OCLN Originclear Inc (PK)

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS-UNAUDITED

MARCH 31, 2018

Going Concern

The accompanying condensed consolidated financial statements have been prepared on a going concern basis of accounting, which contemplates continuity of operations, realization of assets and liabilities and commitments in the normal course of business.  The accompanying condensed financial statements do not reflect any adjustments that might result if the Company is unable to continue as a going concern. The Company’s revenue is not yet sufficient to cover its operating expenditures and has negative cash flows from operations, which raise substantial doubt about the Company’s ability to continue as a going concern. The ability of the Company to continue as a going concern and appropriateness of using the going concern basis is dependent upon, among other things, additional cash infusion. Management believes the existing shareholders, the prospective new investors, current and future sales will provide the additional cash needed to meet the Company’s obligations as they become due, and will allow the development of its core business operations. No assurance can be given that any future financing will be available or, if available, that it will be on terms that are satisfactory to the Company. Even if the Company is able to obtain additional financing, it may contain undue restrictions on our operations, in the case of debt financing, or cause substantial dilution for our stockholders, in case of equity financing.

This summary of significant accounting policies of the Company is presented to assist in understanding the Company’s financial statements. The financial statements and notes are representations of the Company’s management, which is responsible for their integrity and objectivity. These accounting policies conform to accounting principles generally accepted in the United States of America and have been consistently applied in the preparation of the financial statements.

Principles of Consolidation

The accompanying consolidated financial statements include the accounts of OriginClear, Inc. and its wholly owned operating subsidiaries, Progressive Water Treatment, Inc.  (“PWT”) and OriginClear Technology Limited. All material intercompany transactions have been eliminated upon consolidation of these entities.

Loss per Share Calculations

Basic loss per share calculations are computed by dividing income (loss) available to common shareholders by the weighted-average number of common shares available. Diluted earnings per share is computed similar to basic earnings per share except that the denominator is increased to include securities or other contracts to issue common stock that would have been outstanding if the potential common shares had been issued and if the additional common shares were dilutive.

The Company has excluded 3,714,637 shares of common stock issuable pursuant to outstanding stock options, 40,931,531 shares of common stock issuable pursuant to outstanding warrants, shares of common stock issuable pursuant to outstanding convertible debt of $3,543,068 and shares of common stock issuable pursuant to outstanding convertible preferred stock for the three months ended March 31, 2018, because their impact on the loss per share is anti-dilutive.

The Company has excluded 3,697,495 shares of common stock issuable pursuant to outstanding stock options, 506,026 shares of common stock issuable pursuant to outstanding warrants, shares of common stock issuable pursuant to outstanding convertible debt of $3,867,068 and shares of common stock issuable pursuant to outstanding convertible preferred stock for the three months ended March 31, 2017, because their impact on the loss per share is anti-dilutive.

Work-in-Process

The Company recognizes as an asset the accumulated costs for work-in-process on projects expected to be delivered to customers. Work in Process includes the cost price of materials and labor related to the construction of equipment to be sold to customers.

ORIGINCLEAR, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS-UNAUDITED

MARCH 31, 2018

Use of Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Significant estimates include estimates used to review the Company’s impairments and estimations of long-lived assets, revenue recognition on percentage of completion type contracts, allowances for uncollectible accounts, warranty reserves, inventory valuation, debt beneficial conversion features, valuations of non-cash capital stock issuances and the valuation allowance on deferred tax assets. The Company bases its estimates on historical experience and on various other assumptions that are believed to be reasonable in the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

Stock-Based Compensation

The Company periodically issues stock options and warrants to employees and non-employees in non-capital raising transactions for services and for financing costs. The Company accounts for stock option and warrant grants issued and vesting to employees based on the authoritative guidance provided by the Financial Accounting Standards Board whereas the value of the award is measured on the date of grant and recognized over the vesting period. The Company accounts for stock option and warrant grants issued and vesting to non-employees in accordance with the authoritative guidance of the Financial Accounting Standards Board whereas the value of the stock compensation is based upon the measurement date as determined at either a) the date at which a performance commitment is reached, or b) at the date at which the necessary performance to earn the equity instruments is complete. Non-employee stock-based compensation charges generally are amortized over the vesting period on a straight-line basis. In certain circumstances where there are no future performance requirements by the non-employee, option grants are immediately vested and the total stock-based compensation charge is recorded in the period of the measurement date.

Revenue Recognition

We recognize revenue when services are performed, and at the time of shipment of products, provided that evidence of an arrangement exists, title and risk of loss have passed to the customer, fees are fixed or determinable, and collection of the related receivable is reasonably assured.

Revenues and related costs on construction contracts are recognized as the performance obligations for work are satisfied over time in accordance with Accounting Standards Codification (“ASC”) 606, Revenue from Contracts with Customers. Under ASC 606, revenue and associated profit, will be recognized as the customer obtains control of the goods and services promised in the contract (i.e., performance obligations). All un-allocable indirect costs and corporate general and administrative costs are charged to the periods as incurred. However, in the event a loss on a contract is foreseen, the Company will recognize the loss as it is determined.

Revisions in cost and profit estimates during the course of the contract are reflected in the accounting period in which the facts which require the revision, become known. Provisions for estimated losses on uncompleted contracts are made in the period in which such losses are determined. Changes in job performance, job conditions, and estimated profitability, including those arising from contract penalty provisions and final contract settlements, may result in revisions to costs and income and are recognized in the period in which the revisions are determined.

Contract receivables are recorded on contracts for amounts currently due based upon progress billings, as well as retention, which are collectible upon completion of the contracts. Accounts payable to material suppliers and subcontractors are recorded for amounts currently due based upon work completed or materials received, as are retention due subcontractors, which are payable upon completion of the contract. General and administrative expenses are charged to operations as incurred and are not allocated to contract costs.

Contract Receivable

The Company bills its customers in accordance with contractual agreements. The agreements generally require billing to be on a progressive basis as work is completed. Credit is extended based on evaluation of clients financial condition and collateral is not required. The Company maintains an allowance for doubtful accounts for estimated losses that may arise if any customer is unable to make required payments. Management performs a quantitative and qualitative review of the receivables past due from customers on a monthly basis. The Company records an allowance against uncollectible items for each customer after all reasonable means of collection have been exhausted, and the potential for recovery is considered remote. The allowance for doubtful accounts was approximately $6,996 and $6,996 as of March 31, 2018 and December 31, 2017, respectively. The net contract receivable balance was $432,148 and $490,441 as of March 31, 2018 and December 31, 2017, respectively.

ORIGINCLEAR, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS-UNAUDITED

MARCH 31, 2018

Fair Value of Financial Instruments

Fair Value of Financial Instruments, requires disclosure of the fair value information, whether or not recognized in the balance sheet, where it is practicable to estimate that value. As of March 31, 2018, the balances reported for cash, contract receivables, cost in excess of billing, prepaid expenses, accounts payable, billing in excess of cost, and accrued expenses approximate the fair value because of their short maturities.

We adopted ASC Topic 820 for financial instruments measured as fair value on a recurring basis. ASC Topic 820 defines fair value, established a framework for measuring fair value in accordance with accounting principles generally accepted in the United States and expands disclosures about fair value measurements.

Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. ASC Topic 820 established a three-tier fair value hierarchy which prioritizes the inputs used in measuring fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (level 1 measurements) and the lowest priority to unobservable inputs (level 3 measurements). These tiers include:

The following table presents certain investments and liabilities of the Company’s financial assets measured and recorded at fair value on the Company’s balance sheets on a recurring basis and their level within the fair value hierarchy as of March 31, 2018.

The following is a reconciliation of the derivative liability for which level 3 inputs were used in determining the approximate fair value:

For purpose of determining the fair market value of the derivative liability, the Company used Binomial lattice formula valuation model. The significant assumptions used in the Binomial lattice formula valuation of the derivative are as follows:

ORIGINCLEAR, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS-UNAUDITED

MARCH 31, 2018

Segment Reporting

The Company’s business currently operates in one segment based upon the Company’s organizational structure and the way in which the operations are managed and evaluated.

Recently Issued Accounting Pronouncements

In February 2016, the FASB issued ASU No. 2016-2, which creates ASC Topic 842, “Leases.” This update increases transparency and comparability among organizations by recognizing lease assets and lease liabilities on the balance sheet and disclosing key information about leasing arrangements. This guidance is effective for interim and annual reporting periods beginning after December 15, 2018. We are evaluating what impact, if any, the adoption of this guidance will have on our financial condition, results of operations, cash flows or financial disclosures.

In August 2017, FASB issued accounting standards update ASU-2017-12, “D” (Topic 815) – “Targeted Improvements to Accounting for Hedging Activities”, to require an entity to present the earnings effect of the hedging instrument in the same statement line item in which the earnings effect of the hedged item is reported. The amendments in this update are effective for fiscal years beginning after December 15, 2018, and interim periods within those fiscal years. For all other entities, the amendments are effective for fiscal years beginning after December 15, 2019, and interim periods with the fiscal years beginning after December 15, 2020. Early adoption is permitted in any interim period after issuance of the update. The Company is currently evaluating the impact of the adoption of ASU 2017-12 on the Company’s financial statements.

In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers (ASC 606), to clarify the principles of recognizing revenue and create common revenue recognition guidance between U.S. GAAP and International Financial Reporting Standards. Under ASC 606, revenue is recognized when a customer obtains control of promised goods or services and is recognized at an amount that reflects the consideration expected to be received in exchange for such goods or services. In addition, ASC 606 requires disclosure of the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers. The ASC is effective for fiscal years beginning after December 15, 2017. The Company has adopted ASC 606 beginning on January 1, 2018. The adoption of ASC 606 did not have a significant impact on the Company’s revenue recognition policies. See Note 7 for additional disclosures in accordance with the new revenue recognition standard.

Management reviewed currently issued pronouncements during the period ended March 31, 2018, and does not believe that any other recently issued, but not yet effective, accounting standards, if currently adopted, would have a material effect on the accompanying condensed financial statements.

Preferred Stock

Series B convertible preferred stock (“Series B Preferred Stock”)

On October 1, 2015, the Company filed a Certificate of Designation for Series B preferred stock with the Secretary of State of Nevada authorizing 10,000 shares of preferred stock as Series B Preferred Stock which were issued to a shareholder of PWT in connection with a share exchange agreement, dated October 1, 2015, by and between PWT and the Company. One third (1/3) of the shares of Series B Preferred Stock received by the holder may be converted into common stock beginning one (1) year after the first date on which a share of Series B Preferred Stock was issued (the “Original Issue Date); one third (1/3) may be converted beginning two (2) years after the Original Issue Date; and the remaining one third (1/3) may be converted beginning three years after the Original Issue Date. The number of shares of common stock issuable for each share of converted Series B Preferred Stock shall be calculated by dividing the stated value by the market price, with the market price being the average of the closing trade prices of the twenty-five (25) days prior to the date of the conversion notice. On August 12, 2016, the agreement was amended to include make-good shares. Upon any conversion, the conversion price shall be the lower of $1.05 or the price of the Company’s common stock calculated using the average closing prices of the Company’s common stock on the last three (3) trading days prior to the date of conversion, provided, however, if the average closing price is less than $0.35 per share, the adjusted conversion price shall be $0.35 per share. The conversion price is subject to adjustment in the case of reverse splits, stock dividends, reclassifications and the like. In addition, the conversion price is subject to certain full ratchet anti-dilution protection. Accordingly, the Series B Preferred Stock is valued under the provision of ASC Topic 815, Derivatives and Hedging, because the conversion feature of the preferred stock was not afforded the exemption for conventional convertible instruments due to its variable conversion rate. The Series B Preferred Stock shall have the rights, preferences and privileges as set forth in the exchange agreement. As of March 31, 2018, there are 3,333 shares of Series B Preferred Stock outstanding.

ORIGINCLEAR, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS-UNAUDITED

MARCH 31, 2018

Series C preferred stock (“Series C Preferred Stock”)

On March 14, 2017, the Company filed a Certificate of Designation for its Series C Preferred Stock with the Secretary of State of Nevada (the “Certificate of Designation”) designating 1,000 shares of its authorized preferred stock as Series C Preferred Stock. The shares of Series C Preferred Stock have a par value of $0.0001 per share. The shares of Series C Preferred Stock do not have a dividend rate or liquidation preference and are not convertible into shares of common stock.

For so long as any shares of the Series C Preferred Stock remain issued and outstanding, the holders thereof, voting separately as a class, shall have voting power equal to 51% of the total vote (representing a super majority voting power) on all shareholder matters of the Company. Such vote shall be determined by the holder(s) of a majority of the then issued and outstanding shares of Series C Preferred Stock.

The shares of the Series C Preferred Stock shall be automatically redeemed by the Company at their par value on the first to occur of the following triggering events: (i) on the date that Mr. Eckelberry ceases, for any reason, to serve as officer, director or consultant of the Company, or (ii) on the date that the Company’s shares of common stock first trade on any national securities exchange provided that the listing rules of any such exchange prohibit preferential voting rights of a class of securities of the Company, or listing on any such national securities exchange is conditioned upon the elimination of the preferential voting rights of the Series C Preferred Stock set forth in the Certificate of Designation.

Additionally, the Company is prohibited from adopting any amendments to the Company’s Bylaws, Articles of Incorporation, as amended, making any changes to the Certificate of Designation establishing the Series C Preferred Stock, or effecting any reclassification of the Series C Preferred Stock, without the affirmative vote of at least 66-2/3% of the outstanding shares of Series C Preferred Stock. However, the Company may, by any means authorized by law and without any vote of the holders of shares of Series C Preferred Stock, make technical, corrective, administrative or similar changes to such Certificate of Designation that do not, individually or in the aggregate, adversely affect the rights or preferences of the holders of shares of Series C Preferred Stock.

On March 14, 2017, the Company entered into a securities purchase agreement pursuant to which the Company sold 1,000 shares of Series C Preferred Stock to the Company’s Chief Executive Officer and Director, T. Riggs Eckelberry.

Common Stock

Three months ended March 31, 2018

The Company issued 7,442,162 shares of common stock for the settlement of convertible promissory notes in an aggregate principal in the amount of $50,000, plus interest in the amount of $16,979, with an aggregate fair value loss on settlement of $126,330, based upon conversion prices of $0.0190 to $0.0329.

The Company issued 15,256,054 shares of common stock for services at fair value of $402,512.

Maturities of long-term debt for the next three years are as follows:

At March 31, 2018, the $4,020,818 in convertible promissory notes has a remaining debt discount of $375,349, leaving a net balance of $3,645,469.

ORIGINCLEAR, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS-UNAUDITED

MARCH 31, 2018

On various dates, the Company issued unsecured convertible promissory notes (the “Notes”), that matured during the period and were extended sixty (60) days from the effective date of each Note. The Notes bear interest at 10% per annum. The Notes may be converted into shares of the Company’s common stock at conversion prices ranging from the lesser of $2.10 to $4.90 (subject to adjustment for stock splits, dividends, combinations and other similar transactions) or 50% of the lowest trade price on any trade day following issuance of the Notes.  In addition, for as long as the Notes or other convertible notes in effect between the purchaser and the Company are outstanding, if the Company issues any security with terms more favorable than the terms of the Notes or such other convertible notes or a term was not similarly provided to the purchaser of the Notes or such other convertible notes, then such more favorable or additional term shall, at the purchaser’s option, become part of the Notes and such other convertible notes. The conversion feature of the Notes was considered a derivative in accordance with current accounting guidelines because of the reset conversion features of the Notes. During the three months ended March 31, 2018, the Company issued 7,442,162 shares of common stock, upon conversion of $50,000 in principal, plus accrued interest of $16,979, with a fair value loss on settlement of $126,330. As of March 31, 2018, the Notes had an aggregate remaining balance of $1,436,000.

As of March 31, 2018, certain unsecured convertible promissory notes (the “OID Notes”) had an aggregate remaining principal balance of $184,124, plus accrued interest of $13,334. The OID Notes included an original issue discount and one time interest, which has been fully amortized. The OID Notes matured on December 31, 2017, and were extended through June 30, 2018. The OID Notes were convertible into shares of the Company’s common stock at a conversion price initially of $15.31. After an amendment to the OID Notes, the conversion price changed to the lesser of $2.80 per share, or b) fifty percent (50%) of the lowest trade price of common stock recorded since the original effective date of this note, or c) the lowest effective price per share granted to any person or entity after the effective date.  The conversion feature of the OID Notes was considered a derivative in accordance with current accounting guidelines, because of the reset conversion features of the OID Notes.

The Company issued various, unsecured convertible promissory notes (together, the “May 2016 Notes”), on various dates ending on May 19, 2016. The May 2016 Notes matured and were extended from the date of each tranche through maturity dates ending on May 19, 2020. The May 2016 Notes bear interest at 10% per annum. The May 2016 Notes may be converted into shares of the Company’s common stock at conversion prices ranging from the lesser of $0.70 to $2.80 (subject to adjustment for stock splits, dividends, combinations and other similar transactions) or 50% of the lowest trade price on any trade day following issuance of the May 2016 Notes.  The conversion feature of the May 2016 Notes was considered a derivative in accordance with current accounting guidelines because of the reset conversion features of the May 2016 Notes. The remaining balance of the May 2016 Notes as of March 31, 2018, was $1,325,000.

The Company issued a convertible note (“Dec 2015 Note”) in exchange for an accounts payable in the amount of $432,048, which could be converted into shares of the Company’s common stock after December 31, 2015. The Dec 2015 Note was accounted for under ASC 470, whereby, a beneficial conversion feature was recorded at time of issuance. The Dec 2015 Note did not meet the criteria of a derivative, and was accounted for as a beneficial conversion feature, which was amortized over the life of the Dec 2015 Note and recognized as interest expense in the financial statements. On January 1, 2016, the Dec 2015 Note met the criteria of a derivative and was accounted for under ASC 815. The Dec 2015 Note has zero stated interest rate, and the conversion price shall be equal to 75% of the average three lowest last sale prices traded during the 25 trading days immediately prior to conversion. As of March 31, 2018, the remaining balance of the Dec 2015 Note was $167,048.

The Company issued a convertible note (“Sep 2016 Note”) in exchange for an accounts payable in the amount of $430,896, which could be converted into shares of the Company’s common stock after September 15, 2016. The Sep 2016 Note was accounted for under ASC 470, whereby, a beneficial conversion feature was recorded at time of issuance. On September 15, 2016, the Sep 2016 Note met the criteria of a derivative and was accounted for under ASC 815. The Sep 2016 Note has zero stated interest rate, and the conversion price shall be equal to 75% of the average three lowest last sale prices traded during the 25 trading days immediately prior to conversion. The Sep 2016 Note did not meet the criteria of a derivative at the time it was entered into, and was accounted for as a beneficial conversion feature, which was amortized over the life of the Sep 2016 Note and recognized as interest expense in the financial statements. The conversion feature of the Sep 2016 Note was considered a derivative in accordance with current accounting guidelines because of the reset conversion feature of the Sep 2016 Note. The Company recorded amortization of debt discount, which was recognized as interest expense in the amount of $46,333 during the three months ended March 31, 2018.

The Company issued an unsecured convertible promissory note (the “Dec 20 Note”), in the amount of $150,000 on December 20, 2017. The Dec 20 Note matures on December 20, 2018. The Dec 20 Note bears interest at 10% per annum. The Dec 20 Note may be converted into shares of the Company’s common stock at a conversion price of the lesser of $0.03 per share or 50% of the lowest trade price during the twenty trading days immediately before the conversion. The conversion feature of the Dec 20 Note was considered a derivative in accordance with current accounting guidelines because of the reset conversion features of the Dec 20 Note. The Company recorded amortization of debt discount, which was recognized as interest expense in the amount of $2,126 during the three months ended March 31, 2018. 

The Company issued an unsecured convertible promissory note (the “Dec 22 Note”), in the amount of $75,000 on December 22, 2017. The Dec 22 Note matures on December 22, 2018. The Dec 22 Note bears interest at 10% per annum. The Dec 22 Note may be converted into shares of the Company’s common stock at a conversion price of the lesser of $0.05 per share or 50% of the lowest trade price during the twenty trading days upon default of the prepayment date. The conversion feature of the Dec 22 Note was considered a derivative in accordance with current accounting guidelines because of the reset conversion features of the Dec 22 Note. The Company recorded amortization of debt discount, which was recognized as interest expense in the amount of $11,078 during the three months ended March 31, 2018. 

ORIGINCLEAR, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS-UNAUDITED

MARCH 31, 2018

The Company issued various unsecured convertible promissory notes in the aggregate amount of $174,000 on dates of January 24, 2018, February 20, 2018 and March 21, 2018. The January 24, 2018 note matures on January 24, 2019, the February 20, 2018 note matures on February 20, 2019, and the March 21, 2018 note matures on March 21, 2019. Each of the January 24, 2018, February 20, 2018 and March 21, 2018 notes bear interest at 10% per annum and may be converted into shares of the Company’s common stock at a variable conversion price of 61% of the lowest one (1) trading day during the ten (10) trading days prior to conversion. The conversion feature was considered a derivative in accordance with current accounting guidelines because of the reset conversion features. The Company recorded amortization of debt discount, which was recognized as interest expense in the amount of $15,169 during the three months ended March 31, 2018.

The Company issued two (2) unsecured convertible promissory notes (together, the “Feb 2018 Notes”), in the aggregate principal amount of $157,500 (each in the amount of $78,750) on February 23, 2018. The Feb 2018 Notes mature on February 23, 2019 and bear interest at 10% per annum. The first of the two Feb 2018 Notes shall be paid for by the buyer as set forth herein. The second of the two Feb 2018 Notes shall initially be paid for by the issuance of an offsetting $78,750 secured note issued to the Company by the buyer. The first of the two Feb 2018 Notes was funded with cash and the Company must agree to the funding of the second note, before it can be funded with cash. The second of the Feb 2018 Notes is secured by assets of the buyer having a fair market value of at least $78,750, and provided that prior to conversion of the second Feb 2018 Note, the buyer must have paid off the buyer note in cash. The Feb 2018 Notes may be converted into shares of the Company’s common stock at a conversion price of $0.03 or 50% discount of the lowest trading price during the twenty (20) trading days prior to conversion. The conversion feature of the Feb 2018 Notes was considered a derivative in accordance with current accounting guidelines because of the reset conversion features of the Feb 2018 Notes. The Company recorded amortization of debt discount, which was recognized as interest expense in the amount of $4,252 during the three months ended March 31, 2018. 

We evaluated the financing transactions in accordance with ASC Topic 815, Derivatives and Hedging, and determined that the conversion feature of the convertible promissory notes was not afforded the exemption for conventional convertible instruments due to its variable conversion rate. The note has no explicit limit on the number of shares issuable so they did not meet the conditions set forth in current accounting standards for equity classification. The Company elected to recognize the note under paragraph 815-15-25-4, whereby, there would be a separation into a host contract and derivative instrument. The Company elected to initially and subsequently measure the note in its entirety at fair value, with changes in fair value recognized in earnings. The Company recorded a derivative liability representing the imputed interest associated with the embedded derivative. The derivative liability is adjusted periodically according to the stock price fluctuations.

The derivative liability recognized in the financial statements as of March 31, 2018 was $17,418,475.

We evaluated the financing transactions in accordance with ASC Topic 815, Derivatives and Hedging, and determined that the conversion feature of the convertible promissory note was not afforded the exemption for conventional convertible instruments due to its variable conversion rate. The note has no explicit limit on the number of shares issuable so they did not meet the conditions set forth in current accounting standards for equity classification. The Company elected to recognize the note under paragraph 815-15-25-4, whereby, there would be a separation into a host contract and derivative instrument. The Company elected to initially and subsequently measure the note in its entirety at fair value, with changes in fair value recognized in earnings. The Company recorded a derivative liability representing the imputed interest associated with the embedded derivative. The derivative liability is adjusted periodically per the stock price fluctuations.

The convertible notes issued and described in Note 4 do not have fixed settlement provisions because their conversion prices are not fixed. The conversion feature has been characterized as derivative liabilities to be re-measured at the end of every reporting period with the change in value reported in the statement of operations.

During the three months ended March 31, 2018, as a result of the convertible notes issued that were accounted for as derivative liabilities, we determined that the fair value of the conversion feature of the convertible notes at issuance was $214,171, based upon a Binomial-Model calculation. We recorded the full value of the derivative as a liability at issuance with an offset to valuation discount, which will be amortized over the life of the convertible notes.

During the three months ended March 31, 2018, the Company converted $50,000 in principal of convertible promissory notes, plus accrued interest of $16,979. As a result of the conversion of these notes and the change in fair value of the remaining notes, the Company recorded a loss on net change in derivative and conversion of debt in the amount of $11,797,873 in the statement of operations for the three months ended March 31, 2018. At March 31, 2018, the fair value of the derivative liability was $17,418,475.

ORIGINCLEAR, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS-UNAUDITED

MARCH 31, 2018

For purpose of determining the fair market value of the derivative liability for the embedded conversion, the Company used the Binomial lattice valuation model. The significant assumptions used in the Binomial lattice valuation model for the derivative are as follows:

Options

On June 14, 2013, the Board of Directors adopted a new OriginOil, Inc. 2013 Incentive Stock Option Plan (the “2013 Plan”) for the purposes of granting stock options to its employees and others providing services to the Company, which reserves and sets aside for the granting of options for 114,286 shares of common stock.  Options granted under the 2013 Plan may be either incentive options or nonqualified options and shall be administered by the Company's Board of Directors.  Each option shall state the number of shares to which it pertains. The exercise price will be determined by the holders’ percentage owned as follows: If the holder owns more than 10% of the total combined voting power or value of all classes of stock of the Company, then the exercise price will be no less than 110% of the fair market value of the stock as of the date of grant; if the person is not a 10% holder, then the exercise price will be no less than 100% of the fair market value of the stock as of the date of grant. Notwithstanding any other provision of the 2013 Plan or of any option agreement, each option shall expire on the date specified in the option agreement, which date shall not be later than the tenth (10th) anniversary from the date of grant. If the status of an employee terminates for any reason other than disability or death, then the optionee or their representative shall have the right to exercise the portion of any options which were exercisable as of the date of such termination, in whole or in part, not less than 30 days nor more than three (3) months after such termination.

On September 29, 2015, the Board of Directors adopted a new OriginClear, Inc. 2015 Equity Incentive Stock Option Plan (the “2015 Plan”) for the purposes of granting stock options to its employees and others providing services to the Company, which reserves and sets aside for the granting of options for 3,315,714 shares of common stock. On October 2, 2015, the Board of Directors amended the number of shares to reserve for issuance to 4,571,429 shares. Options granted under the 2015 Plan may be either incentive options or nonqualified options and shall be administered by the Company's Board of Directors.  Each option shall be exercisable to the nearest whole share, in installments or otherwise, as the respective option agreements may provide. Notwithstanding any other provision of the 2015 Plan or of any option agreement, each option shall expire on the date specified in the option agreement, which date shall not be later than the fifth (5th) anniversary from the effective date of grant.

During the year ended December 31, 2016, the Company granted 31,429 shares of incentive stock options to employees, and 428,571 shares of non-statutory options to consultants. Each option shall be exercisable to the nearest whole share, in installments or otherwise, as the respective option agreements may provide. The stock options mature on March 29, 2021 and October 17, 2021, at prices of $0.29 and $1.31.

With respect to non-statutory options granted to employees, directors or consultants, the Board of Directors or Committee of the Board of Directors may specify such period for exercise that the option shall automatically terminate following the termination of employment or services as to shares covered by the option as the Board of Directors or Committee of the Board of Directors deems reasonable and appropriate.

ORIGINCLEAR, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS-UNAUDITED

MARCH 31, 2018

The weighted average remaining contractual life of options outstanding issued under the 2013 Plan and 2015 Plan as of March 31, 2018 was as follows: 

Stock-based compensation expense recognized during the year is based on the value of the portion of stock-based payment awards that is ultimately expected to vest. Stock-based compensation expense recognized in the financial statements of operations during the three months ended March 31, 2018 and 2017 were $13,032 and $34,600, respectively.

Restricted Stock to CEO

On May 12, 2016, the Company entered into a Restricted Stock Grant Agreement (the “RSGA”) with its Chief Executive Officer, Riggs Eckelberry, to create management incentives to improve the economic performance of the Company and to increase its value and stock price. All shares issuable under the RSGA are performance based shares and none have yet vested nor have any been issued. The RSGA provides for the issuance of up to 1,714,286 shares of the Company’s common stock to Mr. Eckelberry provided certain milestones are met in certain stages: a) if the Company’s consolidated gross revenue, calculated in accordance with generally accepted accounting principles, consistently applied, equals or exceeds $15,000,000 for the trailing twelve month period as reported in the Company’s quarterly or annual financial statements, the Company will issue up to 857,143 shares of its common stock and b) if the Company’s consolidated operating profit ( Operating Profit = Operating Revenue - Cost of Goods Sold - Operating Expenses - Depreciation & Amortization), calculated in accordance with generally accepted accounting principles, equals or exceeds $1,500,000 for the trailing twelve month period as reported in the Company’s reports filed with the SEC (the “SEC Reports”), the Company will issue up to 857,143 shares of its common stock. The Company has not recognized any costs associated with the milestones, due to not being able to estimate the probability of it being achieved. As the performance goals are achieved, the shares shall become eligible for vesting and issuance.

On August 10, 2016, the Company entered into a Restricted Stock Grant Agreement (the “August RSGA”) with its Chief Executive Officer, Riggs Eckelberry, to create management incentives to improve the economic performance of the Company and to increase its value and stock price. All shares issuable under the August RSGA are performance based shares and none have yet vested nor have any been issued. The August RSGA provides for the issuance of up to 1,714,286 shares of the Company’s common stock to the CEO provided certain milestones are met in certain stages: a) if the Company’s consolidated gross revenue, calculated in accordance with generally accepted accounting principles, consistently applied, equals or exceeds $15,000,000 for the trailing twelve month period, the Company will issue up to 857,143 shares of its common stock and b) if the Company’s consolidated operating profit ( Operating Profit = Operating Revenue - Cost of Goods Sold - Operating Expenses - Depreciation & Amortization), calculated in accordance with generally accepted accounting principles, equals or exceeds $1,500,000 for the trailing twelve month 

ORIGINCLEAR, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS-UNAUDITED

MARCH 31, 2018

Restricted Stock to CEO (Continued)

period as reported as reported in the Company’s SEC Reports, the Company will issue up to 857,143 shares of its common stock. The Company has not recognized any costs associated with the milestones, due to not being able to estimate the probability of it being achieved. As the performance goals are achieved, the shares shall become eligible for vesting and issuance.

Restricted Stock to Employees and Consultants

On May 12, 2016, the Company entered into a Restricted Stock Grant Agreement (the “First Employee RSGA”) with an employee, to create management incentives to improve the economic performance of the Company and to increase its value and stock price. All shares issuable under the First Employee RSGA are performance based shares and none have yet vested nor have any been issued. The First Employee RSGA provides for the issuance of up to 857,143 shares of the Company’s common stock to the employee provided certain milestones are met in certain stages: a) if the Company’s consolidated gross revenue, calculated in accordance with generally accepted accounting principles, consistently applied, equals or exceeds $15,000,000 for the trailing twelve month period as reported in the Company’s quarterly or annual financial statements, the Company will issue up to 428,571 shares of its common stock and b) if the Company’s consolidated operating profit ( Operating Profit = Operating Revenue - Cost of Goods Sold - Operating Expenses - Depreciation & Amortization), calculated in accordance with generally accepted accounting principles, equals or exceeds $1,500,000 for the trailing twelve month period as reported as reported in the Company’s SEC Reports, the Company will issue up to 428,571 shares of its common stock. The Company has not recognized any costs associated with the milestones, due to not being able to estimate the probability of it being achieved. As the performance goals are achieved, the shares shall become eligible for vesting and issuance.

On May 12, 2016, the Company entered into a Restricted Stock Grant Agreement (the “Second Employee RSGA”) with an employee, to create management incentives to improve the economic performance of the Company and to increase its value and stock price. All shares issuable under the Second Employee RSGA are performance based shares and none have yet vested nor have any been issued. The Second Employee RSGA provides for the issuance of up to 571,429 shares of the Company’s common stock to the employee provided certain milestones are met in certain stages: a) if the Company’s consolidated gross revenue, calculated in accordance with generally accepted accounting principles, consistently applied, equals or exceeds $15,000,000 for the trailing twelve month period as reported in the Company’s quarterly or annual financial statements, the Company will issue up to 285,714 shares of its common stock and b) if the Company’s consolidated operating profit ( Operating Profit = Operating Revenue - Cost of Goods Sold - Operating Expenses - Depreciation & Amortization), calculated in accordance with generally accepted accounting principles, equals or exceeds $1,500,000 for the trailing twelve month period as reported as reported in the Company’s SEC Reports, the Company will issue up to 285,714 shares of its common stock. The Company has not recognized any costs associated with the milestones, due to not being able to estimate the probability of it being achieved. As the performance goals are achieved, the shares shall become eligible for vesting and issuance.

On August 10, 2016, the Company entered into a Restricted Stock Grant Agreement (together, the “Consultants RSGA”) with two of its consultants, to create management incentives to improve the economic performance of the Company and to increase its value and stock price. All shares issuable under the Consultants RSGA are performance based shares and none have yet vested nor have any been issued. The Consultants RSGA provides to each of the consultants the issuance of up to 285,714 shares of the Company’s common stock provided certain milestones are met in certain stages: a) if the Company’s consolidated gross revenue, calculated in accordance with generally accepted accounting principles, consistently applied, equals or exceeds $15,000,000 for the trailing twelve month period, the Company will issue to each of the consultants up to 142,857 shares of its common stock and b) if the Company’s consolidated operating profit ( Operating Profit = Operating Revenue - Cost of Goods Sold - Operating Expenses - Depreciation & Amortization), calculated in accordance with generally accepted accounting principles, equals or exceeds $1,500,000 for the trailing twelve month period as reported as reported in the Company’s SEC Reports, the Company will issue up to 142,857 shares of common stock to each of the consultants. The Company has not recognized any costs associated with the milestones, due to not being able to estimate the probability of it being achieved. As the performance goals are achieved, the shares shall become eligible for vesting and issuance.

ORIGINCLEAR, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS-UNAUDITED

MARCH 31, 2018

At March 31, 2018, the weighted average remaining contractual life of warrants outstanding:

At March 31, 2018, the aggregate intrinsic value of the warrants outstanding was $0.

Equipment Contracts

Revenues and related costs on equipment contracts are recognized as the performance obligations for work are satisfied over time in accordance with Accounting Standards Codification (“ASC”) 606, Revenue from Contracts with Customers. Under ASC 606, revenue and associated profit, will be recognized as the customer obtains control of the goods and services promised in the contract (i.e., performance obligations). All un-allocable indirect costs and corporate general and administrative costs are charged to the periods as incurred. However, in the event a loss on a contract is foreseen, the Company will recognize the loss as it is determined.

The following table represents a disaggregation of revenue by type of good or service from contracts with customers for the three months ended March 31, 2018 and 2017.

ORIGINCLEAR, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS-UNAUDITED

MARCH 31, 2018

Revenue recognition for other sales arrangements, such as sales for components, service and licensing fees will remain materially consistent.

Contract assets represents revenues recognized in excess of amounts billed on contracts in progress. Contract liabilities represents billings in excess of revenues recognized on contracts in progress. Assets and liabilities related to long-term contracts are included in current assets and current liabilities in the accompanying balance sheets, as they will be liquidated in the normal course of the contract completion. The cost in excess of billings for the three months ending March 31, 2018 was $214,067 and for the year ending December 31, 2017 was $88,589. The billing in excess of cost for the three months ending March 31, 2018 was $141,198 and for the year ending December 31, 2017 was $154,048.

Operating Lease – Related Party

The Company entered into a month-to-month lease agreement with a shareholder of the Company for office space in McKinney, Texas at a base rent of $4,750 per month.

Operating Lease – Equipment

The Company entered into a five (5) year equipment lease in the amount of $45,440, which was recorded as a capital lease. There are no escalation or renewal options associated with this lease. The lease has a purchase option to buy the equipment at the end of the lease for one dollar ($1). The monthly lease payments are $757 per month. The future minimum lease payments due as of March 31, 2018 are $42,822.

Warranty Reserve

Generally, a PWT project is guaranteed against defects in material and workmanship for one year from the date of completion, while certain areas of construction and materials may have guarantees extending beyond one year. The Company has various insurance policies relating to the guarantee of completed work, which in the opinion of management will adequately cover any potential claims. A warranty reserve has been provided under PWT based on the opinion of management and based on Company history in the amount of $20,000 as of March 31, 2018.

Management has evaluated subsequent events according to the requirements of ASC TOPIC 855 and has determined that there are the following subsequent events:

On April 4, 2018, the Company entered into a securities purchase agreement with an accredited investor pursuant to which it sold and issued an unsecured convertible promissory note (the “Apr 4 Note”), in the aggregate principal face amount of $150,000. The Apr 4 Note matures 12 months from the date of issuance and bears interest at a rate of 10% per annum. The Apr 4 Note may be converted into shares of the Company’s common stock at a price per share equal to 50% of the lowest trade price of the Company’s common stock recorded during the twenty five prior trading days from receipt of the conversion notice (subject to adjustment for stock splits, dividends, combinations and other similar transactions). 

ORIGINCLEAR, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS-UNAUDITED

MARCH 31, 2018

On April 13, 2018, the Company issued to two members of the Board of Directors an aggregate of 400,000 shares of the Company’s common stock for services in lieu of cash consideration.

On April 13, 2018, the Company filed a Certificate of Amendment to its Articles of Incorporation, as amended, with the Secretary of State of the State of Nevada to effectuate an increase to the number of authorized shares of common stock of the Company to 2,000,000,000 from 900,000,000 and increased the number of authorized shares of all series of its preferred stock to 550,000,000 from 750,000. As a result of the increase of authorized shares of its common and preferred stock, the aggregate number of the Company’s authorized shares is 2,550,000,000.

On April 13, 2018, the Company filed a Certificate of Designation (the “Series D Certificate of Designation”) for its Series D convertible preferred stock (the “Series D Preferred Stock”) with the Secretary of State of Nevada designating 400,000,000 shares of its authorized preferred stock as Series D Preferred Stock. The shares of Series D Preferred Stock have a par value of $0.0001 per share, do not have a dividend rate or liquidation preference and do not carry any voting rights. The shares of Series D Preferred Stock are convertible into the Company’s common stock at a conversion rate which shall be the greater of (A) one share of common stock and (B) the number of shares of common stock the holder of the Series D Preferred Stock would have received pursuant to each holders respective Subscription Agreement (as defined in the Series D Certificate of Designation) if the shares of Series D Preferred Stock were priced based on the average Closing Sale Price (as defined in the Series D Certificate of Designation) of the common stock during the three trading days prior to the date the holder requests a conversion, provided the lowest price for which an adjustment will be made is $0.005 (1/2 of one cent). In the event the Company does not conduct an Initial Coin Offering (as defined in the Series D Certificate of Designation) within one (1) year of the Initial Issuance Date (as defined in the Series D Certificate of Designation), the conversion rate shall be adjusted to read as follows: the greater of (A) one share of common stock and (B) the number of shares of common stock the holder of the Series D Preferred Stock would have received pursuant to each holders respective Subscription Agreement (as defined in the Series D Certificate of Designation) if the shares of Series D Preferred Stock were priced based on the average Closing Sale Price (as defined in the Series D Certificate of Designation) of the common stock during the three trading days prior to the date the holder requests a conversion, provided the lowest price for which an adjustment will be made is $0.01 (one cent). Notwithstanding anything to the contrary set forth in the Series D Certificate of Designation, at no time may all or a portion of the Series D Preferred Stock be converted if the number of shares of common stock to be issued pursuant to such conversion would exceed, when aggregated with all other shares of common stock owned by the holder at such time, the number of shares of common stock that would result in the holder beneficially owning (as determined in accordance with Section 13(d) of the Exchange Act and the rules thereunder) more than 4.99% of all of the common stock outstanding at such time, which amount may be increased to 9.99% at the holders discretion.

On April 13, 2018, the Company filed a Certificate of Designation for its Series D-1 convertible preferred stock (the “Series D-1 Preferred Stock”) with the Secretary of State of Nevada designating 50,000,000 shares of its authorized preferred stock as Series D-1 Preferred Stock. The shares of Series D-1 Preferred Stock have a par value of $0.0001 per share, do not have a dividend rate or liquidation preference and do not carry any voting rights. Each share of Series D-1 Preferred Stock is convertible into one share of common stock. At no time may all or a portion of the Series D-1 Preferred Stock be converted if the number of shares of common stock to be issued pursuant to such conversion would exceed, when aggregated with all other shares of common stock owned by the holder at such time, the number of shares of common stock that would result in the holder beneficially owning (as determined in accordance with Section 13(d) of the Exchange Act and the rules thereunder) more than 4.99% of all of the common stock outstanding at such time, which amount may be increased to 9.99% at the holders discretion.

On April 13, 2018, the Company began offering in a private placement (the “Offering”), units (“Units”), each Unit consisting of one share of Series D Preferred Stock, and one right to purchase future digital coins, or certain other securities, issued by the Company or WaterChain, Inc., our wholly owned subsidiary. The Company is offering up to a maximum of 50,000,000 Units at a purchase price of $0.02 per Unit for an aggregate offering amount of $1,000,000, provided, that the Company may increase the Offering amount to $2,000,000 at its sole discretion.

Between April 13, 2018 and May 4, 2018, the Company entered into subscription agreements with certain accredited investors pursuant to which the Company sold an aggregate of 11,777,777 Units of the Company’s securities for an aggregate purchase price of $230,000.

On April 30, 2018, the Company issued to consultants an aggregate of 709,034 shares of the Company’s common stock for services in lieu of cash considerations. 

On May 3, 2018, holders of convertible promissory notes converted an aggregate principal and interest amount of $51,763 into an aggregate of 5,751,476 shares of the Company’s common stock.

On May 14, 2018, the Board of Directors of the Company approved an amendment to the transaction documents for the Offering providing for (i) an extension of the Offering period, (ii) an increase to the maximum Offering amount from $2,000,000 to $3,000,000 and (iii) two new discounts pursuant to which (a) investors purchasing Units for an aggregate purchase price of $1,000,000 or greater, but less than $2,000,000, will be entitled to a 40% discount, for a purchase price of $0.012 per Unit, and (b) investors purchasing Units for an aggregate purchase price of $2,000,000 or greater will be entitled to a 50% discount, for a purchase price of $0.01 per Unit.

On May 16, 2018, the Board of Directors of the Company approved the issuance of an aggregate of 2,000,000 shares of the Company’s common stock to a consultant for services in lieu of cash considerations.

On May 16, 2018, the Company entered into separate Restricted Stock Grant Agreements (the “May 2018 RSGAs”) with its Chief Executive Officer, Riggs Eckelberry, one employee and one consultant to create incentives to improve the economic performance of the Company and to increase its value and stock price. The May 2018 RSGAs provide for the issuance of 30,000,000 shares of common stock to Mr. Eckelberry and 2,000,000 shares to each of the employee and consultant, however all shares issuable under the May 2018 RSGAs are performance based shares and none have yet vested nor have any been issued. The May 2018 RSGAs provide for the issuance of the Company’s common stock provided certain milestones are met in certain stages with a) 50% of each employee’s or consultant’s respective award vesting if the Company’s consolidated gross revenue, calculated in accordance with generally accepted accounting principles, consistently applied, equals or exceeds $15,000,000 for the trailing twelve month period and b) 50% of each employee’s or consultant’s respective award vesting if the Company’s consolidated operating profit ( Operating Profit = Operating Revenue - Cost of Goods Sold - Operating Expenses - Depreciation & Amortization), calculated in accordance with generally accepted accounting principles, equals or exceeds $1,500,000 for the trailing twelve months.

In connection with certain one-time make good agreements, between April 30, 2018 and May 18, 2018, the Company issued an aggregate of 4,092,293 shares of its common stock to certain holders of its common stock.