NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(As Adjusted -- Note 16)
NOTE 1. NATURE OF OPERATIONS, HISTORY AND PRESENTATION
Nature of Operations
General Cannabis Corp, a Colorado Corporation (the Company, we, us, our, or GCC) (formerly, Advanced Cannabis Solutions, Inc.), was incorporated on June 3, 2013, and provides services and products to the regulated cannabis industry. On April 28, 2015, our common stock was uplisted and on May 6, 2015, resumed quotation on the OTC Markets OTCQB. Our operations are segregated into the following four segments:
Security and Cash Transportation Services (Security Segment)
We provide advanced security, including on-site professionals and cash transport, to licensed cannabis cultivators and retail shops, under the business name IPG, and security services to non-cannabis customers in the hospitality business, such as hotels, under the business name Mile High Protection Services (MHPS). The drop in wholesale prices in Colorado has negatively impacted security services in Colorado, as grow facilities and retailers seek cheaper alternatives or curtail services. We acquired Mile High in order to expand our Colorado security business into the non-cannabis space, as we believe that market provides an opportunity for growth. We have opened an IPG office in California, which recently legalized recreational cannabis in addition to previously legal medical marijuana.
In states that have recently legalized cannabis, whether medical, recreational or both, license applications require a security plan and, if approved, implementation of that security plan. Accordingly, we are assessing the opportunity to expand our security consulting business to assist companies with their application process and the subsequent implementation of compliant security services.
Marketing Consulting and Apparel (Marketing Segment)
Chieftons apparel business, Chiefton Supply, strives to create innovative, unique t-shirts, hats, hoodies and accessories. Our apparel is sold through our on-line shop, cannabis retailers, and specialty t-shirt and gift shops. We are pursuing relationships with national apparel retailers and distributors, as well as expanding our offerings nationwide within the cannabis industry.
Chiefton Design provides design, branding and marketing strategy consulting services to the cannabis industry. We assist clients in developing a comprehensive marketing strategy, as well as designing and sourcing client-specific apparel and products. We now have the capacity of a full service marketing agency. Chiefton Design also supports our other segments with marketing designs and apparel.
Operations Consulting and Products (Operations Segment)
Through Next Big Crop (NBC), we deliver comprehensive consulting services to the cannabis industry that include obtaining licenses, compliance, cultivation, retail operations, logistical support, facility design and construction, and expansion of existing operations. Our business plan for NBC correlates to future growth of the regulated cannabis market in the United States.
NBC oversees our wholesale equipment and supply business, operated under the name GC Supply, which provides turnkey sourcing and stocking services to cultivation, retail and infused products manufacturing facilities. Our products include infrastructure, equipment, consumables and compliance packaging.
Finance and Real Estate (Finance Segment)
Real Estate Leasing
Until December 29, 2017, we owned a cultivation property in a suburb of Pueblo, Colorado, consisting of approximately three acres of land, which currently includes a 5,000 square foot steel building and a parking lot. The property is zoned for cultivating cannabis and is leased to a medical cannabis grower until December 31, 2022. On December 19, 2017, the Company entered into an agreement to sell this property for $625,000 in cash, which closed on December 29, 2017.
Our real estate leasing business plan includes the potential future acquisition and leasing of cultivation space and related facilities to licensed marijuana growers and dispensary owners for their operations. Management anticipates that these facilities would range in size from 5,000 to 50,000 square feet. These facilities would only be leased to tenants that possess the requisite state licenses to operate cultivation facilities. The leases with the tenants would include certain requirements that permit us to continually evaluate our tenants compliance with applicable laws and regulations.
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Shared Office Space, Networking and Event Services
In October 2014, we purchased a former retail bank located at 6565 East Evans Avenue, Denver, Colorado 80224, which has been branded as The Greenhouse. The building is a 16,056 square foot facility, which we use as our corporate headquarters.
The Greenhouse has approximately 10,000 square feet of existing office space and 5,000 square feet on its ground floor that is dedicated to a consumer banking design. We continue to assess the opportunity to lease shared workspace for entrepreneurs, professionals and others serving the cannabis industry. Clients would be able to lease office, meeting, lecture, educational and networking space, and individual workstations. We expect to continue the renovation of The Greenhouse in 2018.
We plan to continue to acquire commercial real estate and lease office space to participants in the cannabis industry. These participants may include media, internet, packaging, lighting, cultivation supplies and financial services-related companies. In exchange for certain services that may be provided to these tenants, we expect to receive rental income in the form of cash. In certain cases, we may acquire equity interests or provide debt capital to these businesses.
Industry Finance
Our industry finance strategy includes evaluating opportunities to make direct term loans or to provide revolving lines of credit to businesses involved in the cultivation and sale of cannabis and related products. These loans would generally be secured to the maximum extent permitted by law. We believe there is a significant demand for this type of financing. We are assessing other finance services including customized finance, capital formation and banking, for participants in the cannabis industry.
Desert Created Company LLC / DB Products Arizona, LLC
In January 2018, we entered into a limited liability company operating agreement with DNFC LLC (DNFC), pursuant to the formation of Desert Created Company LLC (Desert Created Company). Each party owns a 50% interest in Desert Created Company, the successor company to DB Arizona. Desert Created Company is the successor entity to DB Products Arizona, LLC (DB Arizona).
DB Arizona produced and distributed cannabis-infused elixirs and edible products in Arizona. We loaned $26,500 and $75,000, respectively, to DB Arizona during the years ended December 31, 2017 and 2016. In June 2017, we purchased 100% of the ownership interests in GC Finance Arizona LLC (GC Finance Arizona) from Infinity Capital for $106,000 in cash. GC Finance Arizona holds a 50% ownership interest in DB Arizona, an $825,000 loan to DB Arizona, and no liabilities. We expected future positive cash flows, if any, would first go towards paying the holders of DB Arizonas notes payable. Accordingly, we allocated the entire consideration of $106,000 to the note receivable from DB Arizona. During the quarter ended December 31, 2017, DB Arizona ceased operations and we impaired the full amount of our notes receivable from DB Arizona.
Basis of Presentation
The accompanying consolidated financial statements include the results of GCC and its six wholly-owned subsidiary companies: (a) ACS Colorado Corp., a Colorado corporation formed in 2013; (b) Advanced Cannabis Solutions Corporation, a Colorado corporation formed in 2013; (c) 6565 E. Evans Avenue LLC, a Colorado limited liability company formed in 2014; (d) General Cannabis Capital Corporation, a Colorado corporation formed in 2015; (e) GC Security LLC (GCS), a Colorado limited liability company formed in 2015; and (f) GC Finance Arizona LLC (GC Finance Arizona), an Arizona limited liability company . Advanced Cannabis Solutions Corporation has one wholly-owned subsidiary company, ACS Corp., which was formed in Colorado on June 6, 2013. Intercompany accounts and transactions have been eliminated.
The preparation of our consolidated financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses. Although these estimates are based on our knowledge of current events and actions we may undertake in the future, actual results may ultimately differ from these estimates and assumptions. Furthermore, when testing assets for impairment in future periods, if management uses different assumptions or if different conditions occur, impairment charges may result.
Certain reclassifications have been made to the prior period segment reporting to conform to the current period presentation related to now including GC Supply in our Operations Segment. The reclassifications had no effect on net loss, total assets, or total stockholders equity (deficit).
During the year ended December 31, 2017, we adopted Financial Accounting Standards Board, or FASB, Accounting Standards Update, or FASB ASU 2017-11, which impacts accounting for financial instruments with down round features. This change in accounting principle was applied retrospectively and, accordingly, impacted all periods presented. See Note 16.
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Significant Accounting Policies
Cash and Cash Equivalents
Cash and cash equivalents include cash on hand, deposits with banks, and investments that are highly liquid and have maturities of three months or less at the date of purchase. We maintain our cash balances in financial institutions that, from time to time, may exceed amounts insured by the Federal Deposit Insurance Corporation ($250,000 as of December 31, 2017).
Inventory
Our inventory consists of finished goods, including apparel and supplies for the cannabis market. Inventory is stated at the lower of cost or market, using the first-in, first-out method (FIFO) to determine cost. We monitor inventory cost compared to selling price in order to determine if a lower of cost or market reserve is necessary.
Property and Equipment
Property and equipment are recorded at historical cost. The cost of maintenance and repairs, which are not significant improvements, are expensed when incurred. Depreciation is computed using the straight-line method over the estimated useful lives of the assets: thirty years for buildings, the lesser of five years or the life of the lease for leasehold improvements, and three to five years for furniture, fixtures and equipment. Land is not depreciated.
Business Combinations
Amounts paid for acquisitions are allocated to the assets acquired and liabilities assumed based on their estimated fair value at the date of acquisition. The fair value of identifiable intangible assets is based on detailed valuations that use information and assumptions provided by management, including expected future cash flows. We allocate any excess purchase price over the fair value of the net assets and liabilities acquired to goodwill. Identifiable intangible assets with finite lives are amortized over their useful lives. Acquisition-related costs, including advisory, legal, accounting, valuation and other costs, are expensed in the periods in which the costs are incurred. The results of operations of acquired businesses are included in the consolidated financial statements from the acquisition date.
Intangible Assets and Goodwill
Goodwill is the cost of an acquisition less the fair value of the net assets of the acquired business.
Intangible assets consist primarily of customer relationships and marketing-related intangibles. Our intangible assets are being amortized on a straight-line basis over a period of two years.
Impairment of Long-lived Assets and Goodwill
We periodically evaluate whether the carrying value of property, equipment and intangible assets has been impaired when circumstances indicate the carrying value of those assets may not be recoverable. The carrying amount is not recoverable if it exceeds the sum of the undiscounted cash flows expected to result from the use and eventual disposition of the asset. If the carrying value is not recoverable, the impairment loss is measured as the excess of the assets carrying value over its fair value.
We evaluate goodwill for impairment annually in the fourth quarter, and whenever events or changes in circumstances indicate it is more likely than not that the fair value of a reporting unit containing goodwill is less than its carrying amount. The goodwill impairment test consists of a two-step process, if necessary. The first step is to compare the fair value of a reporting unit to its carrying value, including goodwill. We typically use discounted cash flow models to determine the fair value of a reporting unit. The assumptions used in these models are consistent with those we believe hypothetical marketplace participants would use. If the fair value of the reporting unit is less than its carrying value, the second step of the impairment test must be performed in order to determine the amount of impairment loss, if any. The second step compares the implied fair value of the reporting unit's goodwill with the carrying amount of that goodwill. If the carrying amount of the reporting unit's goodwill exceeds its implied fair value, an impairment charge is recognized in an amount equal to that excess. The loss recognized cannot exceed the carrying amount of goodwill.
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Our impairment analyses require management to apply judgment in estimating future cash flows as well as asset fair values, including forecasting useful lives of the assets, assessing the probability of different outcomes, and selecting the discount rate that reflects the risk inherent in future cash flows. If the carrying value is not recoverable, we assess the fair value of long-lived assets using commonly accepted techniques, and may use more than one method, including, but not limited to, recent third party comparable sales and discounted cash flow models. If actual results are not consistent with our assumptions and estimates, or our assumptions and estimates change due to new information, we may be exposed to an impairment charge in the future.
Debt
We issue debt that may have separate warrants, conversion features, or no equity-linked attributes.
Debt with warrants
When we issue debt with warrants, we treat the warrants as a debt discount, record as a contra-liability against the debt, and amortize the balance over the life of the underlying debt as amortization of debt discount expense in the consolidated statements of operations. When the warrants do not have certain terms, the offset to the contra-liability is recorded as additional paid in capital in our consolidated balance sheets. If we issue debt with warrants that have certain terms, the warrants may be considered to be a derivative that is recorded as a liability at fair value. If the initial value of the warrant derivative liability is higher than the fair value of the associated debt, the excess is recognized immediately as interest expense. The warrant derivative liability is adjusted to its fair value at the end of each reporting period, with the change being recorded as expense or gain. If the debt is retired early, the associated debt discount is then recognized immediately as amortization of debt discount expense in the consolidated statement of operations. The debt is treated as conventional debt.
We determine the value of the non-complex warrants using the Black-Scholes Option Pricing Model (Black-Scholes) using the stock price on the date of issuance, the risk free interest rate associated with the life of the debt, and the volatility of our stock. For warrants with complex terms, we use the binomial lattice model to estimate their fair value.
Convertible debt
derivative treatment
When we issue debt with a conversion feature, we must first assess whether the conversion feature meets the requirements to be treated as a derivative, as follows: a) one or more underlyings, typically the price of our common stock; b) one or more notional amounts or payment provisions or both, generally the number of shares upon conversion; c) no initial net investment, which typically excludes the amount borrowed; and d) net settlement provisions, which in the case of convertible debt generally means the stock received upon conversion can be readily sold for cash. An embedded equity-linked component that meets the definition of a derivative does not have to be separated from the host instrument if the component qualifies for the scope exception for certain contracts involving an issuers own equity. The scope exception applies if the contract is both a) indexed to its own stock; and b) classified in stockholders equity in its statement of financial position.
If the conversion feature within convertible debt meets the requirements to be treated as a derivative, we estimate the fair value of the convertible debt derivative using Black-Scholes upon the date of issuance. If the fair value of the convertible debt derivative is higher than the face value of the convertible debt, the excess is immediately recognized as interest expense. Otherwise, the fair value of the convertible debt derivative is recorded as a liability with an offsetting amount recorded as a debt discount, which offsets the carrying amount of the debt. The convertible debt derivative is revalued at the end of each reporting period and any change in fair value is recorded as a gain or loss in the consolidated statement of operations. The debt discount is amortized over the life of the debt.
Convertible debt beneficial conversion feature
If the conversion feature is not treated as a derivative, we assess whether it is a beneficial conversion feature (BCF). A BCF exists if the conversion price of the convertible debt instrument is less than the stock price on the commitment date. This typically occurs when the conversion price is less than the fair value of the stock on the date the instrument was issued. The value of a BCF is equal to the intrinsic value of the feature, the difference between the conversion price and the common stock into which it is convertible, and is recorded as additional paid in capital and as a debt discount in the consolidated balance sheet. We amortize the balance over the life of the underlying debt as amortization of debt discount expense in the consolidated statement of operations. If the debt is retired early, the associated debt discount is then recognized immediately as amortization of debt discount expense in the consolidated statement of operations.
If the conversion feature does not qualify for either derivative treatment or as a BCF, the convertible debt is treated as traditional debt.
Modification of debt instruments
Modifications or exchanges of debt that are not considered to be a troubled debt restructuring, are considered extinguishments if the terms of the new debt and the original instrument are substantially different. The instruments are considered substantially different when the present value of the cash flows under the terms of the new debt instrument are at least 10% different from the present value of the remaining cash flows under the terms of the original instrument. The fair value of non-cash consideration associated with the new debt instrument, such as warrants, are included as a day one cash flow in the 10% cash flow test. If the original and new debt instruments are substantially different, the original debt is derecognized and the new debt is initially recorded at fair value, with the difference recognized as an extinguishment gain or loss. If the original and new debt instruments are not substantially different, the new effective interest rate is applied to the modified agreement based on the original terms and the increase, if any, in fair value under the modified agreement.
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Fair Value Measurements
Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability, in an orderly transaction between market participants on the measurement date. Valuation techniques used to measure fair value must maximize the use of observable inputs and minimize the use of unobservable inputs. The fair value hierarchy is based on three levels of inputs, of which the first two are considered observable and the last unobservable, as follows:
Level 1 Quoted prices in active markets for identical assets or liabilities.
Level 2 Inputs other than Level 1 that are observable, either directly or indirectly, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.
Level 3 Unobservable inputs that are supported by little or no market activity and that are significant to the measurement of the fair value of the assets or liabilities.
Our financial instruments include cash, accounts receivable, notes receivable, accounts payables and tenant deposits. The carrying values of these financial instruments approximate their fair value due to their short maturities. The carrying amount of our debt approximates fair value because the interest rates on these instruments approximate the interest rate on debt with similar terms available to us.
Revenue Recognition
We recognize revenue when the four revenue recognition criteria are met, as follows:
Persuasive evidence of an arrangement exists
our customary practice is to obtain written evidence, typically in the form of a contract or purchase order;
Delivery
when services are completed in accordance with the underlying contract, or for the sale of goods when custody is transferred to our customers either upon shipment to or receipt at our customers locations, with no right of return or further obligations;
The price is fixed or determinable
prices are typically fixed and no price protections or variables are offered; and
Collectability is reasonably assured
we typically work with businesses with which we have a long standing relationship, as well as continually monitoring and evaluating customers ability to pay.
Refunds and returns, which are minimal, are recorded as a reduction of revenue.
Share-based Payments
Nonemployees
We may enter into agreements with nonemployees to make share-based payments in return for services. These payments may be made in the form of common stock or common stock warrants. We recognize expense for fully-vested warrants at the time they are granted. For awards with service or performance conditions, we generally recognize expense over the service period or when the performance condition is met; however, there may be circumstances in which we determine that the performance condition is probable before the actual performance condition is achieved. In such circumstances, the amount recognized as expense is the pro rata amount, depending on the estimated progress towards completion of the performance condition. Nonemployee share-based payments are measured at fair value, based on either the fair value of the equity instrument issued or on the fair value of the services received. Typically, it is not practical to value the services received, so we determine the fair value of common stock grants based on the price of the common stock on the measurement date (which is the earlier of the date at which a commitment for performance by the counterparty to earn the equity instruments is reached, if there are sufficient disincentives to ensure performance, or the date at which the counterpartys performance is complete), and the fair value of common stock warrants using Black-Scholes. We use historical data to estimate the expected price volatility, the expected stock option life and expected forfeiture rate. The risk-free interest rate is based on the United States Treasury yield curve in effect at the time of grant for the estimated life of the stock option. For awards that are recognized when a performance condition is probable, the fair value is estimated at each reporting date. The cost ultimately recognized is the fair value of the equity award on the date the performance condition is achieved. Accordingly, the expense recognized may change between interim reporting dates and the date the performance condition is achieved.
Awards of common stock with a service or performance condition, where the ultimate number of shares to be issued is uncertain, are classified as liabilities. All other nonemployee awards are classified as equity.
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Employees
We issue options to purchase our common stock to our employees, which are measured at fair value using Black-Scholes. We use historical data to estimate the expected price volatility, the expected stock option life and expected forfeiture rate. The risk-free interest rate is based on the United States Treasury yield curve in effect at the time of grant for the estimated life of the stock option. We recognize expense on a straight-line basis over the service period, net of an estimated forfeiture rate, resulting in a compensation cost for only those shares expected to vest. Awards to employees are classified as equity.
Market price-based awards
We may issue share-based payments that vest when certain market conditions are met, such as our common stock trading above a certain value for a specific number of days. We recognize expense for market price-based options at the estimated fair value of the options using the binomial lattice model over the estimated life of the options used in the model, or immediately upon the market conditions being met. We use historical data to estimate the expected price volatility, the expected stock option life and expected forfeiture rate. The risk-free interest rate is based on the United States Treasury yield curve in effect at the time of grant for the estimated life of the stock option.
Shipping and Handling
Payments by customers to us for shipping and handling costs are included in revenue on the consolidated statements of operations, while our expense is included in cost of goods sold. Shipping and handling for inventory is included as a component of inventory on the consolidated balance sheets, and in cost of goods sold in the consolidated statements of operations when the product is sold.
Income Taxes
We recognize deferred income tax assets and liabilities for the expected future tax consequences of temporary differences between the income tax and financial reporting carrying amount of our assets and liabilities. We monitor our deferred tax assets and evaluate the need for a valuation allowance based on the estimate of the amount of such deferred tax assets that we believe do not meet the more-likely-than-not recognition criteria. We also evaluate whether we have any uncertain tax positions and would record a reserve if we believe it is more-likely-than-not our position would not prevail with the applicable tax authorities. Our assessment of tax positions as of December 31, 2017 and 2016, determined that there were no material uncertain tax positions.
Reportable Segments
Our reporting segments consist of: a) Security and Cash Transportation Services; b) Marketing Consulting and Apparel; c) Operations Consulting and Products; and d) Finance and Real Estate. Our Chief Executive Officer has been identified as the chief decision maker. Our operations are conducted primarily within the United States of America.
Related Parties
Related parties are any entities or individuals that, through employment, ownership or other means, possess the ability to direct or cause the direction of the management and policies of the Company. We disclose related party transactions that are outside of normal compensatory agreements, such as salaries or board of director fees. We had related party transactions with the following individuals / companies:
·
Michael Feinsod
Chairman of our Board of Directors (Board).
·
Infinity Capital West, LLC (Infinity Capital)
An investment management company that was founded and is controlled by Michael Feinsod.
·
GC Finance Arizona
A company that holds a 50% ownership in DB Arizona, and was owned 100% by Infinity Capital prior to our purchase in June 2017.
·
DB Arizona
A company that borrowed $825,000 from GC Finance Arizona. Prior to our purchase in June 2017, we did not possess the ability to influence DB Arizona and DB Arizona did not have the ability to influence us. We include DB Arizona as a related party due to our relationship with Michael Feinsod and Infinity Capital, and their relationship with DB Arizona.
Recently Issued Accounting Standards
FASB ASU 2017-11 Earnings Per Share (Topic 260), Distinguishing Liabilities from Equity (Topic 480) and Derivatives and Hedging (Topic 815)
In July 2017, the FASB issued 2017-11. The guidance eliminates the requirement to consider down round features when determining whether certain equity-linked financial instruments or embedded features are indexed to an entitys own stock. Our 12% Warrants were treated as derivative instruments, because they include a down round feature, whereby if we issue equity-based instruments at a price below the exercise price of the 12% Warrants, the exercise price of the 12% Warrants would be adjusted. We have early adopted this standard. See Note 16.
FASB ASU 2017-09 Scope of Modification Accounting (Topic 718)
In May 2017, the FASB issued 2017-09. The guidance clarifies the accounting for when the terms of a share-based award are modified. The ASU is effective for annual reporting periods beginning after December 15, 2017, and for interim periods within those years, with early adoption permitted. This new guidance would only impact our consolidated financial statements if, in the future, we modified the terms of any of our share-based awards.
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FASB ASU 2017-04 Simplifying the Test for Goodwill Impairment (Topic 350)
In January 2017, the FASB issued 2017-04. The guidance removes Step Two of the goodwill impairment test, which required a hypothetical purchase price allocation. A goodwill impairment will now be the amount by which a reporting units carrying value exceeds its fair value, not to exceed the carrying amount of goodwill. The ASU is effective for annual reporting periods beginning after December 15, 2019, and for interim periods within those years, with early adoption permitted. We do not currently expect this ASU to have a significant impact on our consolidated financial statements and related disclosures.
FASB ASU 2017-01 Clarifying the Definition of a Business (Topic 805)
In January 2017, the FASB issued 2017-1. The new guidance that changes the definition of a business to assist entities with evaluating when a set of transferred assets and activities is a business. The guidance requires an entity to evaluate if substantially all of the fair value of the gross assets acquired is concentrated in a single identifiable asset or a group of similar identifiable assets; if so, the set of transferred assets and activities is not a business. The guidance also requires a business to include at least one substantive process and narrows the definition of outputs by more closely aligning it with how outputs are described in ASC 606. The ASU is effective for annual reporting periods beginning after December 15, 2017, and for interim periods within those years. Adoption of this ASU is not currently expected to have a significant impact on our consolidated results of operations, cash flows and financial position.
FASB ASU 2016-15 Statement of Cash Flows (Topic 230)
In August 2016, the FASB issued 2016-15. Stakeholders indicated that there is a diversity in practice in how certain cash receipts and cash payments are presented and classified in the statement of cash flows. ASU 2016-15 addresses eight specific cash flow issues with the objective of reducing the existing diversity in practice. This ASU is effective for annual reporting periods beginning after December 15, 2017, and interim periods within those fiscal years. Early adoption is permitted. Adoption of this ASU will not have a significant impact on our statement of cash flows.
FASB ASU 2016-02 Leases (Topic 842)
In February 2016, the FASB issued ASU 2016-02, which will require lessees to recognize almost all leases on their balance sheet as a right-of-use asset and a lease liability. For income statement purposes, the FASB retained a dual model, requiring leases to be classified as either operating or finance. Classification will be based on criteria that are largely similar to those applied in current lease accounting, but without explicit bright lines. Lessor accounting is similar to the current model, but updated to align with certain changes to the lessee model and the new revenue recognition standard. This ASU is effective for fiscal years beginning after December 18, 2018, including interim periods within those fiscal years. As of January 1, 2018, we do not have any material leases, so adoption of this ASU will not have a significant impact on our consolidated results of operations, cash flows and financial position.
FASB ASU 2015-17Income Taxes (Topic 740)
In November 2015, the FASB issued ASU 2015-17, which simplifies the presentation of deferred tax assets and liabilities on the balance sheet. Previous GAAP required an entity to separate deferred income tax liabilities and assets into current and noncurrent amounts on the balance sheet. The amendment requires that deferred tax liabilities and assets be classified as noncurrent in a classified balance sheet. This ASU is effective for annual periods beginning after December 15, 2017, and interim periods within annual periods beginning after December 15, 2018. Adoption of this ASU is not currently expected to have a significant impact on our consolidated results of operations, cash flows and financial position.
The following recently issued accounting standards all impact revenue recognition for annual reporting periods beginning after December 15, 2017:
FASB ASU 2016-12 Revenue from Contracts with Customers (Topic 606)
In May 2016, the FASB issued 2016-12. The core principle of the guidance is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. ASU 2016-12 provides clarification on assessing collectability, presentation of sales taxes, noncash consideration, and completed contracts and contract modifications.
FASB ASU 2016-11 Revenue Recognition (Topic 605) and Derivatives and Hedging (Topic 815)
In May 2016, the FASB issued 2016-11, which clarifies guidance on assessing whether an entity is a principal or an agent in a revenue transaction. This conclusion impacts whether an entity reports revenue on a gross or net basis.
FASB ASU 2016-10 Revenue from Contracts with Customers (Topic 606)
In April 2016, the FASB issued ASU 2016-10, clarify identifying performance obligations and the licensing implementation guidance, while retaining the related principles for those areas.
We have reviewed our contracts with customers, identified the rights of the parties, evaluated the payment terms, assessed the commercial substance of the contracts, and estimated the probability of collectability. We have also considered the goods and services we deliver compared to the contractual performance obligations. Our agreements predominantly have a fixed price for the goods or services to be delivered, we do not provide financing, and settle in cash. Each separate performance obligation within our contracts with customers is priced individually, and we recognize revenue as each good or service is delivered, that is, when the performance obligation is satisfied. Based on this assessment, adoption of these ASUs will not have a significant impact on our consolidated results of operations, cash flows or financial position.
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NOTE 2.
BUSINESS ACQUISITION
On August 18, 2017, we entered into an Asset Purchase Agreement (the Mile High APA) with Mile High Protection Services LLC, a Colorado limited liability company, and its sole member (together Seller) whereby we acquired the tradename, workforce, customer contracts, and other intangible assets of the business. Pursuant to the Mile High APA, we agreed to deliver to Seller 224,359 restricted shares of our common stock. The shares vest over a six month period. The Mile High APA contains certain provisions that require Seller to forfeit a portion of such shares in the event that Seller does not meet the obligations under the Mile High APA. In accordance with the terms of the Mile High APA, the number of shares to be delivered was reduced by 120,000, thus 104,359 shares of our common stock are due upon vesting. Seller also agreed to a three year non-compete agreement.
The 104,359 shares of restricted common stock were valued based on the closing price per share of our common stock on August 18, 2017, or $1.75 per share, reduced by a discount of 15% due to the vesting period and the restrictions on the Sellers ability to immediately sell such shares. The $155,000 value of stock consideration was recorded as accrued stock payable on the December 31, 2017, consolidated balance sheet, which was reduced when the vesting requirements for the shares was met and we issued the common stock in February 2018.
The purchase price allocation was as follows:
|
|
|
Intangible assets:
|
|
|
Customer relationships
|
$
|
100,000
|
Tradename
|
|
55,000
|
|
$
|
155,000
|
We finalized the purchase price allocation in the quarter ended December 31, 2017.
The accompanying consolidated financial statements include the results of MHPS from the date of acquisition, August 18, 2017. The pro forma effects of the acquisition on the results of operations as if the transaction had been completed on January 1, 2016, are as follows:
|
|
|
|
|
|
|
Year ended December 31,
|
|
|
2017
|
|
2016
|
|
|
(Unaudited)
|
Total revenues
|
$
|
4,103,416
|
$
|
3,802,492
|
Net loss
|
|
(8,135,847)
|
|
(10,118,044)
|
Net loss per common share:
|
|
|
|
|
Basic and diluted
|
$
|
(0.40)
|
$
|
(0.65)
|
NOTE 3. RECEIVABLES
Our accounts receivables consisted of the following:
|
|
|
|
|
|
|
December 31,
|
|
|
2017
|
|
2016
|
Accounts receivable
|
$
|
586,219
|
$
|
225,314
|
Less: Allowance for doubtful accounts
|
|
(140,000)
|
|
(43,100)
|
Total
|
$
|
446,219
|
$
|
182,214
|
Our Notes receivable DB Arizona consisted of loans of $26,500 and $75,000, respectively, and interest of $11,969 and $2,202, respectively, during the years ended December 31, 2017 and 2016, along with consideration of $106,000 paid for the acquisition of GC Finance Arizona in June 2017. GC Finance Arizona held a 50% ownership interest in DB Arizona, an $825,000 loan to DB Arizona, and no liabilities. At the time of purchase of GC Finance Arizona, we estimated the fair value of the $825,000, which was subordinate to the $101,500 notes, to be $106,000. The loans bear interest at 14%, with principal and interest due on May 30, 2017. During the year ended December 31, 2017, we determined that it was not probable that we would recover the amounts due under the notes receivable and, accordingly, recorded an impairment charge of $221,671 in our consolidated statement of operations for the year ended December 31, 2017.
39
NOTE 4. PREPAIDS AND OTHER CURRENT ASSETS
Our Prepaids and other current assets consist of the following:
|
|
|
|
|
|
|
December 31,
|
|
|
2017
|
|
2016
|
Prepaid insurance
|
$
|
53,498
|
$
|
42,119
|
Employee receivable payroll tax withholding for stock option exercise
|
|
499,587
|
|
|
Other
|
|
119,551
|
|
34,374
|
|
$
|
672,636
|
$
|
76,493
|
NOTE 5. PROPERTY AND EQUIPMENT
Property and equipment consisted of the following:
|
|
|
|
|
|
|
December 31,
|
|
|
2017
|
|
2016
|
Land
|
$
|
800,000
|
$
|
812,340
|
Buildings
|
|
423,104
|
|
871,767
|
Leasehold improvements
|
|
|
|
41,534
|
Furniture, fixtures and equipment
|
|
161,430
|
|
107,741
|
|
|
1,384,534
|
|
1,833,382
|
Less: Accumulated depreciation
|
|
(90,773)
|
|
(118,579)
|
|
$
|
1,293,761
|
$
|
1,714,803
|
Depreciation expense was $65,282 and $51,913, respectively, for the years ended December 31, 2017 and 2016.
In December 2017, we sold our Pueblo property, consisting of land, building and leasehold improvements with a net carrying value of approximately $410,000 for cash consideration of $579,823, net of certain expenses, and recognized a gain on sale of approximately $196,000.
NOTE 6. INTANGIBLE ASSETS AND GOODWILL
Intangible Assets
Intangible assets consisted of the following:
|
|
|
|
|
|
|
|
|
December 31, 2017
|
|
Gross
|
|
Accumulated Amortization
|
|
Net
|
|
Estimated Life
(in years)
|
MHPS Customer relationships
|
$
|
100,000
|
$
|
22,739
|
$
|
77,261
|
|
2
|
MHPS Tradename
|
|
55,000
|
|
12,507
|
|
42,493
|
|
2
|
Chiefton brand and graphic designs
|
|
69,400
|
|
69,400
|
|
|
|
2
|
Intangible assets, net
|
$
|
224,400
|
$
|
104,646
|
$
|
119,754
|
|
|
|
|
|
|
|
|
|
|
|
December 31, 2016
|
|
Gross
|
|
Accumulated Amortization
|
|
Net
|
|
Estimated Life
(in years)
|
Chiefton brand and graphic designs
|
$
|
69,400
|
$
|
44,017
|
$
|
25,383
|
|
2
|
Amortization expense was $60,629 and $342,302 for the years ended December 31, 2017 and 2016. Future amortization expense is $77,500 and $42,254, respectively, during the years ending December 31, 2018 and 2019.
Impairment of Intangible Assets and Goodwill
During the year ended December 31, 2016, we recorded an impairment charge for goodwill and the remaining unamortized value of the IPG intangible assets. Colorado placed a limit on the number of licenses they would issue for cannabis cultivation facilities, which resulted in the aggregation of licenses by just a few companies. Colorado did not, however, limit the level of production for these facilities. As a result, since IPG was acquired, and the related intangible assets and goodwill were valued, there has been significant growth in the supply of cannabis in the Colorado market, which has led to significantly lower wholesale prices for cannabis towards the end of 2016 compared to earlier in the year and in 2015. As a result of lower prices and aggregation of operations, cultivation companies are not using outside security services to the extent originally projected. Due to these changes to the Colorado market, as of December 31, 2016, expected future cash flows for IPGs operations in Colorado are estimated to remain at or near break even. Accordingly, we have recorded an impairment charge of $1,344,242.
40
NOTE 7. ACCOUNTS PAYABLE AND ACCRUED EXPENSES
Our accounts payable and accrued expenses consist of the following:
|
|
|
|
|
|
|
December 31,
|
|
|
2017
|
|
2016
|
Accounts payable
|
$
|
192,204
|
$
|
191,298
|
Accrued payroll, taxes and vacation
|
|
243,659
|
|
127,178
|
Payroll tax liability for stock option exercises
|
|
519,278
|
|
|
Property taxes and other
|
|
42,653
|
|
45,142
|
|
$
|
997,794
|
$
|
363,618
|
NOTE 8. ACCRUED STOCK PAYABLE
The following tables summarize the changes in accrued common stock payable:
|
|
|
|
|
|
|
Amount
|
|
Number of Shares
|
December 31, 2015
|
$
|
1,532,420
|
|
730,000
|
Feinsod Agreement accrual
|
|
192,800
|
|
|
Feinsod Agreement issued
|
|
(663,000)
|
|
(150,000)
|
Consulting services accrual
|
|
6,988
|
|
|
Consulting services issued
|
|
(25,000)
|
|
(50,000)
|
Employment agreements accrual
|
|
567
|
|
|
Employment agreements issued
|
|
(132,175)
|
|
(50,000)
|
IPG acquisition issued
|
|
(843,200)
|
|
(400,000)
|
Chiefton acquisition issued
|
|
(69,400)
|
|
(80,000)
|
December 31, 2016
|
|
|
|
|
Acquisition of MHPS
|
|
155,000
|
|
104,359
|
Warrant exercises
|
|
166,860
|
|
154,500
|
December 31, 2017
|
$
|
321,860
|
|
258,859
|
Acquisition of MHPS
The MHPS shares are issuable on February 27, 2018, if the terms of the Mile High APA are met.
Warrant Exercises
We received cash for the exercise of warrants in 2017 and the shares of common stock were issued in January 2018.
Feinsod Agreement
On August 4, 2014, we entered into an agreement with Michael Feinsod in consideration for serving as Executive Chairman of the Board and as a member of the Board and pursuant to the terms of the Executive Board and Director Agreement (the Feinsod Agreement). The Board approved the issuance to Infinity Capital of (a) 200,000 shares of our common stock on August 4, 2014; (b) 1,000,000 shares of our common stock upon the uplisting of our common stock to the OTC Markets OTCQB; (c) 150,000 shares of our common stock on August 4, 2015; and (d) 150,000 shares of our common stock on August 4, 2016. Mr. Feinsod must remain a member of the Board in order for the common stock to be issued. In addition, the Feinsod Agreement required the issuance of a number of shares of our common stock to Infinity Capital equal to 10% of any new issuances not to exceed 600,000 shares of our common stock in the aggregate during the time that Mr. Feinsod remains a member of the Board (the New Issuance Allowance). Under the terms of the Feinsod Agreement, the New Issuance Allowance would not be triggered upon issuances relating to convertible securities existing as of the date of the Feinsod Agreement. For illustrative purposes, if we issue 7,000,000 new shares of common stock, then the New Issuance Allowance issued to Infinity Capital would be capped at 600,000 shares of our common stock. No shares were issued under the New Issuance Allowance.
The 1,000,000 shares of our common stock were valued at $2.97 per share, based on the closing price of our common stock of $3.49 on April 27, 2015, and then reduced by 15% due to restrictions on the ability to trade our shares. The other shares under the Feinsod Agreement were valued at $4.42 per share, based on the closing price of our common stock of $5.20 on August 4, 2014, and then reduced by 15% due to restriction on the ability to trade our common stock. We recognized expense for the unissued shares ratably over the vesting period.
41
Employment Agreements
On May 13, 2015, we hired two individuals and granted them a total of 100,000 shares of our common stock with a vesting date of January 1, 2016. We valued the 100,000 shares on the date of grant, based on a closing price per share of our common stock of $3.11 on May 13, 2015, and then reduced by 15% due to restriction on the ability to trade our common stock, resulting in a fair value of $264,350. One individual forfeited his shares, so expense was only recognized for 50,000 shares. These shares were issued in April 2016.
Consulting Agreement
On July 15, 2015, we entered into an agreement with an individual to provide consulting services to customers in exchange for 50,000 shares of our common stock to be delivered on March 15, 2016. The fair value of the common stock was determined at the end of each reporting period and the pro rata amount earned is recognized as accrued stock payable over the term of the agreement. These shares were issued in March 2016.
NOTE 9. DEBT
Infinity Note Related Party
In February 2015, we issued a senior secured note to Infinity Capital, as amended in April 2015, bearing interest at 5% payable monthly in arrears commencing June 30, 2015, until the maturity date of August 31, 2015 (the Infinity Note). On December 31, 2016, the Infinity Note was amended to aggregate principal and interest, and extend the due date of principal and interest to September 21, 2018. On July 1, 2015, the outstanding principal and interest of $309,000 was settled by our issuing a 10% private placement note. Subsequent to the settlement on July 1, 2015, we continued to borrow under the Infinity Note through September 1, 2016. No additional advances may be made after December 31, 2016. The Infinity Note is collateralized by a security interest in substantially all of our assets. Interest expense for the Infinity Note for the years ended December 31, 2017 and 2016, was approximately $68,500 and $61,000, respectively. The Infinity Note is subordinate to the 12% Notes.
Notes Payable
|
|
|
|
|
|
|
December 31,
|
|
|
2017
|
|
2016
|
12% Notes
|
$
|
1,621,250
|
$
|
2,750,000
|
Unamortized debt discount
|
|
(443,917)
|
|
(1,500,467)
|
|
|
1,177,333
|
|
1,249,533
|
Less: Current portion
|
|
(1,177,333)
|
|
|
Long-term portion
|
$
|
|
$
|
1,249,533
|
12% Notes
In September 2016, we completed a $3,000,000 private placement pursuant to a promissory note and warrant purchase agreement (the 12% Agreement) with certain accredited investors, bearing interest at 12%, with principal due September 21, 2018, and interest payable quarterly (each such note, a 12% Note, and collectively, the 12% Notes). In the event of default, the interest rate increases to 18%. The 12% Notes are collateralized by a security interest in substantially all of our assets. We may prepay the 12% Notes at any time, but in any event must pay at least one year of interest.
Subject to the terms and conditions of the 12% Agreement, each investor was granted fully-vested warrants equal to their note principal times three (the 12% Warrants), or nine million warrants, with a life of three years. 4.5 million warrants have an exercise price of $0.35 per share and the other 4.5 million warrants have an exercise price of $0.70 per share. Should we issue any equity-based instruments at a price lower than the exercise price(s) of the 12% Warrants, other than under our Incentive Plan, the exercise price(s) of the 12% Warrants will be adjusted to the lower price. The participants in the Fall 2017 Capital Raise (Note 12) waived this provision for that offering. The 12% Warrants may be exercised at the option of the holder (a) by paying cash, (b) by applying the amount due under the 12% Notes as consideration, or (c) if there is no effective registration statement for the 12% Warrants within six months of being granted, the holder may exercise on a cashless basis. The registration statement related to the 12% Warrants was declared effective on December 23, 2016. If our common stock closes above $5.00 for ten consecutive days, we may call the warrants, giving the warrant holders 30 days to exercise.
We received $2,450,000 of cash for issuing the 12% Notes. $300,000 of 10% Notes and $250,000 of the 14% Greenhouse Mortgage were converted into 12% Notes. We concluded that these conversions met the criteria for a debt extinguishment and, accordingly, recorded a loss on extinguishment of $1,728,280 during the year ended December 31, 2016. The loss on extinguishment represents the fair value of the 12% Warrants issued to the previous 10% Note holders and the 14% Greenhouse Mortgage lender. The initial fair value of the 12% Warrants not associated with the conversions was recorded as a debt discount of $1,855,000. The 12% Notes are otherwise treated as conventional debt.
42
For purposes of determining the loss on extinguishment and the debt discount, the underlying assumptions used in the binomial lattice model to determine the fair value of the warrant as of September 21, 2016, were:
|
|
|
Current stock price
|
$
|
1.20
|
Risk-free interest rate
|
|
0.92 %
|
Expected dividend yield
|
|
|
Expected term (in years)
|
|
3.0
|
Expected volatility
|
|
146%
|
Number of iterations
|
|
5
|
The fair value of the 12% Warrants, recorded as additional paid in capital, was allocated as follows:
|
|
|
Extinguishment of debt
|
$
|
1,715,000
|
Debt discount
|
|
1,855,000
|
|
$
|
3,570,000
|
The Infinity Note and the 12% Notes, totaling $2,991,376, are due and payable on September 21, 2018. We paid off the 12% Notes in January 2018 and paid off the Infinity Note in February 2018.
8% Notes
In August 2016, we completed a private placement pursuant to a promissory note and warrant purchase agreement (the 8% Notes) with two accredited investors, bearing interest at 8%, payable on demand by the lenders. Subject to the terms of the 8% Notes, we issued 100,000 warrants having an exercise price of $0.78 per share, with a life of three years. We received cash of $50,000. The debt was treated as conventional debt and the fair value of the warrants is included in additional paid-in capital. Since the 8% Notes were payable on demand, the $31,100 relative fair value of the warrants was expensed immediately, included in amortization of debt discount on the consolidated statements of operations for the year ended December 31, 2016. One of the 8% Notes, of $25,000, was with one of our board members. Both 8% Notes were paid off with proceeds from the 12% Notes in September 2016.
10% Notes
In September 2016, we extinguished the 10% Notes by paying cash of $359,000 and converting $300,000 into 12% Notes.
In 2015, we completed a private placement pursuant to a promissory note and warrant purchase agreement (the 10% Agreement) with certain accredited investors, bearing interest at 10% payable quarterly (each such note, a 10% Note, and collectively, the 10% Notes). Subject to the terms and conditions of the 10% Agreement, each investor was granted fully-vested warrants equal to their note principal divided by two (the 10% Warrants) (with standard dilution clauses). The 10% Warrants are exercisable for a period of eighteen months after grant date and have an exercise price of $1.08 per share. The debt was treated as conventional debt. The 10% Notes were collateralized by a security interest in substantially all of our assets.
$309,000 of the 10% Notes were due to a related party, Infinity Capital. During the years ended December 31, 2016, approximately $22,500 of interest expense under the 10% Notes related to Infinity Capital. The Infinity Capital portion of the principle and accrued interest of the 10% Notes was settled for cash of $347,000, in September 2016.
On June 3, 2016, we reached an agreement with the 10% Note holders to extend the maturity date from May 1, 2016 to January 31, 2017. In exchange for the extension, we issued the holders an aggregate of 659,000 additional warrants to purchase our common stock at $1.07 per share for a period of five years, with an aggregate fair value of $358,000, determined using Black-Scholes, a risk-free rate of 1.2% and volatility of 151%. We concluded that this modification of the debt instruments met the criteria for a debt extinguishment and, accordingly, recorded additional paid-in capital and a loss on extinguishment of debt of $358,000 during the year ended December 31, 2016. Absent the warrants, the fair value of the new debt remained the same as the fair value of the original debt. In December 2016, the expiration date of the remaining original warrants was extended from December 23, 2016 to December 31, 2017, resulting in expense of $84,000, included in loss on extinguishment of debt during the year ended December 31, 2016.
14% Greenhouse Mortgage
In September 2016, we extinguished the 14% Greenhouse Mortgage by paying cash of $350,000 and converting $250,000 into 12% Notes. The remaining unamortized debt discount of $13,280 was included in loss on extinguishment of debt in the consolidated statements of operations during the year ended December 31, 2016.
In October 2014, we executed a mortgage on The Greenhouse in the amount of $600,000, bearing 14.0% interest payable monthly, with a maturity date of October 21, 2016 (the 14% Greenhouse Mortgage). The debt was treated as conventional debt.
43
In addition, we granted warrants to Evans Street Lendco LLC (Evans Lendco), the note holder of the 14% Greenhouse Mortgage, which were set to expire on October 21, 2016. The warrants vested immediately and allowed for Evans Lendco to purchase 600,000 shares of our common stock at a price of $4.40 per share, (with standard dilution clauses). Due to the drop in our stock price, on July 29, 2015, we agreed with Evans Lendco to replace the warrants previously issued to Evans Lendco with warrants to purchase 225,000 shares of our stock at $1.20 per share with a term of two years. The estimated fair value of the replacement warrants was less than the fair value of the original warrants on their date of grant. Accordingly, we continued to amortize the remaining fair value of the original warrants over the remaining life of the underlying debt until the debt was extinguished in September 2016, at which time the remaining debt discount was fully expensed.
8.5% Pueblo Mortgage
In September 2016, we extinguished the 8.5% Pueblo Mortgage by paying cash of $153,189.
In December 2013, we executed a mortgage on our Pueblo West Property in the amount of $170,000, bearing 8.5% interest with monthly principal and interest payments totaling $1,674, with the balance due on December 31, 2018 (the 8.5% Pueblo Mortgage). This note was convertible at any time at $5.00 per share.
Derivative treatment was not required, as the conversion feature meets the scope exception. The conversion feature was not beneficial, because the conversion price was higher than the stock price on the commitment date. Accordingly, we treated the Pueblo Mortgage as conventional debt.
NOTE 10. COMMITMENTS AND CONTINGENCIES
Legal
To the best of our knowledge and belief, no material legal proceedings of merit are currently pending or threatened.
NOTE 11. DEFERRED TAXES
The components of net deferred tax assets are as follows:
|
|
|
|
|
|
|
December 31,
|
|
|
2017
|
|
2016
|
Net operating loss carryforwards
|
$
|
3,446,733
|
$
|
2,761,830
|
Equity-based instruments
|
|
3,648,787
|
|
5,043,533
|
Long-lived assets and other
|
|
427,779
|
|
504,721
|
Deferred tax asset valuation allowance
|
|
(7,523,299)
|
|
(8,310,084)
|
|
$
|
|
$
|
|
A reconciliation of our income tax provision and the amounts computed by applying statutory rates to income before income taxes is as follows:
|
|
|
|
|
|
|
Year ended December 31,
|
|
|
2017
|
|
2016
|
Income tax benefit at statutory rate
|
$
|
(2,795,089)
|
$
|
(3,456,426)
|
State income tax benefit, net of Federal benefit
|
|
(251,213)
|
|
(470,684)
|
Equity-based instruments
|
|
(315,589)
|
|
|
Amortization of debt discount
|
|
391,513
|
|
251,786
|
Loss on extinguishment of debt
|
|
|
|
838,379
|
Tax Cuts and Jobs Act rate change
|
|
991,223
|
|
|
Other
|
|
(242,781)
|
|
2,377
|
Valuation allowance
|
|
2,218,936
|
|
2,834,568
|
|
$
|
|
$
|
|
NOTE 12. STOCKHOLDERS EQUITY
Fall 2017 Capital Raise
During the year ended December 31, 2017, in a private placement we raised $4 million of equity by issuing four million shares of our common stock and four million warrants (Fall 2017 Warrants) to purchase shares of our common stock (together Units) for $1.00 per Unit. The Fall 2017 Warrants have an exercise price of $0.50 per share and are exercisable for two years. If our common stock closes above $5.00 for ten consecutive days, we may call the warrants, giving the warrant holders 10 days to exercise. All four million Fall 2017 Warrants were outstanding as of December 31, 2017. In consideration for the sale of the Units, we received $3,750,000 in cash and extinguished $250,000 of 12% Notes.
44
Share-based compensation
Share-based compensation expense consisted of the following:
|
|
|
|
|
|
|
Year ended December 31,
|
|
|
2017
|
|
2016
|
Employee Awards
|
$
|
3,742,294
|
$
|
3,347,259
|
Consulting Awards
|
|
34,399
|
|
157,153
|
Feinsod Agreement
|
|
104,134
|
|
192,800
|
DB Option Agreement
|
|
|
|
55,100
|
|
$
|
3,880,827
|
$
|
3,752,312
|
Employee Stock Options
On October 29, 2014, the Board authorized the adoption of and on June 26, 2015, our stockholders ratified our 2014 Equity Incentive Plan (the Incentive Plan). The Incentive Plan provides for the issuance of up to 10 million shares of our common stock, and is designed to provide an additional incentive to executives, employees, directors and key consultants, aligning our long term interests with participants. As of December 31, 2017, there were 8,834,478 shares available to issue under the Incentive Plan. In April 2016, we filed a Registration Statement on Form S-8 (the Registration Statement), which automatically became effective in May 2016. The Registration Statement relates to 10,000,000 shares of our common stock, which are issuable pursuant to, or upon exercise of, options that have been granted or may be granted under our Incentive Plan.
Share-based compensation costs for award grants to employees and directors (Employee Awards) are recognized on a straight-line basis over the service period for the entire award, with the amount of compensation cost recognized at any date equaling at least the portion of the award that is vested. The following summarizes the Black-Scholes assumptions used for Employee Awards:
|
|
|
|
|
|
|
Year ended December 31,
|
|
|
2017
|
|
2016
|
Exercise price
|
|
$1.34 4.23
|
|
$0.61 3.20
|
Stock price on date of grant
|
|
$1.34 4.23
|
|
$0.63 3.20
|
Volatility
|
|
140 153%
|
|
146 153%
|
Risk-free interest rate
|
|
1.4 2.3%
|
|
0.7 1.9%
|
Expected life (years)
|
|
3.0 5.0
|
|
3.0 5.0
|
Dividend yield
|
|
|
|
|
We use an estimated forfeiture rate of 78% and 67%, respectively, for our hourly employees, who were granted 47,600 and 80,500 options, respectively, during the years ended December 31, 2017 and 2016. We assume options granted to salaried employees will all vest.
The following summarizes Employee Awards activity:
|
|
|
|
|
|
|
|
|
|
|
Number of Shares
|
|
Weighted-average Exercise Price per Share
|
|
Weighted-average Remaining Contractual Term
(in years)
|
|
Aggregate Intrinsic Value
|
Outstanding at December 31, 2015
|
|
2,509,000
|
$
|
1.49
|
|
|
|
|
Granted
|
|
6,826,000
|
|
0.87
|
|
|
|
|
Exercised
|
|
(153,000)
|
|
1.00
|
|
|
|
|
Forfeited or expired
|
|
(363,600)
|
|
0.97
|
|
|
|
|
Outstanding at December 31, 2016
|
|
8,818,400
|
|
1.04
|
|
|
|
|
Granted
|
|
1,496,100
|
|
2.29
|
|
|
|
|
Exercised
|
|
(1,012,522)
|
|
0.78
|
|
|
|
|
Forfeited or expired
|
|
(596,700)
|
|
1.19
|
|
|
|
|
Outstanding at December 31, 2017
|
|
8,705,278
|
|
1.28
|
|
2.1
|
$
|
45,290,000
|
|
|
|
|
|
|
|
|
|
Exercisable at December 31, 2017
|
|
7,385,378
|
$
|
1.08
|
|
1.7
|
$
|
39,858,000
|
Based on our estimated forfeiture rates, we expect 1,305,995 Employee Awards will vest. As of December 31, 2017, there was approximately $1,712,998 of total unrecognized compensation expense related to unvested Employee Awards, which is expected to be recognized over a weighted-average period of 7 months.
45
Warrants for Consulting Services
As needed, we may issue warrants to third parties in exchange for consulting services. Stock-based compensation costs for award grants to third parties for consulting services (Consulting Awards) are recognized on a straight-line basis over the service period for the entire award, with the amount of compensation cost recognized at any date equaling at least the portion of the award that is vested. Service Awards are revalued at each reporting date until fully vested, which may generate an expense or benefit.
The fair value of each warrant grant is estimated using Black-Scholes. We use historical data to estimate the expected price volatility. The risk-free interest rate is based on the United States Treasury yield curve in effect at the time of valuation for the estimated life of the option. The following summarizes the Black-Scholes assumptions used for Consulting Awards granted:
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Year ended December 31,
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2017
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2016
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Exercise price
|
$
|
1.40
|
$
|
0.60 1.20
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Stock price, date of valuation
|
$
|
1.40
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$
|
1.91 2.33
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Volatility
|
|
128%
|
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146 163%
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Risk-free interest rate
|
|
1.7%
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|
0.8 1.3%
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Expected life (years)
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|
2.0
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2.0 4.8
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Dividend yield
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|
|
|
|
The following summarizes Consulting Awards activity:
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Number of Shares
|
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Weighted-average Exercise Price per Share
|
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Weighted-average Remaining Contractual Term
(in years)
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Aggregate Intrinsic Value
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Outstanding at December 31, 2015
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225,500
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$
|
3.62
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|
|
|
|
Granted
|
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55,000
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1.01
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|
|
|
|
Forfeited or expired
|
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(150,000)
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4.40
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|
|
|
|
Outstanding at December 31, 2016
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|
157,500
|
|
1.96
|
|
|
|
|
Granted
|
|
10,000
|
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1.40
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|
|
|
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Forfeited or expired
|
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(40,000)
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|
3.62
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|
|
|
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Outstanding and exercisable at
December 31, 2017
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127,500
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2.40
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|
1.7
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$
|
647,550
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Feinsod Employment Agreement
On December 8, 2017, we entered into an employment agreement with Michael Feinsod for his continued service as our Executive Chairman of our Board of Directors. Pursuant to the agreement, Mr. Feinsod received (a) 600,000 stock options that vest on the anniversary date of the agreement for the next three years, or 200,000 per year (Time-based Options); and (b) three tranches of 100,000 stock options that vest when our stock price has an average trading price for 20 days of $3.50, $5.00 and $6.50 (Market-based Options). The options have an exercise price of $3.45 per share and a ten year life. These options were not issued under the Incentive Plan and, accordingly, the underlying shares are not registered. As of December 31, 2017, none of the options had vested.
The Time-based Options were valued using the Black-Scholes model and the Market-based Options were valued using the binomial lattice model, with the following assumptions:
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Time-based
Options
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Market-based
Options
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Exercise price
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$
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3.45
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$
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3.45
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Stock price, date of valuation
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$
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3.45
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Trigger Price
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Volatility
|
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140%
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144%
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Risk-free interest rate
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|
2.4%
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1.9%
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Expected life (years)
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10.0
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3.0
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Dividend yield
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46
DB Option Agreement warrants
In order to extend the DB Option Agreement with Infinity Capital, in March 2016 we granted Infinity Capital warrants to purchase 100,000 shares of our common stock at an exercise price of $0.67 per share with a five year life. The fair value of $55,100 is included in share-based compensation expense. All 100,000 warrants were still outstanding as of December 31, 2017. The following summarizes the Black-Scholes assumptions used to estimate the fair value of the DB Option Agreement warrants:
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Stock price on date of grant
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$
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0.61
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Volatility
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150%
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Risk-free interest rate
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1.2%
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Expected life (years)
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5.0
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Dividend yield
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IPG Acquisition Warrants
In connection with the IPG APA, we issued to IPG 500,000 fully-vested warrants to purchase a) 250,000 shares of our common stock at $4.50 per share, (the IPG $4.50 Warrants), and b) 250,000 shares of our common stock at $5.00 per share (the IPG $5.00 Warrants) (collectively, the IPG Warrants). All of these warrants were still outstanding as of December 31, 2017.
Warrants with Debt
The fair value of each warrant grant is estimated using Black-Scholes, except for the 12% Warrants (see Note 16). We use historical data to estimate the expected price volatility. The risk-free interest rate is based on the United States Treasury yield curve in effect at the time of grant for the estimated life of the warrant. The following summarizes the Black-Scholes assumptions used for warrants granted for debt during the year ended December 31, 2016:
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Volatility
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148 158%
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Risk-free interest rate
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0.8 1.2%
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Expected life (years)
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1.1 5.0
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Dividend yield
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|
|
The following summarizes warrants issued with debt activity:
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Number of Shares
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Weighted-average Exercise Price per Share
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|
Weighted-average Remaining Contractual Term
(in years)
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Aggregate Intrinsic Value
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Outstanding at December 31, 2015
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597,200
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$
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1.41
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Granted
|
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9,759,000
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0.58
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|
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Cancelled
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(1,330,357)
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0.53
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|
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Outstanding at December 31, 2016
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9,025,843
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0.63
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|
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Exercised
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(5,633,517)
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0.61
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|
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Expired
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(40,626)
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1.16
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|
|
|
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Outstanding and exercisable at
December 31, 2017
|
|
3,351,700
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|
0.65
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2.0
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$
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19,541,136
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NOTE 13. NET LOSS PER SHARE
Basic net loss per share is computed by dividing net loss by the weighted-average number of common shares outstanding during the reporting period. Diluted net loss per share is computed similarly to basic loss per share, except that it includes the potential dilution that could occur if dilutive securities are exercised.
Outstanding stock options and common stock warrants are considered anti-dilutive because we are in a net loss position. Accordingly, the number of weighted average shares outstanding for basic and fully diluted net loss per share are the same.
47
The following summarizes equity instruments that may, in the future, have a dilutive effect on earnings per share:
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December 31,
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2017
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2016
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Stock options
|
|
9,605,278
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|
8,818,400
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Warrants
|
|
8,119,200
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|
9,783,343
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Accrued stock payable
|
|
258,859
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|
|
|
|
17,983,337
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|
18,601,743
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NOTE 14. SUBSEQUENT EVENTS
Subsequent to December 31, 2017, and up to the date of this filing, 6,900,000 and 507,221 shares, respectively, of our common stock were issued upon the exercise of warrants and stock options for consideration of $3,725,860 and $443,322, respectively, in cash. In January 2018, we exercised our option to call the 12% Warrants and Fall 2017 Warrants. All holders exercised their warrants, thus we will not be required to buy them back.
In January 2018, we paid off the outstanding balance of the 12% Notes of $1,621,250. In February 2018, we paid off the outstanding balance of the Infinity Note of $1,370,126.
In January 2018, we entered into a limited liability company operating agreement with DNFC LLC (DNFC), pursuant to the formation of Desert Created Company LLC (Desert Created Company). Each party owns a 50% interest in Desert Created Company, the successor company to DB Arizona. In connection with the formation of Desert Created Company, we contributed 75,000 shares of our common stock and warrants to purchase 75,000 shares of our common stock, at an exercise price of $2.00 per share, to members of DNFC. This agreement was initially discussed and priced in November 2017, however, the transaction did not close until January 2018. In the interim, our stock price increased substantially. We anticipate recording a loss during the quarter ending March 31, 2018, due to the change in stock price between initial discussions and closing, as it relates to the value of our 50% interest in Desert Created Company.
In January 2018, we issued 154,500 shares of our common stock related to warrants exercised in late December 2017.
In February 2018, we issued 104,359 shares of our common stock related to the acquisition of MHPS.
NOTE 15. SEGMENT INFORMATION
Our operations are organized into four segments: Security and Cash Management Services; Marketing and Products; Consulting and Advisory; and Finance and Real Estate. All revenue originates and all assets are located in the United States. We have revised our disclosure to correspond to the information provided to the chief operating decision maker.
Year ended December 31
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2017
|
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Security
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Marketing
|
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Operations
|
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Finance
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Total
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Revenues
|
$
|
1,884,618
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$
|
239,605
|
$
|
1,265,072
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$
|
132,780
|
$
|
3,522,075
|
Costs and expenses
|
|
(2,320,042)
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|
(527,590)
|
|
(1,453,436)
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|
(277,114)
|
|
(4,578,182)
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Gain on sale
|
|
|
|
|
|
|
|
196,003
|
|
196,003
|
|
$
|
(435,424)
|
$
|
(287,985)
|
$
|
(188,364)
|
$
|
51,669
|
|
(860,104)
|
Corporate expenses
|
|
|
|
|
|
|
|
|
|
(7,360,747)
|
|
|
|
|
|
|
|
|
Net loss
|
$
|
(8,220,851)
|
|
|
|
|
|
|
|
|
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|
2016
|
|
Security
|
|
Marketing
|
|
Operations
|
|
Finance
|
|
Total
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Revenues
|
$
|
2,232,915
|
$
|
188,594
|
$
|
432,046
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$
|
128,427
|
$
|
2,981,982
|
Costs and expenses
|
|
(2,253,194)
|
|
(387,330)
|
|
(555,892)
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|
(32,143)
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|
(3,228,559)
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Interest expense
|
|
|
|
|
|
|
|
(8,669)
|
|
(8,669)
|
|
$
|
(20,279)
|
$
|
(198,736)
|
$
|
(123,846)
|
$
|
87,615
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|
(255,246)
|
Corporate expenses
|
|
|
|
|
|
|
|
|
|
(9,910,714)
|
|
|
|
|
|
|
|
|
Net loss
|
$
|
(10,165,960)
|
|
|
|
|
|
|
|
December 31,
|
Total assets
|
|
2017
|
|
2016
|
Security
|
$
|
488,299
|
$
|
141,140
|
Marketing
|
|
57,833
|
|
50,919
|
Operations
|
|
231,670
|
|
55,750
|
Finance
|
|
|
|
515,205
|
Corporate
|
|
6,826,124
|
|
2,094,857
|
|
$
|
7,603,926
|
$
|
2,857,871
|
48
NOTE 16. CHANGE IN ACCOUNTING PRINCIPLE
During the quarter ended December 31, 2017, we early adopted ASU 2017-11, which eliminates the requirement to consider down round features when determining whether certain equity-linked instruments or embedded features are indexed to an entitys own stock. Our 12% Warrants were treated as derivative instruments, because they include a down round feature, whereby if we issue equity-based instruments at a price below the exercise price of the 12% Warrants, the exercise price of the 12% Warrants would be adjusted. Upon adoption of the new accounting principle, the 12% Warrants qualify for the exception from derivative treatment. We have retrospectively adjusted our consolidated financial statements for each prior reporting period to reflect this change in accounting principle.
The changes to our December 31, 2016, consolidated balance sheet are as follows:
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|
|
|
|
|
|
|
|
Previously Reported
|
|
Currently Reported
|
|
Effect of Change
|
Warrant derivative liability
|
$
|
23,120,000
|
$
|
|
$
|
(23,120,000)
|
Total current liabilities
|
|
23,539,579
|
|
419,579
|
|
(23,120,000)
|
Notes payable (net of discount)
|
|
815,250
|
|
1,249,533
|
|
434,283
|
Total liabilities
|
|
25,733,809
|
|
3,048,092
|
|
(22,685,717)
|
Common stock
|
|
17,129
|
|
17,193
|
|
64
|
Additional paid-in capital
|
|
26,333,988
|
|
26,385,924
|
|
51,936
|
Accumulated deficit
|
|
(49,227,055)
|
|
(26,593,338)
|
|
22,633,717
|
Total Stockholders Equity (Deficit)
|
|
(22,875,938)
|
|
(190,221)
|
|
22,685,717
|
Total Liabilities and Stockholders Equity (Deficit)
|
|
2,857,871
|
|
2,857,871
|
|
|
The effect of change for common stock and additional paid-in capital include an unrelated adjustment for number of shares of common stock outstanding from the year ended December 31, 2014.
The changes to our consolidated statement of operations for the year ended December 31, 2016, are as follows:
|
|
|
|
|
|
|
|
|
Previously Reported
|
|
Currently Reported
|
|
Effect of Change
|
Amortization of debt discount
|
$
|
812,505
|
$
|
651,788
|
$
|
(160,717)
|
Interest expense
|
|
5,476,084
|
|
287,084
|
|
(5,189,000)
|
Net loss on derivative liability
|
|
17,284,000
|
|
|
|
(17,284,000)
|
Total other (income) expense, net
|
|
25,742,869
|
|
3,109,152
|
|
(22,633,717)
|
Net loss
|
|
(32,799,677)
|
|
(10,165,960)
|
|
22,633,717
|
Net loss per share
|
$
|
(2.13)
|
$
|
(0.66)
|
$
|
1.47
|
The changes to our consolidated statement of cash flows for the year ended December 31, 2016, are as follows:
|
|
|
|
|
|
|
|
|
Previously Reported
|
|
Currently Reported
|
|
Effect of Change
|
Net loss
|
$
|
(32,799,677)
|
$
|
(10,165,960)
|
$
|
22,633,717
|
Amortization of debt discount
|
|
812,505
|
|
651,788
|
|
(160,717)
|
Initial fair value of derivative warrant liability included as interest expense
|
|
5,189,000
|
|
|
|
(5,189,000)
|
Loss on derivative liability, net
|
|
17,284,000
|
|
|
|
(17,284,000)
|
Net cash used in operating activities
|
|
(1,854,751)
|
|
(1,854,751)
|
|
|
|
|
|
|
|
|
|
Non-Cash Transactions
|
|
|
|
|
|
|
Derivative warrant liability recorded as debt discount
|
$
|
2,450,000
|
$
|
|
$
|
(2,450,000)
|
Warrants issued in connection with debt recorded as debt discount
|
|
31,100
|
|
1,886,100
|
|
1,855,000
|
Portion of Warrant derivative liability recorded as Additional paid-in capital upon exercise of warrants
|
|
3,518,000
|
|
|
|
(3,518,000)
|
None of the changes impacted our segments.
49