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 managing compost and soil manufacturing facilities, and is pursuing a plan of strategic acquisitions and investments in this
sector through an unconsolidated investee called Earth Property Holdings LLC, a Delaware limited liability company (“EPH”).
Through EPH, the Company completed one acquisition in November 2018 and a second in January 2019. The Company owns a 19.9% equity
interest in EPH and manages all of its operations pursuant to an eight-year management contract. 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.
NOTE
2 – BASIS OF PRESENTATION AND GOING CONCERN
For
the year ended December 31, 2018, the Company used cash in operating activities of $1,068,638. The accumulated deficit since inception
is $10,367,231, which is comprised of operating losses and other expenses. Additionally, certain of the Company’s
debentures and redeemable convertible preferred stock mature on July 1, 2019. 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 which may result in added management fees for the Company,
and continue to raise funds for the Company through debt or equity offerings.
The
consolidated financial statements do not include any adjustments that might result from the outcome of these uncertainties. The
Company has concluded that EPH is an unconsolidated investment. The primary investor and not the Company has ultimate control
over major decisions affecting EPH and the greatest economic risk.
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 2018, the
Company raised an additional $980,000 in convertible notes on substantially same terms as the Bridge Offering with three accredited
investors and one institutional investor (the “Follow-On Bridge Offering”).
In
July 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. The closing of this agreement was
subject to funding and other closing conditions. On November 9, 2018, the Company transferred the agreement to acquire GBWA to
EPH, and through EPH, consummated the GBWA acquisition. Concurrently with the GBWA closing: (i) the Company signed an eight-year
Management Agreement (the “Management Agreement”) with EPH to oversee all of the operations of EPH and its acquired
subsidiaries for an initial annual fee of $200,000; (ii) appointed the Company’s CEO and President to serve as President
and Secretary, respectively, of EPH; and (iii) pursuant to the terms of EPH’s Limited Liability Company Agreement (the “LLC
Agreement”) acquired 124,999 Class B Membership Units of EPH, equal to 19.9% of the voting interests of EPH, for $50,000.
To complete the GBWA acquisition, EPH raised $4.4 million from one institutional investor for 500,000 Class A Membership Units,
equal to 80.1% of the voting interest of EPH.
On
January 18, 2019, EPH completed its second acquisition of Employee Owned Nursery Enterprises Ltd., a Texas limited partnership
d/b/a Organics “by Gosh” (“OBG”). Concurrently with the OBG acquisition, the Company: (i) acquired an
additional 53,970 Class B Membership Units in EPH for $21,588; and (ii) received an additional annual management fee of $500,000
plus expenses in connection with the transaction.
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
On
January 1, 2018, the Company adopted ASC Topic 606, “Revenue from Contracts with Customers (“ASC 606”) and all
the related amendments. The Company elected to adopt this guidance using the modified retrospective method. The adoption of this
guidance did not have a material effect on the Company’s financial position, results of operations, or cash flows.
The
core principle of ASC 606 requires that an entity recognize revenue to depict the transfer of promised goods or services to customers
in an amount that reflects the consideration to which the company expects to be entitled in exchange for those goods or services.
ASC 606 defines a five-step process to achieve this core principle and, in doing so, it is possible more judgment and estimates
may be required within the revenue recognition process than previously required under U.S. GAAP, including identifying performance
obligations in the contract, estimating the amount of variable consideration to include in the transaction price and allocating
the transaction price to each separate performance obligation.
Revenue
for services in 2018 included a contract where the Company was paid for management of a related entity. 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 a specific performance obligation. Payments received before all the relevant criteria for revenue recognition are satisfied
are recorded as deferred revenue.
The
management services to be provided to our related party are performance obligations satisfied evenly over a period of time. Therefore,
revenue from this management service agreement are recognized on a straight-line basis over the one-year service period.
In
2017, revenue for services from the Company’s business included contracts where the Company was 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. Revenue from such services were recognized at the date of delivery of deliverables to customers when a formal arrangement
existed, the price was fixed or determinable, the delivery or milestone deliverable was completed, no other significant obligations
of the Company existed, and collectability was reasonably assured. 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
Black-Scholes option pricing valuation method is used to determine fair value of stock 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.
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 fair value of the Company’s stock on
contract execution.
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.
Equity
Method Investment
Investments
in partnerships, joint ventures and less-than majority-owned subsidiaries in which we have significant influence are
accounted for under the equity method. The Company’s consolidated net income includes the Company’s proportionate
share of the net income or loss of our equity method investee. When we record our proportionate share of net income, it
increases income (loss) — net in our consolidated statements of operations and our carrying value in that
investment. Conversely, when we record our proportionate share of a net loss, it decreases income (loss) — net
in our consolidated statements of income and our carrying value in that investment. The Company’s proportionate share
of the net income or loss of our equity method investees includes significant operating and nonoperating items recorded by
our equity method investee. These items can have a significant impact on the amount of income (loss) — net in
our consolidated statements of operations and our carrying value in those investments.
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 its long-lived assets to determine whether there are any impairment
losses. If indicators of impairment are present and future cash flows are not expected to be sufficient to recover the assets’
carrying amount, an impairment loss would be charged to expense in the period identified. To date, the Company has not recognized
any impairment charges.
Income
Taxes
Income
taxes are accounted for under the asset and liability method as stipulated by FASB ASC 740, “
Income Taxes
”
(“ASC 740”). Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences
between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating
loss and tax credit carry forwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply
to taxable income in the years in which those temporary differences are expected to be recovered or settled. Under ASC 740, the
effect on deferred tax assets and liabilities or a change in tax rate is recognized in income in the period that includes the
enactment date. Deferred tax assets are reduced to estimated amounts to be realized by the use of a valuation allowance. A valuation
allowance is applied when in management’s view it is more likely than not (50%) that such deferred tax will not be utilized.
In
the event that an uncertain tax position exists in which the Company could incur income taxes, the Company would evaluate whether
there is a probability that the uncertain tax position taken would be sustained upon examination by the taxing authorities. Reserves
for uncertain tax positions would be recorded if the Company determined it is probable that a position would not be sustained
upon examination or if payment would have to be made to a taxing authority and the amount is reasonably estimated. As of December
31, 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; however, federal returns have not been filed since the Company’s inception in 2014. Such delinquencies
are being resolved by management and a retained tax expert. Interest and penalties related to any unrecognized tax benefits
is recognized in the consolidated financial statements as a component of income taxes.
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 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.
Basic
and Diluted Loss Per Share
Net loss per share is
computed by dividing the net loss attributable to common stockholders by the weighted average number of common shares outstanding
during the period. Diluted net loss per share is calculated by dividing the net loss attributable to common stockholders
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.
At
December 31, 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, 37,970,259 shares that may be converted from Bridge Notes (based
upon an assumed conversion price at December 31, 2018 of $0.082 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 December 31, 2017, there were the following potentially dilutive securities that were excluded from
diluted net loss per share because their effect would be anti-dilutive: 6,915,480 shares from common stock options, 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 Bridge Notes, 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 fair value of stock based compensation, 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
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 expects
cash to be the asset most likely to subject the Company to concentrations of credit risk. The Company’s bank deposits
may at times exceed federally insured limits. The Company’s policy is to maintain its cash with high credit quality
financial institutions to limit its risk of loss exposure.
All the Company’s
revenue for the year ended December 31, 2018 was from fees earned from its 19.9% equity method investment, EPH, under a
management agreement. This is currently the Company’s sole source of revenue, and that agreement is terminable at will
by EPH.
NOTE
4 –PROPERTY AND EQUIPMENT, NET
Property
and equipment, net consists of the following:
|
|
December
31,
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 years ended December 31, 2018 and 2017 was $199 and $1,252 respectively.
NOTE
5 – EQUITY METHOD INVESTMENT
During November 2018,
the Company invested $50,000 for a 19.9% Class B limited liability membership interest in EPH and recorded this transaction
as an equity method investment due to the Company’s ability to exercise significant influence over EPH. The carrying
value of the investment in EPH was reduced to zero after recording the proportionate share of the investee’s net
loss for the year. The loss in equity investment has been presented on the consolidated statement of operations for
the year ended December 31, 2018. As EPH was formed in 2018, there were no assets, liabilities or results of operations in
2017. There were no distributions received from the equity method investment in 2018.
NOTE
6 – CYCLONE SEPARATION, LICENSE RIGHTS AND DEFERRED REVENUE
In
2014, Q2P purchased for $175,000 certain licensing rights to use Cyclone Power Technologies’ (“Cyclone”) patented
waste-to-power engine technology. 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 year ended December 31, 2018 and 2017 was $0 and $21,875, respectively.
In
January 2017, the Company transferred and assigned to Phoenix a Technology Sales Agreement to deliver a waste-to-power system
to a customer (the “Sales Agreement”). Under the Sales 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 Sales Agreement. Phoenix assumed
the Sales 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 Sales 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 year ended December 31, 2017.
In
August 2017, the Company closed a Technology Transfer and Assignment Agreement (the “Transfer Agreement”) with Phoenix
to transfer to Phoenix all of the Company’s technology and materials associated with Q2P’s external combustion engine,
controls and auxiliary systems (the “Q2P Technology”), developed both in conjunction with its license agreement with
Cyclone and such other Q2P Technology developed independently from the license agreement. Pursuant to a consent from Cyclone,
the Company also transferred and assigned the license agreement to Phoenix. In consideration for the transfer and assignment,
which included net property and equipment of $4,927, unamortized license fees to Cyclone of $47,396 and a payment to Cyclone of
$15,000 to consent to the license transfer, Phoenix satisfied and provided releases for $162,500 in past liabilities of Q2P associated
with the development of the Q2P Technology, made certain other payments to the Company’s prior engine manufacturer, and
provided full releases from liability from both Phoenix and Cyclone. The Company recorded a net gain from the extinguishment of
liabilities of $95,178 in the consolidated statement of operations for the year ended December 31, 2017.
In connection with the
separation agreement with Cyclone, the Company also assumed a contract with Clean Carbon of Australia and a corresponding $10,064
prepayment for services or other value to be provided in the future. This deposit has been presented as contract liabilities
on the December 31, 2018 and 2017 consolidated balance sheets.
NOTE
7 – 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 9). Further, $75,000 of the proceeds
from the Bridge Offering was received from the Company’s Chief Executive Officer and a Director.
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.
In
May 2018, we received $12,500 from our Chief Executive Officer and a Director in the Follow-On Bridge Offering (see Note 9).
During the year ended
December 31, 2018, the Company received $151,000 from our equity method investment (see Note 5) for prepaid management fees. As
of December 31, 2018, $117,667 of these fees remain as contract liabilities and we recognized $33,333 as revenues based on the
service period.
During the year ended
December 31, 2018, the Company incurred legal fees of approximately $48,000 from a law firm in which our audit committee chair
is an employee. As of December 31, 2018, our accounts payable and accrued expenses include approximately $30,000 due to
this law firm.
NOTE
8 – INCOME TAXES
A
reconciliation of the differences between the effective income tax rates and the statutory federal tax rates for the years ended
December 31, 2018 and 2017 (computed by applying the U.S. Federal corporate tax rate of 34 percent to the loss before taxes) is
as follows:
|
|
2018
|
|
|
2017
|
|
Tax benefit at U.S. statutory
rate
|
|
$
|
72,924
|
|
|
$
|
924,190
|
|
State taxes, net of federal benefit
|
|
|
15,088
|
|
|
|
60,548
|
|
Stock and stock based compensation
|
|
|
—
|
|
|
|
(80,291
|
)
|
Change in fair value of convertible
bridge notes and derivatives
|
|
|
339,559
|
|
|
|
(426,489
|
)
|
Amortization of preferred stock discount
|
|
|
—
|
|
|
|
(42,552
|
)
|
Gain on extinguishment of liabilities
|
|
|
—
|
|
|
|
155,285
|
|
Change of U.S. federal rate
|
|
|
—
|
|
|
|
(695,021
|
)
|
Other permanent differences
|
|
|
2,551
|
|
|
|
36,973
|
|
Change in valuation
allowance
|
|
|
(490,122
|
)
|
|
|
67,357
|
|
|
|
$
|
—
|
|
|
$
|
—
|
|
The
tax effect of temporary differences that give rise to significant portions of the deferred tax assets and liabilities for the
years ended December 31, 2018 and 2017 consisted of the following:
|
|
2018
|
|
|
2017
|
|
Net operating loss carry-forward
|
|
$
|
1,830,186
|
|
|
$
|
1,387,476
|
|
A
ccrued
interest
|
|
|
46,069
|
|
|
|
46,069
|
|
Stock based compensation
|
|
|
44,861
|
|
|
|
—
|
|
Deferred revenue
|
|
|
2,551
|
|
|
|
—
|
|
Depreciation
expense
|
|
|
343
|
|
|
|
343
|
|
Net deferred tax assets
|
|
|
1,924,010
|
|
|
|
1,433,888
|
|
Valuation allowance
|
|
|
(1,924,010
|
)
|
|
|
(1,433,888
|
)
|
Total net deferred
tax asset
|
|
$
|
—
|
|
|
$
|
—
|
|
At December 31, 2018 and
2017, the Company had net deferred tax assets of $1,924,010 and $1,433,888 principally arising from net operating loss
carry-forwards for income tax purposes (“NOLs”). As management of the Company cannot determine that it is more
likely than not that the Company will realize the benefit of the net deferred tax asset, a valuation allowance equal to the net
deferred tax asset has been established at December 31, 2018 and 2017. At December 31, 2018, the Company has net operating loss
carry forwards totaling $7,221,095, which will begin to expire in 2034. The Company is delinquent in filing its federal
tax returns for several of the previous year periods since inception. Therefore, all tax years since the Company’s inception
remain open for examination. Management has retained a tax professional to assist in bringing these filings current.
The
Tax Cut and Jobs Act which was enacted on December 22, 2017 reduced the federal corporate income tax rate from a maximum of 35%
to a flat 21%. On December 22, 2017, Staff Accounting Bulletin No. 118 (“SAB 118”) was issued to address the application
of U.S. GAAP in situations when a registrant does not have the necessary information available, prepared, or analyzed (including
computations) in reasonable detail to complete the accounting for certain income tax effects of the Act. Additionally, SAB 118
allows the Company to record provisional amounts during a measurement period not to extend beyond one year of the enactment date.
Because the Company is still in the process of analyzing certain provisions of the Tax Act, the Company has determined that the
adjustment to its deferred taxes is a provisional amount as permitted under SAB 118. Due to the reduction of the federal corporate
income tax rate the Company reduced the value of its net deferred tax asset in 2017 by approximately $695,000. This amount
was offset by a corresponding change to the valuation allowance against the net deferred tax assets.
The
Company’s NOL and tax credit carryovers may be significantly limited under the Internal Revenue Code (“IRC”).
NOL and tax credit carryovers are limited under Section 382 when there is a significant “ownership change” as defined
in the IRC. During the year ended December 31, 2018 and in prior years, the Company may have experienced such ownership changes,
which could impose such limitations.
The
limitations imposed by the IRC would place an annual limitation on the amount of NOL and tax credit carryovers that can be utilized.
When the Company completes the necessary studies, the amount of NOL carryovers available may be reduced significantly. However,
since the valuation allowance fully reserves for all available carryovers, the effect of the reduction would be offset by a reduction
in the valuation allowance.
NOTE
9 – 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 (the “Warrants”), 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 December 31, 2018 and 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. In March 2019, the Company and the holders
again extended the maturity date of the debentures to July 1, 2019 for no additional consideration.
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 (the “Bridge Notes”)
offering (collectively, the “Bridge Offering”). In addition, as part of that initial closing, three of
the Company’s directors converted $156,368 and one shareholder converted $11,784 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 2018, the Company raised an additional $980,000 in Follow-On
Bridge Offering notes on substantially same terms as the Bridge Offering (but with a two-year maturity) with three accredited
investors, one being our Chief Executive Officer and another a Director who each entered into a $12,500 Bridge Note, and one institutional
investor. In June 2018, one of the original Bridge Notes for $50,000 plus $7,664 accrued interest was converted by its
holder into 613,451 shares of common stock.
The
Bridge Notes from the Bridge Offering and the Follow-On Bridge Offering conducted in 2018 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 Bridge Notes are able to be converted. As of the date of filing, the Company
has not completed an Equity Offering defined in the Bridge Notes.
Pursuant
to ASC 825-10-25-1, Fair Value Option, the Company made an irrevocable election at the time of issuance to report the Bridge Notes
at fair value, with changes in fair value recorded through the Company’s consolidated statements of operations as other
income (expense) in each reporting period. The fair value recorded as of December 31, 2018 was $2,960,000 (see Note 10) and the
principal amount due was $2,771,908. The change in fair value resulted in a gain for the year ended December 31, 2018. The
fair value recorded as of December 31, 2017 was $3,270,000 (see Note 10) and the principal amount due was $1,841,908. The change
in fair value resulted in a charge to earnings for the year ended December 31, 2017 of $1,254,379.
The
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 subsequently issued 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.
NOTE
10 – 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 9, 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 December 31, 2018 and 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
|
|
|
|
|
|
|
|
|
|
|
|
|
December
31, 2018
|
|
|
Level
1
|
|
|
Level
2
|
|
|
Level
3
|
|
Convertible
Bridge Notes
|
|
$
|
2,960,000
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
2,960,000
|
|
Total
|
|
$
|
2,960,000
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
2,960,000
|
|
|
|
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 December 31, 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 of 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 periods.
|
|
Year
Ended
December 31, 2018
|
|
Fair value, December 31, 2017
|
|
$
|
3,270,000
|
|
Issuances of debt
|
|
|
980,000
|
|
Accrued interest
|
|
|
339,146
|
|
Conversions of debt and accrued interest
to shares of common stock
|
|
|
(57,664
|
)
|
Amortization of debt issuance costs
|
|
|
5,000
|
|
Net unrealized
gain on convertible bridge notes
|
|
|
(1,576,482
|
)
|
Fair value, December 31, 2018
|
|
$
|
2,960,000
|
|
|
|
Year
Ended
December 31, 2017
|
|
Fair value, December 31, 2016
|
|
$
|
0
|
|
Issuances of debt
|
|
|
1,841,908
|
|
Accrued interest
|
|
|
184,963
|
|
Amortization of debt issuance costs
|
|
|
(11,250
|
)
|
Net
unrealized loss on convertible bridge notes
|
|
|
1,254,379
|
|
Fair value, December 31, 2017
|
|
$
|
3,270,000
|
|
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 December 31, 2018: dividend yield
of -0-%, volatility of 170%, risk free rate of 2.59% and an expected term of 1.25 years. The fair value of the Bridge Note was
estimated based on the present value expected future cash flows using a discount rate of 20%.
NOTE
11 – COMMON STOCK, PREFERRED STOCK AND WARRANTS
Common
Stock
The
Company issued 3,000,000 fully vested shares of common stock in 2018 in connection with a seven-month services agreement
that ends March 31, 2019. The Company measured the fair value of the common stock issued based on the market price on contract
execution date as no specific performance by the grantee is required to retain the issued shares. For the year ended December
31, 2018, we recognized $154,286 of compensation expense for this service agreement based on the total fair value of shares issued
of $270,000 and the term of the service agreement.
The
Company issued
613,451 shares of common stock in 2018
in connection with the conversion of $50,000 of principal plus $7,664 of interest on the Bridge Notes (see Note 9).
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 1, 2019 pursuant to a new modification agreement signed in March 2019. 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 redemption date of the unconverted shares of Preferred Stock was extended to July 1, 2019 per a modification
agreement signed in March 2019.
Management
has determined that the Preferred Stock is more akin to a debt security than equity primarily because it contains a mandatory
2-year redemption at the option of the holder, which only occurs if the Preferred Stock is not converted to common stock.
Therefore, management has presented the Preferred Stock outside of permanent equity as mezzanine equity, which does not
factor in to the totals of either liabilities or equity. In 2016, the proceeds were allocated between the three features of
the stock offering: the embedded conversion feature in the Preferred Stock, the warrants, and the Preferred Stock itself. The
fair values of the embedded conversion feature and warrants were recorded as a discount against the stated value of
the Preferred Stock on the date of issuance. This discount was amortized to interest expense over the term of the
redemption period (2 years), which would result in the accretion of the Preferred Stock to its full redemption value.
Unamortized discount as of December 31, 2018 and 2017 was $0 and $1,062, respectively. Interest expense related to the
preferred stock discount for the years ended December 31, 2018, and 2017 was $1,062 and $125,155,
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 December 31, 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
|
|
|
|
0.75
|
|
Warrants issued in connection with issuance
of Preferred Stock
|
|
|
1,153,845
|
|
|
$
|
0.50
|
|
|
|
2.05
|
|
Warrants issued in connection with a
services contract
|
|
|
1,000,000
|
|
|
$
|
0.20
|
|
|
|
1.48
|
|
Warrants issued in connection with a
services contract
|
|
|
1,000,000
|
|
|
$
|
0.35
|
|
|
|
1.48
|
|
During
the year ended December 31, 2018, we committed to issuing warrants to purchase 150,000 shares of common stock at $.04 per share
and expiring in five years, to one of our consultants prior to the consummation of any merger or equity financing of more than
$1,000,000. These warrants are provisional and are not considered outstanding or granted as of December 31, 2018.
NOTE
12 – 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.
This authorized amount was increased to 10 million shares by Board resolution and amendment to the 2016 Plan in 2017.
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 estimated expected term 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 5,331,000 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 as stock
option expense in 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 year ended December 31, 2018 was $177,178.
A
summary of the common stock options issued under the Option Plans and the 2016 Plan for the period from December 31, 2017 through
December 31, 2018 follows:
|
|
Number
Outstanding
|
|
|
Weighted
Avg.
Exercise
Price
|
|
|
Weighted
Avg.
Remaining
Contractual
Life (Years)
|
|
Balance, December 31, 2016
|
|
|
6,115,480
|
|
|
$
|
0.21
|
|
|
|
7.1
|
|
Options issued
|
|
|
800,000
|
|
|
|
0.21
|
|
|
|
9.2
|
|
Options exercised
|
|
|
-
|
|
|
|
|
|
|
|
|
|
Options cancelled
|
|
|
-
|
|
|
|
|
|
|
|
|
|
Balance, December 31, 2017
|
|
|
6,915,480
|
|
|
$
|
0.21
|
|
|
|
5.6
|
|
Options issued
|
|
|
1,600,000
|
|
|
|
0.10
|
|
|
|
9.3
|
|
Options exercised
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
Options cancelled
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
Balance, December 31, 2018
|
|
|
8,515,480
|
|
|
$
|
0.12
|
|
|
|
5.5
|
|
The
vested and exercisable options at period end follows:
|
|
Exercisable/
Vested
Options
Outstanding
|
|
|
Weighted
Avg. Exercise
Price
|
|
|
Weighted
Avg.
Remaining
Contractual
Life
(Years)
|
|
Balance, December 31,
2018
|
|
|
8,515,480
|
|
|
$
|
0.19
|
|
|
|
6.00
|
|
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 for the year ended December 31, 2018:
|
|
Year
Ended
December
31, 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
|
|
The fair value of new
stock options and warrants granted using the Black-Scholes option pricing model was calculated using the following assumptions
for the year ended December 31, 2017:
|
|
Year
Ended
December
31, 2017
|
|
Risk
free interest rate
|
|
|
1.28-1.84
|
%
|
Expected
volatility
|
|
|
101.2-125.0
|
%
|
Expected
dividend yield
|
|
|
0
|
%
|
Expected
term in years
|
|
|
2.08-5.25
|
|
Average
value per options
|
|
$
|
0.04-0.08
|
|
Expected
volatility is based on historical volatility of 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
13 – COMMITMENTS AND CONTINGENCIES
In
April 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 annual salaries under these Employment Agreements
are $350,000 and $220,000, respectively, and agreements have provisions for severances in the instance either executive is terminated
without cause or after a change in control (24 months for the CEO and 12 months for the President).
Pursuant
to a services agreement signed in 2018, an additional 150,000 warrants with a five-year term and exercisable at $0.04 per share
are issuable to the provider, but were not formally issued in 2018.
NOTE
14 - SUBSEQUENT EVENTS
On
January 18, 2019, in connection with the closing of EPH’s second acquisition and additional equity funding, the Company
purchased 53,970 Class B Units in EPH for $21,588. With this purchase, the Company maintained its 19.9% voting interest in EPH.
Also in connection with this acquisition closing, EPH paid the Company an additional $500,000 annual management fee.
In
March 2019, the Company signed modification agreements with the two holders of the Company’s Preferred Stock and Convertible
Debentures to extend the redemption and maturity dates of those securities to July 1, 2019, and to waive any prior defaults thereunder.