NOTES
TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE
1 – ORGANIZATION AND DESCRIPTION OF BUSINESS
Q2Power
Technologies, Inc. (hereinafter the “Company”), incorporated in Delaware on August 26, 2004, is currently engaged
in the business of compost and soil manufacturing, and is pursuing a plan of strategic acquisitions in this sector. The Company
also owns and licenses technology developed over the last three years that converts waste fuels and heat to power. Formerly, the
Company’s name was Anpath Group, Inc. (“Anpath”).
Q2Power
Corp. (the “Subsidiary” or “Q2P”) has operated as a renewable power R&D company focused on the conversion
of waste to energy and other valuable “reuse” products since July 2014. The operations of the Company have from the
time of the Merger (described below) until recently been essentially those of the Subsidiary. In 2017, the Company shifted its
focus from technology R&D to the acquisition and operation of facilities that manufacture compost and sustainable soils from
waste resources.
On
November 12, 2015, the Company and its special purpose merger subsidiary completed a merger (the “Merger”) with Q2P.
As a result of the Merger, all outstanding shares of Q2P were exchanged for 24,034,475 shares of the Company’s common stock.
In addition, the Company assumed both the Q2P 2014 Founders Stock Option Plan and the 2014 Employees Stock Option Plan (the “Option
Plans”), and 1,095,480 options outstanding thereunder. Also pursuant to the Merger, the officers and directors of Q2P assumed
control over the management and Board of Directors of the Company. Subsequent to the Merger, the Company officially changed its
name to Q2Power Technologies, Inc.
On
December 1, 2015, in connection with the Merger the Company also sold its prior operating subsidiary, EnviroSystems Inc. (“ESI”),
to three former shareholders in exchange for a return of 470,560 shares of the Company’s common stock. ESI assumed all debt,
payables and a litigation judgment that was on its books as of the Merger date. On February 12, 2016, the Board of Directors of
the Company approved a change in the fiscal year end for the Company from March 31 to December 31. This change is a result of
the Merger, and reflects the fiscal year-end period for Q2P.
In
May 2016, the Company began exploring other synergistic business lines such as compost and soil manufacturing from waste water
biosolids. Moving forward the Company intends to phase out its R&D activities, including the possibility of selling
its waste-to-power technology, and focus entirely on the business of compost and engineered soils manufacturing and sales.
NOTE
2 – BASIS OF PRESENTATION AND GOING CONCERN
The
unaudited condensed consolidated financial statements include all accounts of the Company. The accompanying unaudited condensed
consolidated financial statements have been prepared in accordance with generally accepted accounting principles applicable to
interim financial information. Accordingly, they do not include all of the information and disclosures required by accounting
principles generally accepted in the United States of America for complete financial statements. Interim results are not necessarily
indicative of results for a full year. In the opinion of management, all adjustments considered necessary for a fair presentation
of the financial position and the results of operations and cash flows for the interim periods have been included. The December
31, 2016 condensed consolidated balance sheet information contained herein was derived from the audited consolidated financial
statements as of that date included in the Annual Report on Form 10-K filed on May 25, 2017.
The
Company has incurred a net loss of $1,151,104 for the six months ended June 30, 2017 and used cash in operating
activities of $487,370. The accumulated deficit since inception is $8,402,873, which is comprised of operating losses and
other expenses. These conditions raise substantial doubt about the Company’s ability to continue as a going concern. There
is no guarantee whether the Company will be able to generate sufficient revenue and/or raise capital sufficient to support its
operations. The ability of the Company to continue as a going concern is dependent on management’s plans which include implementation
of its business model to generate revenue from product sales and royalties, acquisition of cash-flowing businesses, and continuing
to raise funds through debt or equity offerings.
On
March 31, 2017, the Company completed the first $1,050,000 tranche of a $1,500,000 convertible bridge note offering (the “Bridge
Offering”); and as of June 30, 2017, the Company closed an additional $400,000 of follow-on investments in the Bridge Offering.
The proceeds from this offering are expected to provide working capital for the Company through at least the end of 2017.
The
condensed consolidated financial statements do not include any adjustments that might result from the outcome of these uncertainties.
U.S.
Generally Accepted Accounting Principles (“GAAP”) requires the Company to make judgments, estimates and assumptions
that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of
the consolidated financial statements, the reported amounts of revenues and expenses, cash flows and the related footnote disclosures
during the period. On an on-going basis, the Company reviews and evaluates its estimates and assumptions, including, but not limited
to, those that relate to the realizable value of identifiable intangible assets and other long-lived assets, derivative liabilities,
income taxes and contingencies. Actual results could differ from these estimates.
NOTE
3 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles
of Consolidation
The
condensed consolidated financial statements include the accounts of the Company and its Subsidiary. All significant inter-company
transactions and balances have been eliminated in consolidation. References herein to the Company include the Company and its
Subsidiary, unless the context otherwise requires.
Cash
The
Company considers all unrestricted cash, short-term deposits, and other investments with original maturities of no more than ninety
days when acquired to be cash and cash equivalents for the purposes of the statement of cash flows. The Company maintains cash
balances at two financial institutions, and has experienced no losses with respect to amounts on deposit.
Revenue
Recognition
Revenue
for services from the Company’s compost and soil business is recognized at the date of delivery of deliverables to customers
when a formal arrangement exists, the price is fixed or determinable, the delivery or milestone deliverable is completed, no other
significant obligations of the Company exist and collectability is reasonably assured. Payments received before all of the relevant
criteria for revenue recognition are satisfied are recorded as deferred revenue.
Revenue
from the Company’s prior waste-to-power operations is recognized at the date of shipment of engines and systems, engine
prototypes, engine designs or other deliverables to customers when a formal arrangement exists, the price is fixed or determinable,
the delivery or milestone deliverable is completed, no other significant obligations of the Company exist and collectability is
reasonably assured. Payments received before all of the relevant criteria for revenue recognition are satisfied are recorded as
deferred revenue. The Company does not allow its customers to return prototype products.
Research
and Development
Research
and development activities for product development are expensed as incurred and are primarily comprised of salaries. Costs for
the three months ended June 30, 2017 and 2016 were $0 and $122,300, respectively. Costs for the six months ended June 30, 2017
and 2016 were $0 and $309,429, respectively.
Stock
Based Compensation
The
Company applies the fair value method of Financial Accounting Standards Board (“FASB”) Accounting Standards Codification
(“ASC”) 718, “
Share Based Payment
”, in accounting for its stock based compensation. This standard
states that compensation cost is measured at the grant date based on the fair value of the award and is recognized over the service
period, which is usually the vesting period. The Company values stock based compensation at the market price for the Company’s
common stock and other pertinent factors at the grant date.
The
Company accounts for transactions in which services are received from non-employees in exchange for equity instruments based on
the fair value of the equity instruments exchanged, in accordance with ASC 505-50, “
Equity Based payments to Non-employees
”.
The Company measures the fair value of the equity instruments issued based on the market price of the Company’s stock at
the time services or goods are provided.
Common
Stock Options
The
Black-Scholes option pricing valuation method is used to determine fair value of these options consistent with ASC 718, “
Share
Based Payment”.
Use of this method requires that the Company make assumptions regarding stock volatility, dividend yields,
expected term of the awards and risk-free interest rates.
Derivatives
Derivatives
are recognized initially at fair value. Subsequent to initial recognition, derivatives are measured at fair value, and changes
are therein generally recognized in profit or loss.
Property
and Equipment
Property
and equipment are recorded at cost. Depreciation is computed on the straight-line method, based on the estimated useful lives
of the assets as follows:
|
|
Years
|
|
Furniture and equipment
|
|
7
|
|
Computers
|
|
5
|
|
Expenditures
for maintenance and repairs are charged to operations as incurred.
Impairment
of Long Lived Assets
The
Company continually evaluates the carrying value of intangible assets and other long lived assets to determine whether there are
any impairment losses. If indicators of impairment are present and future cash flows are not expected to be sufficient to recover
the assets’ carrying amount, an impairment loss would be charged to expense in the period identified. To date, the Company
has not recognized any impairment charges.
Income
Taxes
Income
taxes are accounted for under the asset and liability method as stipulated by FASB ASC 740, “Income Taxes” (“ASC
740”). Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between
the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss
and tax credit carry forwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable
income in the years in which those temporary differences are expected to be recovered or settled. Under ASC 740, the effect on
deferred tax assets and liabilities or a change in tax rate is recognized in income in the period that includes the enactment
date. Deferred tax assets are reduced to estimated amounts to be realized by the use of a valuation allowance. A valuation allowance
is applied when in management’s view it is more likely than not (50%) that such deferred tax will not be utilized.
In
the event that an uncertain tax position exists in which the Company could incur income taxes, the Company would evaluate whether
there is a probability that the uncertain tax position taken would be sustained upon examination by the taxing authorities. Reserves
for uncertain tax positions would be recorded if the Company determined it is probable that a position would not be sustained
upon examination or if payment would have to be made to a taxing authority and the amount is reasonably estimated. As of June
30, 2017, the Company does not believe it has any uncertain tax positions that would result in the Company having a liability
to the taxing authorities. Interest and penalties related to any unrecognized tax benefits is recognized in the condensed consolidated
financial statements as a component of income taxes.
Basic
and Diluted Income (Loss) Per Share
Net
income (loss) per share is computed by dividing the net income (loss) less preferred dividends by the weighted average number
of common shares outstanding during the period. Diluted net income (loss) per share is calculated by dividing the net loss less
preferred dividends by the weighted average number of common shares outstanding during the period plus any potentially dilutive
shares related to the issuance of stock options, shares from the issuance of stock warrants, shares issued from the conversion
of redeemable convertible preferred stock and shares issued for the conversion of convertible debt. There were no potentially
dilutive shares as of June 30, 2017 and 2016.
At
June 30, 2017, there were the following potentially dilutive securities that were excluded from diluted net loss per share
because their effect would be anti-dilutive: 6,915,480 shares from common stock options, 3,568,845 shares from common stock warrants,
1,100,000 shares from the conversion of debentures (not inclusive of shares that may be converted from the Bridge Round, as the
valuation and corresponding share price will not be determined until the closing of the next financing by the Company in an amount
of at least $5,000,000 or December 31, 2017, whichever is sooner), and 4,000,000 shares from the conversion of redeemable convertible
preferred stock. At June 30, 2016, there were the following potentially dilutive securities that were excluded from diluted net
loss per share because their effect would be anti-dilutive: 5,165,480 shares from common stock options, 1,568,845 shares from
common stock warrants, 1,584,524 shares from the conversion of debentures and 2,857,142 shares from the conversion of redeemable
convertible preferred stock.
Effective
January 1, 2016, the number of shares issued and outstanding was adjusted by 32,760 shares to align the Company’s records
with its independent transfer agent. The shares previously reported in the consolidated balance sheet at December 31, 2016 were
29,651,431 and are now reported at 29,684,191. The impact to the condensed consolidated financial statements of this adjustment
was not material.
Recent
Accounting Pronouncements
In
May 2014, the FASB issued Accounting Standards Update (“ASU”), No. 2014-09, “
Revenue from Contracts with
Customers
”, to replace the existing revenue recognition criteria for contracts with customers and to establish the disclosure
requirements for revenue from contracts with customers. The ASU is effective for interim and annual periods beginning after December
15, 2017. Adoption of the ASU is either retrospective to each prior period presented or retrospective with a cumulative adjustment
to retained earnings or accumulated deficit as of the adoption date. The Company is currently assessing the future impact of the
ASU on its consolidated financial statements; however, in light of the material changes in the Company’s business model
which have occurred, the Company expects to do further review in the third quarter of 2017.
In
January 2016, the FASB issued ASU No. 2016-01, “
Recognition and Measurement of Financial Assets and Financial Liabilities
”,
requiring management to address certain aspects of recognition, measurement, presentation, and disclosure of financial instruments.
This ASU is effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years.
The Company is currently assessing the impact of the ASU on its financial position, results of operations and cash flows.
In
February 2016, the FASB issued ASU No. 2016-02, “
Leases (Topic 842) (the Update)
”, requiring management to
recognize any right-to-use-asset and lease liability on the statement of financial position for those leases previously classified
as operating leases. The criteria used to determine such classification is essentially the same as under the previous guidance,
but it is more subjective. The lessee would classify the lease as a finance lease if certain criteria at lease commencement are
met. This ASU is effective for fiscal years beginning after December 15, 2018. The Company is currently assessing the impact of
the ASU on its financial position, results of operations and cash flows.
In
August 2016, the FASB issued ASU 2016-15, Statement of Cash Flows (Topic 230) Classification of Certain Cash Receipts and Cash
Payments. This standard amends and adjusts how cash receipts and cash payments are presented and classified in the statement of
cash flows. ASU 2016-15 is effective for fiscal years beginning after December 15, 2017, and interim periods within those fiscal
years and will require adoption on a retrospective basis unless impracticable. If impracticable the Company would be required
to apply the amendments prospectively as of the earliest date possible. The Company is currently evaluating the impact that ASU
2016-15 will have on its financial position, results of operations and cash flows.
In
May 2017, the FASB issued ASU 2017-09, Compensation - Stock Compensation (Topic 718) Scope of Modification Accounting. The amendments
in ASU 2017-09 provide guidance about which changes to the terms or conditions of a share-based payment award require an entity
to apply modification accounting in Topic 718. The adoption of ASU 2017-09 will become effective for annual periods beginning
after December 15, 2017; and
the Company is currently
evaluating the impact that it will have on its financial position, results of operations and cash flows
.
In
July 2017, the FASB issued ASU 2017-11,
Earnings Per Share (Topic 260); Distinguishing Liabilities from Equity (Topic 480);
Derivatives and Hedging (Topic 815).
The amendment changes the classification of certain equity-linked financial instruments
(or embedded features) with down round features. The amendments also clarify existing disclosure requirements for equity-classified
instruments.
When determining whether certain financial instruments (or embedded features)
should be classified as liabilities or equity instruments, under ASU 2017-11, a down round feature no longer precludes equity
classification when assessing whether the instrument (or embedded feature) is indexed to an entity's own stock. As a result, a
freestanding equity-linked financial instrument (or embedded conversion option) no longer would be accounted for as a derivative
liability at fair value solely as a result of the existence of a down round feature. The adoption of ASU 2017-11 is effective
for annual periods beginning after December 15, 2018
. The Company has early adopted this standard for this interim period,
applying the standard retrospectively by means of a cumulative-effect adjustment to the opening balance of accumulated deficit
in the amount of $388,667 as of January 1, 2017 (see Note 8).
Concentration
of Risk
The
Company does not have any off-balance sheet concentrations of credit risk. The Company expects cash and accounts receivable to
be the two assets most likely to subject the Company to concentrations of credit risk. The Company’s policy is to maintain
its cash with high credit quality financial institutions to limit its risk of loss exposure.
The
Company historically purchased much of its machined parts through Precision CNC, a related party company that sublet office space
to Q2P through June 27, 2016, and owns a non-controlling interest in the Company. See Note 6.
NOTE
4 –PROPERTY AND EQUIPMENT, NET
Property
and equipment, net consists of the following:
|
|
June 30, 2017
|
|
|
December 31 ,2016
|
|
Furniture and Computers
|
|
$
|
1,328
|
|
|
$
|
1,328
|
|
Shop Equipment
|
|
|
9,540
|
|
|
|
9,540
|
|
Total
|
|
|
10,868
|
|
|
|
10,868
|
|
Accumulated depreciation
|
|
|
(5,113
|
)
|
|
|
(4,136
|
)
|
Net property and equipment
|
|
$
|
5,755
|
|
|
$
|
6,732
|
|
Depreciation
expense for the three months ended June 30, 2017 and 2016 was $494 and $13,267, respectively, and for the six months ended June
30, 2017 and 2016 was $977 and $26,533, respectively.
NOTE
5 – CYCLONE SEPARATION, LICENSE RIGHTS AND DEFERRED REVENUE
In
2014, Q2P purchased for $175,000 certain licensing rights to use Cyclone Power Technologies’ (“Cyclone”) patented
technology on a worldwide, exclusive basis for 20 years with two 10-year renewal terms for Q2P’s waste heat and waste-to-power
business. This agreement contains a royalty provision equal to 5% of gross sales payable to Cyclone on sales of engines derived
from technology licensed from Cyclone. Also, as part of a separation agreement with Cyclone, Q2P assumed a license agreement between
Cyclone and Phoenix Power Group (“Phoenix”), which included deferred revenue of $250,000 from payments previously
made to Cyclone for undelivered products. The net balances as of June 30, 2017 and December 31, 2016 for the Cyclone licensing
rights were $47,396 and $69,271, respectively; and the net balances as of June 30, 2017 and December 31, 2016 for the Phoenix
deferred revenue were $0 and $250,000, respectively, which are included as a component of deferred revenue on the condensed consolidated
balance sheets. The licensing rights are amortized over its estimated useful life of 4 years. Amortization expense for the three
months ended June 30, 2017 and 2016 was $10,938 and $10,938, respectively, and for the six months ended June 30, 2017 and 2016
was $21,875 and $21,875 respectively.
On
January 9, 2017, the Company transferred and assigned to Phoenix its Technology Sales Agreement with MagneGas Corporation (the
“MagneGas Agreement”) to deliver a waste-to-power system to this customer. Under the MagneGas Agreement, the Company
had been paid $90,000 as of the date of transfer, and $68,000 was still due from the customer based on milestones set forth in
the MagneGas Agreement. Phoenix assumed the MagneGas Agreement with all rights to receive the future payments thereunder, and
responsibility to perform the services and provide the products to the customer. The Company has no further responsibility under
the MagneGas Agreement. In consideration for this transfer, Phoenix agreed that the Company had completed and satisfied all financial
obligations associated with all past agreements between Phoenix and the Company, specifically: (1) $150,000 previously paid by
Phoenix for durability testing of the Q2P engine, and (2) delivery by the Company of the first ten (10) Q2P engines at the rate
of $10,000 per delivered Engine for $100,000 in total. This deferred revenue in the total amount of $250,000 was recorded as gain
from the extinguishment of liabilities in the condensed consolidated statement of operations for the six months ended June 30,
2017.
In
connection with the separation agreement with Cyclone, the Company also assumed a contract with Clean Carbon of Australia and
a corresponding $10,064 prepayment for services or other value to be provided in the future. This deposit has been presented as
deferred revenue on the June 30, 2017 and December 31, 2016 condensed consolidated balance sheets.
NOTE
6 – RELATED PARTY TRANSACTIONS
Through
June 2016, the Company sublet approximately 2,500 square feet of assembly, warehouse and office space within the Precision CNC
facility located at 1858 Cedar Hill Road in Lancaster, Ohio. The sublease provided for the Company to pay rent monthly in the
amount of $2,500, which covered space and some utilities. Occupancy costs for the three months ended June 30, 2017 and 2016 were
$0 and $7,500, respectively, and for the six months ended June 30, 2017 and 2016 were $0 and $15,000, respectively. The sublease
was terminated as of June 27, 2016.
The
Company also purchased much of its machined parts through Precision CNC up until June 2016. Precision CNC owns a non-controlling
interest in the Company. For the three months ended June 30, 2017 and 2016, the amounts invoiced from Precision CNC totaled $0
and $11,560, respectively, and for the six months ended June 30, 2017 and 2016, the amounts invoiced totaled $0 and $32,119, respectively,
and consisted of rent and research and development expenses for machined parts.
On
June 27, 2016, the Company and Precision CNC entered into an agreement to eliminate $49,299 in payables owed to Precision CNC
in return for the transfer of certain net assets of the Company with a remaining book value of $70,495, which included office
furniture, software and computer systems, and 50,000 shares of restricted common stock valued at $10,500. The Company recorded
a loss on this transaction in the amount of $31,696. There were no accounts payable and accrued expenses at June 30, 2017 and
December 31, 2016 to Precision CNC.
The
Company also maintains an executive office in Florida, which is leased by GreenBlock Capital LLC, an investment firm that the
Company’s President serves as a Managing Director, but holds no equity or voting rights. The Company has no formal agreement
for this space and pays no rent.
In
March 2017, all outstanding Director accounts payable, accrued expenses and notes payable – related parties with an aggregate
amount of $
156,368
were converted into the Company’s Bridge Offering (see Note 7).
In
April 2017, the Company’s President forgave $112,797 of deferred salary. This amount was reclassified from accrued expenses
to additional paid in capital during the three months ended June 30, 2017.
NOTE
7 – NOTES PAYABLE AND DEBENTURES
In
March 2017, the Company entered into a Modification and Extension Agreement with two holders of its Original Issue Discount Senior
Secured Convertible Debentures (the “Debentures”) to extend the maturity date to July 31, 2017, reset the conversion
price from $0.21 to $0.15, and waive any defaults under the Debentures from the expiration of the maturity date or otherwise.
The exercise price of the Warrants that were issued with the Debentures’ exercise price, which had been reset to $0.50 per
verbal agreement of the parties in the third quarter of 2016, was formally documented under this March 2017 modification agreement.
The Debentures do not bear interest, but contained an Original Issue Discount of $20,750.
All assets of the Company are secured under the Debentures, including our Subsidiary and its assets. The Debentures and warrants
contain certain anti-dilutive protection provisions in the instance that the Company issues stock at a price below the stated
conversion price of the Debentures, as well as other standard protections for the holder.
As of June 30, 2017 and December
31, 2016, the aggregate outstanding principal amount of the two Debentures was $165,000. As of the date of this Quarterly Report,
the Debentures were in default based on the July 31, 2017 maturity date. The Company is in discussions with the holders to
extend the maturity date or amend the terms of the Debentures.
On
March 15, 2016, the Company entered into a 120-day term loan agreement with one accredited investor in the principal amount of
$150,000. The loan bears 20% interest with interest payments due monthly. The Company incurred loan issuance costs of 100,000
shares of common stock valued at $26,000, $3,000 cash and provided a second security interest in the assets of the Company to
the holders. The issuance costs were fully expensed in 2016. As of June 30, 2017, the loan balance was $150,000, and accrued interest
related to the loan was $2,500. This loan matured on July 15, 2016, and a 10% late penalty was assessed on July 15, 2016.
On
March 22, 2017, the Company and the term loan holder entered into an Addendum to the loan agreement which extended the maturity
date to December 31, 2017, allowed for conversion of the principal amount and accrued interest at the discretion of the holder
to common stock at a price of $0.15 per share, and waived all defaults in return for payment of $30,000 which included a $15,000
late penalty and $15,000 of accrued but unpaid interest. This payment was made in April 2017 and the loan is now current. The
Company determined that the new conversion feature has no intrinsic value and that the amended terms did not result in a significantly
different instrument, and, accordingly, accounted for the addendum as a modification of debt.
On
March 31, 2017, the Company closed the initial $1,050,000 tranche in a Convertible Promissory Note (the Bridge Offering).
In addition, as part of that initial closing, three of the Company’s directors and one shareholder converted $168,152 of
prior notes and cash advances, including interest thereon, into the Bridge Offering. As of May 31, 2017, an additional $400,000
was raised under the Bridge Offering and $23,756 of additional prior notes were converted into this round.
The
Convertible Promissory Notes (the “Notes”) from the Bridge Offering convert at a 50% discount to the post-funding
valuation of the Company at the closing of its next offering in the minimum amount of $5,000,000 (the “Equity Offering”).
The conversion valuation has a ceiling of $12,000,000, and a “floor” company value of $6,000,000 in the event there
is no Equity Offering before the Notes are able to be converted.
Pursuant
to ASC 825-10-25-1, Fair Value Option, the Company made an irrevocable election at the time of issuance to report the Notes at
fair value, with changes in fair value recorded through the Company’s condensed consolidated statements of operations as
other income (expense) in each reporting period. The fair value recorded as of June 30, 2017 was $2,300,000 (see Note 8) and the
principal amount due was $1,641,908. The change in fair value resulted in a charge to earnings in the three months ended June
30, 2017 of $625,277.
The
Notes convert into common stock, or preferred stock if received by investors in the Equity Offering, commencing on the earliest
of the Equity Offering closing or December 31, 2017, at the discretion of each holder. Maturity is 36 months from issuance with
15% annual interest which will be capitalized each year into the principal of the Notes and paid in kind. There are no warrants
issued in connection with the Offering.
Funds
from the Bridge Offering will be used to secure acquisitions of compost and soil companies with closings expected to occur concurrently
with the closing of the Equity Offering, and up to 12 months of operating capital. A limited portion of the funds were also used
to eliminate liabilities on the Company’s balance sheet. The Bridge Offering was led by two accredited investors, and joined
by approximately 25 additional accredited investors which included $75,000 of new cash investment by the Company’s Directors,
as well as conversion of $156,368 of old payables, notes and advances made by them in 2016 and 2017. Management conducted the
Offering and no broker fees were paid in connection with the initial closing. All securities issued in the Offering and debt settlements
were issued pursuant to an exemption from registration under Section 4(a)(2) under the Securities Act of 1933.
NOTE
8 – FAIR VALUE MEASUREMENT AND DERIVATIVES
The
Company measures fair value in accordance with a fair value hierarchy that prioritizes the inputs to valuation techniques 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 measurements) and the lowest priority to unobservable inputs (Level 3 measurements). The three levels
of the fair value hierarchy are described below:
|
Level
1
|
Unadjusted
quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities;
|
|
|
|
|
Level
2
|
Quoted
prices in markets that are not active, or inputs that are observable, either directly or indirectly, for substantially the
full term of the asset or liability; and
|
|
|
|
|
Level
3
|
Prices
or valuation techniques that require inputs that are both significant to the fair value measurement and unobservable (supported
by little or no market activity).
|
All
derivatives recognized by the Company are reported as derivative liabilities on the condensed consolidated balance sheets and
are adjusted to their fair value at each reporting date. Unrealized gains and losses on derivative instruments are included in
change in value of derivative liabilities on the condensed consolidated statement of operations.
The
following tables set forth the Company’s condensed consolidated financial assets and liabilities measured at fair value
by level within the fair value hierarchy at June 30, 2017 and December 31, 2016. Assets and liabilities are classified in their
entirety based on the lowest level of input that is significant to the fair value measurement.
|
|
Fair value at
|
|
|
|
|
|
|
|
|
|
|
|
|
June 30, 2017
|
|
|
Level 1
|
|
|
Level 2
|
|
|
Level 3
|
|
Convertible bridge notes
|
|
$
|
2,300,000
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
2,300,000
|
|
Total
|
|
$
|
2,300,000
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
2,300,000
|
|
|
|
Fair value at
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31, 2016
|
|
|
Level 1
|
|
|
Level 2
|
|
|
Level 3
|
|
Preferred stock embedded conversion feature
|
|
$
|
123,266
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
123,266
|
|
Anti-dilution provision in common stock warrants included with preferred stock
|
|
|
52,904
|
|
|
|
-
|
|
|
|
-
|
|
|
|
52,904
|
|
Debenture embedded conversion feature
|
|
|
25,884
|
|
|
|
-
|
|
|
|
-
|
|
|
|
25,884
|
|
Anti-dilution provision in common stock warrants included with debentures
|
|
|
10,988
|
|
|
|
-
|
|
|
|
-
|
|
|
|
10,988
|
|
Total
|
|
$
|
213,042
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
213,042
|
|
There
were no transfers between levels during the six months ended June 30, 2017. However, in accordance with ASU 2017-11
Earnings
Per Share (Topic 260); Distinguishing Liabilities from Equity (Topic 480); Derivatives and Hedging (Topic 815),
the financial
instruments previously classified and fair valued as derivative liabilities due to down round features, have been retrospectively
adjusted by means of a cumulative-effect to the condensed consolidated balance sheet as January 1, 2017. The cumulative change
effect of $388,667 is recognized as an adjustment of the opening balance of accumulated deficit for the year.
On
March 31, 2017, the Company issued $1,218,152 of Convertible Promissory Notes (the “Notes”), and closed an additional
$423,756 of Notes by May 31, 2017. The Notes convert at a 50% discount to the post-funding valuation of the Company at the closing
of its next offering in the minimum amount of $5,000,000 (the “Equity Offering”). The conversion valuation has a ceiling
of $12,000,000, and a “floor” company value of $6,000,000 in the event there is no Equity Offering before the Notes
are able to be converted. The fair value of the Bridge Notes was determined using various Monte Carlo simulations.
The
following table presents a reconciliation of the beginning and ending balances of items measured at fair value on a recurring
basis that use significant unobservable inputs (Level 3) and the related realized and unrealized gains (losses) recorded in the
condensed consolidated statement of operations during the period. The table also shows the cumulative change effect of the derivative
liabilities that were recorded as an adjustment of the opening balance of accumulated deficit for the year:
|
|
Preferred
stock
embedded
conversion
feature
|
|
|
Anti-dilution
provision
in
common
stock
warrants
included
with
preferred
stock
|
|
|
Debenture
embedded
conversion
feature
|
|
|
Anti-dilution
provision
in
common
stock
warrants
included
with
debentures
|
|
|
Convertible Bridge
Notes
|
|
|
Total
|
|
Fair value, December 31, 2016
|
|
$
|
123,266
|
|
|
$
|
52,904
|
|
|
$
|
25,884
|
|
|
$
|
10,988
|
|
|
$
|
-
|
|
|
$
|
213,042
|
|
Reclassification of derivatives to equity upon adoption of ASU 2017-11
|
|
|
(123,266
|
)
|
|
|
(52,904
|
)
|
|
|
(25,884
|
)
|
|
|
(10,988
|
)
|
|
|
-
|
|
|
|
(213,042
|
)
|
Issuances of debt
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
1,641,908
|
|
|
|
1,641,908
|
|
Accrued interest
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
46,565
|
|
|
|
46,565
|
|
Unamortized debt issuance costs
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
(13,750
|
)
|
|
|
(13,750
|
)
|
Net unrealized loss on convertible bridge notes
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
625,277
|
|
|
|
625,277
|
|
Fair value, June 30, 2017
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
2,300,000
|
|
|
$
|
2,300,000
|
|
The
Company’s convertible bridge notes are valued by using Monte Carlo Simulation methods and discounted future cash flow models.
Where possible, the Company verifies the values produced by its pricing models to market prices. Valuation models require a variety
of inputs, including contractual terms, market prices, yield curves, credit spreads, measures of volatility and correlations of
such inputs. These convertible bridge notes do not trade in liquid markets, and as such, model inputs cannot generally be verified
and do involve significant management judgment. Such instruments are typically classified within Level 3 of the fair value hierarchy.
The following assumptions were used to value the Company’s convertible bridge notes at June 30, 2017: dividend yield of
-0-%, volatility of 85 – 90%, risk free rate of 1.51% and an expected term of 2.75 years.
NOTE
9 – COMMON STOCK, PREFERRED STOCK AND WARRANTS
Common
Stock
During
the six months ended June 30, 2017, the Company issued 18,738,195 shares of common stock valued at $470,279. Details of
these issuances are provided below.
On
February 27, 2017, the Company issued 15,000,000 shares of restricted common stock subject to forfeiture to its CEO and President.
The expense of these shares is not recorded until the terms of forfeiture have been satisfied by the respective employees. Those
terms of the stock issuances and forfeitures are materially as follows:
To
fully earn 10,000,000 shares, the Company’s CEO serve with the Company for a period of at least 12 months, during which
12 month or extended period: (1) the Company must complete at least $3 million in funding and (2) complete its first strategic
acquisition. To fully earn 5,000,000 shares, the Company’s President must continue to serve the Company as a senior executive
on a full-time basis for a period of at least 18 months from December 2016, during which 18 month or extended period: (1) the
Company must complete at least $3 million in funding and (2) complete its first strategic acquisition. If these conditions are
not met, the executives may forfeit all of their shares at the discretion of the Board.
In
April 2017, the Company issued 1,738,195 shares of common stock valued at $260,679 as consideration for the payment of
accounts payable and accrued expenses to former employees and vendors.
On
May 1, 2017, the Company issued 2,000,000 shares of common stock valued at $209,600 to a consultant for investor relations services.
Redeemable
Convertible Preferred Stock
The
Company has 600 shares of Preferred Stock issued and outstanding, which currently are convertible at $0.15 per share of the Company’s
common stock (the “Conversion Price”), as per the terms of the March 2017 Modification and Extension Agreement. The
Preferred Stock bears a 6% dividend per annum, calculable and payable per quarter in cash or additional shares of common stock
as determined in the Certificate of Designation. The Preferred Stock has no voting rights until converted to common stock, and
has a liquidation preference equal to the Purchase Price. On the second anniversary of the Original Issue Dates (the “Two
Year Redemption Date”), which occur in December 2017 and January 2018, the Company is obligated to redeem all of the then
outstanding Preferred Stock, for an amount in cash equal to the Two Year Redemption Amount (such redemption, the “Two Year
Redemption”). Each share of Preferred Stock received warrants (the “Warrants”) equal to one-half of the Purchase
Price to purchase common stock in the Company exercisable for five (5) years following closing at a price of $0.50 per share.
The
Preferred Stock has price protection provisions in the case that the Company issues any shares of stock not pursuant to an “Exempt
Issuance” at a price below the Conversion Price. Exempt Issuances include: (i) shares of Common Stock or common stock equivalents
issued pursuant to the Merger or any funding contemplated by the Merger; (ii) any common stock or convertible securities outstanding
as of the date of closing; (iii) common stock or common stock equivalents issued in connection with strategic acquisitions; (iv)
shares of common stock or equivalents issued to employees, directors or consultants pursuant to a plan, subject to limitations
in amount and price; and (v) other similar transactions. The Certificate of Designation contains restrictive covenants not to
incur certain debt, repurchase shares of common stock, pay dividends or enter into certain transactions with affiliates without
consent of holders of 67% of the Preferred Stock. The unconverted shares of Preferred Stock must be redeemed in two years from
issuance.
Management
has determined that the Preferred Stock is more akin to a debt security than equity primarily because it contains a mandatory
2-year redemption at the option of the holder, which only occurs if the Preferred Stock is not converted to common stock. Therefore,
management has presented the Preferred Stock outside of permanent equity as mezzanine equity, which does not factor in to the
totals of either liabilities or equity. In 2016, the proceeds were allocated between the three features of the stock offering:
the embedded conversion feature in the Preferred Stock, the warrants, and the Preferred Stock itself. The fair values of the embedded
conversion feature and warrants were recorded as a discount against the stated value of the Preferred Stock on the date of issuance.
This discount was amortized to interest expense over the term of the redemption period (2 years), which would result in the accretion
of the Preferred Stock to its full redemption value. Unamortized discount as of June 30, 2017 and December 31, 2016 was $56,894
and $126,217, respectively. Interest expense related to the preferred stock discount for the six months ended June 30, 2017 and
2016 was $69,323 and $68,261, respectively.
In
accordance with ASU 2017-11, the embedded conversion feature of the Preferred Stock previously classified and fair valued as a
derivative liability has been retrospectively adjusted by means of a cumulative-effect to the consolidated balance sheet as January
1, 2017. The cumulative change effect of $42,925 is recognized as an adjustment of the opening balance of accumulated deficit
for the year. The agreement setting forth the terms of the common stock warrants issued to the holders of the Preferred Stock
also includes an anti-dilution provision that requires a reduction in the warrant’s exercise price, currently $0.50, should
the conversion ratio of the Preferred Stock be adjusted due to anti-dilution provisions. In accordance with ASU 2017-11, these
warrants previously classified and fair valued as a derivative liability have been retrospectively adjusted by means of a cumulative-effect
to the consolidated balance sheet as January 1, 2017. The cumulative change effect of $69,957 is recognized as an adjustment of
the opening balance of accumulated deficit for the year.
The
Preferred Stock also carries a 6% per annum dividend calculated on the stated value of the stock and is cumulative and payable
quarterly beginning July 1, 2016. These dividends are accrued at each reporting period. They add to the redemption value of the
stock; however, as the Company shows an accumulated deficit, the charge has been recognized in additional paid-in capital.
Warrants
The
following is a summary of all outstanding common stock warrants as of June 30, 2017:
|
|
Number of
Warrants
|
|
|
Exercise price
per share
|
|
|
Average
remaining
term in years
|
|
Warrants issued in connection with issuance of Debentures
|
|
|
415,000
|
|
|
$
|
0.50
|
|
|
|
2.00
|
|
Warrants issued in connection with issuance of Preferred Stock
|
|
|
1,153,845
|
|
|
$
|
0.50
|
|
|
|
3.35
|
|
Warrants issued in connection with a services contract
|
|
|
1,000,000
|
|
|
|
0.20
|
|
|
|
2.83
|
|
Warrants issued in connection with a services contract
|
|
|
1,000,000
|
|
|
$
|
0.35
|
|
|
|
2.83
|
|
NOTE
10 – STOCK OPTIONS AND RESTRICTED STOCK UNITS
On
July 31, 2014, the Board of Directors of Q2P approved the Founders Stock Option Plan (“Founders Plan”) and the 2014
Employee Stock Option Plan (the “2014 Plan”), collectively the “Option Plans”. The Option Plans were developed
to provide a means whereby directors and selected employees, officers, consultants, and advisors of the Company may be granted
incentive or non-qualified stock options to purchase restricted common stock of the Company. On February 25, 2016, to accommodate
the appointment of new Board members and additional incentive stock options and stock grants to key employees of the Company,
the Board approved the 2016 Omnibus Equity Incentive Plan (“2016 Plan”), which allowed for an additional 4 million
shares of common stock, stock options, stock rights (restricted stock units), or stock appreciation rights to be granted by the
Board in its discretion.
In
May 2017, the Company issued 400,000 common stock options under the 2016 Plan to one new Board member and 400,000 common stock
options under the 2016 Plan to one new Board of Advisor Member. The options vest one-half immediately and the balance in 6 months,
with a 10-year term and exercisable at $0.21 per share. The options were valued at $96,800 (pursuant to the Black Scholes valuation
model, and as shown in the table detailing the calculation of fair value below), based on an exercise price of $0.21 per share
and with a maturity life of 5.25 years.
For
the six months ended June 30, 2017, the charge to the condensed consolidated statement of operations for the amortization of stock
option grants awarded under the Option Plans and 2016 Plan was $145,718.
A
summary of the common stock options issued under the Option Plans and the 2016 Plan for the period from December 31, 2016 through
June 30, 2017 follows:
|
|
Number
Outstanding
|
|
|
Weighted Avg.
Exercise Price
|
|
|
Weighted Avg.
Remaining
Contractual
Life (Years)
|
|
Balance, December 31, 2016
|
|
|
6,115,480
|
|
|
$
|
0.21
|
|
|
|
6.1
|
|
Options issued
|
|
|
800,000
|
|
|
$
|
0.21
|
|
|
|
9.7
|
|
Options exercised
|
|
|
—
|
|
|
|
|
|
|
|
|
|
Options cancelled
|
|
|
—
|
|
|
|
|
|
|
|
|
|
Balance, June 30, 2017
|
|
|
6,915,480
|
|
|
$
|
0.21
|
|
|
|
6.1
|
|
The
vested and exercisable options at period end follows:
|
|
Exercisable/
Vested
Options Outstanding
|
|
|
Weighted Avg.
Exercise Price
|
|
|
Weighted
Avg.
Remaining Contractual
Life (Years)
|
|
Balance, June 30, 2017
|
|
|
5,910,480
|
|
|
$
|
0.21
|
|
|
|
5.9
|
|
The
fair value of new stock options granted using the Black-Scholes option pricing model was calculated using the following assumptions:
|
|
Six Months Ended
June
30, 2017
|
|
Risk free interest rate
|
|
|
1.84
|
%
|
Expected volatility
|
|
|
101.2
|
%
|
Expected dividend yield
|
|
|
0
|
%
|
Expected term in years
|
|
|
5.25
|
|
Average value per options
|
|
$
|
0.10
|
|
Expected
volatility is based on historical volatility of the Company’s own common stock. Short Term U.S. Treasury rates were utilized
as the risk free interest rate. The expected term of the options was calculated using the alternative simplified method codified
as ASC 718 “
Accounting for Stock Based Compensation,
” which defined the expected life as the average of the
contractual term of the options and the weighted average vesting period for all issuances.
NOTE
11 – COMMITMENTS AND CONTINGENCIES
On
April 1, 2017, the Company entered into new Employment Agreements with its Chairman and, as of July 2017, CEO; and its previous
CEO and, as of July 2017, President and General Counsel. The Chairman receives a $12,500 per month fee starting April 1 and continuing
until the Company raises its next round of funding in the minimum amount of $5,000,000, at which time, his base salary will be
increased to $350,000 per year. The President and General Counsel receives a $10,000 per month fee starting on April 1,
and at such time that the Company raises its next round of funding in the minimum amount of $5,000,000, he will receive a base
salary of $220,000 per year. Both agreements have provisions for a 12-month severance in the instance either executive is terminated
without cause or after a change in control.
NOTE
12 - SUBSEQUENT EVENTS
In
July 2017, the Company created an Audit Committee by resolution of the full Board of Directors and implemented an Audit Committee
Charter to provide written guidance for the Committee.