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 and investments in this sector. The Company previously owned
and licensed technology that converts waste fuels and heat to power, which 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 an 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 2014 until early 2017 been essentially those of the Subsidiary.
In May 2016, the Company began exploring other synergistic business lines such as compost and soil manufacturing from waste water
biosolids and other waste feedstocks. In 2017, the Company formally shifted its focus from waste-to-energy technology R&D,
including selling its technology to a license in August 2017, to facilitating the acquisition of, investment in, and operation
of facilities that manufacture compost and sustainable soils from waste resources. In November 2018, the Company, through a
variable interest entity anticipated to be unconsolidated, consummated the first acquisition of a compost manufacturing and environmental
services company and received an eight-year management agreement to run that entity. See Note 12 – Subsequent Events.
NOTE
2 – BASIS OF PRESENTATION AND GOING CONCERN
For the nine months ended
September 30, 2018, the Company used cash in operating activities of $759,068. The accumulated deficit since inception is $11,363,645,
which is comprised of operating losses and other expenses. Additionally, certain of the Company’s debentures and redeemable
convertible preferred stock matured on July 31, 2018 and have not been repaid or extended as of the date of this filing. 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 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
facilitate the acquisition of and investment in 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 convertible bridge note offering (the “Bridge Offering”). Through
the end of 2017, the Company closed an additional $600,000 of follow-on investments in the Bridge Offering. In June 2018, the Company
raised an additional $290,000 in convertible notes on substantially same terms as the Bridge Offering with three accredited investors
and one institutional investor (the “Follow-On Bridge Offering”), and then in the third quarter of 2018, completed
an additional $650,000 in the Follow-On Bridge Offering with the same institutional investor.
On July 27, 2018, the
Company signed a Stock Purchase Agreement for the purchase of all of the outstanding capital stock of George B. Wittmer Associates
Inc. (“GBWA”) of Callahan, Florida, from its sole shareholder. A $50,000 deposit was paid to GBWA during the
third quarter of 2018, and on October 31, 2018, the outside termination date of the agreement was amended to November 9, 2018
by the parties. On November 9, 2018, the Company transferred the agreement to acquire GBWA to Earth Property Holdings LLC,
a Delaware limited liability company (“Earth Property”), and through Earth Property, consummated the GBWA acquisition.
See Note 12 – Subsequent Events.
The consolidated financial
statements do not include any adjustments that might result from the outcome of these uncertainties.
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 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 business includes contracts where the Company is paid to do feasibility studies, site assessment
studies, management work, and other similar services in connection with a third-party soil or compost manufacturing business.
In its review, management identifies that a contract exists with a customer, identifies the performance obligations in the contract,
determines the transaction price, allocates the transaction price to the performance obligations in the contract, and then recognizes
revenue when the Company satisfies specific performance obligation. Payments received before all the relevant criteria for revenue
recognition are satisfied are recorded as deferred revenue.
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
On
January 1, 2017, the Company 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. Prior to January 1, 2017, derivatives were recognized initially
at fair value with subsequent changes in fair value recognized in profit or loss.
Property
and Equipment
Property
and equipment are recorded at cost. Depreciation is computed on the straight-line method, based on the estimated useful lives
of the assets as follows:
|
|
Years
|
Furniture
and equipment
|
|
7
|
Computers
|
|
5
|
Expenditures
for maintenance and repairs are charged to operations as incurred.
Impairment
of Long-Lived Assets
The
Company continually evaluates the carrying value of intangible assets and other long-lived assets to determine whether there are
any impairment losses. If indicators of impairment are present and future cash flows are not expected to be sufficient to recover
the assets’ carrying amount, an impairment loss would be charged to expense in the period identified. To date, the Company
has not recognized any impairment charges.
Income
Taxes
Income
taxes are accounted for under the asset and liability method as stipulated by FASB ASC 740, “
Income Taxes
”
(“ASC 740”). Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences
between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating
loss and tax credit carry forwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply
to taxable income in the years in which those temporary differences are expected to be recovered or settled. Under ASC 740, the
effect on deferred tax assets and liabilities or a change in tax rate is recognized in income in the period that includes the
enactment date. Deferred tax assets are reduced to estimated amounts to be realized by the use of a valuation allowance. A valuation
allowance is applied when in management’s view it is more likely than not (50%) that such deferred tax will not be utilized.
In
the event that an uncertain tax position exists in which the Company could incur income taxes, the Company would evaluate whether
there is a probability that the uncertain tax position taken would be sustained upon examination by the taxing authorities. Reserves
for uncertain tax positions would be recorded if the Company determined it is probable that a position would not be sustained
upon examination or if payment would have to be made to a taxing authority and the amount is reasonably estimated. As of September
30, 2018, 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 September 30,
2018 and 2017.
At
September 30, 2018, there were the following potentially dilutive securities that were excluded from diluted net loss per share
because their effect would be anti-dilutive: 8,515,480 shares from common stock options, 5,337,345 shares from common stock warrants,
1,650,000 shares from the conversion of debentures, 22,985,751 shares that may be converted from the Bridge Round (based upon
an assumed conversion price at September 30, 2018 of $0.0884 per share), and 6,000,000 shares from the conversion of redeemable
convertible preferred stock (not inclusive of cumulative dividends which may be converted to shares of common stock under certain
conditions). At September 30, 2017, there were the following potentially dilutive securities that were excluded from diluted net
income per share because their effect would be anti-dilutive: 6,915,480 shares from common stock options, 5,187,345 shares from
common stock warrants, 1,100,000 shares from the conversion of debentures (not inclusive of shares that may be converted from
the Bridge Round, as the valuation and corresponding share price were not determinable at such time), and 4,000,000 shares from
the conversion of redeemable convertible preferred stock.
Significant
Estimates
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, the fair value of
derivative liabilities and convertible bridge notes, and the assessment and recognition of income taxes and contingencies. Actual
results could differ from these estimates.
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. 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. The Company has completed the evaluation of this ASU impact on the results of operations and financial condition.
The Company has concluded 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
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
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. In addition, the Company determined that the impact to the income/(loss) per share as a result of the down
round features was not material.
In
June 2018, the FASB issued ASU No. 2018-07,
Compensation – Stock Compensation (Topic 718), Improvements to Nonemployee
Share-Based Payment Accounting
, which is intended to simplify the accounting for nonemployee share-based payment transactions
by expanding the scope of Topic 718 to include share-based payment transactions for acquiring goods and services from nonemployees.
The guidance is effective for fiscal years and interim periods within those years beginning after December 15, 2018. Early adoption
is permitted, but no earlier than an entity’s adoption date of ASC 606. The Company is currently evaluating the impact of
this new guidance on its consolidated financial statements and disclosures.
In
August 2018, the FASB issued guidance that amends fair value disclosure requirements. The guidance removes disclosure requirements
on the transfers between Level 1 and Level 2 of the fair value hierarchy in addition to the disclosure requirements on the policy
for timing of transfers between levels and the valuation process for Level 3 fair value measurements. The guidance clarifies the
measurement uncertainty disclosure and adds disclosure requirements for Level 3 unrealized gains and losses and significant unobservable
inputs used to develop Level 3 fair value measurements. The guidance is effective for fiscal years beginning after December 15,
2019. Entities are permitted to early adopt any removed or modified disclosures upon issuance and delay adoption of the additional
disclosures until the effective date. The Company is currently evaluating the impact of this new guidance on its consolidated
financial statements and disclosures.
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.
NOTE
4 –PROPERTY AND EQUIPMENT, NET
Property
and equipment, net consists of the following:
|
|
September 30,
2018
|
|
|
December 31,
2017
|
|
Furniture and computers
|
|
$
|
1,328
|
|
|
$
|
1,328
|
|
Total
|
|
|
1,328
|
|
|
|
1,328
|
|
Accumulated depreciation
|
|
|
(974
|
)
|
|
|
(775
|
)
|
Net property and equipment
|
|
$
|
354
|
|
|
$
|
553
|
|
Depreciation
expense for the three months ended September 30, 2018 and 2017 was $66 and $209 respectively; and for the nine months ended September
30, 2018 and 2017 was $199 and $1,196 respectively.
NOTE
5 – CYCLONE SEPARATION, LICENSE RIGHTS AND DEFERRED REVENUE
In
2014, Q2P purchased for $175,000 certain licensing rights to use Cyclone Power Technologies’ (“Cyclone”) patented
technology on a worldwide, exclusive basis for 20 years with two 10-year renewal terms for Q2P’s waste heat and waste-to-power
business. This agreement 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 licensing rights were amortized over its estimated useful life of 4 years. Amortization
expense for the three months ended September 30, 2018 and 2017 was $0, and for the nine months ended September 30, 2018 and 2017
was $0 and $21,875, respectively.
On
January 9, 2017, the Company transferred and assigned to Phoenix its Technology Sales Agreement with MagneGas Corporation (the
“MagneGas Agreement”) to deliver a waste-to-power system to this customer. Under the MagneGas Agreement, the Company
had been paid $90,000 as of the date of transfer, and $68,000 was still due from the customer based on milestones set forth in
the MagneGas Agreement. Phoenix assumed the MagneGas Agreement, 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 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 nine months ended
September 30, 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 three and nine months ended September 30, 2017.
In
connection with the separation agreement with Cyclone, the Company also assumed a contract with Clean Carbon of Australia and
a corresponding $10,064 prepayment for services or other value to be provided in the future. This deposit has been presented as
deferred revenue on the September 30, 2018 and December 31, 2017 consolidated balance sheets.
NOTE
6 – RELATED PARTY TRANSACTIONS
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 7).
In
April 2017, the Company’s President forgave $112,797 of deferred salary. This amount was reclassified from accrued expenses
to additional paid in capital during 2017.
NOTE
7 – NOTES PAYABLE AND DEBENTURES
In March 2017, the Company
entered into a Modification and Extension Agreement with two holders of its Original Issue Discount Senior Secured Convertible
Debentures (the “Debentures”) to extend the maturity date to July 31, 2017, reset the conversion price from $0.21 to
$0.15, and waive any defaults under the Debentures from the expiration of the maturity date or otherwise. The exercise price of
the Warrants that were issued with the Debentures, 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
contain 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 September 30, 2018, and December 31, 2017, the aggregate outstanding principal amount of the two Debentures was $165,000.
In March 2018, the Company and holders 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. As of the date of filing, the Debentures were in default. The Company and the holders
are in discussions to extend the maturity date or seek an alternative resolution.
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, 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. This debt was repaid in full in December 2017.
On
March 31, 2017, the Company closed the initial $1,050,000 tranche in a Convertible Promissory Note offering (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. In June 2018,
the Company raised an additional $290,000 in Follow-On Bridge Offering notes on substantially same terms as the Bridge Offering
(but with a two-year maturity) with three accredited investors and one institutional investor. In the third quarter of 2018, the
Company raised an additional $650,000 in the Follow-On Bridge Offering with the same institutional investor. Also, in June 2018,
one of the original Notes for $50,000 plus $7,664 accrued interest was converted by its holder into 613,451 shares of common stock.
The
Convertible Promissory Notes (the “Notes”) from the Bridge Offering and the Follow-On 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 September 30, 2018 was $4,300,000 (see Note 8) and the principal amount due was $2,731,908.
The change in fair value resulted in a loss for the three months ended September 30, 2018 of $254,893 and a gain for the nine
months ended September 30, 2018 of $90,431.
For the three months ended September 30, 2017, the
change in fair value was a gain of $
205,793,
and for the nine months ended September 30, 2017
the change was a loss of $
419,484.
The
Notes and Follow-On Bridge Offering notes (collectively, the “Bridge Notes”) are currently convertible into common
stock, or preferred stock if received by investors in the Equity Offering, at the discretion of each holder based on the conversion
formula provided in the Bridge Notes. Maturity is 36 months from issuance (24 for the Follow-On Bridge notes) with 15% annual
interest which will be capitalized each year into the principal of the Bridge Notes and paid in kind. There are no warrants issued
in connection with either of the offerings.
NOTE 8 – FAIR VALUE MEASUREMENT
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 7, the Bridge 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.
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 September 30, 2018 and December 31, 2017. 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
|
|
|
|
|
|
|
|
|
|
|
|
|
September 30, 2018
|
|
|
Level 1
|
|
|
Level 2
|
|
|
Level 3
|
|
Convertible Bridge Notes
|
|
$
|
4,300,000
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
4,300,000
|
|
Total
|
|
$
|
4,300,000
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
4,300,000
|
|
|
|
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
|
|
There
were no transfers between levels during 2017 and through September 30, 2018. 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 was recognized as an adjustment of the opening balance of accumulated deficit for 2017.
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:
|
|
Nine months Ended
September 30, 2018
|
|
|
|
Convertible Bridge
Notes
|
|
Fair value, December 31, 2017
|
|
$
|
3,270,000
|
|
Issuances of debt
|
|
|
940,000
|
|
Accrued interest
|
|
|
234,345
|
|
Conversions of debt and accrued interest to shares of common stock
|
|
|
(57,664
|
)
|
Amortization of debt issuance costs
|
|
|
3,750
|
|
Net unrealized gain on convertible bridge notes
|
|
|
(90,431
|
)
|
Fair value, September 30, 2018
|
|
$
|
4,300,000
|
|
The
Company’s convertible Bridge Notes are valued by using Monte Carlo Simulation methods and discounted future cash flow models.
Where possible, the Company verifies the values produced by its pricing models to market prices. Valuation models require a variety
of inputs, including contractual terms, market prices, yield curves, credit spreads, measures of volatility and correlations of
such inputs. These convertible Bridge Notes do not trade in liquid markets, and as such, model inputs cannot generally be verified
and do involve significant management judgment. Such instruments are typically classified within Level 3 of the fair value hierarchy.
The following assumptions were used to value the Company’s convertible Bridge Notes at September 30, 2018: dividend yield
of -0-%, volatility of 70-170%, risk free rate of 2.7% and an expected term of 1.5 years.
NOTE
9 – COMMON STOCK, PREFERRED STOCK AND WARRANTS
Common
Stock
The
Company issued 3,000,000 shares of common stock in the first nine months of 2018 in connection with a services agreement, and
another 613,451 shares of common stock in the period in connection with the conversion of $50,000 of principal plus $7,664 of
interest on the Notes.
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
extended the redemption date to July 31, 2018 per the 2018 Modification. The Company is negotiating an additional redemption extension
or conversion to common stock as of the filing of this report. 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 years following closing,
currently exercisable 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 original merger of the company or any funding contemplated by that transaction; (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 holders of the Preferred Stock consented to the
Bridge Offering. The unconverted shares of Preferred Stock were required to be redeemed on July 31, 2018, per the 2018 Modification,
which is currently being negotiated with the holders.
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 September 30, 2018 and December 31, 2017 was $0
and $1,062, respectively. Interest expense related to the preferred stock discount for the nine months ended September 30, 2018,
and 2017 was $1,062 and $103,985, respectively.
The
Preferred Stock 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 September 30, 2018:
|
|
Number of
Warrants
|
|
|
Exercise price
per share
|
|
|
Average
remaining
term in years
|
|
Warrants issued in connection with issuance of Debentures
|
|
|
2,033,500
|
|
|
$
|
0.50
|
|
|
|
1.00
|
|
Warrants issued in connection with issuance of Preferred Stock
|
|
|
1,153,845
|
|
|
$
|
0.50
|
|
|
|
2.30
|
|
Warrants issued in connection with a services contract
|
|
|
1,000,000
|
|
|
$
|
0.20
|
|
|
|
1.73
|
|
Warrants issued in connection with a services contract
|
|
|
1,000,000
|
|
|
$
|
0.35
|
|
|
|
1.73
|
|
Warrants issued in connection with a services contract
|
|
|
150,000
|
|
|
$
|
0.04
|
|
|
|
4.25
|
|
NOTE
10 – STOCK OPTIONS AND RESTRICTED STOCK UNITS
On
July 31, 2014, the Board of Directors of Q2P approved the Founders Stock Option Plan (“Founders Plan”) and the 2014
Employee Stock Option Plan (the “2014 Plan”), collectively the “Option Plans”. The Option Plans were developed
to provide a means whereby directors and selected employees, officers, consultants, and advisors of the Company may be granted
incentive or non-qualified stock options to purchase restricted common stock of the Company. On February 25, 2016, to accommodate
the appointment of new Board members and additional incentive stock options and stock grants to key employees of the Company,
the Board approved the 2016 Omnibus Equity Incentive Plan (“2016 Plan”), which allowed for an additional four 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
June 2018, the Company issued a total of 1,600,000 common stock options under the 2016 Plan to three independent Board members
and one Board observer. The options vest one-half immediately and the balance in 6 months, with a 10-year term and exercisable
at $0.10 per share. The options were valued at $64,440 (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 $0.10 per share and with a maturity life of 3.0
years.
Option
Repricing
On
July 13, 2018, the compensation committee of the Company’s Board of Directors, approved a one-time stock option repricing
program (the “Option Repricing”) to permit the Company to reprice certain options to purchase the Company’s
Common Stock held by its current directors, officers and employees (the “Eligible Options”), which actions became
effective on July 13, 2018. Under the Option Repricing, as of the date the Option Repricing became effective, Eligible Options
with an exercise price at or above $0.21 per share (representing an aggregate of 5,031,000 options, or 59% of the total outstanding)
were amended to reduce such exercise price to $0.10.
The
impact of the repricing was a one-time incremental non-cash charge of approximately $49,722, which was recorded to stock option
expense in the three months ended September 30, 2018. An additional $333 of expense is being charged to operations over the remaining
term of the options.
Total
stock-based compensation to employees and non-employees for the three months and nine months ended September 30, 2018 was $68,086
and $164,937, respectively.
During
the three-month period ended September 30, 2018 the Company granted no new options. A summary of the common stock options issued
under the Option Plans and the 2016 Plan for the period from December 31, 2017 through September 30, 2018 follows:
|
|
Number
Outstanding
|
|
|
Weighted
Avg. Exercise
Price
|
|
|
Weighted
Avg.
Remaining
Contractual
Life (Years)
|
|
Balance, December 31, 2017
|
|
|
6,915,480
|
|
|
$
|
0.21
|
|
|
|
5.6
|
|
Options issued
|
|
|
1,600,000
|
|
|
|
0.10
|
|
|
|
9.5
|
|
Options exercised
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
Options cancelled
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
Balance, September 30, 2018
|
|
|
8,515,480
|
|
|
$
|
0.12
|
|
|
|
5.7
|
|
The
vested and exercisable options at period end follows:
|
|
Exercisable/
Vested
Options Outstanding
|
|
|
Weighted
Avg.
Exercise
Price
|
|
|
Weighted
Avg.
Remaining Contractual
Life (Years)
|
|
Balance, September 30, 2018
|
|
|
7,672,147
|
|
|
$
|
0.13
|
|
|
|
5.3
|
|
The
fair value of new stock options and warrants granted and repriced stock options using the Black-Scholes option pricing model was
calculated using the following assumptions:
|
|
Nine Months
September 30, 2018
|
|
Risk free interest rate
|
|
|
2.61 – 2.66
|
%
|
Expected volatility
|
|
|
131.4
|
%
|
Expected dividend yield
|
|
|
0
|
%
|
Expected term in years
|
|
|
3.0
|
|
Average value per options
|
|
$
|
0.04 – 0.05
|
|
Expected
volatility is based on historical volatility of a group of 5 comparable companies, due to the low trading volume of the Company’s
own stock. Short Term U.S. Treasury rates were utilized as the risk-free interest rate. The expected term of the options was calculated
using the alternative simplified method codified as ASC 718 “
Accounting for Stock Based Compensation,
” which
defined the expected life as the average of the contractual term of the options and the weighted average vesting period for all
issuances.
NOTE
11 – COMMITMENTS AND CONTINGENCIES
On April 1, 2017, the Company
entered into 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 initially received a $12,500 per month fee starting April
1,2017 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 initially received a $10,000 per month fee
starting on April 1, 2017, 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. In July 2018, the Board approved an increase
of the CEO’s and President’s salaries to $275,000 and $220,000, respectively.
On
August 1, 2018, the Company entered into an employment agreement with its Chief Financial Officer, which provides for a two-year
term with renewal options, base salary of $220,000, an equity grant subject to vesting and forfeiture (exact number of shares
has not yet been determined), performance-based cash and equity bonuses to be determined by the Board of Directors and other benefits
commensurate with the other executive level employees of the Company, a 12-month severance for termination without cause or for
“good reason”, non-compete / non-solicitation covenants, and other standard benefits and features.
NOTE
12 - SUBSEQUENT EVENTS
The Company’s
institutional investor in the Follow-On Bridge Offering has provided an additional $40,000 in funding under that structure since
the end of the third quarter.
On November 9, 2018,
the Company completed the following transactions:
The Company transferred
the Stock Purchase Agreement (the “Purchase Agreement”) for the purchase of all the capital stock of George B. Wittmer
Associates Inc. (“GBWA”) and a previously paid deposit thereunder to Earth Property Holdings LLC, a Delaware limited
liability company (“Earth Property”), pursuant to a Transfer and Assignment Agreement (the “Transfer Agreement”).
In consideration for
the transfer of the Purchase Agreement to Earth Property, the Company was issued 124,999 Class B Units in Earth Property (the
“Class B Units”), equal to approximately 19.9% of the voting equity of that limited liability company at closing,
and received reimbursement for $109,020 of expenses incurred in connection with the diligence of GBWA and per terms in the Purchase
Agreement.
In connection with
the Transfer Agreement, the Company also signed an eight-year Management Agreement to oversee and manage all of the daily operations
of Earth Property (the “Management Agreement”) and GBWA. The Management Agreement provides a $200,000 per year fee
to the Company and can be terminated by Earth Property upon payment of a severance payment equal to one-year of management fees.
Concurrently with the
closing of the Transfer Agreement, Earth Property consummated a private offering in the amount of $4,400,000 for 500,000 of its
Class A Units (the “Class A Units”) to one institutional investor (the “Class A Unit Offering”), equal
at closing to approximately 80.1% of the voting equity of Earth Property. The Company’s CEO also participated in the Class
A Unit Offering through the institutional investor. The Class A Units provide an 8% per annum preferred distribution, and liquidation
preferences so that the Class A Unit holders will receive their preferred distribution and their capital account balance prior
to any distributions to the Class B Unit holder.
The rights and preferences
of the Class A Unit and Class B Unit members are set forth in a Limited Liability Company Agreement (the “LLC Agreement”),
executed concurrently with the Class A Unit Offering closing. Under the LLC Agreement and as contemplated in the Management Agreement,
the Company’s CEO, CFO and President were appointed to serve as President, Treasurer and Secretary, respectively, of Earth
Property. Also, the Company’s CEO was appointed to serve on the Board of Directors of Earth Property along with two other
appointees of the Class A Unit members.
Immediately subsequent
to the closing of the Class A Unit Offering, Earth Property closed the Purchase Agreement with GBWA and assumed control of that
company, its assets and operations. Based on a preliminary assessment, the Company will not consolidate the financial statements
of Earth Property or GBWA on an ongoing basis, as Earth Property is expected to be classified as an unconsolidated variable interest
entity, accounted for as an equity investment on the Company’s balance sheet with a cost basis of $50,000.