GNAL Generation Alpha Inc (CE)

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2021 AND 2020

(Unaudited)

NOTE 1 – ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

History and Organization

Generation Alpha, Inc. (the “Company”) was originally incorporated under the laws of the State of Nevada on March 2, 2007 as Cinjet, Inc. (“Cinjet”). Effective September 1, 2015, Cinjet changed its corporate name to Solis Tek Inc. (“Solis Tek”). Effective September 25, 2018, Solis Tek changed its corporate name to Generation Alpha, Inc. Effective September 25, 2018, Generation Alpha, Inc. (f/k/a Solis Tek Inc.) (the “Company”) entered into an agreement and plan of merger (the “Merger Agreement”), whereby a wholly-owned subsidiary of the Company (the “Merger Sub”) was merged into the Company (the “Merger”). Upon consummation of the Merger, the separate existence of Merger Sub ceased. On June 23, 2015, the Company entered into an Agreement of Merger and Plan of Reorganization (the “Agreement”) with Solis Tek Inc., a California corporation (“STI”), and CJA Acquisition Corp., a California corporation and a wholly owned subsidiary of the Company (“Merger Sub”), providing for the merger of Merger Sub with and into STI (the “Merger”), with STI surviving the Merger as a wholly-owned subsidiary of the Company. The Merger was accounted for as a recapitalization of the Company with STI being deemed the accounting acquirer.

Overview of Business

The Company is a vertically integrated technology innovator, developer, manufacturer, and distributor focused on bringing products and solutions to commercial and retail cannabis growers in both the medical and adult use recreational space in legal markets across the U.S. The Company’s lighting and nutrient customers include retail stores, distributors and commercial growers in the United States and abroad.

COVID-19 Considerations

During the six months ended June 30, 2021, the COVID-19 pandemic did not have a material net impact on our operating results. In the future, the pandemic may cause reduced demand for our products if, for example, the pandemic results in a recessionary economic environment which negatively effects the consumers who purchase our products. The Company has not observed any material impairments of its assets or a significant change in the fair value of its assets due to the COVID-19 pandemic.

Our ability to operate without significant negative operational impact from the COVID-19 pandemic will in part depend on our ability to protect our employees and our supply chain. The Company has endeavored to follow the recommended actions of government and health authorities to protect our employees. Since the onset of the COVID-19 pandemic, we maintained the consistency of our operations. However, the uncertainty resulting from the pandemic could result in an unforeseen disruption to our workforce and supply chain (for example an inability of a key supplier or transportation supplier to source and transport materials) that could negatively impact our operations.

Going Concern

The accompanying consolidated financial statements have been prepared on a going concern basis, which contemplates the realization of assets and the settlement of liabilities and commitments in the normal course of business. As reflected in the accompanying consolidated financial statements, during the six months ended June 30, 2021, the Company incurred a net loss of $1,211,000 and had a shareholders’ deficit of $9,691,000 as of June 30, 2021. In addition, $3,065,000 of notes payable to related parties, $649,000 of accrued interest to related parties, and $824,000 of contract obligations are past due. These factors raise substantial doubt about the Company’s ability to continue as a going concern within one year after the date of the financial statements being issued. In addition, the Company’s independent registered public accounting firm, in its report on the Company’s December 31, 2020 financial statements, raised substantial doubt about the Company’s ability to continue as a going concern. The ability of the Company to continue as a going concern is dependent upon the Company’s ability to raise additional funds and implement its business plan. The financial statements do not include any adjustments that might be necessary if the Company is unable to continue as a going concern.

At June 30, 2021, the Company had cash on hand in the amount of $273,000. Management estimates that the current funds on hand will be sufficient to continue operations through March 31, 2022. The continuation of the Company as a going concern is dependent upon its ability to obtain necessary debt or equity financing to continue operations until it begins generating positive cash flow. No assurance can be given that any future financing will be available or, if available, that it will be on terms that are satisfactory to the Company. Even if the Company is able to obtain additional financing, it may contain undue restrictions on our operations, in the case of debt financing or cause substantial dilution for our stockholders, in case of equity financing.

Basis of Consolidation

The consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries: STI; Solis Tek East, Corporation (“STE”), an entity incorporated under the laws of the State of New Jersey, Zelda Horticulture, Inc. (“Zelda”), an entity incorporated under the laws of the State of California, and YLK Partners NV, LLC (“YLK”), Generation Alpha Brands, Inc., Trilogy Dispensaries, Inc., Extracting Point, LLC (“Extracting Point”), and GrowPro Solutions, Inc., all entities formed under the laws of Nevada. Intercompany transactions and balances have been eliminated in consolidation.

Use of Estimates

The preparation of the consolidated financial statements in conformity with accounting principles generally accepted in the U.S. requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the financial statement date, and reported amounts of revenue and expenses during the reporting period. Significant estimates are used in valuing our allowances for doubtful accounts, reserves for inventory obsolescence, valuing derivative liabilities, valuing equity instruments issued for services, and valuation allowance for deferred tax assets, among others. Actual results could differ from these estimates.

Revenue Recognition

The Company recognizes revenue in accordance with Financial Accounting Standards Board (“FASB”) Accounting Standard Codification (“ASC”) 606, Revenue from Contracts with Customers (“ASC 606”). This standard provides authoritative guidance clarifying the principles for recognizing revenue and developing a common revenue standard for U.S. generally accepted accounting principles. The core principle of the guidance is that an entity should recognize revenue to depict the transfer of promised goods and services to customers in an amount that reflects the consideration to which the entity expects to be entitled in the exchange for those goods or services.

Under this guidance, revenue is recognized when control of promised goods or services is transferred to the Company’s customers, in an amount that reflects the consideration the Company expects to be entitled to in exchange for those goods or services. The Company reviews its sales transactions to identify contractual rights, performance obligations, and transaction prices, including the allocation of prices to separate performance obligations, if applicable. Revenue and cost of sales are recognized once products are delivered to the customer’s control and performance obligations are satisfied.

All products sold by the Company are distinct individual products and consist of advanced energy efficient indoor horticulture lighting, plant nutrient products, and ancillary equipment. The products are offered for sale as finished goods only, and there are no performance obligations required post-shipment for customers to derive the expected value from them. Contracts with customers contain no incentives or discounts that could cause revenue to be allocated or adjusted over time.

The Company does not offer a general right of return on any of its sales and considers all sales as final. The Company generally provides a three-year warranty on its ballasts. However, the Company does not maintain a warranty reserve as the Company is able to chargeback its vendors for all warranty claims. As of June 30, 2021 and December 31, 2020, the Company determined that no reserves for returned product were necessary.

In the following table, revenue is disaggregated by major product line for three months ended June 30, 2021:

  SCHEDULE OF DISAGGREGATED REVENUE

In the following table, revenue is disaggregated by major product line for three months ended June 30, 2020:

In the following table, revenue is disaggregated by major product line for six months ended June 30, 2021:

In the following table, revenue is disaggregated by major product line for six months ended June 30, 2020:

Derivative Financial Instruments

The Company evaluates its financial instruments to determine if such instruments are derivatives or contain features that qualify as embedded derivatives. For derivative financial instruments that are accounted for as liabilities, the derivative instrument is initially recorded at its fair value and is then re-valued at each reporting date, with changes in the fair value reported in the consolidated statements of operations. The classification of derivative instruments, including whether such instruments should be recorded as liabilities or as equity, is evaluated at the end of each reporting period. Derivative instrument liabilities are classified in the balance sheet as current or non-current based on whether or not net-cash settlement of the derivative instrument could be required within 12 months of the balance sheet date.

Research and Development

Research and development costs are expensed in the period incurred. The costs primarily consist of personnel and supplies.

Shipping and Handling Costs

The Company’s shipping and handling costs relating to inbound freight are reported as cost of goods sold in the consolidated Statements of Operations, while shipping and handling costs relating to outbound freight are reported as selling, general and administrative expenses in the consolidated Statements of Operations. The Company classifies amounts billed to customers for shipping fees as revenues.

Fair Value Measurements

The Company determines the fair value of its assets and liabilities based on the exchange price in U.S. dollars that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. Valuation techniques used to measure fair value maximize the use of observable inputs and minimize the use of unobservable inputs. The Company uses a fair value hierarchy with three levels of inputs, of which the first two are considered observable and the last unobservable, to measure fair value:

The carrying amounts of financial instruments such as cash, accounts receivable, inventories, and accounts payable and accrued liabilities, approximate the related fair values due to the short-term maturities of these instruments. The carrying values of notes payable approximate their fair values due to the fact that the interest rates on these obligations are based on prevailing market interest rates.

The fair value of the derivative liabilities of $2,886,000 and $2,161,000 at June 30, 2021 and December 31, 2020, respectively, was valued using Level 2 inputs.

Loss per Share Calculations

Basic earnings per share are computed by dividing net income (loss) available to common shareholders by the weighted-average number of common shares available. Diluted earnings per share is computed by dividing the net income applicable to common stock holders by the weighted average number of common shares outstanding plus the number of additional common shares that would have been outstanding if all dilutive potential common shares had been issued using the treasury stock method. Potential common shares are excluded from the computation when their effect is antidilutive. The dilutive effect of potentially dilutive securities is reflected in diluted net income per share if the exercise prices were lower than the average fair market value of common shares during the reporting period.

For the six months ended June 30, 2021, options to acquire 10,709,056 shares of common stock, warrants to acquire 32,283,140 shares of common stock, and 101,732,281 shares to be issued upon conversion of our convertible notes have been excluded from the calculation of weighted average common shares, as their effect would have been anti-dilutive. For the six months ended June 30, 2020, options to acquire 5,995,800 shares of common stock, warrants to acquire 21,283,140 shares of common stock, and 187,773,607 shares to be issued upon conversion of our convertible notes have been excluded from the calculation of weighted average common shares, as their effect would have been anti-dilutive.

Concentration Risks

Cash includes cash on hand and cash in banks and are reported as “Cash” in the consolidated balance sheets. At June 30, 2021 and December 31, 2020, cash includes cash on hand of $165,000 and $289,000, respectively, and cash in banks of $108,000 and $83,000, respectively. The balance of cash on hand is not insured by the Federal Deposit Insurance Corporation. The balance of cash in banks is insured by the Federal Deposit Insurance Corporation for up to $250,000.

The Company operates in markets that are highly competitive and rapidly changing. Significant technological changes, shifting customer needs, the emergence of competitive products or services with new capabilities, and other factors could negatively impact the Company’s operating results. State and federal government laws could have a material adverse impact on the Company’s future revenues and results of operations.

The Company’s products require specific components that currently are available from a limited number of sources. The Company purchases some of its key products and components from single vendors. During the six months ended June 30, 2021 and 2020, its ballasts, lamps, and reflectors, which comprised the majority of the Company’s purchases during those periods, were each only purchased from one separate vendor.

Two customers accounted for 29% and 18% of the Company’s revenue for the three months ended June 30, 2021, and one customer accounted for 16% of the Company’s revenue for the three months ended June 30, 2020. One customer accounted for 21% of the Company’s revenue for the six months ended June 30, 2021, and five customers accounted for 24%, 15%, 11%, 11%, and 11% of the Company’s revenue for the six months ended June 30, 2020. There were no other customers that accounted for more than 10% of the Company’s revenue. Shipments to customers outside the United States comprised less than 5% of our sales for the three and six months ended June 30, 2021 and 2020.

As of June 30, 2021, two customers accounted for 76% and 11% of the Company’s trade accounts receivable balance, and as of December 31, 2020, three customers accounted for 37%, 23%, and 15% of the Company’s trade accounts receivable balance.

Segment Reporting

The Company operates in one segment for the manufacture and distribution of its products. In accordance with the “Segment Reporting” Topic of the ASC, the Company’s chief operating decision maker has been identified as the Chief Executive Officer and President, who reviews operating results to make decisions about allocating resources and assessing performance for the entire Company. Existing guidance, which is based on a management approach to segment reporting, establishes requirements to report selected segment information quarterly and to report annually entity-wide disclosures about products and services, major customers, and the countries in which the entity holds material assets and reports revenue. All material operating units qualify for aggregation under “Segment Reporting” due to their similar customer base and similarities in: economic characteristics; nature of products and services; and procurement, manufacturing and distribution processes. Since the Company operates in one segment, all financial information required by “Segment Reporting” can be found in the accompanying consolidated financial statements.

Reclassification

In presenting the Company’s consolidated balance sheet as of December 31, 2020, the Company presented derivative liabilities of $2,161,000 as a long term liability. In presenting the Company’s consolidated balance sheet as of June 30, 2021, the Company has reclassified the derivative liabilities amount to a current liability. This reclassification has no effect on the Company’s results of operations, stockholders’ deficit, and cash flows previously reported.

Recently Issued Accounting Pronouncements

In June 2016, the Financial Accounting Standards Board (“FASB”) issued ASU 2016-13, Measurement of Credit Losses on Financial Instruments. ASU 2016-13 requires entities to use a forward-looking approach based on current expected credit losses (“CECL”) to estimate credit losses on certain types of financial instruments, including trade receivables. This may result in the earlier recognition of allowances for losses. ASU 2016-13 is effective for the Company beginning January 1, 2023, and early adoption is permitted. The Company does not believe the potential impact of the new guidance and related codification improvements will be material to its financial position, results of operations and cash flows.

In August 2020, the FASB issued ASU No. 2020-06 (“ASU 2020-06”) “Debt—Debt with Conversion and Other Options (Subtopic 470-20) and Derivatives and Hedging—Contracts in Entity’s Own Equity (Subtopic 815-40).” ASU 2020-06 reduces the number of accounting models for convertible debt instruments by eliminating the cash conversion and beneficial conversion models. As a result, a convertible debt instrument will be accounted for as a single liability measured at its amortized cost as long as no other features require bifurcation and recognition as derivatives. By removing those separation models, the effective interest rate of convertible debt instruments will be closer to the coupon interest rate. Further, the diluted net income per share calculation for convertible instruments will require the Company to use the if-converted method. For contracts in an entity’s own equity, the type of contracts primarily affected by this update are freestanding and embedded features that are accounted for as derivatives under the current guidance due to a failure to meet the settlement conditions of the derivative scope exception. This update simplifies the related settlement assessment by removing the requirements to (i) consider whether the contract would be settled in registered shares, (ii) consider whether collateral is required to be posted, and (iii) assess shareholder rights. ASU 2020-06 will be effective January 1, 2024, for the Company and the provisions of this update can be adopted using either the modified retrospective method or a fully retrospective method. Early adoption is permitted, but no earlier than January 1, 2021, including interim periods within that year. Effective January 1, 2021, the Company early adopted ASU 2020-06 and that adoption did not have an impact on our financial statements and the related disclosures.

In May 2021, the FASB issued ASU 2021-04, Earnings Per Share (Topic 260), Debt—Modifications and Extinguishments (Subtopic 470-50), Compensation—Stock Compensation (Topic 718), and Derivatives and Hedging—Contracts in Entity’s Own Equity (Subtopic 815-40): Issuer’s Accounting for Certain Modifications or Exchanges of Freestanding Equity-Classified Written Call Options. ASU 2021-04 provides clarification and reduces diversity in an issuer’s accounting for modifications or exchanges of freestanding equity-classified written call options (such as warrants) that remain equity classified after modification or exchange. An issuer measures the effect of a modification or exchange as the difference between the fair value of the modified or exchanged warrant and the fair value of that warrant immediately before modification or exchange. ASU 2021-04 introduces a recognition model that comprises four categories of transactions and the corresponding accounting treatment for each category (equity issuance, debt origination, debt modification, and modifications unrelated to equity issuance and debt origination or modification). ASU 2021-04 is effective for all entities for fiscal years beginning after December 15, 2021, including interim periods within those fiscal years. An entity should apply the guidance provided in ASU 2021-04 prospectively to modifications or exchanges occurring on or after the effective date. Early adoption is permitted for all entities, including adoption in an interim period. If an entity elects to early adopt ASU 2021-04 in an interim period, the guidance should be applied as of the beginning of the fiscal year that includes that interim period. The adoption of ASU 2021-04 is not expected to have a material impact on the Company’s financial statements or disclosures.

Other recent accounting pronouncements issued by the FASB, its Emerging Issues Task Force, the American Institute of Certified Public Accountants, and the Securities and Exchange Commission did not or are not believed by management to have a material impact on the Company’s present or future financial statements.

NOTE 2 – CONTRACT OBLIGATION ACQUIRED FROM RELATED PARTIES

In May 2018, the Company entered into an acquisition agreement with the members, which in the aggregate, owned 100% of the membership interests in YLK, a related party. The major asset of YLK is a Cultivation Management Services Agreement (the “Management Agreement”) with an Arizona licensee that was entered into on January 5, 2018. During the year ended December 31, 2019, the Company determined the acquired assets were fully impaired, and recorded an impairment charge of $1,139,000 accordingly. The Company has a continuing obligation under the Management Agreement of $816,000 (net of discount of $34,000) as of December 31, 2020. As of June 30, 2021, the remaining Management Agreement obligation was $824,000 (net of discount of $26,000) and is reflected as a current liability in the accompanying consolidated balance sheet. As of June 30, 2021, the Company is past due on its installment payments obligations under the Management Agreement.

NOTE 3 – NOTES PAYABLE TO RELATED PARTIES – PAST DUE

Notes payable to related parties consists of the following at June 30, 2021 and December 31, 2020:

At December 31, 2020, accrued interest on the notes payable to related parties was $187,000. During the six months ended June 30, 2021, the Company added $35,000 of additional accrued interest, and made interest payments of $15,000, leaving an accrued interest on the notes payable to related parties balance of $207,000 at June 30, 2021.

NOTE 4 – LEASE LIABILITEIS

The Company leases its executive offices and warehouse space. The Company analyzes all leases at inception to determine if a right-of-use (“ROU”) asset and lease liability should be recognized. Leases with an initial term of 12 months or less are not included on the condensed consolidated balance sheets. The ROU asset and lease liability is measured at the present value of future lease payments as of the lease commencement date. The Company accounts for the lease and non-lease components of its leases as a single lease component. Rent expense is recognized on a straight-line basis over the lease term.

In 2019, we occupied a 17,640 square foot facility located at 853 Sandhill Avenue, Carson, California under a five-year lease with an independent party ending on June 30, 2023, pursuant to which we paid $15,000 per month in rental charges. On December 31, 2019, we abandoned our Carson, California lease. The Company remains obligated under its Carson, California lease, until such time the landlord releases us from our lease agreement. During the six months ended June 30, 2020, management determined it no longer had access to the Carson, California facility, and recorded an impairment charge for the remaining ROU asset balance of $82,000. As of the date of this report, the Company has not been released from the lease agreement, and no lease payments were made during the six months ended June 30, 2021. The remaining balance of the lease liability was $556,000 at both June 30, 2021 and December 31, 2020.

On January 1, 2020, the Company relocated its principal executive offices and warehouse to 1689-A Arrow Rt., Upland, California, 91786. The Upland, California lease is for a 2,974 square foot facility under a three-year lease with an independent party ending on January 31, 2023, pursuant to which the Company pays $2,800 per month in rental charges. The operating lease ROU asset balance related to the Upland, California operating lease was $63,000 as of December 31, 2020. During the six months ended June 30, 2021, the Company reflected amortization of the ROU assets of $14,000 related to its Upland, California operating lease, resulting in an ROU asset balance of $49,000 as of June 30, 2021.

On January 11, 2021, the Company opened a regional sales and distribution office at Windolph Plaza Center, 1020 NW 6^th Street, Bay G, Deerfield Beach in Broward County, Florida. The Florida lease is for a 4,304 square foot facility under a five-year and two-month lease with an independent party ending on March 31, 2026, pursuant to which it pays an average $3,691 per month in rental charges. On January 11, 2021, the Company recognized an operating lease ROU asset and lease liability of $173,000, related to the Florida operating lease. During the six months ended June 30, 2021, the Company reflected amortization of the ROU assets of $10,000 related to its Florida operating lease, resulting in an ROU asset balance of $163,000 as of June 30, 2021.

As of December 31, 2020, liabilities recorded under operating leases were $622,000. During the six months ended June 30, 2021, the Company added $173,000 in lease liabilities related to its Florida operating lease, and made lease payments of $16,000 towards its operating lease liability. As of June 30, 2021, liabilities under operating leases amounted to $779,000, of which $424,000 were reflected as current due.

The lease agreements above have a weighted average remaining lease term of 2.58 years as of June 30, 2021, and the weighted average discount rate for operating leases is 10%. Rent expense during the three and six months ended June 30, 2021 and 2020 was $28,000 and $6,000, and $47,000 and $63,000, respectively.

Maturities of the Company’s lease liabilities are as follows:

NOTE 5 – LEGAL SETTLEMENT PAYABLE

Effective June 25, 2018, Matthew Geschke (the “Plaintiff”) filed a breach of contract case against the Company in the San Diego Superior Court of San Diego, California. The Plaintiff claimed damages for breach of an employment contract when the Company terminated the Plaintiff’s employment agreement on February 22, 2018. On June 26, 2020, the Plaintiff was awarded a default judgment against the Company in the amount of $448,000. No payments have been made, and $448,000 is payable at June 30, 2021 and December 31, 2020.

NOTE 6 – LOANS PAYABLE

Notes payable consists of the following at June 30, 2021 and December 31, 2020:

NOTE 7 – CONVERTIBLE SECURED NOTE PAYABLE TO RELATED PARTY

Secured notes payable to related party consists of the following as of June 30, 2021 and December 31, 2020:

On May 10, 2018 and October 29, 2019, the Company issued convertible secured debentures (“Notes”) to YA II PN Ltd. (“YA II PN”) in the principal amounts of $1,500,000 and $275,000, respectively, with interest rates of 8% and 10%, as amended, respectively, which matured in June 2020 and April 2020, respectively. The notes are currently past due. The Company is in discussion with YA II PN to extend the maturity date of the Notes. The Notes provide a conversion right, in which the principal amount of the Note, together with any accrued but unpaid interest, could be converted into the Company’s common stock at a conversion price at 75% of the lowest volume weighted average price (VWAP) of the Company’s Common Stock during the 10 trading days immediately preceding the conversion date.

As part of the issuance of the Notes, the Company also granted YA II PN 5-year warrants, which were modified, to purchase a total of 13,000,000 shares of the Company at an exercise price of $0.05 per share, with expiration dates ranging from May 2024 to December 2024. 7,500,000 warrants granted as part of the Note issuances were also modified to ultimately change the exercise price from $0.50 per share (1,000,000 warrants), $0.75 per share (2,250,000 warrants), $1.00 per share (2,250,000 warrants) and $1.25 per share (2,000,000 warrants) to $0.05 per share for all four warrants. Furthermore, the amendments removed the Company’s right of redemption and right to compel exercise on certain Warrants. The Company calculated the fair market value of the warrants before and after the modifications above and recorded the difference of $194,000 as a financing cost in 2019.

On February 13, 2020, the Company issued a note (the “2020 Note”) to YAII PN in the amount of $150,000. The 2020 Note bears interest at a rate of 10% per annum (15% on default) and has a maturity date of August 10, 2021. The Company received net proceeds of $125,000, net of closing costs of $25,000. The 2020 Note is secured by all the assets of the Company and its subsidiaries. The 2020 Note provides a conversion right, in which any portion of the principal amount of the 2020 Note, together with any accrued but unpaid interest, may be converted into the Company’s common stock at a conversion price equal to 75% of the lowest VWAP of the Company’s common stock during the ten (10) trading days immediately preceding the date of conversion, subject to adjustment. As such, the Company determined that the conversion feature created a derivative with a fair value of $109,000 at the date of issuance. The Company also granted YA II PN 5-year warrants with a fair value of $66,000, to purchase a total of 3,000,000 shares of the Company at an exercise price of $0.05 per common share. The aggregate amount of the closing costs, and the fair value of the derivative liability, was $177,000, of which $150,000 was recorded as a valuation discount on the 2020 Note to be amortized over the life of the 2020 Note, and $27,000 was recorded as a financing cost.

On September 23, 2020, the Company issued a note (the “September 2020 Note”) to YAII PN in the amount of $350,000. The September 2020 Note bears interest at a rate of 10% per annum (15% on default) and has a maturity date of March 23, 2021. The Company received net proceeds of $340,000, net of closing costs of $10,000. The September 2020 Note is secured by all the assets of the Company and its subsidiaries. The September 2020 Note provides a conversion right, in which any portion of the principal amount of the September 2020 Note, together with any accrued but unpaid interest, may be converted into the Company’s common stock at a conversion price equal to 75% of the lowest VWAP of the Company’s common stock during the ten (10) trading days immediately preceding the date of conversion, subject to adjustment. As such, the Company determined that the conversion feature created a derivative with a fair value of $322,000 at the date of issuance. The Company also granted YA II PN 5-year warrants with a fair value of $68,000, to purchase a total of 7,000,000 shares of the Company at an exercise price of $0.05 per common share. The aggregate amount of the closing costs, and the fair value of the warrants and derivative liability, was $389,000, of which $350,000 was recorded as a valuation discount on the September 2020 Note to be amortized over the life of the September 2020 Note, and $39,000 was recorded as a financing cost.

The remaining unamortized balance of the valuation discount was $220,000 at December 31, 2020. During the six months ended June 30, 2021, amortization of valuation discount was $208,000 and was recorded as an interest cost, leaving a $12,000 remaining unamortized balance of the valuation discount at June 30, 2021.

At December 31, 2020, accrued interest on the convertible secured notes payable to related parties of $344,000 was included in accrued interest to related parties on the consolidated balance sheet. During the six months ended June 30, 2021, the Company added $98,000 of additional accrued interest, leaving an accrued interest to related parties balance of $442,000 at June 30, 2021.

As of June 30, 2021, 101,732,281 shares of common stock were potentially issuable under the conversion terms of the convertible secured notes.

NOTE 8 – DERIVATIVE LIABILITY

The FASB has issued authoritative guidance whereby instruments which do not have fixed settlement provisions are deemed to be derivative instruments. The conversion prices and the exercise prices of the warrants described in Note 8 were not a fixed amount because they were either subject to an adjustment based on the occurrence of future offerings or events or they were variable. Since the number of shares is not explicitly limited, the Company is unable to conclude that enough authorized and unissued shares are available to settle the conversion option. In accordance with the FASB authoritative guidance, the conversion features have been characterized as derivative liabilities to be re-measured at the end of every reporting period with the change in value reported in the statement of operations.

As of June 30, 2021 and December 31, 2020, the derivative liabilities were valued using a Black-Scholes Merton pricing model with the following assumptions:

 The risk-free interest rate was based on rates established by the Federal Reserve Bank. The Company uses the historical volatility of its common stock to estimate the future volatility for its common stock. The expected life of the conversion feature of the notes was based on the remaining term of the notes. The expected dividend yield was based on the fact that the Company has not customarily paid dividends in the past and does not expect to pay dividends in the future.

The following table sets forth a summary of the changes in the estimated fair value of our embedded derivative during the six months ended June 30, 2021 and 2020:

NOTE 9 – SHAREHOLDERS’ EQUITY

Common Shares Issued to Directors

The Company appointed certain directors and issued shares as part of their director compensation agreements. During the six months ended June 30, 2021, the Company issued an aggregate of 1,052,423 shares of common stock, with a fair value of $40,000 at date of grant. During the six months ended June 30, 2020, the Company issued an aggregate of 2,631,290 shares of common stock, with a fair value of $52,000 at date of grant. The issued shares were recognized as compensation cost.

Common Shares Issued on Conversion of Convertible Note Payable

During the six months ended June 30, 2020, the Company was notified by YA II PN (See Note 7) in writing of their election to convert $29,000 of interest accrued into 2,287,066 shares of the Company’s common at $0.0127 per share.

Summary of Stock Options

A summary of stock options for the six months ended June 30, 2021, is as follows:

On January 1, 2021, the Company entered into a new five-year employment agreement with Tiffany Davis as the Company’s Chief Executive Officer. Ms. Davis is entitled to receive stock options of $12,500 of shares per quarter at the then closing market price on the last trading day at the end of each calendar quarter, which expire five years from the date of issuance. Accordingly, during the six months ended June 30, 2021, Davis was granted a total of 706,846 stock options, with the fair value determined to be $25,000, and was recorded to stock-based compensation expense during the six months ended June 30, 2021. The fair value of options on the date of grant was estimated using the Black-Scholes option pricing model with the following weighted average assumptions: stock price of $0.035, risk-free interest rate of 0.42%, expected volatility of 251%, and an expected life of 3.0 years.

Information relating to outstanding options at June 30, 2021, summarized by exercise price, is as follows:

As of June 30, 2021, the Company has no outstanding unvested options with future compensation costs. In addition, there will be future compensation related to the options to be awarded to Ms. Davis under her employment agreement discussed above. The weighted-average remaining contractual life of options outstanding and exercisable at June 30, 2021 was 2.13 years. Both the outstanding and exercisable stock options had an intrinsic value of $126,000 at June 30, 2021.

Summary of Warrants

A summary of warrants for the six months ended June 30, 2021, is as follows:

Information relating to outstanding warrants at June 30, 2021, summarized by exercise price, is as follows:

During the six months ended June 30, 2021, the Company issued five-year warrants with a fair value of $191,000 to purchase 4,000,000 shares of common stock at an exercise price of $0.001 as part of a settlement agreement regarding a trade vendor payable (see Note 10). The fair value of warrants on the date of grant was estimated using the Black-Scholes option pricing model with the following weighted average assumptions: stock price of $0.048, risk-free interest rate of 0.35%, expected volatility of 248%, and an expected life of 3.0 years.

The weighted-average remaining contractual life of warrants outstanding and exercisable at December 31, 2020 was 3.14 years. Both the outstanding and exercisable warrants had an intrinsic value of $198,000 at June 30, 2021.

NOTE 10 – COMMITMENTS AND CONTINGENCIES

On March 30, 2021, the Company entered into a Settlement Agreement and Release (“Agreement”) with Sichenzia Ross Ference LLP (“SRF”), for services that were performed for the Company. The Company owed SRF $160,000, of which the Company agreed to pay SRF the sum total $75,000. The $75,000 is payable in fifteen monthly installments, commencing on March 31, 2021, and with the last installment payment due no later than May 31, 2022. As an alternative to the Settlement Payment, the Company shall have the option to pay to SRF:

a. An initial installment payment of $5,000 on or before March 31, 2021, $5,000 on or before April 30, 2021, and a lump sum payment of $40,000 on or before June 7, 2021, for a total payments of $50,000; or

b. An initial installment payment of $5,000 on or before March 31, 2021, $5,000 on or before April 30, 2021, $5,000 on or before May 31, 2021, $5,000 on or before June 30, 2021, $5,000 on or before July 30, 2021 and a lump sum payment of $50,000 on or before August 6, 2021 for a total payments of $75,000.

As further consideration of the full and final settlement of these matters, the Company issued to SRF, a cashless five-year warrant to purchase 4,000,000 shares of common stock of the Company at an exercise price per share equal to $0.001 per share and a fair value of $191,000 on the date granted.

The total settlement amount was $266,000, made up the $75,000 reduced payable to SFR, plus the fair value of the warrants of $191,000, which was more than the original trade vendor balance owed of $160,000. The difference of $106,000 was recorded as a component of loss on settlement of trade vendor payable on the accompanying condensed consolidated statements of operations for the six months ended June 30, 2021.

Technology License Agreement

The Company entered into a Technology License Agreement with a third-party vendor for consulting services. Under the agreement, the Company will pay the vendor a minimum consulting amount of $100,000 per year, plus a royalty of 7% of all net sales of the vendor’s products above $1,429,000 per calendar year. For the three and six months ended June 30, 2021 and 2020, $25,000 and $50,000, and $25,000 and $50,000 was recorded as research and development expense under the agreement on the condensed consolidated statements of operations related to the minimum annual fee. For each of six months ended June 30, 2021 and 2020, no royalty was recorded as cost of goods sold on the Condensed Consolidated Statements of Operations. A total of $389,000 and $339,000 was owed under the amended agreement at June 30, 2021 and December 31, 2020, respectively, and is included in accounts payable and accrued liabilities on the accompanying condensed consolidated balance sheets.