NOTES
TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
NOTE
1 – ORGANIZATION AND DESCRIPTION OF BUSINESS
QSAM
Biosciences Inc. (f/k/a Q2Earth, Inc.) (hereinafter the “Company”), incorporated in Delaware on August 26, 2004,
is currently engaged in the business of developing a novel radiopharmaceutical drug candidate for the treatment of bone cancer.
This business line commenced in earnest after the end of the third fiscal quarter of 2020, as a result of the separation and transfer
pursuant to an Omnibus Separation Agreement (the “Separation Agreement”) of the Company’s prior business of
managing compost and soil manufacturing facilities (the “Legacy Business”) through an unconsolidated investee entity
called Earth Property Holdings LLC, a Delaware limited liability company (“EPH”). The financial statements presented
herein represent primarily the operations of the Legacy Business prior to the Separation Agreement which was consummated on November
6, 2020 (see Note 11). The Company owns approximately an 18% subordinated equity interest in EPH.
In
April 2020, the Company established QSAM Therapeutics Inc. (“QSAM”) as a wholly-owned subsidiary incorporated in the
state of Texas, and through 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 establishment
of QSAM and execution of the License Agreement is part of the Company’s strategic plan to transition its business into other
technologies in the broader biosciences sector which currently is the Company’s focus.
In connection with
the transition to the biosciences sector and other events occurring subsequent to September 30, 2020, as disclosed in Note 11,
the Company changed its name to QSAM Biosciences Inc. on September 4, 2020, and subsequently changed its stock symbol to QSAM,
to better reflect its business moving forward.
On
September 4, 2020, the Company completed a 25:1 reverse stock split of its common shares. All shares and share prices set forth
in this report have been adjusted to account for this reverse stock split as if it had occurred on the date presented.
Prior
to 2017, the Company owned and licensed technology that converts waste fuels and heat to power, which it sold to a licensee in
August of that year. Much of these operations were conducted through a wholly-owned subsidiary of the Company called Q2Power Corp.
(“Q2P”), which still exists but has no current operations. Q2P and QSAM are sometimes referred to herein as the “Subsidiaries”.
Formerly, the Company’s name was Q2Power Technologies, Inc., and before that, Anpath Group, Inc. (“Anpath”).
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
2 – BASIS OF PRESENTATION AND GOING CONCERN
The
accompanying unaudited condensed financial statements are prepared in accordance with Rule 8-01 of Regulation S-X of the Securities
Exchange Commission (“SEC”). Accordingly, certain information and note disclosures normally included in financial
statements prepared in accordance with generally accepted accounting principles in the United States of America (“US GAAP”)
have been condensed or omitted pursuant to such rules and regulations. However, the Company believes that the disclosures included
in these unaudited condensed financial statements are adequate to make the information presented not misleading. The unaudited
condensed financial statements included in this document have been prepared on the same basis as the annual financial statements,
and in our opinion reflect all adjustments, which include normal recurring adjustments necessary for a fair presentation in accordance
with US GAAP and SEC regulations for interim financial statements. The results for the three and nine months ended September 30,
2020 are not necessarily indicative of the results that the Company will have for any subsequent period or for the calendar year
ended December 31, 2020. These unaudited condensed financial statements should be read in conjunction with the audited financial
statements and the notes to those statements for the year ended December 31, 2019 which was filed with the SEC on April 14, 2020.
For
the nine months ended September 30, 2020, the Company used cash in operating activities of $620,118 and incurred a loss of $3,734,635.
The accumulated deficit as of September 30, 2020 since inception is $14,783,844, 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 September 30, 2020, $1,777,516 of principal and accrued capitalized interest under multiple convertible bridge notes (the “Bridge
Notes”), which were issued by the Company primarily between March 31, 2017 and the end of 2018, were in default;
and $2,511,975 in principal and accrued and capitalized interest under additional Bridge Notes were settled during the
period ended September 30, 2020, with the holders of these notes converting their debt into 11,418,069 shares of common stock
of the Company. After September 30, 2020, an additional $130,000 of Bridge Notes including accrued and capitalized interest that
was previously in default was also settled for the issuance of, and agreement to issue, a total of 590,909 shares of common
stock (see Note 11). The Company is in discussions with the remaining group of Bridge Note holders – amounting to
$1,646,646 in principal and accrued and capitalized interest — to reach a settlement which may include an extension of the
notes, conversion into equity, or some other combination of these options.
As
of September 30, 2020, the Company had a working capital deficit of $4,960,244.
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 new business model
to develop and commercialize its drug candidate, and continue to raise funds for the Company through equity offerings. The unaudited
condensed consolidated financial statements do not include any adjustments that might result from the outcome of these uncertainties.
Management
is aware of the Company’s liquidity and going concern issues and is actively taking steps to improve its negative cashflow
and reduce its significant debt burden. Such steps were advanced in the fourth quarter of 2020 (see Note 11). Further,
the Company expects to raise up to $3 million of new equity to pursue the QSAM drug development opportunity. There are no guarantees
that the Company will be successful in these efforts.
NOTE
3 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles
of Consolidation
The
consolidated financial statements include the accounts of the Company and its Subsidiaries. All significant inter-company transactions
and balances have been eliminated in consolidation. References herein to the Company include the Company and its Subsidiaries
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 one financial
institution and has experienced no losses with respect to amounts on deposit. The Company held no cash equivalents as of September
30, 2020 and December 31, 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 related to the Legacy Business 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 provided to the Company’s related parties, as well as other 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 nine months ended September 30, 2020, revenues generated by the Company’s Legacy Business were primarily from
one customer which is related to the Company. Additional revenue in the period was generated from a feasibility study performed
and satisfied in the same period for a soil customer unrelated to the Company in the amount of $16,200. The Company recognizes
revenue in accordance with ASC Topic 606, “Revenue from Contracts with Customers (“ASC 606”) and all the related
amendments. During the nine months ended September 30, 2019, revenues generated by the Company’s Legacy Business were
from two customers, both of which are 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.
Research
and Development
Research
and development costs are expensed as incurred. Research and development costs were $206,943 for the nine-month period ended September
30, 2020 and are a result of the License Agreement executed during the period (see Notes 2 and 10). The Company did not incur
any research and development costs during the nine-month period ended September 30, 2019.
Income
Taxes
Income
taxes are accounted for under the asset and liability method as stipulated by FASB ASC 740, “Income Taxes”
(“ASC 740”). Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences
between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating
loss and tax credit carry forwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply
to taxable income in the years in which those temporary differences are expected to be recovered or settled. Under ASC 740, the
effect on deferred tax assets and liabilities or a change in tax rate is recognized in income in the period that includes the
enactment date. Deferred tax assets are reduced to estimated amounts to be realized by the use of a valuation allowance. A valuation
allowance is applied when in management’s view it is more likely than not (50%) that such deferred tax will not be utilized.
In
the event that an uncertain tax position exists in which the Company could incur income taxes, the Company would evaluate whether
there is a probability that the uncertain tax position taken would be sustained upon examination by the taxing authorities. Reserves
for uncertain tax positions would be recorded if the Company determined it is probable that a position would not be sustained
upon examination or if payment would have to be made to a taxing authority and the amount is reasonably estimated. As of September
30, 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
September 30, 2020, there were the following potentially dilutive securities that were excluded from diluted net loss per share
because their effect would be anti-dilutive:
|
●
|
468,619
shares from common stock options;
|
|
●
|
46,154
shares from common stock warrants;
|
|
●
|
66,000
shares from the conversion of debentures;
|
|
●
|
8,079,617
shares that may be converted from Bridge Notes (based upon
an assumed conversion price at September 30, 2020 of $0.22 per share); and
|
|
●
|
309,988
shares from the conversion of redeemable convertible preferred
stock (inclusive of cumulative dividends which may be converted to shares of common stock).
|
At
September 30, 2019, there were the following potentially dilutive securities that were excluded from diluted net loss per share
because their effect would be anti-dilutive:
|
●
|
340,619
shares from common stock options,
|
|
●
|
213,494
shares from common stock warrants,
|
|
●
|
66,000
shares from the conversion of debentures,
|
|
●
|
1,823,631
shares that may be converted from Bridge Notes (based upon an assumed conversion
price at September 30, 2019 of $2.05 per share), and
|
|
●
|
240,000
shares from the conversion of redeemable convertible preferred stock (inclusive of cumulative dividends which may be converted
to shares of common 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 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.
Most
of the Company’s revenue for the nine months ended September 30, 2020 and 2019 was from fees earned from its equity method
investment, EPH, under the Management Agreement. As of September 30, 2020, this has been the Company’s primary source of
on-going revenue. That agreement was terminated in the fourth quarter of 2020 (see Note 11).
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 September 30, 2020 and December 31, 2019 and is included in accounts payable and accrued expenses on the unaudited
condensed consolidated balance sheets. The carrying value of the investment remains at zero at September 30, 2020 and December
31, 2019 due to continued losses incurred by EPH. There were no distributions received from the equity method investment in 2020
or 2019.
In
2019 and 2020, EPH issued an additional 317,784 Class A Units in consideration for $2,796,500 additional investments. The Company
did not purchase additional Class B Units during this time, and as a result, its equity stake in EPH has been diluted to approximately
18%. 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 nine months ended September 30, 2020, EPH generated unaudited revenue of $7,736,370 and recorded an unaudited net loss of
$1,765,240.
See
Note 5 for transactions with our equity method investment during the nine months ended September 30, 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 nine months
ended September 30, 2020 and 2019, the Company recognized $524,997 and $672,556 as revenues based on management services provided
to the Company’s equity method investee (see Note 4) and, for the 2019 period, also for service fees under its agreement
with Community Eco Power (CECO), which have been presented as revenues – related parties on the unaudited condensed
consolidated statement of operations. The Company’s CEO and President each own minority interests in CECO.
On April 7, 2020, the
Company received $15,000 under multiple demand notes with interest payable at 10% annually from three Directors of the Company.
These notes matured on June 30, 2020 and are in default. As of September 30, 2020, the principal amount due of $15,000 has
been included on the unaudited condensed consolidated balance sheets as notes payable – related parties.
In the current quarter,
the Company received $25,000 and $5,500 under two convertible notes with interest payable at 10% annuals from its President and
one of its Directors. These notes are convertible into the security issued in the Company’s next equity raise. As of September
30, 2020, the principal amount due of $30,500 has been presented on the unaudited condensed consolidated balance sheets as convertible
notes payable – related parties.
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.
During the nine months ended September 30, 2020, the Company received an additional $290,373 from EPH with the same terms.
As of September 30, 2020 and December 31, 2019, accrued interest on these notes payable was $57,821 and $15,426 which is
presented on the unaudited condensed consolidated balance sheets as accrued interest – related parties.
As of September 30, 2020 and December 31, 2019, the balance due on these demand notes payable was $1,078,873 and $788,500,
respectively, which has been presented as notes payable – related parties on the condensed consolidated balance sheets.
In the fourth quarter of 2020, these notes were settled through the Separation Agreement with EPH (see Note 11).
During
the nine months ended September 30, 2020 and 2019, the Company incurred approximately $52,753 and $10,993, in legal fees with
a law firm in which the Company’s audit committee chair is an employee. As of September 30, 2020 and December 31, 2019,
accounts payable and accrued expenses include $24,808 and $10,993, 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. 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 September 30, 2020 and December 31, 2019, $37,500 and $15,000 of license fees have been accrued
and included in accounts payable and accrued expenses on the unaudited condensed consolidated balance sheets. In the fourth
quarter of 2020, this license agreement was transferred to EPH, and the related liabilities are expected to be assumed by EPH
(see Note 11).
NOTE
6 – DEBENTURES, CONVERTIBLE BRIDGE NOTES, AND NOTES PAYABLE
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 September 30, 2020 and December 31, 2019, and which currently are convertible at $2.50 per share and were
due July 1, 2019. All assets of the Company are secured under the Debentures. 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.
Convertible
Bridge Notes
In
2017 and 2018, the Company issued a total of $2,771,908 in a convertible promissory note (the “Bridge Notes”) offering
(collectively, the “Bridge Offering”), which included three of the Company’s directors converting $156,368 and
one shareholder converting $11,784 of prior notes and cash advances, including interest thereon, into the Bridge Offering. In
2019, an additional $30,000 Bridge Note was issued to one investor. In June 2018, one of the original Bridge Notes for $50,000
plus $7,664 accrued interest was converted by its holder into 24,538 shares of common stock. Maturity is 36 months from
issuance (24 months for the Bridge Notes issued in 2018 and 2019) with 15% annual interest which is capitalized each year into
the principal of the Bridge Notes and paid in kind.
As
of September 30, 2020, $1,777,516 of principal and accrued capitalized interest under the Bridge Notes was in default; and $2,511,975
in principal and accrued and capitalized interest under additional Bridge Notes was settled during the period ended September
30, 2020, with the holders of these notes converting their debt into 11,418,069 shares of common stock of the Company with
a fair value of $2,397,794 based on the stock price of the Company on the date of conversion. The Company recorded a loss on extinguishment
of these Bridge Notes of $503,762 as presented on the unaudited condensed consolidated financial statements. After September
30, 2020, an additional $130,000 of Bridge Notes including accrued and capitalized interest that was previously in default was
also settled for the issuance of 590,909 shares of common stock (see Note 11). The Company is currently in discussions
with the holders of the remaining Bridge Notes in an effort to reach a similar settlement.
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 remaining outstanding Bridge Notes as of September
30, 2020 and December 31, 2019 was $2,981,000 and $2,473,000 (see Note 7), and the principal amount due was $1,093,415
and $2,801,908, respectively. During the nine months ended September 30, 2020 and 2019, the change in fair value resulted
in a (loss) gain of ($1,666,422) and $490,079, respectively, which is presented as change in fair value of convertible
bridge notes on the unaudited condensed consolidated statements of operations (see Note 6).
Paycheck
Protection Program
On
April 14, 2020, the Company received $142,942 under the Paycheck Protection Program (PPP) overseen by the U.S. Small Business
Administration. The loan has an annual interest rate of 1% with loan payments being deferred six months from the date of the loan
with a maturity date of April 14, 2022. The Company used these funds for payroll costs only and will apply for forgiveness of
the loan under the program once the U.S. Small Business Administration starts accepting the forgiveness applications. As of September
30, 2020, the amount due on the loan of $142,929 has been presented in current liabilities in the accompanying unaudited
condensed consolidated balance sheets.
Convertible
Notes Payable
On
June 8 through September 9, 2020, the Company received a total of $142,500 under a promissory note with an unrelated third party
with multiple tranches with interest payable at 8% annually. All outstanding principal and interest accrued and unpaid on the
note shall be due and payable twelve (12) months after the respective tranche date. The principal and accrued interest is convertible
into the Company’s equity on the same terms, conditions and other rights provided to investors in the next equity offering
in an amount of at least $1 million. As of September 30, 2020, $142,500 remains due under these convertible notes payable
and has been presented as such on the accompanying unaudited condensed consolidated balance sheets.
See
Note 5 for notes payable outstanding with the Company’s related parties.
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 September 30, 2020 and December 31, 2019. 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
|
|
|
|
|
|
|
|
|
|
|
|
|
Sept. 30, 2020
|
|
|
Level 1
|
|
|
Level 2
|
|
|
Level 3
|
|
Convertible Bridge Notes
|
|
$
|
2,674,000
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
2,674,000
|
|
Total
|
|
$
|
2,674,000
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
2,674,000
|
|
|
|
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.
|
|
Nine
Months Ended
Sept. 30, 2020
|
|
Fair
value, December 31, 2019
|
|
$
|
2,473,000
|
|
Conversion
to common shares
|
|
|
(1,894,032
|
)
|
Accrued
interest
|
|
|
(427,360
|
)
|
Amortization
of debt issuance costs
|
|
|
1,250
|
|
Net
unrealized loss on convertible bridge notes
|
|
|
1,666,422
|
|
Fair value,
September 30, 2020 – current portion
|
|
$
|
2,674,000
|
|
The
Company’s convertible Bridge Notes are valued by using Monte Carlo Simulation methods and discounted future cash flow models.
Where possible, the Company verifies the values produced by its pricing models to market prices. Valuation models require a variety
of inputs, including contractual terms, market prices, yield curves, credit spreads, measures of volatility and correlations of
such inputs. These convertible Bridge Notes do not trade in liquid markets, and as such, model inputs cannot generally be verified
and do involve significant management judgment. Such instruments are typically classified within Level 3 of the fair value hierarchy.
The following assumptions were used to value the Company’s convertible Bridge Notes at September 30, 2020: dividend yield
of -0-%, volatility of 177.2%, risk free rate of 0.09% and an expected term of 0.25 years. The fair value
of the Bridge Note was estimated based on the present value expected future cash flows using a discount rate of 20%.
NOTE
8 – COMMON STOCK, PREFERRED STOCK AND WARRANTS
Common
Stock
On
September 4, 2020, the Company completed a 25:1 reverse stock split of its common shares. All shares and share prices set forth
in the report have been adjusted to account for this reverse stock split as if it had occurred on the date presented.
As
of September 30, 2020, the Company issued 11,418,069 shares of common stock in connection with Bridge Note conversions (see
Note 6).
In
September 2020, the Company issued 600,000 shares of common stock to three consultants in connection with services provided.
All services were provided in the third quarter of 2020, and the Company incurred a professional fee expense of $127,000
related to the issuance of these shares during the three-month period ended September 30, 2020. The Company measured the
fair value of the common stock issued based on the market price on contract execution date.
The
Company issued 200,000 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 nine months ended September
30, 2020, the Company recognized $50,000 of stock-based compensation which is included in professional fees on the unaudited
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 nine months September 30, 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 $2.50 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 $12.50 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 nine months ended September 30, 2020, the Company did not issue any warrants, and 80,000 warrants expired. The following is
a summary of all outstanding common stock warrants as of September 30, 2020:
|
|
Number of
Warrants
|
|
|
Exercise price
per share
|
|
|
Average
remaining
term in years
|
|
Warrants issued in connection with issuance of Preferred Stock
|
|
|
46,154
|
|
|
$
|
12.50
|
|
|
|
0.20
|
|
During
the year ended December 31, 2018, we committed to issuing warrants to purchase 6,000 shares of common stock at $1.00 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 September 30, 2020.
NOTE
9 – STOCK OPTIONS AND RESTRICTED STOCK UNITS
On February 25, 2016,
to compensate officers, directors and other key service providers with equity grants, the Board approved the 2016 Omnibus Equity
Incentive Plan (“2016 Plan”), which initially allowed for 160,000 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 400,000 shares by Board resolution and amendment in 2017. The 2016 Plan, as amended, was approved by the Company’s
shareholders in January 2020.
The
Company issued 128,000 stock options in the first nine months of 2020, 40,000 each to two of the Company’s independent directors,
20,000 each to one other independent director and one Board observer, and 8,000 to a new director. The options issued to the current
directors and Board observer were fully vested upon issuance, are exercisable at a price of $0.50 per share, and expire ten years
after issuance. The 8,000 options to the new director vest half in 12 months and the balance in 24 months, expire in five years,
and are exercisable at $0.50 per share. The options were valued at $18,023 (pursuant to the Black Scholes valuation model see
below), based on an exercise price of $0.50 per share and estimated expected term of 5.0 years. This has been classified in general
and administrative expense in the unaudited condensed consolidated statements of operations.
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 $2.50 per share
(representing an aggregate of 252,440 options, or 54% of the total outstanding) were amended to reduce such exercise price to
$0.50.
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 unaudited 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 nine months
ended September 30, 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 2016 Plan and prior stock option plans for the nine months ended September
30, 2020 is as follows (shares and prices have been adjusted to account for a 25:1 reverse split):
|
|
Number
Outstanding
|
|
|
Weighted
Avg. Exercise
Price
|
|
|
Weighted
Avg.
Remaining
Contractual
Life (Years)
|
|
Balance, December 31, 2019
|
|
|
340,619
|
|
|
$
|
3.00
|
|
|
|
3.9
|
|
Options issued
|
|
|
128,000
|
|
|
|
0.50
|
|
|
|
9.2
|
|
Balance, September 30, 2020
|
|
|
468,619
|
|
|
|
1.75
|
|
|
|
5.9
|
|
The
vested and exercisable options at period end follows:
|
|
Exercisable/
Vested
Options Outstanding
|
|
|
Weighted
Avg. Exercise
Price
|
|
|
Weighted
Avg.
Remaining Contractual
Life (Years)
|
|
Balance, September 30, 2020
|
|
|
460,619
|
|
|
$
|
1.75
|
|
|
|
5.9
|
|
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 nine months ended September 30, 2020:
|
|
Nine Months Ended
Sept. 30, 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
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). In the fourth quarter of 2020, the CEO’s
agreement was terminated by mutual consent of the parties, and all severance payments were released (see Note 11).
Pursuant
to a services agreement signed in 2018, an additional 6,000 warrants with a five-year term and exercisable at 1.00 per share are
issuable to the provider but have not formally been issued as of September 30, 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. As of September 30, 2020, quarterly
fees totaling $37,500 since execution of this agreement have not been paid but accrued and are included in accounts payable and
accrued expenses on the condensed consolidated balance sheets. In the fourth quarter of 2020, this license agreement was transferred
to EPH and accrued fees are expected to be assumed by EPH (see Note 11).
As
disclosed in Note 2, the QSAM License Agreement requires multiple milestone based payments including: $60,000 and other expense
reimbursements within 60 days of signing, which have been paid, 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, which has not yet been issued. 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. As of September 30, 2020, the Company has paid $60,000 under the QSAM
License Agreement representing the full upfront license fee, as well $60,000 in expense reimbursements required under that
agreement. Total costs of $120,000 paid under and in connection with this license, as well as an additional $86,943 in drug
development costs paid to service providers, have been reflected as research and development expenses on the unaudited
condensed consolidated statements of operations.
NOTE
11 - SUBSEQUENT EVENTS
Separation
Agreement
On November 6, 2020 (the
“Effective Date”), the Company entered into an Omnibus Separation Agreement (the “Separation Agreement”)
with its unconsolidated investee entity, EPH. Under the terms of the Separation Agreement, the parties have agreed that the Company
will continue to operate and pursue opportunities in the biosciences and pharmaceutical fields while EPH will continue to operate
in the compost and soil manufacturing fields. More specifically:
|
1.
|
On
the Effective Date, the Management Agreement, dated January 18, 2019, as amended,
between EPH and the Company (then Q2Earth) was terminated by mutual agreement of the
parties.
|
|
|
|
|
|
|
|
|
a.
|
In
lieu of any severance or other termination payments due thereunder, EPH has released QSAM from a total of $993,985
in liabilities, inclusive of advanced management fees and multiple promissory notes, including accrued and unpaid interest.
Such promissory notes have been cancelled and are no longer enforceable. An additional $114,700 in promissory notes
owed to an affiliate of EPH was agreed to be converted into Company common stock at a price of $0.22 per share.
|
|
|
|
|
|
|
|
|
b.
|
The
prior officers and employees of the Company engaged in the compost and soil manufacturing business have been released from
any non-competition, non-solicitation or other restricted covenants pursuant to their respective employment agreements (as
agreed in the Separation Agreement and further defined in individual release agreements with each such employee).
|
|
|
|
|
|
|
2.
|
As
of the Effective Date, EPH has the right in its sole discretion to use the name “Q2Earth” in all jurisdictions
of the United States and worldwide.
|
|
|
|
|
|
|
3.
|
The
Company has agreed to transfer to EPH the License Agreement for the ABS product and all
associated knowhow, trade secrets and trademark/service marks. Additionally, the Company has agreed to transfer to EPH the
distributorship agreement, dated June 1, 2019, with Senn, Senn & Senn LLC (the “Senn Agreement”). Both
these transfers are subject to consent by the granting parties, which has not been received as of the current date. The Company’s
Board determined that these agreements had no material value, were not generating revenue, and had accumulated $37,500 in
liabilities.
|
|
|
|
|
|
|
4.
|
The
Company has agreed that up to $175,000 in funds raised in a next financing will be used to pay any remaining legacy debt and
liabilities after the Effective Date.
|
Conversion
of Debt for Common Shares
In
addition to Bridge Notes settled and converted to common stock as of September 30, 2020, in October 2020, an additional $130,000
of principal and interest in defaulted Bridge Notes were
converted into 590,909 shares of common stock issued or to be issued as of the date hereof.
On
November 6, 2020, $147,797 in deferred employee compensation owed to the Company’s CEO was converted to 444,527 shares of
common stock issued or to be issued as of the date hereof, plus the employee forgave an additional $32,598 in deferred
compensation.
On
November 1, 2020, the Company issued 800,000 shares of common stock to a service provider under a 12 month consulting agreement
in connection with corporate communications and investor relations activities.
Resignation
of former CEO and Chairman, and appointment of new CEO and Executive Chairman
On
November 6, 2020, Kevin Bolin resigned as Chairman and CEO of the Company. At such time, Mr. Bolin was owed $180,395 in deferred
unpaid salary, of which $147,797 was converted into 444,527 shares of common stock issued or to be issued, and $32,598
was forgiven. Further, the forfeiture provision on 400,000 shares of common stock issued to Mr. Bolin in 2018 was terminated.
On
November 6, 2020, Douglas Baum, age 53, was appointed as Chief Executive Officer of the Company. Mr. Baum has been a director
of the Company since January 2020. Mr. Baum received a three year employment agreement with the Company providing for $250,000
per year in base salary, of which only half will be paid in the first year or until certain results have been achieved in the
ongoing drug development program. He will receive additional equity compensation to be subsequently approved and granted by the
Board. Mr. Baum’s employment agreement provides for a 12 month severance payment if he is terminated for cause or leaves
for “good reason” as defined in the agreement.
On
November 6, 2020, C. Richard Piazza, age 73, was appointed as a Member of and the Executive Chairman of the Board of the Company.
Mr. Piazza received a three year employment agreement with the Company providing for $220,000 per year in base salary, of which
only half will be paid in the first year or until certain results have been achieved in the ongoing drug development program.
He will also receive additional equity compensation to be subsequently approved and granted by the Board. Mr. Piazza’s employment
agreement provides for a 12 month severance payment if he is terminated for cause or leaves for “good reason” as defined
in the agreement. Mr. Piazza also serves as President, and is a minority shareholder, of IGL Pharma Inc., the licensor of the
Company’s drug technology, and a consultant to IsoTherapeutics Group, LLC, the inventors of the technology. Mr. Piazza does
not have any family relationship with other directors or officers of the Company.