NOTES
TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
NOTE
1 – ORGANIZATION AND DESCRIPTION OF BUSINESS
Q2Earth,
Inc. (hereinafter the “Company” or “we”, “our”, “us”), 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. As of March 31, 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
Basis
of Presentation
The
accompanying interim unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles
generally accepted in the United States of America and the rules and regulations of the United States Securities and Exchange
Commission for interim financial information, which includes condensed consolidated financial statements and present the consolidated
financial statements of the Company and its wholly-owned subsidiary as of March 31, 2019. All intercompany transactions and balances
have been eliminated. Accordingly, the condensed consolidated financial statements do not include all the information and notes
necessary for a comprehensive presentation of financial position and results of operations and should be read in conjunction with
the audited financial statements of the Company for the year ended December 31, 2018 and included in the form 10-K filed with
the SEC on April 1, 2019. It is management’s opinion that all material adjustments (consisting of normal recurring
adjustments) have been made, which are necessary for a fair financial statement presentation. The results for the interim period
are not necessarily indicative of the results to be expected for the year ending December 31, 2019.
Going Concern
For the three months
ended March 31, 2019 the Company had cash provided by operating activities of $42,825. For the three months ended March
31, 2019, the Company incurred a loss of $505,488 and the accumulated deficit since inception was $10,872,719, which
was comprised of operating losses and other expenses. Additionally, certain of the Company’s debentures and redeemable
convertible preferred stock mature on July 1, 2019. The total principal due on the debentures as of March 31, 2019 is $165,000.
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
condensed 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 equity method 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 (which was subsequently increased by amendment to $700,000, $300,000
of which is provided for the management of GBWA); (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 through a subscription payable which is included in accrued expenses on the consolidated
balance sheets; and (ii) received an additional annual management fee of $500,000 plus expenses in connection with
the transaction.
Our
net loss resulted largely from our funding of activities related to the execution of our business strategy of facilitating the
acquisition of and investment in and managing compost manufacturing businesses, including conducting due diligence and incurring
consulting and professional expenses and hiring additional employees to support these operations, as well as ongoing general and
administrative expenses.
Management
is aware of the Company’s liquidity and going concern issues and is taking steps to improve its negative cashflow. Management
anticipates facilitating additional acquisitions through EPH in 2019, and upon the completion of such transactions, expects that
its management fee to oversee the operations of EPH and its subsidiaries may be increased. Further, management is pursuing other
revenue producing contracts and opportunities for the Company including licensing or developing soil science and product brands
that can generate revenue through sublicenses and soil sales either from EPH or other companies, and also utilizing its experience
in completing acquisitions to help facilitate non-competitive transactions for third parties for a fee. Management may also seek
to raise additional capital through equity and debt offerings.
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.
During the three
months ended March 31, 2019, revenue consists of management services performed by the Company for our equity method investment,
EPH. In its review of contracts with customers, 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 contract liabilities.
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.
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.
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 March
31, 2019, 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 March 31, 2019,
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, 41,984,478 shares that may be converted from Bridge Notes (based upon an assumed conversion
price at March 31, 2019 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 March 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: 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. Effective January 1, 2019 the Company
adopted ASU 2016-02 which did not have an impact on our condensed interim financial statements as the Company has no
leases that meet the scope of ASC 842.
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. Effective January 1, 2019 the Company adopted ASC 2018-07 and
it did not have an impact on our interim financial statements.
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 three months ended March 31, 2019 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. See
Note 5.
NOTE
4 –PROPERTY AND EQUIPMENT, NET
Property
and equipment, net consists of the following:
|
|
March 31, 2019
|
|
|
December 31, 2018
|
|
Furniture and computers
|
|
$
|
1,328
|
|
|
$
|
1,328
|
|
Total
|
|
|
1,328
|
|
|
|
1,328
|
|
Accumulated depreciation
|
|
|
(1,107
|
)
|
|
|
(974
|
)
|
Net property and equipment
|
|
$
|
221
|
|
|
$
|
354
|
|
Depreciation
expense for the three months ended March 31, 2019 and 2018 was $133 and $66 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. In January 2019, the Company committed an additional $21,588 through a subscription payable to maintain its 19.9%
Class B limited liability interests in EPH, after additional Class A units were sold to investors. The $21,588 remains due
at March 31, 2019 and is included in accounts payable and accrued expenses on the consolidated balance sheets. The carrying
value of the investment remains at zero at March 31, 2019. The loss in equity investment has been presented on the consolidated
statement of operations for the three months ended March 31, 2019. There were no distributions received from the equity method
investment through the first quarter of 2019.
For
the three months ended March 31, 2019, EPH generated revenue of $2,642,935 and recorded a net loss of $531,894. The net loss was
due in material part from fees paid to the Company under its Management Agreement, as well as expenses incurred in connection
with the OBG closing on January 18, 2019, and related funding activities.
See
Note 6 for transactions with our equity method investment during the three-month period ended March 31, 2019.
NOTE
6 – RELATED PARTY TRANSACTIONS
The
Company currently maintains an executive office in Florida, which is leased by GreenBlock Capital LLC, an investment firm in which
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 for which our CEO previously served as a senior executive.
In
May 2018, we received $12,500 from our Chief Executive Officer and a Director in the Follow-On Bridge Offering (see Note 7).
During the three months ended March 31, 2019, the Company received an additional $549,000 from our equity
method investment (see Note 5) for prepaid management fees. As of March 31, 2019, $492,857 of these accumulated fees remain as
contract liabilities and we recognized $173,810 as revenues based on the service period. As of December 31, 2018, $117,667 of these
fees remained as contract liabilities.
During
the three months ended March 31, 2019, the Company received $62,500 from EPH as a note payable with interest payable at 6% annually.
This has been presented as note payable – related party on the consolidated balance sheets.
During the three
months ended March 31, 2019, the Company did not incur any legal fees with a related party; however, during the three months ended
March 31, 2018, the Company incurred approximately $14,773 from a law firm in which our audit committee chair is an employee.
As of March 31, 2019 and December 31, 2018, our accounts payable and accrued expenses include approximately $3,356
and $30,000, respectively, for legal fees incurred in the prior year with this law firm.
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 (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 March 31, 2019, and December 31, 2018, 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
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 March 31, 2019 was $2,850,000 (see Note 8) and
the principal amount due was $2,771,908. The change in fair value resulted in a gain for the three months ended March 31, 2019
of $250,188. The fair value recorded as of December 31, 2018 was $2,960,000 (see Note 8) and the principal amount due was
$2,771,908.
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
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 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 March 31, 2019 and December 31, 2018. 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
|
|
|
|
|
|
|
|
|
|
|
|
|
March 31, 2019
|
|
|
Level 1
|
|
|
Level 2
|
|
|
Level 3
|
|
Convertible Bridge Notes
|
|
$
|
2,850,000
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
2,850,000
|
|
Total
|
|
$
|
2,850,000
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
2,850,000
|
|
|
|
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
|
|
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.
|
|
Three Months Ended
March
31, 2019
|
|
Fair value, December 31, 2018
|
|
$
|
2,960,000
|
|
Issuances of debt
|
|
|
-
|
|
Accrued interest
|
|
|
138,938
|
|
Conversions of debt and accrued interest to shares of common stock
|
|
|
-
|
|
Amortization of debt issuance costs
|
|
|
1,250
|
|
Net unrealized gain on convertible bridge notes
|
|
|
(250,188
|
)
|
Fair value, March 31, 2019
|
|
$
|
2,850,000
|
|
|
|
Three
Months Ended
March 31, 2018
|
|
Fair
value, December 31, 2017
|
|
$
|
3,270,000
|
|
Issuances
of debt
|
|
|
-
|
|
Accrued
interest
|
|
|
68,125
|
|
Conversions
of debt and accrued interest to shares of common stock
|
|
|
-
|
|
Amortization
of debt issuance costs
|
|
|
1,250
|
|
Net
unrealized gain on convertible bridge notes
|
|
|
(449,375
|
)
|
Fair
value, March 31, 2018
|
|
$
|
2,890,000
|
|
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 March 31, 2019: dividend yield of
-0-%, volatility of 135%, risk free rate of 2.43% and an expected term of 1 year. The fair value of the Bridge Note was estimated
based on the present value expected future cash flows using a discount rate of 23%.
NOTE
9 – COMMON STOCK, PREFERRED STOCK AND WARRANTS
Common
Stock
During the three months
ended March 31, 2019, the Company recognized $115,714 of stock-based compensation.
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.
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 March 31, 2019:
|
|
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
|
|
|
|
0.50
|
|
Warrants issued in connection with issuance of Preferred Stock
|
|
|
1,153,845
|
|
|
$
|
0.50
|
|
|
|
1.85
|
|
Warrants issued in connection with a services contract
|
|
|
1,000,000
|
|
|
$
|
0.20
|
|
|
|
1.23
|
|
Warrants issued in connection with a services contract
|
|
|
1,000,000
|
|
|
$
|
0.35
|
|
|
|
1.23
|
|
The following is a
summary of all outstanding common stock warrants as of March 31, 2018:
|
|
Number of
Warrants
|
|
|
Exercise price
per share
|
|
|
Average
remaining
term in years
|
|
Warrants issued in connection with issuance of Debentures
|
|
|
415,000
|
|
|
$
|
0.50
|
|
|
|
0.50
|
|
Warrants issued in connection with issuance of Preferred Stock
|
|
|
1,153,845
|
|
|
$
|
0.50
|
|
|
|
1.85
|
|
Warrants issued in connection with a services contract
|
|
|
1,000,000
|
|
|
$
|
0.20
|
|
|
|
1.23
|
|
Warrants issued in connection with a services contract
|
|
|
1,000,000
|
|
|
$
|
0.35
|
|
|
|
1.23
|
|
Warrants issued in connection with a services contract
|
|
|
150,000
|
|
|
$
|
0.04
|
|
|
|
4.75
|
|
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 March 31, 2019 or December 31, 2018.
NOTE
10 – 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 and remain unissued.