NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
JUNE
30, 2017
Unless
otherwise noted, (1) “Sunworks” refers to Sunworks, Inc., a Delaware corporation formerly known as Solar3D, Inc. (2)
the “Company,” “we,” “us,” and “our,” refer to the ongoing business operations
of Sunworks and its Subsidiaries, whether conducted through Sunworks or a subsidiary of Sunworks, (3) “Subsidiaries”
refers collectively to Sunworks United, Inc. (“Sunworks United”), MD Energy, Inc. (“MD Energy”) and Elite
Solar Acquisition Sub, Inc. (“Elite Solar”), (4) “Common Stock” refers to Sunworks’ Common Stock,
and (5) “Stockholder(s)” refers to the holders of Sunworks’ Common Stock.
1.
BASIS OF PRESENTATION
The
accompanying unaudited condensed consolidated financial statements have been prepared in accordance with generally accepted accounting
principles for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly,
they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial
statements. The financial statements and notes are representations of the Company’s management, which is responsible for
their integrity and objectivity. In the opinion of management, all normal recurring adjustments considered necessary for a fair
presentation have been included. Operating results for the three months and six months ended June 30, 2017 are not necessarily
indicative of the results that may be expected for the year ending December 31, 2017. For further information, refer to the consolidated
financial statements and footnotes thereto included in the Company’s Form 10-K for the year ended December 31, 2016.
2.
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
This
summary of significant accounting policies of Sunworks, Inc. is presented to assist in understanding the Company’s financial
statements. The financial statements and notes are representations of the Company’s management, which is responsible for
their integrity and objectivity. These accounting policies conform to accounting principles generally accepted in the United States
of America and have been consistently applied in the preparation of the financial statements.
Principles
of Consolidation
The
accompanying consolidated financial statements include the accounts of Sunworks, Inc., and its wholly owned operating subsidiaries,
Sunworks United, Inc. (d/b/a Sunworks United), MD Energy, Inc., and Elite Solar Acquisition Sub, Inc. All material intercompany
transactions have been eliminated upon consolidation of these entities.
Use
of Estimates
The
preparation of financial statements in conformity with accounting principles generally accepted in the United States of America
requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of
contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during
the reporting period. Actual results could differ from those estimates. Significant estimates include estimates used to review
the Company’s goodwill, impairments and estimations of long-lived assets, revenue recognition on percentage of completion
type contracts, allowances for uncollectible accounts, warranty reserves, inventory valuation, debt beneficial conversion features,
valuations of non-cash capital stock issuances and the valuation allowance on deferred tax assets. The Company bases its estimates
on historical experience and on various other assumptions that are believed to be reasonable in 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 may differ from these estimates under different assumptions or conditions.
Reclassifications
and Corrections
Certain
reclassifications have been made to conform prior period data to the current presentation. In addition, the Company identified
an error and revised its financial statements for the three months and six months ended June 30, 2016 related to the elimination
of certain intercompany revenues. Management concluded that the errors had no material impact on any of the Company’s previously
issued financial statements, are immaterial to the Company’s results for the first and second quarters of 2016 and full
year 2016 results, and had no material effect on the trend of the Company’s financial results. As a result of the immaterial
errors discussed above, the unaudited condensed consolidated financial statements reflect the following adjustments for the three
months ended June 30, 2016: a reduction in revenue of $460,000, a decrease in cost of goods sold of $345,000 and a net decrease
in SG&A and Other Income (expense) of $115,000. The effect of the reclassifications and immaterial errors had no effect on
reported net income. The unaudited condensed consolidated financial statements reflect the following adjustments for the six months
ended June 30, 2016: a reduction in revenue of $603,000, a decrease in cost of goods sold of $224,000 and a net decrease in SG&A
and Other Income (expenses) of $379,000.
Revenue
Recognition
Revenues
and related costs on construction contracts are recognized using the “percentage of completion method” of accounting
in accordance with ASC 605-35, Accounting for Performance of Construction-Type and Certain Production Type Contracts (“ASC
605-35”). Under this method, contract revenues and related expenses are recognized over the performance period of the contract
in direct proportion to the costs incurred as a percentage of total estimated costs for the entirety of the contract. Costs include
direct material, direct labor, subcontract labor and any allocable indirect costs. All un-allocable indirect costs and corporate
general and administrative costs are charged to the periods as incurred. However, in the event a loss on a contract is foreseen,
the Company will recognize the loss as it is determined.
Revisions
in cost and profit estimates during the course of the contract are reflected in the accounting period in which the facts, which
require the revision, become known. Provisions for estimated losses on uncompleted contracts are made in the period in which such
losses are determined. Changes in job performance, job conditions, and estimated profitability, including those arising from contract
penalty provisions, and final contract settlements may result in revisions to costs and income and are recognized in the period
in which the revisions are determined.
The
Asset, “Costs in excess of billings”, represents revenues recognized in excess of amounts billed on contracts in progress.
The Liability, “Billings in excess of costs”, represents billings in excess of revenues recognized on contracts in
progress. At June 30, 2017 and December 31, 2016, the costs in excess of billings balance were $5,839,000 and $4,307,000, and
the billings in excess of costs balance were $8,879,000 and $4,997,000, respectively. Residential contract revenues are recognized
using the “completed contract” method of accounting.
Contract
receivables are recorded on contracts for amounts currently due based upon progress billings, as well as retention, which are
collectible upon completion of the contracts. Accounts payable to material suppliers and subcontractors are recorded for amounts
currently due based upon work completed or materials received, as are retention due subcontractors, which are payable upon completion
of the contract. General and administrative expenses are charged to operations as incurred and are not allocated to contract costs.
Contract
Receivable
The
Company performs ongoing credit evaluation of its customers. Management monitors outstanding receivables based on factors surrounding
the credit risk of specific customers, historical trends, age of receivables and other information, and records bad debts using
the allowance method. Accounts receivable are presented net of an allowance for doubtful accounts of $160,000 at June 30, 2017,
and $50,000 at December 31, 2016.
Cash
and Cash Equivalent
The
Company considers all highly liquid investments with an original maturity of three months or less to be cash equivalents.
Concentration
Risk
Cash
includes amounts deposited in financial institutions in excess of insurable Federal Deposit Insurance Corporation (FDIC) limits.
At times throughout the year, the Company may maintain cash balances in certain bank accounts in excess of FDIC limits. As of
June 30, 2017, the cash balance in excess of the FDIC limits was $3,676,900. The Company has not experienced any losses in such
accounts and believes it is not exposed to any significant credit risk in these accounts.
Inventory
Inventory
is valued at the lower of cost or market and is determined by the first-in, first-out method. Inventory primarily consists of
modules, inverters, mounting racks and other materials.
Property
and Equipment
Property and equipment are stated
at cost. Depreciation for property and equipment commences when it’s put into service and are depreciated using the straight-line
method over its estimated useful lives:
Machinery
& equipment
|
|
3-7
Years
|
Furniture
& fixtures
|
|
5-7
Years
|
Computer
equipment
|
|
3-5
Years
|
Vehicles
|
|
5-7
Years
|
Leaseholder
improvements
|
|
3-5
Years
|
Depreciation
expense for the three months ended June 30, 2017 and 2016 was $103,000 and $96,000, respectively. Depreciation expense for the
six months ended June 30, 2017 and 2016 was $206,000 and $116,000, respectively.
Advertising
and Marketing
The
Company expenses advertising and marketing costs as incurred. Advertising and marketing costs include printed material, direct
mail, radio, telemarketing, tradeshow costs, magazine, and catalog advertisement. Included within selling and marketing expenses
are advertising and marketing costs for the three months ended June 30, 2017 and 2016 were $269,600 and $1,058,400, respectively.
Advertising and marketing costs for the six months ended June 30, 2017 and 2016 were $700,900 and $1,979,900, respectively.
Warranty
Liability
The Company establishes warranty
liability reserves to provide for estimated future expenses as a result of installation and product defects, product recalls and
litigation incidental to the Company’s business. Liability estimates are determined based on management’s judgment,
considering such factors as historical experience, the likely current cost of corrective action, manufacturers’ and subcontractors’
participation in sharing the cost of corrective action, consultations with third party experts such as engineers, and discussions
with the Company’s general counsel and outside counsel retained to handle specific product liability cases. Solar panel
manufacturers currently provide substantial warranties between ten to twenty-five years with full reimbursement to replace and
install replacement panels while inverter manufacturers currently provide warranties covering ten to fifteen-year replacement
and installation. Warranty reserve liability as of June 30, 2017 and December 31, 2016 is $186,000 and $116,000,
respectively.
Stock-Based
Compensation
The Company periodically issues
stock options, restricted stock, and warrants to employees and non-employees in non-capital raising transactions for services
and for financing costs. The Company accounts for stock option, restricted stock and warrant grants issued and vesting to employees
based on the authoritative guidance provided by the Financial Accounting Standards Board whereas the value of the award is measured
on the date of grant and recognized over the vesting period. The Company accounts for stock option and warrant grants issued and
vesting to non-employees in accordance with the authoritative guidance of the Financial Accounting Standards Board whereas the
value of the stock compensation is based upon the measurement date as determined at either a) the date at which a performance
commitment is reached, or b) at the date at which the necessary performance to earn the equity instruments is complete. Non-employee
stock-based compensation charges generally are amortized over the vesting period on a straight-line basis. In certain circumstances
where there are no future performance requirements by the non-employee, option grants are immediately vested and the total stock-based
compensation charge is recorded in the period of the measurement date.
Basic
and Diluted Net (Loss) Income per Share Calculations
Income
(Loss) per Share dictates the calculation of basic earnings per share and diluted earnings per share. Basic earnings per share
are computed by dividing income available to common shareholders by the weighted-average number of common shares available. Diluted
earnings per share is computed similar to basic earnings per share except that the denominator is increased to include the number
of additional common shares that would have been outstanding if the potential common shares had been issued and if the additional
common shares were dilutive. The shares for employee options, restricted stock, warrants and convertible notes were used in the
calculation of the net (loss) income per share.
A net loss causes all outstanding
common stock options, restricted stock, warrants, convertible preferred stock, and convertible notes to be anti-dilutive.
As a result, the basic and diluted losses per common share are the same for the six months ended June 30, 2017.
As
of June 30, 2017, the potentially dilutive securities that have been excluded from the computations of weighted average shares
outstanding include 1,125,924 stock options, 1,134,615 restricted stock grants, 2,997,000 warrants, shares underlying convertible
notes and preferred stock.
As
of June 30, 2016, the potentially dilutive securities that have been excluded from the computations of weighted average shares
outstanding include 671,924 stock options and 2,997,000 warrants because they were below the period ending stock price. We also
excluded 1,506,024 shares of Series B preferred stock convertible into common stock at a 1 to 1 ratio because of trading restrictions.
Dilutive
per share amounts are computed using the weighted-average number of common shares outstanding and potentially dilutive securities,
using the treasury stock method if their effect would be dilutive.
Long-Lived
Assets
The
Company reviews its property and equipment and any identifiable intangibles for impairment whenever events or changes in circumstances
indicate that the carrying amount of an asset may not be recoverable. The test for impairment is required to be performed by management
at least annually. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset
to the future undiscounted operating cash flow expected to be generated by the asset. If such assets are considered to be impaired,
the impairment to be recognized is measured by the amount by which the carrying amount of the asset exceeds the fair value of
the asset. Long-lived assets to be disposed of are reported at the lower of carrying amount or fair value less costs to sell.
Indefinite
Lived Intangibles and Goodwill Assets
The
Company accounts for business combinations under the acquisition method of accounting in accordance with ASC 805, “Business
Combinations,” where the total purchase price is allocated to the tangible and identified intangible assets acquired and
liabilities assumed based on their estimated fair values. The purchase price is allocated using the information currently available,
and may be adjusted, up to one year from acquisition date, after obtaining more information regarding, among other things, asset
valuations, liabilities assumed and revisions to preliminary estimates. The purchase price in excess of the fair value of the
tangible and identified intangible assets acquired less liabilities assumed is recognized as goodwill.
The
Company tests for indefinite lived intangibles and goodwill impairment in the fourth quarter of each year and whenever events
or circumstances indicate that the carrying amount of the asset exceeds its fair value and may not be recoverable. In accordance
with its policies, the Company performed a qualitative assessment of indefinite lived intangibles and goodwill at December 31,
2016.
Fair
Value of Financial Instruments
Disclosures
about fair value of financial instruments, requires disclosure of the fair value information, whether or not recognized in the
balance sheet, where it is practicable to estimate that value. As of June 30, 2017, the amounts reported for cash, accrued interest
and other expenses, and notes payable approximate the fair value because of their short maturities.
We
adopted ASC Topic 820 as of January 1, 2008 for financial instruments measured as fair value on a recurring basis. ASC Topic 820
defines fair value, established a framework for measuring fair value in accordance with accounting principles generally accepted
in the United States and expands disclosures about fair value measurements.
Fair
value is defined as 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. ASC Topic 820 established a three-tier fair value hierarchy which prioritizes
the inputs used in measuring fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets
for identical assets or liabilities (level 1measurements) and the lowest priority to unobservable inputs (level 3 measurements).
These tiers include:
|
●
|
Level
1, defined as observable inputs such as quoted prices for identical instruments in active markets;
|
|
|
|
|
●
|
Level
2, defined as inputs other than quoted prices in active markets that are either directly or indirectly observable such as
quoted prices for similar instruments in active markets or quoted prices for identical or similar instruments in markets that
are not active; and
|
|
|
|
|
●
|
Level
3, defined as unobservable inputs in which little or no market data exists, therefore requiring an entity to develop its own
assumptions, such as valuations derived from valuation techniques in which one or more significant inputs or significant value
drivers are unobservable.
|
Business
Combinations
We
allocate the fair value of purchase consideration to the tangible assets acquired, liabilities assumed and intangible assets acquired
based on their estimated fair values. The excess of the fair value of purchase consideration over the fair values of these identifiable
assets and liabilities is recorded as goodwill. Such valuations require management to make significant estimates and assumptions,
especially with respect to intangible assets. Significant estimates in valuing certain intangible assets include, but are not
limited to, future expected cash flows from acquired customer lists, acquired technology, and trade names from a market participant
perspective, useful lives and discount rates. Management’s estimates of fair value are based upon assumptions believed to
be reasonable, but which are inherently uncertain and unpredictable and, as a result, actual results may differ from estimates.
During the measurement period, which is one year from the acquisition date, we may record adjustments to the assets acquired and
liabilities assumed, with the corresponding offset to goodwill. Upon the conclusion of the measurement period, any subsequent
adjustments are recorded to earnings.
Income
Taxes
The
Company uses the liability method of accounting for income taxes. Deferred tax assets and liabilities are recognized for the future
tax consequences attributable to financial statements carrying amounts of existing assets and liabilities and their respective
tax bases and operating loss and tax credit carry-forwards. The measurement of deferred tax assets and liabilities is based on
provisions of applicable tax law. The measurement of deferred tax assets is reduced, if necessary, by a valuation allowance based
on the amount of tax benefits that, based on available evidence, is not expected to be realized.
Segment
Reporting
Operating
segments are defined as components of an enterprise for which separate financial information is available and evaluated regularly
by the chief operating decision maker, or decision making group, in deciding the method to allocate resources and assess performance.
The Company currently has one reportable segment for financial reporting purposes, which represents the Company’s core business.
New
Accounting Pronouncements
In January 2017, the FASB issued
ASU No. 2017-04, Simplifying the Test for Goodwill Impairment, which simplifies the subsequent measurement of goodwill by eliminating
Step 2 from the goodwill impairment test. In computing the implied fair value of goodwill under Step 2, current U.S. GAAP requires
the performance of procedures to determine the fair value at the impairment testing date of assets and liabilities (including
unrecognized assets and liabilities) following the procedure that would be required in determining the fair value of assets acquired
and liabilities assumed in a business combination. Instead, the amendments under this ASU require the goodwill impairment test
to be performed by comparing the fair value of a reporting unit with its carrying amount. An impairment charge should be recognized
for the amount by which the carrying amount exceeds the reporting unit’s fair value; however, the loss recognized should
not exceed the total amount of goodwill allocated to that reporting unit. The ASU becomes effective for the Company on January
1, 2020. The amendments in this ASU should be applied on a prospective basis. Early adoption is permitted for interim or annual
goodwill impairment tests performed. We are currently evaluating the impact ASU No. 2017-04 will have on our consolidated financial
statements and associated disclosures.
In
November 2016, the FASB issued ASU 2016-18, Statement of Cash Flows (Topic 230) – Restricted Cash . ASU 2016-18 requires
that the statement of cash flows explain the change during the period in the total of cash, cash equivalents, and amounts generally
described as restricted cash or restricted cash equivalents when reconciling the beginning-of-period and end-of-period total amounts
shown on the statement of cash flows. The ASU is effective for fiscal years beginning after December 15, 2017. From January 1,
2018 we will begin including amounts generally described as restricted cash and restricted cash equivalents with cash and cash
equivalents when reconciling the beginning-of-period and end-of-period total amounts shown on the statement of cash flows.
In
February 2016, the FASB issued ASU 2016-02, Leases (Topic 842), to increase transparency and comparability among organizations
by recognizing a right-of-use asset and a lease liability on the balance sheet for all leases with terms longer than 12 months.
Leases will be classified as either operating or financing, with such classification affecting the pattern of expense recognition
in the income statement. ASU 2016-02 is effective for fiscal years and interim periods within those years beginning after December
15, 2018, and early adoption is permitted. We are currently evaluating the impact ASU 2016-02 will have on our consolidated financial
statements and associated disclosures.
In May 2014, the FASB issued ASU
2014-09, Revenue from Contracts with Customers (Topic 606), to clarify the principles of recognizing revenue and create
common revenue recognition guidance between U.S. GAAP and International Financial Reporting Standards. Under ASU 2014-09, revenue
is recognized when a customer obtains control of promised goods or services and is recognized at an amount that reflects the consideration
expected to be received in exchange for such goods or services. In addition, ASU 2014-09 requires disclosure of the nature, amount,
timing, and uncertainty of revenue and cash flows arising from contracts with customers. The ASU is effective for fiscal years
beginning after December 15, 2017. The new revenue standard is principle based and interpretation of those principles may vary
from company to company based on their unique circumstances. It is possible that interpretation, industry practice, and guidance
may evolve as companies and the accounting profession work to implement this new standard. The Company is still in the process
of evaluating the effect of the new standard on the Company’s historical financial statements and disclosures. As the Company
completes its evaluation of this new standard, new information may arise that could change the Company’s current understanding
of the impact to revenue and expense recognized. Additionally, the Company will continue to monitor industry activities and any
additional guidance provided by regulators, standards setters, or the accounting profession and adjust the Company’s assessment
and implementation plans accordingly.
3.
LOANS PAYABLE
Plan
B, a subsidiary of the Company, entered into a business loan agreement, prior to being acquired by the Company, with Tri Counties
Bank dated March 14, 2014, in the original amount of $131,000 bearing interest at 4.95%. The loan agreement called for monthly
payments of $2,500 and was scheduled to mature on March 14, 2019. Proceeds from the loan were used to purchase a pile driver and
related equipment and is secured by the equipment. The outstanding balance at June 30, 2017, is $49,300.
Plan
B, a subsidiary of the Company, entered into a business loan agreement prior to being acquired by the Company, with Tri Counties
Bank dated April 9, 2014, in the original amount of $250,000 bearing interest at 4.95%. The loan agreement calls for monthly payments
of $4,700 and is scheduled to mature on April 9, 2019. Proceeds from the loan were used to purchase racking inventory and related
equipment. The loan is secured by the inventory and equipment. The outstanding balance at June 30, 2017, is $99,000.
On
December 31, 2015, the Company entered into a $2.5 million Credit Facility or the Credit Agreement with JPMorgan Chase Bank, N.A.
Availability under the Credit Facility is a Line of Credit with a Letter of Credit Sublimit up to $2.5 million. Upon execution,
the Company accessed $1.8 million that was repaid in full on January 5, 2016. The Company had no borrowings under the Credit Agreement
as of June 30, 2017 and December 31, 2016. The Credit Agreement matures on November 30, 2017, but may be cancelled at any time
by the Company. Loans are secured by a security interest in the Company’s cash accounts held with the Lender. Interest on
any unpaid balance accrues at the Prime Rate, as defined in the Credit Agreement; provided that, on any given day, shall not be
less than the Adjusted One Month LIBOR rate. Until the maturity date, the Company shall pay monthly interest only on loans. The
Credit Facility provides for the payment of certain fees, including fees applicable to each standby letter of credit and standard
transaction fees with respect to any transactions occurring on account of any letter of credit. Subject to customary carve-outs,
the Credit Agreement contains customary negative covenants and restrictions for agreements of this type on actions by the Company
including, without limitation, restrictions on indebtedness, liens, investments, loans, consolidation, mergers, dissolution, asset
dispositions outside the ordinary course of business, change in business and restriction on use of proceeds. In addition, the
Credit Agreement requires compliance by the Company with covenants including, but not limited to, furnishing the lender with certain
financial reports. The Credit Agreement contains customary events of default, including, without limitation, non-payment of principal
or interest, violation of covenants, inaccuracy of representations in any material respect and cross defaults with certain other
indebtedness and agreements.
On
January 5, 2016, the Company entered into a loan agreement for the acquisition of a pile driver in the principal amount of $182,000
bearing interest at 5.5%. The loan agreement calls for monthly payments of $4,200 and is scheduled to mature on January 15, 2020.
The loan is secured by the equipment. The outstanding balance at June 30, 2017, is $121,800.
On
September 8, 2016, the Company entered into a loan agreement for the acquisition of a pile driver in the principal amount of $174,000
bearing interest at 5.5%. The loan agreement calls for monthly payments of $4,000 and is scheduled to mature on January 15, 2020.
The loan is secured by the equipment. The outstanding balance at June 30, 2017, is $144,200.
On
November 14, 2016, the Company entered into a 0% interest loan agreement for the acquisition of an excavator in the principal
amount of $58,600. The loan agreement calls for monthly payments of $1,200 and is scheduled to mature on November 13, 2020. The
loan is secured by the equipment. The outstanding balance at June 30, 2017, is $49,200.
On
December 23, 2016, the Company entered into a loan agreement for the acquisition of modular office systems and related furniture
in the principal amount of $172,000 bearing interest at 4.99%. The loan agreement calls for 16 quarterly payments of $11,900 and
is scheduled to mature in September 2020. The loan is secured by the equipment. The outstanding balance at June 30, 2017, is $142,300.
As
of June 30. 2017 and December 31, 2016, loans payable are summarized as follows:
|
|
June 30, 2017
|
|
|
December 31, 2016
|
|
Business loan agreement dated March 14, 2014
|
|
$
|
49,300
|
|
|
$
|
62,700
|
|
Business loan agreement dated April 9, 2014
|
|
|
99,000
|
|
|
|
124,500
|
|
Equipment notes payable
|
|
|
457,500
|
|
|
|
526,200
|
|
|
|
|
|
|
|
|
|
|
Subtotal
|
|
|
605,800
|
|
|
|
713,400
|
|
Less: Current position
|
|
|
(225,100
|
)
|
|
|
(217,700
|
)
|
|
|
|
|
|
|
|
|
|
Long-term position
|
|
$
|
380,700
|
|
|
$
|
495,700
|
|
4.
ACQUISITION CONVERTIBLE PROMISSORY NOTES
On
January 31, 2014, the Company issued 4% convertible promissory notes in the aggregate principal amount of $1,750,000 as part of
the consideration paid to acquire 100% of the issued and outstanding stock of Sunworks United. The notes are convertible into
shares of the Company’s fully paid and non-assessable common stock at a conversion price of $0.52 per share and was originally
due on March 30, 2015, which was amended to extend to June 30, 2016. The Notes were five (5) year notes and bore interest at the
rate of 4% per annum. In February and March 2014, $625,000 of the notes was converted into 1,201,923 shares of common stock, leaving
a remaining note balance of $1,125,000 as of December 31, 2014. During the twelve months ended December 31, 2015, the Company
issued 721,154 shares of common stock upon conversion of principal in the amount of $375,000. The principal note balance remaining
as of December 31, 2015 was $750,000. On February 29, 2016, the $750,000 balance remaining was fully converted into 1,442,308
shares of common stock.
On
February 28, 2015, the Company issued a 4% convertible promissory note in the aggregate principal amount of $2,650,000 as part
of the consideration paid to acquire 100% of the total outstanding stock of MD Energy. The note is convertible into shares of
common stock on or after each of the following dates: November 30, 2015, November 30, 2016 and November 30, 2017. The conversion
price is $2.60 per share. A beneficial conversion feature of $3,261,500 was calculated but capped at the $2,650,000 value of the
note. The beneficial conversion feature was calculated by multiplying the difference between the fair value of stock at the date
of the note $5.80 less the conversion price of $2.60 multiplied by the maximum number of share subject to conversion, 1,019,231.
In November 2015, the Company issued 339,743 shares of common stock upon conversion of the principal amount of $883,000. Commencing
on March 31, 2015, and each quarter thereafter during the first two (2) years of the note, the Company will make quarterly interest
only payments to the shareholder for accrued interest on the Note during the quarter. Commencing with the quarter ending on June
30, 2017, the Company will make quarterly payments of interest accrued on the convertible note during the prior quarter plus $151,429
with the final payment of all outstanding principal and accrued but unpaid interest on the convertible note due and payable on
February 28, 2020 (the maturity date). The Company recorded amortization of the beneficial conversion feature as interest expense
in the amount of $219,900 and $243,100 during the three months ended June 30, 2017 and 2016, respectively. The Company recorded
amortization of the beneficial conversion feature as interest expense in the amount of $437,400 and $483,500 during the six months
ended June 30, 2017 and 2016, respectively. The debt discount will be amortized over the life of the convertible note, or until
such time that the convertible note is converted, in full or in part, into shares of common stock of the Company with any unamortized
debt discount continuing to be amortized in the event of any partial conversion thereof and any unamortized debt discount being
expensed at such time of full conversion thereof.
We
evaluated the foregoing financing transactions in accordance with ASC Topic 470, Debt with Conversion and Other Options, and determined
that the conversion feature of the convertible promissory note was afforded the exemption for conventional convertible instruments
due to its fixed conversion rate. The convertible promissory notes have explicit limits on the number of shares issuable so they
did meet the conditions set forth in current accounting standards for equity classification. The convertible promissory notes
were issued with non-detachable conversion options that are beneficial to the investors at inception, because the conversion option
has an effective strike price that is less than the market price of the underlying stock at the commitment date. The accounting
for the beneficial conversion feature requires that the beneficial conversion feature be recognized by allocating the intrinsic
value of the conversion option to additional paid-in-capital, resulting in a discount on the convertible notes, which will be
amortized and recognized as interest expense.
5.
CONVERTIBLE PROMISSORY NOTES
Convertible
promissory note at June 30, 2017 and December 31, 2016 are as follows:
|
|
2017
|
|
|
2016
|
|
Convertible promissory notes payable
|
|
$
|
384,000
|
|
|
$
|
654,000
|
|
Less, debt discount
|
|
|
-
|
|
|
|
-
|
|
Convertible promissory notes payable, net
|
|
$
|
384,000
|
|
|
$
|
654,000
|
|
On
January 31, 2014, the Company entered into a securities purchase agreement providing for the sale of a 10% convertible promissory
note in the principal amount of up to $750,000 for consideration of $750,000. The proceeds were restricted and were used for the
purchase of Solar United Network, Inc. The note was convertible into shares of common stock of the Company at a price equal to
a variable conversion price equal to the lesser of $1.30 per share, or fifty percent (50%) of the lowest trading price after the
effective date. At September 30, 2014, the note was exchanged for a new convertible note with a fixed conversion price of $0.338.
Per ASC 815, the derivative liability on the note was extinguished and the new note was re-valued per ASC 470 as a beneficial
conversion feature, which was expensed in the statement of operations during 2014. The note originally matured on October 28,
2014, was extended three months to January 31, 2015, was extended to June 30, 2017, and in March 2016 was subsequently extended
to June 30, 2019 with zero interest. The Company recorded interest expense in the amount of $11,000 during the year ended December
31, 2016 prior to the note being extended at zero interest. During the year ended December 31, 2016, the noteholder made a partial
conversion of principal and accrued interest in the amount of $196,000 and $45,000 respectively in exchange for 711,586 shares
of common stock, with a remaining principal balance of $554,000. On March 1, 2017, the Company issued 798,817 shares of common
stock to the note holder at the fixed conversion price of $0.338 per share. The conversion of the note results in a $270,000 outstanding
principal reduction in the note from $554,000 to $284,000.
On
February 11, 2014, the Company entered into a securities purchase agreement providing for the sale of a 10% convertible promissory
note in the principal amount of up to $100,000. Upon execution of the note, the Company received an initial advance of $20,000.
In February and March of 2014, the Company received additional advances in an aggregate amount of $80,000 for an aggregate total
of $100,000. The note was convertible into shares of common stock of the Company at a price equal to a variable conversion price
equal to the lesser of $1.30 per share, or fifty percent (50%) of the lowest trading price after the effective date. As of September
30, 2014, the note was exchanged for a new convertible note with a fixed conversion price of $0.338. Per ASC 815, the derivative
liability on the note was extinguished and the new note was re-valued per ASC 470 as a beneficial conversion feature. The note
matured on various dates from the effective date of each advance with respect to each advance. At the sole discretion of the lender,
the lender was able to modify the maturity date to be twelve (12) months from the effective date of each advance. The note matured
on various dates in 2014, and was extended to September 30, 2016, and in March 2016 was subsequently extended to June 30, 2019
with zero interest. The Company recorded no interest expense in 2016 prior to the note being extended.
6.
CAPITAL STOCK
Common
Stock
On
February 17, 2017, the Company issued 41,773 shares of common stock for the cashless exercise of 53,419 options at an exercise
price of $0.468 per share.
On
March 1, 2017, the Company issued 798,817 shares of common stock at a conversion price of $0.338 per share for partial conversion
of principal for a convertible promissory note in the aggregate amount of $270,000.
On
March 16, 2017, the Company issued 746,153 shares of restricted common stock per terms of the performance-based RSGA awards. The
Company had previously recorded stock based compensation costs at fair value as of the date of grant of $3,751,500 related to
the vesting of these awards in the year ended December 31, 2016.
On
May 18, 2017, the Company issued 15,000 shares of common stock at $1.43 per share in the aggregate amount of $21,450 as payment
for executive recruiting services.
Preferred
Stock
On
November 25, 2015, the Company designated 1,700,000 shares, of its authorized preferred stock, as Series B Preferred Stock, $0.001
par value per share. Pursuant to the Certificate of Designation and subject to the rights of any other series of preferred stock
that may be established by the Board of Directors, holders of Series B Preferred Stock (the “Holders”) will have liquidation
preference over the holders of the Company’s Common Stock in any distribution upon winding up, dissolution, or liquidation.
Holders will also be entitled to receive dividends, if, when and as declared by the Board of Directors, which dividends shall
be payable in preference and priority to any payment of any dividend to holders of Common Stock. Holders will be entitled to convert
each share of Series B Preferred Stock into one (1) share of Common Stock, and will also be entitled to vote together with the
holders of the Company’ Common Stock on all matters submitted to shareholders at a rate of one (1) vote for each share of
Series B Preferred Stock. In addition, so long as at least 100,000 shares of Series B Preferred Stock are outstanding, the Company
may not, without the consent of the Holders of at least a majority of the shares of Series B Preferred Stock then outstanding:
(i) amend, alter or repeal any provision of the Certificate of Incorporation or bylaws of the Company or the Certificate of Designation
so as to adversely affect any of the rights, preferences, privileges, limitations or restrictions provided for the benefit of
the Holders or (ii) issue or sell, or obligate itself to issue or sell, any additional shares of Series B Preferred Stock, or
any securities that are convertible into or exchangeable for shares of Series B Preferred Stock. 1,506,024 shares of Series B
Preferred stock, at a fair value of $4,500,000 were issued in December 2015 in connection with the acquisition of Plan B.
7. STOCK OPTIONS, RESTRICTED STOCK,
AND WARRANTS
Options
As
of June 30, 2017, the Company has 1,581,155 non-qualified stock options outstanding to purchase 1,581,155 shares of common stock,
per the terms set forth in the option agreements. The stock options vest at various times, and are exercisable for a period of
seven years from the date of grant at exercise prices ranging from $0.26 to $4.42 per share, the market value of the Company’s
common stock on the date of each grant. The Company determined the fair market value of these options by using the Black Scholes
option valuation model.
|
|
June 30, 2017
|
|
|
|
|
|
|
Weighted
|
|
|
|
Number
|
|
|
average
|
|
|
|
of
|
|
|
exercise
|
|
|
|
Options
|
|
|
price
|
|
Outstanding, beginning January 1, 2017
|
|
|
1,634,574
|
|
|
$
|
1.93
|
|
Granted
|
|
|
314,000
|
|
|
|
1.50
|
|
Exercised
|
|
|
(53,419
|
)
|
|
|
0.47
|
|
Expired
|
|
|
-
|
|
|
|
-
|
|
Outstanding, end of June 30, 2017
|
|
|
1,895,155
|
|
|
|
1.90
|
|
Exercisable at the end of June 30, 2017
|
|
|
1,203,036
|
|
|
|
1.68
|
|
During
the three months ended June 30, 2017 and 2016, the Company charged a total of $212,300 and $59,000 respectively, to operations
related to recognized stock based compensation expense for stock options. During the six months ended June 30, 2017 and 2016,
the Company charged a total of $387,800 and $88,000 respectively, to operations related to recognized stock based compensation
expense for stock options.
Restricted
Stock Grants
With
an effective date of March 29, 2017, subject to the Sunworks, Inc. 2016 Equity Incentive Plan, the Company entered into a restricted
stock grant agreement or RSGA with its new Chief Executive Officer, Charles F. Cargile. All shares issuable under the RSGA are
valued as of the grant date at $1.50 per share. The RSGA provides for the issuance of up to 500,000 shares of the Company’s
common stock. The restricted shares shall vest as follows: 166,667 of the restricted shares shall vest on the one (1) year anniversary
of the effective date, and the balance, or 333,333 restricted shares, shall vest in twenty-four (24) equal monthly installments
commencing on the one (1) year anniversary of the effective date
In
the three months ended June 30, 2017, $62,500 of stock based compensation expense was recognized for the March 29, 2017 RSGA.
During
the year ended December 31, 2013, the Company entered into a restricted stock grant agreement or RSGA with its then Chief Executive
Officer, James B. Nelson, intended to provide and incentivize Mr. Nelson to improve the economic performance of the Company and
to increase its value and stock price. All shares issuable under the RSGA are performance-based shares and are valued as of the
grant date at $0.47 per share. The RSGA provides for the issuance of up to 769,230 shares of the Company’s common stock
to Mr. Nelson provided certain milestones are met in certain stages. As of September 30, 2014, two of the milestones were met,
when the Company’s market capitalization exceeded $10 million and the consolidated gross revenue, calculated in accordance
with GAAP, equaled or exceeded $10 million for the trailing twelve-month period. The Company issued 384,615 shares of common stock
to Mr. Nelson at fair value of $786,000 during the year ended December 31, 2014. If the Company’s consolidated net profit,
calculated in accordance to GAAP, equals or exceeds $2 million for a trailing twelve-month period and the sooner of Mr. Nelson’s
retirement, change of control, or January 2019, the Company will issue an additional 384,615 shares of the Company’s common
stock to Mr. Nelson. We have not recognized any cost associated with the third milestone due to the inability to estimate the
probability of it being achieved. As the final performance goal is achieved, the shares shall become eligible for vesting and
issuance.
In
recognition of the efforts of James B. Nelson, the Company’s Chief Executive Officer, in leading the Company through the
uplisting and financing transaction consummated by the Company in 2015, on August 31, 2016, the Company granted Mr. Nelson a restricted
stock grant of 250,000 shares of the Company’s common stock pursuant to the terms of the Company’s 2016 Equity Incentive
Plan (the “2016 Plan”). All shares issuable under the RSGA are valued as of the grant date at $2.90 per share. The
restricted stock grant to Mr. Nelson will vest upon the earlier of (i) January 1, 2021, (ii) a Change of Control as defined in
the 2016 Plan (iii) upon Mr. Nelson’s retirement or (iv) upon Mr. Nelson’s death. “Change of Control”
as defined in the 2016 Plan means (i) a sale of all or substantially all of the Company’s assets or (ii) a merger with another
entity or an acquisition of the Company that results in the existing shareholders of the Company owning less than fifty percent
(50%) of the outstanding shares of capital stock of the surviving entity following such transaction.
In
the three months and six months ended June 30, 2017, $41,800 and $83,700 of stock based compensation expense was recognized for
the August 31, 2016 RSGA.
During the year ended December
31, 2014, the Company entered into RSGAs with the three Shareholders of Sunworks United (Sunworks United Shareholders), intended
to provide incentive to the recipients to ensure economic performance of the Company. All shares issuable under the RSGAs were
performance based shares and were valued as of the grant date at $5.12 per share. Each of the RSGAs provided for the issuance
of up to 276,924 shares of the Company’s common stock in the aggregate to the Sunworks United Shareholders provided certain
milestones were met in certain stages as follows: a) If the Company’s aggregate net income from operations, for any trailing
four (4) quarters equaled or exceeded $2 million, the Company would issue each Sunworks United Shareholder 92,308 shares of common
stock and 276,924 shares in the aggregate; b) If the Company’s aggregate net income from operations, for any trailing four
(4) quarters exceeded $3 million, the Company would issue each Sunworks United Shareholder 92,308 shares and 276,924 shares of
common stock in the aggregate; c) If the Company’s aggregate net income from operations, for any trailing four (4) quarters
exceeded $4 million, the Company would issue each Sunworks United Shareholder 92,307 and 276,924 shares in the aggregate. Based
on the probability that the first milestone would be achieved the Company recognized $100,000 in stock compensation expense during
the year 2015. As of September 30, 2016, the Company achieved each of the three milestones. During the quarter ended June
30, 2016 the Company issued 276,924 shares in aggregate associated with the first milestone. The issuance of the remaining 553,845
shares was completed on March 16, 2017. The stock based compensation expense associated with the achievement of the second and
third milestones totaled $2,837,000 and was recognized in the quarter ended September 30, 2016. No additional compensation expense
was required with the March 16, 2017 issuance of the 553,845 common shares.
During
the year ended December 31, 2014, the Company entered into RSGAs with certain employees of Sunworks United, intended to provide
incentive to the recipients to ensure certain economic performance of the Company. All shares issuable under the RSGA were performance
based shares and were valued as of the grant date at $5.12 per share. Each of the RSGAs provided for the issuance of up to 38,462
shares of the Company’s common stock to each employee provided certain milestones were met in certain stages as follows:
a) If the Company’s aggregate net income from operations, for any trailing four (4) quarters equaled or exceeded $2 million,
the Company would issue to each employee 12,821 shares of common stock and 64,105 shares in the aggregate; b) If the Company’s
aggregate net income from operations, for any trailing four (4) quarters exceeded $3 million, the Company would issue each employee
12,821 shares of common stock and 64,105 shares in the aggregate; c) If the Company’s aggregate net income from operations,
for any trailing four (4) quarters exceeded $4 million, the Company would issue each employee 12,820 and 51,280 shares in the
aggregate. Based on the probability that the first milestone would be achieved the Company recognized $33,000 in stock compensation
expense during the year 2015. As of September 30, 2016, the Company achieved each of the three milestones. During the quarter
ended June 30, 2016 the Company issued 64,105 shares in aggregate associated with the first milestone. The issuance of the remaining
115,385 shares was completed on March 16, 2017. The stock based compensation expense associated with the achievement of the second
and third milestones totaled $591,000 and was recognized in the quarter ended September 30, 2016. No additional compensation expense
was required with the March 16, 2017 issuance of the 115,385 common shares.
On February 1, 2015, the Company
entered into a RSGA with its former Chief Financial Officer, intended to provide incentive to the former CFO to ensure certain
economic performance of the Company. All shares issuable under the RSGA were performance-based shares and were valued as of the
grant date at $4.21 per share. The RSGA provided for the issuance of up to 115,385 shares of the Company’s common stock
provided certain milestones were met in certain stages as follows: a) If the Company’s aggregate net income from operations,
for any trailing four (4) quarters equaled or exceeded $2 million, the Company would issue 38,462 shares of common stock; b) If
the Company’s aggregate net income from operations, for any trailing four (4) quarters exceeded $3 million, the Company
would issue 38,462 shares of common stock; c) If the Company’s aggregate net income from operations, for any trailing four
(4) quarters exceeded $4 million, the Company would issue 38,461. As of September 30, 2016, the Company achieved each of
the three milestones. During the quarter ended June 30, 2016 the Company issued 38,462 shares associated with the first milestone.
The issuance of the remaining 76,723 shares was completed on March 16, 2017. The stock based compensation expense associated with
the achievement of the second and third milestones totaled $324,000 and was recognized in the quarter ended September 30, 2016.
No additional compensation expense was required with the March 16, 2017 issuance of the 76,923 common shares.
The
total combined option and restricted stock compensation expense recognized, in the statement of operations, during the three months
ended June 30, 2017 and 2016 was $317,000 and $1,834,000, respectively. The total combined option and restricted stock compensation
expense recognized, in the statement of operations, during the first six months of 2017 and 2016 was $534,000 and $1,862,000,
respectively
Warrants
As
of June 30, 2017, the Company had 2,997,000 common stock purchase warrants outstanding with an exercise price of $4.15 per share.
8.
SUBSEQUENT EVENTS
None.