NOTES
TO THE CONDENSED 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 18.5% 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 wastewater 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.
The Company is also exploring other technology and business lines in the broader biosciences sector to either add to its soil
health line, or transfer into over the following year.
NOTE
2 – BASIS OF PRESENTATION AND GOING CONCERN
For
the three months ended March 31, 2020, the Company used cash in operating activities of $147,486 and incurred a loss of
$437,402. The accumulated deficit since inception is $11,486,612, which was comprised of operating losses and other
expenses. Additionally, certain of the Company’s debentures totaling $165,000 and redeemable convertible preferred stock
matured on July 1, 2019 and are currently in default. Management is in discussions with the holders to either extend the maturity
dates or find an alternate settlement solution.
As
of March 31, 2020, $2,771,908 of convertible bridge notes plus accrued and capitalized interest of $1,180,526, will
begin to mature through October 2020 with an additional $34,032 in principal and accrued interest maturing in 2021; provided however,
all bridge note that were due to mature on March 31, 2020 have been extended by agreement with the holders until June 15, 2020.
As
of March 31, 2020, the Company had a working capital deficit of $4,182,941.
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.
Alternatively, the Company would need to find another line of business if such current activities cannot support ongoing operations,
which may become likely.
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 and
2019, the Company raised an additional $980,000 and $30,000, respectively, in convertible notes on substantially same terms as
the Bridge Offering with three accredited investors and one institutional investor (the “Follow-On Bridge Offering”).
As of March 31, 2020, a total principal amount of $2,801,908 and approximately $1,183,429 of accrued interest remains
due on the Bridge Offering notes.
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. 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 accounts payable
and 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.
In
May 2019, the Company signed a services agreement with Community Eco Power, LLC (“CECO”) to assist that company complete
an acquisition of two waste-to-power facilities in New England, and to assist management transition operations over the following
six months. The acquisition closed on May 15, 2019. Two of the Company’s officers and directors each own minority equity
stakes in CECO. The fee for the Company’s services was $250,000, all of which was recognized as revenue in 2019.
The
Company’s net loss resulted largely from the
funding of activities related to the execution of the Company’s 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
may be able to facilitate additional acquisitions through EPH in 2020, and upon the completion of such transactions, may receive
additional management fees to oversee the operations of EPH and its subsidiaries. However, this agreement can be terminated at-will
by EPH. 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, looking at synergistic business lines in agricultural technology and the broader biosciences sector, and also
utilizing its experience in completing acquisitions to help facilitate non-competitive transactions for third parties for a fee.
In
the second quarter of 2019, the Company licensed soil technology called ABS from Agrarian Technologies, Inc., for which the Company
is currently pursuing sales and distributorship agreements but has not yet been able to generate any material revenue from these
activities. The Company pays a minimum royalty under this license agreement to the licensor of $7,500 per quarter, $22,500 of
which has been accrued but not paid as of March 31, 2020; and then pays royalties on the sales of the ABS product based on volume
sold to the extent such volume royalties exceed the minimum royalties. 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. The Company held no cash equivalents as of March
31, 2020 and 2019.
Revenue
Recognition
The
Company recognizes revenue in accordance with ASC Topic 606,
“Revenue from Contracts with Customers (“ASC 606”) and all the related amendments.
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 2020 and 2019 included contracts where the Company was paid for management of related entities. 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 contract liabilities.
The
management services to be provided to the Company’s related parties are performance obligations satisfied evenly over a
period of time. Therefore, revenue from these management service agreements are recognized on a straight-line basis over the service
period.
During
the three months ended March 31, 2020 and 2019, revenues generated by the Company were from one customer which is related
to the Company.
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.
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.
Equity
Method Investment
Investments
in partnerships, joint ventures and less-than majority-owned subsidiaries in which the Company has significant influence
are accounted for under the equity method. The Company’s consolidated net loss includes the Company’s proportionate
share of the net income or loss of the Company’s equity method investee. The Company’s proportionate
share of net income from its equity method investee, increases income (loss) — net in the consolidated statements
of operations and the carrying value in that investment. Conversely, the Company’s proportionate share of
a net loss from its equity method investee, decreases income (loss) — net in the consolidated statements of
income and the carrying value in that investment. The Company’s proportionate share of the net income or loss of
any equity method investees includes significant operating and nonoperating items recorded by the Company’s
equity method investee. These items can have a significant impact on the amount of income (loss) — net in the consolidated
statements of operations and the carrying value in those investments.
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, 2020, 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.
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, 2020, there were the following potentially dilutive securities that were excluded from diluted net loss per share because
their effect would be anti-dilutive: 11,715,480 shares from common stock options, 3,153,845 shares from common stock warrants,
1,650,000 shares from the conversion of debentures, 50,314,284 shares that may be converted from Bridge Notes (based upon
an assumed conversion price at March 31, 2020 of $0.079 per share), and 7,569,210 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, 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).
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 convertible bridge notes, and the assessment
and recognition of income taxes and contingencies. Actual results could differ from these estimates.
Recent
Accounting Pronouncements
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 adopted this guidance effective January 1, 2020 and the adoption did not have a material
impact on the condensed 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
of the Company’s revenue for the three months ended March 31, 2020 and 2019 was from fees earned from its equity method
investment, EPH, under a management agreement. This is currently the Company’s primary source of on-going revenue, and that
agreement is terminable at will by EPH. See Note 4.
NOTE
4 – 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 2018 fiscal 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 Class
B units only receive value after all Class A unit holders receive a full return on their investment plus an 8% annual PIK dividend.
The $21,588 remains due at March 31, 2020 and December 31, 2019 and is included in accounts payable and accrued
expenses on the condensed consolidated balance sheets. The carrying value of the investment remains at zero at March
31, 2020 and December 31, 2019 due to continued losses incurred by EPH. The loss in equity investment has been presented on
the condensed consolidated statement of operations for the three-month periods ended March 31, 2020 and 2019. There
were no distributions received from the equity method investment in 2020 or 2019.
In
2019, EPH issued an additional 70,057 Class A Units in consideration for $616,500 additional investments. The Company did not
purchase additional Class B Units during this time, and as a result, its equity stake in EPH was diluted to 18.5%. Management
expects this equity percentage to be significantly diluted in the following reporting periods as EPH raises additional capital
to further its acquisition strategy. While the Company can invest alongside these new investments, management does not anticipate
the Company will have the funds to do so.
For
the quarter ended March 31, 2020, EPH generated unaudited revenue of $2,673,880 and recorded an unaudited net loss of $563,626.
See
Note 5 for transactions with our equity method investment during the three-month periods ended March 31, 2020 and 2019.
NOTE
5 – RELATED PARTY TRANSACTIONS
The
Company currently maintains an executive office in Florida, which is leased by an investment firm in which the Company’s
President previously served as an officer but never held any equity or voting rights. The Company has no formal agreement for
this space and pays no rent.
During
the three months ended March 31, 2020 and 2019, the Company recognized $174,999 and $173,810 as revenues based on management
services provided to the Company’s equity method investee (see Note 4) which have been presented as revenues –
related party on the condensed consolidated statement of operations.
During
the year ended December 31, 2019, the Company received $788,500 from EPH under multiple demand notes payable with interest payable
at 6% annually. This has been presented as note payable – related party on the condensed consolidated balance sheets.
During the three months ended March 31, 2020, the Company received an additional $147,672 from EPH as a note payable with
interest payable at 6% annually. As of March 31, 2020 and December 31, 2019, accrued interest on these notes payable was
$28,507 and $15,426 as presented on the condensed consolidated balance sheets.
During
the three months ended March 31, 2020 and 2019, the Company incurred approximately $27,104 and $0, in legal fees with a law firm
in which the Company’s audit committee chair is an employee. As of March 31, 2020 and December 31, 2019, accounts
payable and accrued expenses include $37,679 and $10,575, respectively, for legal fees due to the law firm for services.
In
May 2019, the Company signed a worldwide, exclusive license agreement with Agrarian Technologies LLC and its affiliates (“Agrarian”)
to sell Agrarian’s proprietary bio-stimulant. The license also provides the Company with the exclusive rights to market
soil and mulch products under the Wild Earth® and Mulch Masters® federally registered trademarks. As part of the transaction,
the Company hired the principal owner of Agrarian and inventor of its technology to serve as the Company’s vice president
of product development (“VP”). The license agreement provides the Company exclusivity for the Agrarian technology
for the longer of two years or the term of the VP with the Company plus an additional two years; provided however, if VP is terminated
without cause, such exclusivity would concurrently terminate. The license agreement requires quarterly licensing fees based on
a percentage of sales and a minimum fee of $30,000 per year paid quarterly. As of March 31, 2020 and December 31, 2019,
$22,500 and $15,000 of license fees have been accrued and included in accounts payable and accrued expenses on the
condensed consolidated balance sheets.
NOTE
6 – NOTES PAYABLE AND DEBENTURES
The
Company has Original Issue Discount Senior Secured Convertible Debentures (the “Debentures”) with two holders in the
aggregate amount of $165,000 as of March 31, 2020 and December 31, 2019, and which currently are convertible at $0.10 per
share and were due July 1, 2019. All assets of the Company are secured under the Debentures, including our Subsidiary and
its assets. The Debentures 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. The Debentures
are currently in default and the Company is in negotiations with the holders to reach a new modification agreement or other resolution.
If a resolution cannot be reached, the holder can accelerate all payments due, demand default interest, foreclose on the assets
of the Company, or pursue other legal remedies available to it.
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
2019, one of these investors provided an additional $30,000 in Bridge Notes. 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 and 2019 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 condensed consolidated statements of operations
as other income (expense) in each reporting period. The estimated fair value of the Bridge Notes as of March 31,
2020 and December 31, 2019 was $2,574,000 and $2,473,000 (see Note 7) and the principal amount due
was $2,801,908. The change in fair value resulted in a gain for the three months ended March 31, 2020 and 2019 of
$31,357 and $250,188, respectively, which is presented as change in fair value of convertible bridge notes on the condensed
consolidated statements of operations.
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.
As
of March 31, 2020, approximately 23 of the Bridge Notes with a principal balance of $1,743,256 were due to mature. The Company
received extensions from the holders of the maturity date until June 15, 2020. No additional consideration was paid to the holders
for their agreement to extend the maturity date.
NOTE
7 – 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 6, the Bridge Notes are reported at fair value, with changes in fair value recorded through the Company’s
condensed consolidated statements of operations as a component of 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, 2019 and 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, 2020
|
|
|
Level
1
|
|
|
Level
2
|
|
|
Level
3
|
|
Convertible
Bridge Notes
|
|
$
|
2,574,000
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
2,574,000
|
|
Total
|
|
$
|
2,574,000
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
2,574,000
|
|
|
|
Fair
value at
|
|
|
|
|
|
|
|
|
|
|
|
|
December
31, 2019
|
|
|
Level
1
|
|
|
Level
2
|
|
|
Level
3
|
|
Convertible
Bridge Notes
|
|
$
|
2,473,000
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
2,473,000
|
|
Total
|
|
$
|
2,473,000
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
2,473,000
|
|
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, 2020
|
|
Fair value, December 31, 2019
|
|
$
|
2,473,000
|
|
Accrued interest
|
|
|
131,107
|
|
Amortization of debt issuance costs
|
|
|
1,250
|
|
Net unrealized
gain on convertible bridge notes
|
|
|
(31,357
|
)
|
Fair value, March 31, 2020
|
|
$
|
2,574,000
|
|
|
|
Three Months Ended
March 31, 2019
|
|
Fair value, December 31, 2018
|
|
$
|
2,960,000
|
|
Accrued interest
|
|
|
138,938
|
|
Amortization of debt issuance costs
|
|
|
1,250
|
|
Net unrealized
gain on convertible bridge notes
|
|
|
(250,188
|
)
|
Fair value, March 31, 2019
|
|
$
|
2,850,000
|
|
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, 2020: dividend yield of
-0-%, volatility of 158.1%, risk free rate of 0.09% and an expected term of .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%. 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
8 – COMMON STOCK, PREFERRED STOCK AND WARRANTS
Common
Stock
On February 7,
2020, the Company’s stockholders approved an increase in the Company’s authorized common shares from 100,000,000 to
300,000,000.
The
Company issued 5,000,000 shares of common stock in the first quarter of 2020 in connection with a services contract valued at
$50,000, which is being expensed over the six-month service term of the contract. During the three months ended
March 31, 2020, the Company recognized $20,833 of stock-based compensation which is included in professional fees on the condensed
consolidated statement of operations. 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.
During
the three months March 31, 2019, the Company recognized $115,714 of stock-based compensation in connection with a six-month service
contract which is included in professional fees on the condensed consolidated statement of operations.
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. The Preferred Stock
is currently in default, and the Company is negotiating a modification with the holders. If a resolution cannot be reached, the
holder can accelerate the redemption due, foreclose on the assets of the Company, or pursue other legal remedies available to
it. 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.
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 into the totals
of either liabilities or equity.
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
During
the three months ended March 31, 2020, the Company did not issue any warrants nor did any warrants expire. The following
is a summary of all outstanding common stock warrants as of March 31, 2020:
|
|
Number
of
Warrants
|
|
|
Exercise
price
per share
|
|
|
Average
remaining
term in years
|
|
Warrants
issued in connection with issuance of Preferred Stock
|
|
|
1,153,845
|
|
|
$
|
0.50
|
|
|
|
0.85
|
|
Warrants
issued in connection with a services contract
|
|
|
1,000,000
|
|
|
$
|
0.20
|
|
|
|
0.23
|
|
Warrants
issued in connection with a services contract
|
|
|
1,000,000
|
|
|
$
|
0.35
|
|
|
|
0.23
|
|
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, 2020.
NOTE
9 – 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. The 2016 Plan, as amended, was approved by the Company’s shareholders in January 2020.
The
Company issued 3,200,000 stock options in the first three months of 2020, one million each to two of the Company’s
independent directors, 500,000 each to one other independent director and one Board observer, and 200,000 to a new director.
The options issued to the current directors and Board obverse were fully vested upon issuance, are exercisable at a
price of $0.02 per share, and expire ten years after issuance. The 200,000 options to the new director vest half in
12 months and the balance in 24 months, expire in five years, and are exercisable at $0.02 per share. The options were valued
at $18,023 (pursuant to the Black Scholes valuation model see below), based on an exercise price of $0.02 per share
and estimated expected term of 5.0 years. The Company did not issue any stock options in the first three months of 2019.
Option
Repricing
On
January 6, 2020, 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 January 6, 2020. Under the Option Repricing, Eligible Options with an exercise price at or above $0.10 per share
(representing an aggregate of 6,311,000 options, or 54% of the total outstanding) were amended to reduce such exercise
price to $0.02.
The
impact of the Option Repricing was a one-time incremental non-cash charge of $6,304, which was recorded as
stock option expense in the first quarter of 2020 which is included in general and administrative expenses on the
condensed consolidated statement of operations.
Total
stock-based compensation for stock options issued and the one-time incremental charge for the Option Repricing for the
three months ended March 31, 2020 was $24,327. There was no stock-based compensation recognized in 2019 related to stock
options.
A
summary of the common stock options issued under the Option Plans and the 2016 Plan for the period March 31, 2020 is
as follows:
|
|
Number
Outstanding
|
|
|
Weighted
Avg. Exercise
Price
|
|
|
Weighted
Avg.
Remaining
Contractual
Life (Years)
|
|
Balance, December 31, 2019
|
|
|
8,515,480
|
|
|
$
|
0.12
|
|
|
|
4.5
|
|
Options issued
|
|
|
3,200,000
|
|
|
|
0.02
|
|
|
|
9.8
|
|
Balance, March 31, 2020
|
|
|
11,715,480
|
|
|
|
0.07
|
|
|
|
6.5
|
|
The
vested and exercisable options at period end follows:
|
|
Exercisable/
Vested
Options
Outstanding
|
|
|
Weighted
Avg. Exercise
Price
|
|
|
Weighted
Avg.
Remaining
Contractual
Life
(Years)
|
|
Balance,
March 31, 2020
|
|
|
11,515,480
|
|
|
$
|
0.07
|
|
|
|
6.5
|
|
The
fair value of new stock options granted and repriced stock options using the Black-Scholes option pricing model was calculated
using the following assumptions for the three months ended March 31, 2020:
|
|
Three
Months Ended
March 31, 2020
|
|
Risk
free interest rate
|
|
|
1.610
|
%
|
Expected volatility
|
|
|
149.67
|
%
|
Expected dividend
yield
|
|
|
-
|
%
|
Expected term
in years
|
|
|
5.0
|
|
Expected
volatility is based on historical volatility of a group of 4 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 defines the expected life as the average of the contractual term of the options and the weighted average vesting
period for all issuances.
NOTE
10 – COMMITMENTS AND CONTINGENCIES
When
the Company sold the ESI subsidiary to three former shareholders following the 2015 Merger, that company had a judgment against
it from a litigation brought in the Superior Court of the County of Iredell, North Carolina, seeking payment of wages of approximately
$25,000, together with vacation pay, the value of health insurance benefits and medical expenses. On April 10, 2015, the Court
entered judgment against ESI in favor of the plaintiff. Claims made by the plaintiff against AnPath (the Company at that time)
and certain of the officers and directors of Anpath at that time were dismissed by the Court. The Company does not believe it
has any liability in this matter, and that the judgment was properly retained by ESI in the sale; however, the judgment is to
the knowledge of management still outstanding and management cannot guaranty that it will not be brought back into the litigation
or collection efforts in the future.
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 have not formally been issued as of March 31, 2020 and are not considered
outstanding.
As
disclosed in Note 5, in May 2019, the Company signed a worldwide, exclusive license agreement with Agrarian Technologies
LLC and its affiliates (“Agrarian”) to sell Agrarian’s proprietary ABS bio-stimulant, an organic, natural compound
designed to enhance root formation, increase vascular strength and promote overall plant health through the entire growth cycle.
The license also provides the Company with the exclusive rights to market soil and mulch products under the Wild Earth® and
Mulch Masters® federally registered trademarks. The agreement is 10-years with renewal terms, and provides Agrarian royalties
based on the sale of the ABS formula including minimum annual guarantees of $30,000 paid quarterly.
In
March 2020, the World Health Organization declared COVID-19 a global pandemic and recommended containment and mitigation measures
worldwide. The Company is monitoring this closely, and although operations have not been materially affected by the COVID-19 outbreak
to date, the ultimate duration and severity of the outbreak and its impact on the economic environment and business is uncertain.
Accordingly, while the Company does not anticipate an impact on its operations, the Company cannot estimate the duration of the
pandemic and potential impact on its business. In addition, a severe or prolonged economic downturn could result in a variety
of risks to the business, including a possible delay in the Company’s ability to raise money. At this time, the Company
is unable to estimate the impact of this event on its operations.
NOTE
11 - SUBSEQUENT EVENTS
On
April 20, 2020, the Company established QSAM Therapeutics Inc. (“QSAM”), as a wholly-owned subsidiary incorporated
in the state of Texas. On the same date, QSAM executed a Patent and Technology License Agreement and Trademark Assignment (the
“License Agreement”) with IGL Pharma, Inc. (“IGL”).
The
License Agreement provides QSAM with exclusive, worldwide and sub-licensable rights to all of IGL’s patents, product data
and knowhow with respect to Samaium-153 DOTMP (the “Technology”), a clinical stage novel radiopharmaceutical meant
to treat different types of bone cancer and related diseases. The Technology was developed by ISO Therapeutics Group, LLC (“ISO”)
and previously transferred to IGL, a company majority owned by the founders of ISO. The License Agreement also transfers to QSAM
the rights to the product name CycloSam for the Technology, and provides QSAM a first right of refusal to license other IGL/ISO
technologies in the future.
The
License Agreement is for 20 years or until the expiration of the multiple patents covered under the license, and requires multiple
milestone based payments including: $60,000 and other expense reimbursements within 60 days of signing, up to $150,000 as the
Technology advances through multiple stages of clinical trials, and $1.5 million upon commercialization. IGL will also receive
equity in QSAM equal to 5% of the company to be issued within 60 days of signing. Upon commercialization, IGL will receive an
on-going royalty equal to 4.5% of Net Sales, as defined in the License Agreement, and up to 50% of any Sublicense Consideration
received by QSAM, as defined in the License Agreement. QSAM will also pay for ongoing patent filing and maintenance fees, and
has certain requirements to defend the patents against infringement claims. The parties have agreed to mutual indemnification.
Either
party may terminate the License Agreement 30 days after notice in the event of an uncured breach, or immediately in the case of
bankruptcy or insolvency of the other party. QSAM may terminate for any reason upon 30 days’ notice. In the case IGL terminates
due to an uncured QSAM breach, IGL will repay to QSAM 25% of its direct clinical costs to assume ownership of data and other information
gained in that process.
In
connection with the License Agreement, QSAM signed a two-year Consulting and Confidentiality Agreement (the “Consulting
Agreement”) with IGL, which provides IGL with payments of $8,500 per month starting 60 days after signing. The Consulting
Agreement is to provide QSAM with additional consulting and advisory services from the Technology’s founders to assist in
the clinical development of the Technology.
Douglas
Baum, a Director of the Company, has been named President and CEO of the subsidiary QSAM, with authority to start building a team
to oversee clinical trials and other operations for the development and commercialization of the Technology.