NOTES
TO THE CONSOLIDATED FINANCIAL STATEMENTS
NOTE
1 – ORGANIZATION AND DESCRIPTION OF BUSINESS
Q2Earth,
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 previously owned
and licensed technology that converts waste fuels and heat to power, technology it sold to a licensee in August 2017. Formerly,
the Company’s name was Q2Power Technologies, Inc., and before that, Anpath Group, Inc. (“Anpath”).
Q2Power
Corp. (the “Subsidiary” or “Q2P”) 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.
In
May 2016, the Company began exploring other synergistic business lines such as compost and soil manufacturing from waste water
biosolids. The Company began to phase out its R&D activities in mid-2016, and in August 2017, sold its waste-to-power
technology to a licensee. The Company’s current focus is entirely on the business of compost and engineered soils manufacturing
and sales.
On
August 28, 2017, the Company signed a definitive Membership Purchase Agreement (the “Purchase Agreement”) with Environmental
Turnkey Solutions LLC (“ETS”) of Naples, Florida, and its three members to acquire 100% of the membership interests
of ETS, and all subsidiaries wholly-owned by ETS. The Company paid ETS $250,000 to secure exclusivity until January 15, 2018 under
the Purchase Agreement, which is reflected as transaction costs in the consolidated statements of operations for the year ended
December 31, 2017. In the first quarter of 2018, the Company has decided to defer the closing of this transaction until a later
date, if at all.
NOTE
2 – BASIS OF PRESENTATION AND GOING CONCERN
The
Company has incurred a net loss of $2,718,205 for the year ended December 31, 2017 and used cash in operating activities
of $1,207,157. The accumulated deficit since inception is $9,969,974, 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 acquire cash-flowing businesses, grow revenue and earnings of those companies, and continue 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”). As of December 31, 2017, the Company closed an additional $600,000 of follow-on investments in the Bridge
Offering. The proceeds from this offering are expected to provide working capital for the Company through the second quarter of
2018, though there can be no assurances.
The
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,
convertible bridge notes, income taxes and contingencies. Actual results could differ from these estimates.
NOTE
3 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles
of Consolidation
The
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 includes contracts where the Company is paid to do feasibility
studies, site assessment studies and other similar services in connection with a third party soil or compost manufacturing business.
Revenue from such services 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 was 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 was recorded
as deferred revenue. The Company did not allow its customers to return prototype products.
Research
and Development
Research
and development activities for product development are expensed as incurred and were primarily comprised of salaries. Costs
for the years ended December 31, 2017 and 2016 were $0 and $352,583, 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
were recognized initially at fair value. Subsequent to initial recognition, derivatives were measured at fair value,
and changes are therein generally recognized in profit or loss. In 2017, the Company early adopted Accounting Standards Update
(“ASU”) 2017-11,
Earnings Per Share (Topic 260); Distinguishing Liabilities from Equity (Topic 480); Derivatives
and Hedging (Topic 815)
which resulted in a reclassification of the Company’s prior year derivative liabilities to equity
on January 1, 2017.
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 December
31, 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 consolidated financial
statements as a component of income taxes.
Basic
and Diluted (Loss) Per Share
Net
loss per share is computed by dividing the net loss less preferred dividends by the weighted average number of common shares outstanding
during the period. Diluted net 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 December 31, 2017
and 2016.
At
December 31, 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, 21,058,000 shares that may be converted from the Bridge Round (based
upon an assumed conversion price at January 1, 2018 of $0.096 per share), and 4,000,000 shares from the conversion of redeemable
convertible preferred stock. At December 31, 2016, there were the following potentially dilutive securities that were excluded
from diluted net loss per share because their effect would be anti-dilutive: 6,115,480 shares from common stock options,
1,568,845 shares from common stock warrants, 785,714 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 5,617 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 29,645,814. The impact to the consolidated financial statements of this adjustment
was not material.
Recent
Accounting Pronouncements
In
May 2014, the FASB issued ASU 2014-09, “
Revenue from Contracts with Customers (Topic 606)
.” ASU 2014-09 eliminated
transaction- and industry-specific revenue recognition guidance under current GAAP and replaced it with a principle based approach
for determining revenue recognition. ASU 2014-09 requires that companies recognize revenue based on the value of transferred goods
or services as they occur in the contract. The ASU also requires additional disclosure about the nature, amount, timing and uncertainty
of revenue and cash flows arising from customer contracts, including significant judgments and changes in judgments and assets
recognized from costs incurred to obtain or fulfill a contract. ASU 2014-09 is effective for reporting periods beginning after
December 15, 2017. Entities can transition to the standard either retrospectively or as a cumulative-effect adjustment as of the
date of adoption. In April 2016, the FASB also issued ASU 2016-10, “
Identifying Performance Obligations and Licensing
,”
implementation guidance on principal versus agent, identifying performance obligations, and licensing. ASU 2016-10 is effective
for reporting periods beginning after December 15, 2017. Entities can transition to the standard either retrospectively or as
a cumulative-effect adjustment as of the date of adoption. The Company has completed the evaluation of this ASU impact on the
results of operations and financial condition. The Company has concluded, after completing a detailed contract review, that the
adoption of the new standard does not have an impact on the financial results and determined that no material adjustments were
necessary to the existing accounting policies. The Company has adopted the ASU using the modified retrospective method on January
1, 2018.
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, , including
implementation if management determines that such action is required for the period beginning January 1, 2018.
In
February 2016, the FASB issued ASU No. 2016-02, “
Leases (Topic 842)
”, 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 for the period beginning
January 1, 2018.
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 for the period beginning January 1, 2018
.
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 the
year ended December 31, 2017, 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 to be the asset 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:
|
|
December
31, 2017
|
|
|
December
31, 2016
|
|
Furniture
and computers
|
|
$
|
1,328
|
|
|
$
|
1,328
|
|
Shop
equipment
|
|
|
-
|
|
|
|
9,540
|
|
Total
|
|
|
1,328
|
|
|
|
10,868
|
|
Accumulated
depreciation
|
|
|
(775
|
)
|
|
|
(4,136
|
)
|
Net
property and equipment
|
|
$
|
553
|
|
|
$
|
6,732
|
|
Depreciation
expense for the years ended December 31, 2017 and 2016 was $1,252 and $22,380, respectively.
The
Company disposed of $4,927 of net property and equipment as part of the transfer of its licensing rights with Cyclone Power
Technologies, Inc. (“Cyclone”) during the year ended December 31, 2017 (see Note 5).
NOTE
5 – CYCLONE SEPARATION, LICENSE RIGHTS AND DEFERRED REVENUE
In
2014, Q2P purchased for $175,000 certain licensing rights to use Cyclone’s 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 contained
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 December 31, 2017 and 2016 for the Cyclone licensing rights were $0 and $69,271, respectively;
and the net balances for the Phoenix deferred revenue in the same periods were $0 and $250,000, respectively, which were
included as a component of deferred revenue on the consolidated balance sheets. The licensing rights were amortized over its estimated
useful life of 4 years. Amortization expense for the years ended December 31, 2017 and 2016 was $21,875 and $43,750,
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, including deferred revenue of $50,000, 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 consolidated statement of operations
for the year ended December 31, 2017.
On
August 14, 2017, the Company closed a Technology Transfer and Assignment Agreement (the “Transfer Agreement”) with
Phoenix to transfer to Phoenix all of the Company’s technology and materials associated with Q2P’s external combustion
engine, controls and auxiliary systems (the “Q2P Technology”), developed both in conjunction with its license agreement
with Cyclone and such other Q2P Technology developed independently from the license agreement. Pursuant to a consent from Cyclone,
the Company also transferred and assigned the license agreement to Phoenix. In consideration for the transfer and assignment,
which included net property and equipment of $4,927, unamortized license fees to Cyclone of $47,396 and a payment to Cyclone of
$15,000 to consent to the license transfer, Phoenix satisfied and provided releases for $162,500 in past liabilities of Q2P associated
with the development of the Q2P Technology, made certain other payments to the Company’s prior engine manufacturer, and
provided full releases from liability from both Phoenix and Cyclone. The Company recorded a net gain from the extinguishment of
liabilities of $95,178 in the consolidated statement of operations for the year ended December 31, 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 December 31, 2017 and 2016 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 years ended December 31, 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 year ended December 31, 2017 and 2016, the amounts invoiced from Precision CNC totaled $0 and
$13,868, 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 December 31, 2017
and 2016 to Precision CNC.
The
Company currently 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. The Company also sublets office space in Atlanta, Georgia, where it pays $500 per month
on a month-to-month basis. The lessor is a company that our CEO previously served as a senior executive.
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 8).
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 2017.
NOTE
7 – INCOME TAXES
A
reconciliation of the differences between the effective income tax rates and the statutory federal tax rates for the years ended
December 31, 2017 and 2016 (computed by applying the U.S. Federal corporate tax rate of 34 percent to the loss before taxes) is
as follows:
|
|
2017
|
|
|
2016
|
|
Tax benefit
at U.S. statutory rate
|
|
$
|
924,190
|
|
|
$
|
509,226
|
|
State taxes, net of
federal benefit
|
|
|
60,548
|
|
|
|
—
|
|
Stock and stock based
compensation
|
|
|
(80,291
|
)
|
|
|
(362,519
|
)
|
Change in fair value
of convertible bridge notes and derivatives
|
|
|
(426,489
|
)
|
|
|
274,724
|
|
Amortization of preferred
stock discount
|
|
|
(42,552
|
)
|
|
|
(46,779
|
)
|
Gain on extinguishment
of liabilities
|
|
|
155,285
|
|
|
|
—
|
|
Change of U.S. federal
rate
|
|
|
(695,021
|
)
|
|
|
—
|
|
Other permanent differences
|
|
|
36,973
|
|
|
|
(24,877
|
)
|
Change
in
valuation allowance
|
|
|
67,357
|
|
|
|
(349,775
|
)
|
|
|
$
|
—
|
|
|
$
|
—
|
|
The
tax effect of temporary differences that give rise to significant portions of the deferred tax assets and liabilities for the
years ended December 31, 2017 and 2016 consisted of the following:
|
|
2017
|
|
|
2016
|
|
Net operating
loss carry-forward
|
|
$
|
1,387,476
|
|
|
$
|
1,410,055
|
|
Deferred tax assets
– accrued salaries
|
|
|
—
|
|
|
|
79,412
|
|
Deferred tax assets
– accrued interest
|
|
|
46,069
|
|
|
|
11,269
|
|
Depreciation
expense
|
|
|
343
|
|
|
|
509
|
|
Net deferred tax assets
|
|
|
1,433,888
|
|
|
|
1,501,245
|
|
Valuation
allowance
|
|
|
(1,433,888
|
)
|
|
|
(1,501,245
|
)
|
Total
net deferred tax asset
|
|
$
|
—
|
|
|
$
|
—
|
|
At
December 31, 2017 and 2016, the Company had net deferred tax assets of $1,433,888 and $1,501,245 principally arising from
net operating loss carry-forwards for income tax purposes. As management of the Company cannot determine that it is more likely
than not that the Company will realize the benefit of the net deferred tax asset, a valuation allowance equal to the net deferred
tax asset has been established at December 31, 2017 and 2016. At December 31, 2017, the Company has net operating loss carry forwards
totaling $5,885,676, which will begin to expire in 2034.
The
Tax Cut and Jobs Act which was enacted on December 22, 2017 reduced the federal corporate income tax rate from a maximum of 35%
to a flat 21%. On December 22, 2017, Staff Accounting Bulletin No. 118 (“SAB 118”) was issued to address the application
of U.S. GAAP in situations when a registrant does not have the necessary information available, prepared, or analyzed (including
computations) in reasonable detail to complete the accounting for certain income tax effects of the Act. Additionally, SAB 118
allows the Company to record provisional amounts during a measurement period not to extend beyond one year of the enactment date.
Because the Company is still in the process of analyzing certain provisions of the Tax Act, the Company has determined that the
adjustment to its deferred taxes is a provisional amount as permitted under SAB 118. Due to the reduction of the federal corporate
income tax rate the Company has reduced the value of its net deferred tax asset by approximately $695,000. This amount was offset
by a corresponding change to the valuation allowance against the net deferred tax assets.
The
Company’s NOL and tax credit carryovers may be significantly limited under the Internal Revenue Code (“IRC”).
NOL and tax credit carryovers are limited under Section 382 when there is a significant “ownership change” as defined
in the IRC. During the year ended December 31, 2017 and in prior years, the Company may have experienced such ownership changes,
which could impose such limitations.
The
limitations imposed by the IRC would place an annual limitation on the amount of NOL and tax credit carryovers that can be utilized.
When the Company completes the necessary studies, the amount of NOL carryovers available may be reduced significantly. However,
since the valuation allowance fully reserves for all available carryovers, the effect of the reduction would be offset by a reduction
in the valuation allowance.
NOTE
8 – 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 December 31, 2017 and 2016,
the aggregate outstanding principal amount of the two Debentures was $165,000. As of the date of this Annual Report, the Debentures
were in default based on the July 31, 2017 maturity date. The Company and holders have extended the maturity date of the
Debentures until July 31, 2018 in return for a reduction of the conversion price to $0.10 per share, per agreement with the holders.
On
December 12, 2017, the Company paid-off in full a term loan agreement with one accredited investor in the principal amount of
$150,000, initially issued in March 2016. The loan bore 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. On March 22, 2017, prior to repayment,
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. The Company determined that the new conversion feature had 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 the end of 2017, an additional $600,000
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 consolidated statements of operations as other income
(expense) in each reporting period. The fair value recorded as of December 31, 2017 was $3,270,000 (see Note 9) and the principal
amount due was $1,841,908. The change in fair value resulted in a charge to earnings for the year ended December 31, 2017 of $1,254,379.
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.
NOTE
9 – 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).
|
As
disclosed in Note 8, the Notes are reported at fair value, with changes in fair value recorded through the Company’s consolidated
statements of operations as other income (expense) in each reporting period.
All
derivatives recognized by the Company were reported as derivative liabilities on the consolidated balance sheets and were
adjusted to their fair value at each reporting date. Unrealized gains and losses on derivative instruments were included
in change in value of derivative liabilities on the consolidated statement of operations.
The
following tables set forth the Company’s consolidated financial assets and liabilities measured at fair value by level within
the fair value hierarchy at December 31, 2017 and 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
|
|
|
|
|
|
|
|
|
|
|
|
|
December
31, 2017
|
|
|
Level
1
|
|
|
Level
2
|
|
|
Level
3
|
|
Convertible
bridge notes
|
|
$
|
3,270,000
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
3,270,000
|
|
Total
|
|
$
|
3,270,000
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
3,270,000
|
|
|
|
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 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 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.
The
following tables present 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
consolidated statement of operations during the period. The tables also show the cumulative change effect of the derivative
liabilities that were recorded as an adjustment of the opening balance of accumulated deficit for the year:
|
|
Year
Ended December 31, 2017
|
|
|
|
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
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
1,841,908
|
|
|
|
1,841,908
|
|
Accrued
interest
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
184,963
|
|
|
|
184,963
|
|
Unamortized
debt issuance costs
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
(11,250
|
)
|
|
|
(11,250
|
)
|
Net
unrealized loss on convertible bridge notes
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
1,254,379
|
|
|
|
1,254,379
|
|
Fair
value, December 31, 2017
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
3,270,000
|
|
|
$
|
3,270,000
|
|
|
|
Year
Ended December 31, 2016
|
|
|
|
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
|
|
|
Total
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fair
value, December 31, 2015
|
|
$
|
376,065
|
|
|
$
|
51,203
|
|
|
$
|
560,778
|
|
|
$
|
79,943
|
|
|
$
|
1,067,989
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
unrealized gain on derivatives
|
|
|
(277,337
|
)
|
|
|
(52,800
|
)
|
|
|
(408,919
|
)
|
|
|
(68,955
|
)
|
|
|
(808,011
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Purchases
and issuances (sales and settlements)
|
|
|
24,538
|
|
|
|
54,501
|
|
|
|
(125,975
|
)
|
|
|
—
|
|
|
|
(46,936
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fair
value, December 31, 2016
|
|
$
|
123,266
|
|
|
$
|
52,904
|
|
|
$
|
25,884
|
|
|
$
|
10,988
|
|
|
$
|
213,042
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Changes
in unrealized gains, included in income on instruments held at end of year
|
|
$
|
(277,337
|
)
|
|
$
|
(52,800
|
)
|
|
$
|
(408,919
|
)
|
|
$
|
(68,955
|
)
|
|
$
|
(808,011
|
)
|
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 December 31, 2017: dividend yield
of -0-%, volatility of 75 – 120%, risk free rate of 1.91% and an expected term of 2.25 years.
NOTE
10 – COMMON STOCK, PREFERRED STOCK AND WARRANTS
Common
Stock
During
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 an aggregate of 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 must continue to serve with the Company for a period of at least 12 months
from July 2017, 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. Additionally, the Company paid $85,623 in cash and recognized
a gain on extinguishment of liabilities of $33,313 in the consolidated statement of operations for the year ended December 31,
2017.
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 $0.10 per share of the Company’s
common stock (the “Conversion Price”), as per the terms of a March 2018 Modification and Extension Agreement (the
“2018 Modification”). 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 aggregate purchase price of $600,000 plus accrued
dividends. In December 2017 and January 2018, the Company was 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”).
The Company has extended the redemption date to July 31, 2018, per the 2018 Modification. 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 December 31, 2017 and 2016 was $1,062 and $126,217,
respectively. Interest expense related to the preferred stock discount for the years ended December 31, 2017 and 2016 was $125,155
and $137,585, 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 December 31, 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
|
|
|
|
1.50
|
|
Warrants
issued in connection with issuance of Preferred Stock
|
|
|
1,153,845
|
|
|
$
|
0.50
|
|
|
|
2.80
|
|
Warrants
issued in connection with a services contract
|
|
|
1,000,000
|
|
|
$
|
0.20
|
|
|
|
2.23
|
|
Warrants
issued in connection with a services contract
|
|
|
1,000,000
|
|
|
$
|
0.35
|
|
|
|
2.23
|
|
NOTE
11 – 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 year ended December 31, 2017,
the charge to the consolidated
statements of operations for the amortization of stock option grants awarded under the Option Plans and 2016 Plan and for warrants
was $236,149.
A
summary of the common stock options issued under the Option Plans and the 2016 Plan for the period from December 31, 2015
through December 31, 2017 follows:
|
|
Number
Outstanding
|
|
|
Weighted
Avg. Exercise Price
|
|
|
Weighted
Avg. Remaining Contractual Life (Years)
|
|
Balance, December 31,
2015
|
|
|
1,745,480
|
|
|
$
|
0.30
|
|
|
|
7.1
|
|
Options issued
|
|
|
4,410,000
|
|
|
|
0.21
|
|
|
|
3.5
|
|
Options exercised
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
Options
cancelled
|
|
|
(40,000
|
)
|
|
|
0.30
|
|
|
|
5.1
|
|
Balance, December 31, 2016
|
|
|
6,115,480
|
|
|
$
|
0.21
|
|
|
|
7.1
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Options issued
|
|
|
800,000
|
|
|
|
0.21
|
|
|
|
9.2
|
|
Options exercised
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
Options
cancelled
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
Balance, December
31, 2017
|
|
|
6,915,480
|
|
|
$
|
0.21
|
|
|
|
5.6
|
|
The
vested and exercisable options at period end follows:
|
|
Exercisable/
Vested
Options Outstanding
|
|
|
Weighted
Avg.
Exercise Price
|
|
|
Weighted
Avg.
Remaining Contractual
Life (Years)
|
|
Balance, December 31, 2017
|
|
|
6,828,813
|
|
|
$
|
0.21
|
|
|
|
5.6
|
|
The
fair value of new stock options and warrants granted using the Black-Scholes option pricing model was calculated using
the following assumptions:
|
|
Year
Ended
December 31, 2017
|
|
Risk
free interest rate
|
|
|
1.28-1.84
|
%
|
Expected
volatility
|
|
|
101.2-125.0
|
%
|
Expected
dividend yield
|
|
|
0
|
%
|
Expected
term in years
|
|
|
2.08-5.25
|
|
Average
value per options
|
|
$
|
0.04-0.08
|
|
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
12 – COMMITMENTS AND CONTINGENCIES
On
April 1, 2017, the Company entered into two Employment Agreements, the first with its Chairman and, as of July 2017, CEO; and
the second with 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; however, the CEO’s severance was extended to 24 months
in the first quarter of 2018 by resolution of the Company’s Compensation Committee.
NOTE
13 - SUBSEQUENT EVENTS
In
March and April 2018, the Company extended the redemption date of its Series A Preferred Stock and the maturity date of its convertible
debentures to July 31, 2018, per agreement with the holders. Any prior defaults were waived by the holders, and the conversion
prices for both securities were reduced to $0.10 per share.