Warrants
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5,125,987
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5,059,320
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Potentially dilutive securities
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10,708,806
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8,155,879
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h.
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Stock Based Compensation - In computing the impact, the fair
value of each option and/or warrant is estimated on the date of grant based on the Black-Scholes options-pricing model
utilizing certain assumptions for a risk-free interest rate; volatility; and expected remaining lives of the awards. The
assumptions used in calculating the fair value of share-based payment awards represent management’s best estimates,
but
these estimates involve inherent uncertainties and the application of management judgment. As a result, if factors change
and
the Company uses different assumptions, the Company’s stock-based compensation expense could be materially different
in
the
future. In addition, the Company is required to estimate the expected forfeiture rate and only recognize expense for
those shares expected to vest. In estimating the Company’s forfeiture rate, the Company analyzed its historical
forfeiture rate, the remaining lives of unvested options, and the amount of vested options as a percentage of total options
outstanding. If the Company’s actual forfeiture rate is materially different from its estimate, or if the Company
reevaluates the forfeiture rate in the future, the stock-based compensation expense could be significantly different from
what we have recorded in the current period. During the three months ended February 28, 2017, 208,596 shares of the
Company’s common stock were issued to satisfy accounts payable obligations amounting to $253,003 in stock
compensation.
For the nine months ended February 28, 2017, 514,775 shares of the Company’s common stock were issued for accounts
payable as mentioned above and 450,000 shares issued for consulting services amounting to $323,000 in stock based
compensation.
There
were no
additional issuances of warrants or options during the three and nine months ended February 28, 2017.
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Stock based compensation expense was $0 for the three months ended February 29, 2016, and $451,521 for the nine months ended February 29, 2016.
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i.
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Use of Estimates - The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, equity based transactions and disclosure of contingent liabilities at the date of the financial statements and revenues and expenses during the reporting period. Actual results could differ from those estimates.
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We believe the following critical
accounting policies affect our more significant judgments and estimates used in the preparation of the financial statements. Significant
estimates include the allowance for doubtful accounts, the useful life of plant and equipment and intangible assets, deferred tax
asset and valuation allowance, and assumptions used in Black-Scholes-Merton, or BSM, valuation methods, such as expected volatility,
risk-free interest rate, and expected dividend rate.
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j.
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Inventory - Inventory, which consists of finished goods and work-in-process (“WIP”) of AES, is valued at the lower of cost on a first-in, first-out basis or market. Inventory consists of the following at February 28, 2017 and May 31, 2016.
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February 28,
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May 31,
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2017
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2016
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(unaudited)
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Finished goods
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$
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60,011
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|
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$
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60,011
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Work-in-process (unbilled labor and consulting)
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1,800
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|
|
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60,399
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$
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61,811
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$
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120,410
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k.
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Property and Equipment – Property and equipment is recorded at cost. Depreciation is computed using straight-line and accelerated methods over the estimated useful lives of the related assets. Expenditures that enhance the useful lives of the assets are capitalized and depreciated. Maintenance and repairs are expensed as incurred. When properties are retired or otherwise disposed of, related costs and related accumulated depreciation are removed from the accounts.
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l.
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Research and Development –All research and development costs are expensed as incurred.
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m.
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Foreign Currency Transactions – The Company accounts for foreign currency translation pursuant to ASC 830. The functional currency of the Company is the United States dollar. Under ASC 830, all assets and liabilities denominated in foreign currencies are translated into United States dollars using the current exchange rate at the end of each fiscal period. Revenues and expenses are translated using the average exchange rates prevailing throughout the respective periods. All transaction gains and losses from the measurement of monetary balance sheet items denominated in foreign currencies are reflected in the statement of operations as gain (loss) on foreign currency transactions.
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n.
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Deferred Financing Costs-Costs incurred in connection with obtaining financing are deferred and amortized on a straight-line basis over the term of the related loan.
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o.
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Convertible Instruments- The Company evaluates and accounts for conversion options embedded in its convertible instruments in accordance with accounting standards for “Accounting for Derivative Instruments and Hedging Activities.”
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Accounting
standards generally provides three criteria that, if met, require companies to bifurcate conversion options from their host instruments
and account for them as free standing derivative financial instruments. These three criteria include circumstances in which (a) the
economic characteristics and risks of the embedded derivative instrument are not clearly and closely related to the economic characteristics
and risks of the host contract, (b) the hybrid instrument that embodies both the embedded derivative instrument and the host
contract is not re-measured at fair value under otherwise applicable generally accepted accounting principles with changes in fair
value reported in earnings as they occur, and (c) a separate instrument with the same terms as the embedded derivative instrument
would be considered a derivative instrument. Professional standards also provide an exception to this rule when the
host instrument is deemed to be conventional as defined under professional standards as “The Meaning of Conventional Convertible
Debt Instrument.”
The Company
accounts for convertible instruments (when it has determined that the embedded conversion options should not be bifurcated from
their host instruments) in accordance with professional standards when “Accounting for Convertible Securities with Beneficial
Conversion Features,” as those professional standards pertain to “Certain Convertible Instruments.” Accordingly,
the Company records, when necessary, discounts to convertible notes for the intrinsic value of conversion options embedded in debt
instruments based upon the differences between the fair value of the underlying common stock at the commitment date of the note
transaction and the effective conversion price embedded in the note. Original issue discounts (“OID”) under these arrangements
are amortized over the term of the related debt to their earliest date of redemption. The Company also records when necessary deemed
dividends for the intrinsic value of conversion options embedded in preferred shares based upon the differences between the fair
value of the underlying common stock at the commitment date of the note transaction and the effective conversion price embedded
in the note.
ASC 815-40
provides that, among other things, generally, if an event is not within the entity’s control could or require net cash settlement,
then the contract shall be classified as an asset or a liability.
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p.
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Reclassifications - Certain reclassifications have been made to conform the prior period data to the current presentations. The Company has reclassified a $40,000 note payable to convertible debt. This reclassification had no impact on reported results of operations.
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q.
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Recent Accounting Pronouncements -
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In January 2017, the Financial Accounting
Standards Board (“FASB”) issued an Accounting Standards Update (“ASU”) 2017-01, “Business Combinations
(Topic 805) Clarifying the Definition of a Business”. The amendments in this Update is to clarify the definition of a business
with the objective of adding guidance to assist entities with evaluating whether transactions should be accounted for as acquisitions
(or disposals) of assets or businesses. The definition of a business affects many areas of accounting including acquisitions, disposals,
goodwill, and consolidation. The guidance is effective for annual periods beginning after December 15, 2017, including interim
periods within those periods. The Company is currently evaluating the impact of adopting this guidance.
In November 2016, the FASB issued
ASU 2016-18, “Statement of Cash Flows (Topic 230) Restricted Cash”. The new guidance requires that the reconciliation
of the beginning-of-period and end-of-period amounts shown in the statement of cash flows include restricted cash and restricted
cash equivalents. If restricted cash is presented separately from cash and cash equivalents on the balance sheet, companies will
be required to reconcile the amounts presented on the statement of cash flows to the amounts on the balance sheet. Companies will
also need to disclose information about the nature of the restrictions. The guidance is effective for fiscal years beginning after
December 15, 2017, and interim periods within those fiscal years. The Company is currently evaluating the impact of adopting this
guidance.
In August 2016, the FASB issued ASU
2016-15, “Statement of Cash Flows (Topic 230) Classification of Certain Cash Receipts and Cash Payments”. The new guidance
is intended to reduce diversity in practice in how certain transactions are classified in the statement of cash flows. ASU 2016-15
is effective for the Company beginning in the first quarter of fiscal 2019. Early adoption is permitted, provided that all of the
amendments are adopted in the same period. The guidance requires application using a retrospective transition method. The Company
is currently evaluating the impact of adopting this guidance.
In April 2016, the FASB issued ASU
2016 – 10 “Revenue from Contract with Customers: identifying Performance Obligations and Licensing”. The amendments
in this Update clarify the two following aspects (a) contracts with customers to transfer goods and services in exchange for consideration
and (b) determining whether an entity’s promise to grant a license provides a customer with either a right to use the entity’s
intellectual property (which is satisfied at a point in time) or a right to access the entity’s intellectual property (which
is satisfied over time). The amendments in this Update are intended to reduce the degree of judgement necessary to comply with
Topic 606. This guidance has no effective date as yet. The Company is currently evaluating the impact of adopting this guidance.
In March 2016, the FASB issued authoritative
guidance regarding the accounting for share-based payment transactions, including income tax consequences, classification of awards
as either equity or liabilities, and classification on the statement of cash flows. The guidance is to be applied for annual periods
beginning after December 15, 2016 and interim periods within those annual periods, and early adoption is permitted. The guidance
requires companies to apply the requirements retrospectively, modified retrospectively, or prospectively depending on the amendment(s)
applied. The Company is currently evaluating the impact of adopting this guidance.
In February 2016, the FASB issued ASU
2016-02, “Leases” (Topic 842). This guidance will be effective for public entities for fiscal years beginning
after December 15, 2018 including the interim periods within those fiscal years. Early application is permitted. Under the
new provisions, all lessees will report a right-of-use asset and a liability for the obligation to make payments for all leases
with the exception of those leases with a term of 12 months or less. All other leases will fall into one of two categories:
(i) Financing leases, similar to capital leases, which will require the recognition of an asset and liability, measured at the
present value of the lease payments and (ii) Operating leases which will require the recognition of an asset and liability measured
at the present value of the lease payments. Lessor accounting remains substantially unchanged with the exception that no leases
entered into after the effective date will be classified as leveraged leases. For sale leaseback transactions, the sale will only
be recognized if the criteria in the new revenue recognition standard are met. The Company is currently evaluating the impact of
adopting this guidance.
In January 2016, the FASB issued
ASU 2016-01, which amends the guidance relating to the classification and measurement of financial instruments. Changes to the
current guidance primarily affect the accounting for equity investments, financial liabilities under the fair value option, and
the presentation and disclosure requirements for financial instruments. In addition, the ASU clarifies guidance related to the
valuation allowance assessment when recognizing deferred tax assets resulting from unrealized losses on available-for-sale debt
securities. The new standard is effective for fiscal years and interim periods beginning after December 15, 2017, and upon adoption,
an entity should apply the amendments by means of a cumulative-effect adjustment to the balance sheet at the beginning of the first
reporting period in which the guidance is effective. Early adoption is not permitted except for the provision to record fair value
changes for financial liabilities under the fair value option resulting from instrument-specific credit risk in other comprehensive
income. The Company is currently evaluating the impact of adopting this guidance.
In August 2015, the FASB issued ASU
2015-14, “Revenue From Contracts With Customers (Topic 606)”. The amendments in this ASU defer the effective date of
ASU 2014-09 “Revenue From Contracts With Customers (Topic 606)”. Public business entities should apply the guidance
in ASU 2014-09 to annual reporting periods beginning after December 15, 2017, including interim reporting periods within that reporting
period. Earlier application is permitted only as of annual reporting periods beginning after December 15, 2016, including interim
reporting periods within that reporting period. The Company is still evaluating the impact of adopting this guidance.
All newly issued but not yet effective
accounting pronouncements have been deemed to be not applicable or immaterial to the Company.
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3.
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ASSET SALE AND DEBT SUBJECT
TO EQUITY BEING ISSUED
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In December 2010, the Company entered into an agreement to sell
substantially all of the assets (the “Asset Sale”) to STMicroelectronics, Inc. (“ST US”), a subsidiary
of STMicroelectronics N.V. (“ST”). The Asset Sale was predicated on the Company settling its secured debt and a significant
part of its unsecured debt and closed in June, 2011. The Company is negotiating with its remaining unsecured debt holders to compromise,
extend the due date or convert outstanding debt into equity. Debt holders who have agreed to settle through receipt of the Company’s
equity are labeled as “Debt Subject to Equity Being Issued” on the balance sheet. Except as set forth above, there
is no binding commitment on anyone’s part to complete the transactions.
Debt Subject to Equity Being Issued
As a direct result of the Sale of the License and IP Agreements
to ST US and the mandate to obtain debt releases, the Company has been able to reach settlements with its secured creditors and
employees, with cash payments to the secured creditors made as of the December 2010 and June 2011 closings. Nothing further is
owed to the Company’s secured creditors. There remains, however, approximately $179,000 of payments due the former employees
as of February 28, 2017 and May 31, 2016.
As of February 28, 2017 and May 31, 2016, there remained $456,930
of debts that have been settled with debt holders who have agreed to accept equity for their remaining debt.
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4.
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ACCOUNTS PAYABLE AND ACCRUED
EXPENSES
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As of February 28, 2017 and May 31, 2016, accounts payable and accrued
expenses consist of the following amounts:
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February 28,
|
|
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May 31,
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|
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|
2017
|
|
|
2016
|
|
|
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(Unaudited)
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|
|
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|
|
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Accounts payable
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$
|
647,694
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|
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$
|
782,654
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Accrued interest payable
|
|
|
144,743
|
|
|
|
116,035
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Accrued payroll
|
|
|
16,805
|
|
|
|
28,320
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Accrued other
|
|
|
97,237
|
|
|
|
95,373
|
|
|
|
$
|
906,479
|
|
|
$
|
1,022,382
|
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Notes Payable
Notes payable transactions include the following:
FY 2016 (Year Ended May 31, 2016) Transactions:
In January 2016, the Company executed a promissory note for a
loan in the principal amount of $60,000. The promissory note bears interest at 6% per year, compounded quarterly, and matures
on January 15, 2017 (the “January Note“). The proceeds from the January Note were used to partially repay two
convertible notes as discussed below. In January 2017, the Company and holder amended this promissory note to extend
the maturity date to March 31, 2017. Effective March 31, 2017, the Company and holder amended this promissory note
further to extend the maturity date to June 15, 2017.
On January 8, 2016, the Company entered into an
Exchange Agreement with the noteholders of two 6% convertible notes in the aggregate principle amount of $130,000
(collectively the “Convertible Notes”) that were in default. On January 15, 2016, the Company applied the
proceeds of the 2016 Notes together with the issuance of 50,000 shares of the Company’s common stock, to the payment of
the Convertible Notes. In exchange for the payment and the shares, the holders of the Convertible Notes surrendered
their notes, and the Company issued a new 6% Convertible Note to them in the original principal amount of $40,000
(“Reissued Note”). The holders further agreed that their extension of the maturity of the Convertible Notes
had been effective from October 31, 2015 until January 15, 2016. The Reissued Note bears interest at the rate of 6% per
year, compounded quarterly, and matured on December 31, 2016. In January 2017, the Company and holder agreed to extend the
maturity date of the Reissued Note to March 31, 2017. Effective March 31, 2017, the Company and holder amended this
promissory note further to extend the maturity date to May 15, 2017. At any time during
the term of the Reissued Note, the holders have the right to convert any unpaid portion of the Reissued Note and accrued
interest into shares of common stock at an original conversion price of $1.20 per share. The Company has evaluated the
conversion terms and determined that a beneficial conversion feature is not applicable for this exchange transaction.
On March 31, 2016 and May 6, 2016, the Company executed
promissory notes for loans, each in the amount of $10,000 (collectively with the January Note, the “2016 Notes”).
The promissory notes bear interest at 6% per year, compounded quarterly. Both notes matured on June 30, 2016. The proceeds
from the promissory notes were used to partially repay the Convertible Notes as discussed above. The holders further agreed
that their extension of the maturity of the outstanding promissory notes had been effective from June 30, 2016 until January
15, 2017. In January 2017, the Company executed an amendment to the promissory notes to extend the maturity date to March 31,
2017. Effective March 31, 2017, the Company and holder amended this promissory note further to extend the
maturity date to May 15, 2017.
FY 2017 (Year Ended May 31, 2017):
In August 2016, the Company issued a promissory note in
the amount of $150,000 with a maturity date in January 15, 2017. The loan bears interest at 10% per annum compounded
quarterly. In January 2017, the Company and holder amended this promissory note to extend the maturity date to March 31,
2017. Effective March 31, 2017, the Company and holder amended this promissory note further to extend the maturity date to
May 15, 2017.
On October 28, 2016, the Company issued a
convertible promissory note for an aggregate principal amount of $38,500 (which includes an Original Issue Discount
(“OID”) of $3,500) with a maturity date of January 30, 2017. The debenture is convertible only upon default after
January 30, 2017 at a conversion price of 65% of the average of the three lowest traded prices occurring during the 25
consecutive trading days immediately preceding the applicable conversion date. As additional consideration, the Company
issued 20,000 shares of common stock upon execution of this agreement. Accordingly, the Company recorded debt discount of
$11,793 related to the restricted shares issued, and an original issue discount of $3,500. The debt discount and OID is
amortized on a straight line basis over the term of the loan and amounted to $15,293 as of February 28, 2017. Net discount
and net loan balance amounted to $0 and $38,500 respectively, as of February 28, 2017 and is recorded in convertible
debentures. On January 27, 2017, the Company and holder amended this promissory note to extend maturity date to March 31,
2017. On March 31, 2017, the Company and holder amended this promissory note to extend the maturity date to April 21, 2017.
On January 27, 2017, the Company issued a
convertible promissory note for an aggregate principal amount of $38,500 (which includes an OID of $3,500) with a maturity
date of March 31, 2017. The debenture is convertible only upon default after March 31, 2017 at a conversion price of 65% of
the average of the three lowest traded prices occurring during the 25 consecutive trading days immediately preceding the
applicable conversion date. As additional consideration, the Company issued 20,000 shares of common stock upon execution of
this agreement. Accordingly, the Company recorded debt discount of $14,398 related to the restricted shares issued, and
an original issue discount of $3,500. The debt discount and OID is amortized on a straight-line basis over the term of the
loan and amounted to $9,091 as of February 28, 2017. Net discount and net loan balance amounted to $8,807 and
$29,693 respectively, as of February 28, 2017 and is recorded in convertible debentures. On March 31, 2017, the Company and
holder amended this promissory note to extend the maturity date to April 21, 2017.
On February 1, 2017, the Company issued a
convertible promissory note for an aggregate principal amount of $125,000 (which includes an OID of $12,000) with a maturity
date of October 1, 2017. The debenture is convertible only upon default after October 1, 2017 at a conversion price of 60% of
the of the lowest traded price occurring during the 20 consecutive trading days immediately preceding the applicable
conversion date. Accordingly the Company recorded a debt discount of $121,886 related to the beneficial conversion feature,
and OID. The debt discount and OID is amortized on a straight-line basis over the term of the loan and
amounted to $13,598 as of February 28, 2017. Net discount and net loan balance amounted to $108,286.81 and $16,713
respectively, as of February 28, 2017 and is recorded in convertible debentures.
Long term convertible debenture:
On November 11, 2016, the Company entered into a Securities
Purchase Agreement whereas, the buyer wishes to purchase from the Company securities consisting of the Company’s
convertible debentures due three years from issuance for an aggregate principal amount of up to $500,000 (which includes an
aggregate purchase price of $450,000 and 10% OID of $50,000) (the “Debentures“). The Debentures are to be issued
in three tranches. On November 11, 2016, the Company issued the first of the three Debentures amounting to $150,000 of
principal, consisting of $135,000 in proceeds and $15,000 OID. The debenture is convertible at a conversion price of $0.65 up
to 150 days after the issuance date and if no event of default. If an Event of Default, as such term is defined in the
Debentures, has occurred, or 150 days after the Issuance Date, as such term is defined in the Debentures, the conversion
price is the lesser of (a) $0.65 or (b) sixty five percent (65%) of the lowest closing bid price of the common stock for the
twenty (20) trading days immediately preceding the date of the date of conversion of the Debentures. Accounting for
derivatives will be evaluated after 150 days of issuance or upon default, if applicable where at that point the conversion
price becomes variable. As additional consideration, the Company issued 50,000 shares of common stock upon execution of this
agreement. In relation to this transaction the Company also incurred deferred financed costs totaling $6,000 for legal fees
and commitment fees. Accordingly, the Company recorded debt discount of $38,337 related to the restricted shares issued, a
debt discount of $74,530 related to the beneficial conversion feature, an OID of $15,000 and deferred finance cost of $6,000.
As of February 28, 2017, total straight line amortization for these transactions amounted to $13,326 which resulted in a net
discount of $120,542 and a net loan balance of $29,458 classified as long term debt.
|
6.
|
STOCKHOLDERS’ DEFICIENCY
|
FY 2016 (Year Ended May 31, 2016):
|
a.
|
On June 25, 2015, the Company issued 108,333 shares of common stock to its chairman/chief executive officer and 35,000 shares of common stock to an officer/former director for services rendered to the Company’s board of directors in fiscal 2015. The shares were valued at $1.75 per share. The value of the shares totaling $250,833 was charged as stock compensation in fiscal 2015.
|
|
b.
|
For the period June 1, 2015 through May 31, 2016, 838,334 shares of common stock have been subscribed for under the PPO and the Company received proceeds of $503,000. These shares were issued in July and August 2015.
|
|
c.
|
On January 8, 2016, the Company issued 50,000 shares as part of a debt conversion and refinance whereby $130,000 of note principle and accrued interest of $11,332 were extinguished and a new note of $100,000 was issued.
|
|
d.
|
On February 23, 2016, we entered into a consulting agreement with LPF Communications under which LPF Communications is to provide certain investor relations services for a period of up to six months. We have agreed to pay for the services by issuing two tranches of 150,000 shares of our Common Stock each, with the second tranche becoming issuable only if we do not terminate the consulting agreement on or prior to June 8, 2016. Pursuant to the agreement, we issued the first tranche of 150,000 shares to the consultant on April 8, 2016.
|
|
e.
|
On April 22, 2016, the Company issued 675,000 shares of common stock to its key employees, including 500,000 shares to its chairman/chief executive officer, for services rendered to the Company in fiscal 2016. The shares were valued at $0.51 per share. The value of the shares totaling $344,250 was charged as stock compensation in fiscal 2016.
|
|
f.
|
On April 28, 2016, the Company entered into an asset purchase agreement pursuant to which the Company purchased intangible assets valued at $249,113 in exchange for 166,667 shares of the Company's common stock and a warrant to purchase 166,667 shares of the Company's common stock at $2.00 per share. As a result of management's evaluation, the intangible asset was deemed impaired and thus fully written off to selling, general and administrative expense of the income statement.
|
FY 2017 (Year Ended May 31, 2017):
|
a.
|
On October 13, 2016, the Company issued 400,000 shares of its common stock for consulting services to two consulting firms. The shares were valued at $0.67 at the time resulting in $268,000 in stock based compensation.
|
|
b.
|
On October 28, 2016, the Company issued 20,000 shares of its common stock as part of a promissory note entered into with an investor (see Note 5).
|
|
c.
|
On November 11, 2016, the Company issued 50,000 shares of its common stock as part of a promissory note entered into with an investor (see Note 5).
|
|
d.
|
In December 2016, the Company issued 50,000 shares of common stock for consulting services valued at $55,000.
|
|
e.
|
In January 2017, the Company issued 15,000 valued at shares of common stock $14,398 to a noteholder as consideration for
an inducement
to amend the
maturity date of a loan.
|
|
f.
|
In January 2017, the Company issued 20,000 shares of common stock as part of a promissory note entered into with an investor.
|
|
g
.
|
On February 15, 2017, the Company issued 208,596 shares of its common stock as payment to satisfy accounts payable balances of two vendors totaling $253,003.
|
|
7.
|
STOCK-BASED COMPENSATION
|
The Company accounted for its stock based compensation in accordance
with the fair value recognition provisions of FASB ASC Topic 718, “Compensation – Stock Compensation”.
A. Options
The Company issued options to purchase an aggregate of 4,100,000
shares of the Company’s common stock in the year ended May 31, 2016, 2,100,000 of which were granted outside of the 2004
Stock Option and Restricted Stock Plan (the “2004 Plan”). There were no options granted during the three or nine months
ended February 28, 2017.
Compensation based stock option activity for qualified and unqualified
stock options are summarized as follows:
|
|
|
|
|
Weighted
|
|
|
|
|
|
|
Average
|
|
|
|
Shares
|
|
|
Exercise Price
|
|
Outstanding at May 31, 2015
|
|
|
1,012,500
|
|
|
$
|
1.20
|
|
Granted
|
|
|
4,100,000
|
|
|
|
0.94
|
|
Exercised
|
|
|
-
|
|
|
|
-
|
|
Expired or cancelled
|
|
|
-
|
|
|
|
-
|
|
Outstanding at May 31, 2016
|
|
|
5,112,500
|
|
|
$
|
0.99
|
|
Granted
|
|
|
-
|
|
|
|
-
|
|
Exercised
|
|
|
-
|
|
|
|
-
|
|
Expired or cancelled
|
|
|
-
|
|
|
|
-
|
|
Outstanding at February 28, 2017
|
|
|
5,112,500
|
|
|
$
|
0.99
|
|
The following table summarizes information about options to purchase shares of the Company’s common
stock outstanding and exercisable at February 28, 2017:
|
|
|
|
|
|
Weighted-
|
|
|
Weighted-
|
|
|
|
|
|
|
|
|
|
|
Average
|
|
|
Average
|
|
|
|
|
Range of
|
|
|
Outstanding
|
|
|
Remaining Life
|
|
|
Exercise
|
|
|
Number
|
|
exercise prices:
|
|
|
Options
|
|
|
In Years
|
|
|
Price
|
|
|
Exercisable
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
0.60
|
|
|
|
2,300,000
|
|
|
|
4.72
|
|
|
$
|
0.60
|
|
|
|
2,300,000
|
|
$
|
1.00
|
|
|
|
700,000
|
|
|
|
1.63
|
|
|
$
|
1.00
|
|
|
|
700,000
|
|
$
|
1.20
|
|
|
|
1,562,500
|
|
|
|
7.83
|
|
|
$
|
1.20
|
|
|
|
1,562,500
|
|
$
|
2.00
|
|
|
|
550,000
|
|
|
|
5.33
|
|
|
$
|
2.00
|
|
|
|
550,000
|
|
|
|
|
|
|
5,112,500
|
|
|
|
5.32
|
|
|
$
|
0.99
|
|
|
|
5,112,500
|
|
The compensation expense attributed to the issuance of the options
will be recognized as they vested/earned. These stock options are exercisable for three to ten years from the grant date.
The employee stock option plan stock options are exercisable for
ten years from the grant date and vest over various terms from the grant date to three years.
B. Warrants
The issuance of warrants to purchase shares of the Company's common
stock including those attributed to debt issuances are summarized as follows:
|
|
|
|
|
Weighted
|
|
|
|
|
|
|
Average
|
|
|
|
Shares
|
|
|
Exercise Price
|
|
Outstanding at May 31, 2015
|
|
|
3,937,986
|
|
|
$
|
1.45
|
|
Granted
|
|
|
1,288,001
|
|
|
|
1.78
|
|
Exercised
|
|
|
-
|
|
|
|
-
|
|
Expired or cancelled
|
|
|
-
|
|
|
|
-
|
|
Outstanding at May 31, 2016
|
|
|
5,225,987
|
|
|
$
|
1.53
|
|
Granted
|
|
|
-
|
|
|
|
-
|
|
Exercised
|
|
|
-
|
|
|
|
-
|
|
Expired or cancelled
|
|
|
(147,833
|
)
|
|
|
3.43
|
|
Outstanding at February 28, 2017
|
|
|
5,078,153
|
|
|
$
|
1.57
|
|
Issuances of warrants to purchase shares of the Company's common
stock were as follows:
|
|
|
Outstanding and exercisable
|
|
|
|
|
|
|
|
Weighted-
|
|
|
Weighted-
|
|
|
|
|
Range of
|
|
|
|
|
|
average
|
|
|
average
|
|
|
|
|
exercise
|
|
|
Number
|
|
|
remaining life
|
|
|
exercise
|
|
|
Number
|
|
prices
|
|
|
outstanding
|
|
|
in years
|
|
|
price
|
|
|
exercisable
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
1.00
|
|
|
|
283,000
|
|
|
|
1.72
|
|
|
$
|
1.00
|
|
|
|
283,000
|
|
$
|
1.20
|
|
|
|
2,956,822
|
|
|
|
2.44
|
|
|
|
1.20
|
|
|
|
2,956,822
|
|
$
|
2.00
|
|
|
|
1,838,331
|
|
|
|
1.32
|
|
|
|
2.00
|
|
|
|
1,838,331
|
|
|
|
|
|
|
5,078,153
|
|
|
|
1.99
|
|
|
$
|
1.57
|
|
|
|
5,078,153
|
|
FY 2016 (Year Ended May 31, 2016):
|
a
|
As discussed in Note 8, in addition to common stock, the Company also issued warrants to purchase 833,334 shares of the Company's common stock under the PPO.
|
|
b
|
In November 2015, a warrant to purchase 250,000 shares of the Company's common stock at $1.00 per share was issued to a vendor as a bonus payment for services rendered in connection with a software development agreement. The warrant issued was valued using the Black Scholes option pricing model under the following assumptions: stock price $1.00; strike price $1.00; expected volatility 87.54%; risk free interest rate 1.21%; dividend rate 0%; and expected term 3 years. The value of the warrant totaling $139,928 was charged as research and development.
|
|
c
|
In November 2015, a warrant to purchase 33,000 shares of the Company's common stock at $1.00 per share was issued to a consultant for services rendered under a consulting contract. The warrant issued was valued using the Black Scholes option pricing model under the following assumptions: stock price $1.00; strike price $1.00; expected volatility 87.54%; risk free interest rate 1.21%; dividend rate 0%; and expected term 3 years. The value of the warrant totaling $18,471 was charged as consulting fees. See Note 11.
|
|
d
|
On April 28, 2016, the Company entered into an asset purchase agreement pursuant to which the Company purchased intangible assets in exchange for 166,667 shares of the Company's common stock and a warrant to purchase 166,667 shares of the Company's common stock at $2.00 per share. The warrant issued was valued using the Black Scholes option pricing model under the following assumptions: stock price $0.75; strike price $2.00; expected volatility 293%; risk free interest rate .93%; dividend rate 0%; and expected term 3 years. The value of the warrant totaling $124,000 was included in the cost of the intangible which was fully impaired as of May 31, 2016.
|
FY 2017 (Year Ended May 31, 2017):
There were no warrants granted during the three or nine months ended
February 28, 2017.
The expense attributed to the issuances of the warrants was recognized
as they vested/earned. These warrants are exercisable for three years from the grant date.
Master Agreement – License of (“PEMS-SF”™)
On July 10, 2014, the Company entered into a Master
Agreement to license our Process and Event Management System (“PEMS-SF”™) with Tatung Corporation (“Tatung”).
The basic fee generation structure of the Master Agreement allows
for (1) a one-time licensing fee for each PEMS-SF-enabled stations or subsystems installed, (2) separate fees of up to 10% of the
software fees for software updates, maintenance and technical support, (3) on-going service fees based on units of products manufactured
utilizing PEMS-SF; and (4) an annual service fee for cloud-based services and data storage.
The Master Agreement has a year-to-year term but
can be terminated by either party upon sixty (60) days’ advance written notice. Upon termination or expiration of this agreement,
we are not required to provide any continuing or ongoing processing of data or other services that, pursuant to a sub-agreement,
are discontinued upon termination, however, the customer shall retain any perpetual rights granted in a sub-agreement or schedule.
The term of any sub-agreements is concomitant and co-terminus with the Master Agreement term.
Revenue recognized under the Master Agreement amounted to $0 and
$14,793 for the three and nine months ended February 28, 2017, respectively. Revenue recognized under the Master Agreement amounted
to $31,300 for the three months ended February 29, 2016 and $169,300 for the nine months ended February 29, 2016.
Agreement – License of Meter Collar and
Bridge Programmable Logic
In October 2014, the Company entered into a year-to-year term agreement
with Tatung to license its meter collar and bridge programmable logic controllers. The license is paid on a per copy (ordered)
fee, and is on a perpetual, worldwide, non-exclusive, transferable basis.
Revenue recognized under the agreement amounted to $0 for both the
three and nine months ended February 28, 2017 and $31,300 and $169,300 for the three and nine months ended February 29, 2016, respectively.
In March 2015, the Company entered into a one-year agreement, with
automatic one year renewals until terminated by either party with sixty (60) days’ notice, with Tatung to provide services
in the area of business development and as a representative to sell its products. Tatung will pay a monthly retainer fee for this
service. Revenue recognized under this agreement was $0 and $60,000 for the three and nine months ended February 28, 2017, respectively.
Leases
Effective October 1, 2014 as amended on January 15, 2015, the Company
entered a lease for its office space at a total monthly rental of $1,874. The lease expired on January 15, 2016. The Company renewed
this lease until January 15, 2017 at a monthly rental of $2,034. In January 2017, the Company renewed this lease until January
15, 2018, with an option to renew for one additional year upon its expiration.
Our AES subsidiary leases offices in Jericho, New York. The facility
is approximately 1,850 square feet, occupied pursuant to a lease that commenced on August 1, 2015 and expires September 30, 2018.
The average annual rent over the term of the lease is approximately $57,300. This amount does not include taxes for the premises.
Rent expense for all locations including occupancy costs
for the three months ended February 28, 2017 and February 29, 2016 was $20,929 and 31,611, respectively. Rent expense for
all locations including occupancy costs for the nine months ended February 28, 2017 and February 29, 2016 was $64,850 and
32,211, respectively.
Consulting Agreements
On September 15, 2016, the Company entered into two consulting agreements
with two consultants, pursuant to which the Company agreed to issue 200,000 shares of common stock to each consultant in exchange
for certain consulting services.
On December 13, 2016, the Company entered into a consulting agreement
with a consultant, pursuant to which the Company agreed to issue 50,000 shares of common stock to each consultant in exchange
for certain consulting services for twelve months.
|
10.
|
CONCENTRATIONS OF CREDIT
RISK
|
Cash
The Company maintains principally all cash balances in two financial
institutions which, at times, may exceed the amount insured by the Federal Deposit Insurance Corporation. The exposure to the Company
is solely dependent upon daily bank balances and the respective strength of the financial institutions. The Company has not incurred
any losses on these accounts.
Net Sales
One customer accounted for 88% of net sales for the three months
ended February 28, 2017 and three customers accounted for 90% of net sales for the three months ended February 29, 2016, as set
forth below:
|
|
Three months ended February 28 / 29,
|
|
|
|
2017
|
|
|
2016
|
|
|
|
|
|
|
|
|
Customer 1
|
|
|
88
|
%
|
|
|
42
|
%
|
Customer 2
|
|
|
-
|
|
|
|
29
|
%
|
Customer 3
|
|
|
-
|
|
|
|
19
|
%
|
Three customers accounted for 87% and 69% of net sales for the nine
months ended February 28, 2017 and February 29, 2016 respectively, as set forth below:
|
|
Nine months ended February 28 / 29,
|
|
|
|
2017
|
|
|
2016
|
|
|
|
|
|
|
|
|
Customer 1
|
|
|
22
|
%
|
|
|
36
|
%
|
Customer 2
|
|
|
46
|
%
|
|
|
20
|
%
|
Customer 3
|
|
|
19
|
%
|
|
|
13
|
%
|
Accounts Receivable
Two customers accounted for 100% of the accounts receivable as of
February 28, 2017, as set forth below:
|
|
February 28, 2017
|
|
|
May 31, 2016
|
|
|
|
(Unaudited)
|
|
|
|
|
Customer 1
|
|
|
94
|
%
|
|
|
83
|
%
|
Customer 2
|
|
|
6
|
%
|
|
|
11
|
%
|
|
11.
|
RELATED PARTY TRANSACTIONS
|
There were no related party transactions during the three and nine
month period ending February 28, 2017.
|
12.
|
BUSINESS SEGMENT INFORMATION
|
As of February 28, 2017, the Company had two operating segments,
Arkados and AES.
The Company’s reportable segments are distinguished by types
of service, customers and methods used to provide their services. The operating results of these business segments are regularly
reviewed by the Company’s chief operating decision maker.
The accounting policies of each of the segments are the same as
those described in the Summary of Significant Accounting Policies in Note 2. The Company evaluates performance based primarily
on income (loss) from operations
Information about segments is as follows:
|
|
Arkados
|
|
|
AES
|
|
|
Consolidated
|
|
|
|
|
|
|
|
|
|
|
|
Three months ended February 28, 2017
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenues
|
|
$
|
(10,299
|
)
|
|
$
|
274,099
|
|
|
$
|
263,800
|
|
Income (loss) from operations
|
|
$
|
(209,696
|
)
|
|
$
|
102,420
|
|
|
$
|
(107,276
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three months ended February 29, 2016
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenues
|
|
$
|
260,590
|
|
|
$
|
488,493
|
|
|
$
|
749,083
|
|
Loss from operations
|
|
$
|
91,279
|
|
|
$
|
(23,019
|
)
|
|
$
|
68,260
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nine months ended February 28, 2017
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenues
|
|
$
|
78,648
|
|
|
$
|
999,315
|
|
|
$
|
1,077,963
|
|
Loss from operations
|
|
$
|
(825,154
|
)
|
|
$
|
(63,382
|
)
|
|
$
|
(888,536
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nine months ended February 29, 2016
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenues
|
|
$
|
542,883
|
|
|
$
|
1,128,255
|
|
|
$
|
1,671,138
|
|
Loss from operations
|
|
$
|
(420,525
|
)
|
|
$
|
(718,611
|
)
|
|
$
|
(1,139,136
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total assets
|
|
|
|
|
|
|
|
|
|
|
|
|
February 28, 2017
|
|
$
|
130,661
|
|
|
$
|
113,474
|
|
|
$
|
244,135
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
May 31, 2016
|
|
$
|
236,797
|
|
|
$
|
347,846
|
|
|
$
|
584,643
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On March 1, 2017 the Company issued a 10% promissory note
in the principal amount of $100,000 due March 31, 2017 to an accredited investor. Effectively March 31, 2017,
the Company and the accredited investor entered into an amendment to 10% promissory note, pursuant to which the parties
agreed to extend the maturity date of the promissory note to May 15, 2017.
On March 3, 2017 the Company issued a 10% convertible
promissory note in the principal amount of $103,000 due November 3, 2017 to an accredited investor (the “Convertible
Promissory Note“). The Convertible Promissory Note may be converted pursuant to the provisions of the
Convertible Promissory Note upon a Prepayment Default or an Event of Default, as such terms are defined in the Convertible
Promissory Note, at a 40% discount to the lowest trading price during the previous (20) trading days to the date of a
Conversion Notice, as such term is defined in the Convertible Promissory Note.
On March 7, 2017 the Company issued a 10% promissory note in
the principal amount of $100,000 due March 31, 2017 to an accredited investor. On April 20, 2017, the Company and the accredited investor entered into an amendment to 10% promissory note, pursuant to which
the parties agreed to extend the maturity date of the promissory note to April 21, 2017.
On April 6, 2017 the Company entered into that certain
Securities Purchase Agreement with four accredited investors, pursuant to which the Company agreed to issue an
aggregate of 325,000 restricted shares of common stock and a warrant to purchase 325,000 shares of common stock at an
exercise price of $1.00 per share in exchange for an aggregate of $195,000.
On April 20, 2017 the Company entered into that certain second amendment to convertible promissory note number 2016-1 with
the holder, pursuant to which the Reissued Note’s maturity date was extended to May 15, 2017.