Notes to Unaudited Consolidated Financial Statements
Note 1—DESCRIPTION OF BUSINESS AND BASIS OF PRESENTATION
Financial Presentation
The unaudited Consolidated Balance Sheets, Consolidated Statements of Operations, and Consolidated Statements of Cash Flows of Pazoo, Inc. (“we”, “our”, “Pazoo” or the “Company”) reflect all normal recurring adjustments the nature of which are, in the opinion of management, necessary for a fair presentation of financial position and the results of operations for the interim periods presented. Certain prior-year amounts have been reclassified to conform to the current period presentation.
Description of Business
We are an early growth stage health and wellness company. Presently, our primary business is pazoo.com, an online, content driven, ad supported health and wellness web site for people and their pets. Additionally, this site has e-commerce functionality which allows pazoo.com to be an online retailer of nutritional foods/supplements, wellness goods, and fitness apparel. Pazoo, Inc. does not have any brick and mortar establishments.
We entered the pharmaceutical testing laboratory market with our acquisitions of MA & Associates, LLC which will operate pharmaceutical testing laboratories in Nevada, and Harris Lee Holdings, LLC which will operate pharmaceutical testing laboratories in other states. These pharmaceutical testing laboratories focus on providing quality control services to the medical cannabis industry. The mission is to protect the public health by providing infrastructure and analytical services to legally-authorized cannabis producers and distributors as well as to regulators. States that have legalized cannabis are developing cannabis health and safety criteria that we will fulfill through our testing laboratories.
Principles of Consolidation
The accompanying consolidated financial statements include the amounts of the Company and its wholly-owned subsidiaries Harris Lee Holdings LLC and MA & Associates, LLC, each a Nevada limited liability company. All intercompany accounts and transactions have been eliminated as of June 30, 2015.
Intangible Assets
Intangible assets as of June 30, 2015 consisted of a license agreement acquired for $307,500 from Steep Hill Labs for the right to take the Steep Hill software and methodology to states above and beyond Nevada, $100,000 from the MA license and $117,329 in in-process research & development. The cost basis of the intangible asset will be amortized over the initial 9-year term of the license. Amortization expense during the three months ended June 30, 2015 was $6,105.
Impairment of Long-Lived Assets
The Company’s intangible assets are reviewed for impairment whenever events or changes in circumstances indicate that the historical-cost carrying value of an asset may no longer be appropriate. The Company assesses recoverability of the asset by comparing the undiscounted future net cash flows expected to result from the asset to its carrying value. If the carrying value exceeds the undiscounted future net cash flows of the asset, an impairment loss is measured and recognized. An impairment loss is measured as the difference between the net book value and the fair value of the long-lived asset. The Steep Hill and MA license, along with the in-process research & development, were evaluated for impairment and no impairment loss was incurred as of June 30, 2015.
Note 2—GOING CONCERN
From inception of November 16, 2010 through June 30, 2015, the Company has incurred net losses of $11,641,723 and the Company has a working capital deficit as of June 30, 2015. These factors, among others, raise significant doubt about the Company’s ability to continue as a going concern. These financial statements do not include any adjustments relating to the recoverability and classification of assets or the amounts and classification of liabilities that might be necessary should the Company be unable to continue as a going concern. The Company’s continuation as a going concern is dependent upon our ability to generate sufficient cash flow to meet our obligations on a timely basis and ultimately attain profitability. Management believes that we can alleviate the facts and circumstances which indicate a going concern by expanding our services, expert advice and online products. We aim to become more than a web based company by providing information, services and products through direct response, retail, and advertising revenue, in addition to our website. Furthermore, we look to expand our business and further eliminate the ongoing concern by establishing our medical marijuana testing labs in Denver, CO, Las Vegas, NV, and Portland, OR.
Note 3—STOCKHOLDERS’ EQUITY
Capital Contributions
MA & Associates: the Company contributed $42,000 for voluntary capital contributions to MA & Associates for the six months ended June 30, 2015.
Common Stock
During the six months ending June 30, 2015, the Company issued 474,818,283 common shares for the following purposes.
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6,158,333
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shares for third-party services valued at $51,194
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5,460,125
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shares issued for cash for cash proceeds of $48,380
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12,165,163
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shares issued for true-up of loan conversion valued and expensed at $93,087
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111,500,000
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shares resulting from Series A Preferred Stock holders converting 1,115,000 shares
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339,534,662
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shares resulting from debt holders converting $952,305 of debt into common stock
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474,818,283
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shares issued total
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193,030,398
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shares at December 31, 2014
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667,848,681
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shares at June 30, 2015
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Preferred Stock
During the first six months ending June 30, 2015, the Company issued 1,260,000 net shares of Series A preferred stock for the following purposes.
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(1,115,000
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)
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shares converted into 111,500,000 common shares
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2,375,000
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shares issued for $580,000 in cash
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1,260,000
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shares total
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1,203,526
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shares at December 31, 2014
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2,463,526
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shares at June 30, 2015
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During the six months ending June 30, 2015, the Company issued 450,000 net shares of Series B preferred stock and issued 1,080,000 shares of Series C preferred stock as a part of its investments in Harris Lee Holdings, LLC and MA & Associates, LLC investments. The total value of preferred shares at issuance was $1,462,250.
Warrants
Simultaneous with issuing Series A Preferred Stock to ICPI in the six month period ended June 30, 2015, and under Investment Agreement No. 5 (October 2014) and Investment Agreement No. 6 (February 2015), we issued 2,325,000 warrants. These warrants allow the holder to purchase one share of Series A Preferred Stock for each Series A Preferred Stock at an exercise price of $0.50, subject to the terms of the warrant agreement between the warrant agent and us. These warrants are exercisable up to five years from the issuance date.
The following table presents the Series A preferred stock warrant activity during the six months ended June 30, 2015:
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Warrants
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Weighted Average Exercise Price
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Outstanding - December 31, 2014
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Outstanding - June 30, 2015
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Exercisable - June 30, 2015
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The weighted average remaining life of the outstanding Series A preferred stock warrants as of June 30, 2015 and December 31, 2014 was 4.22 and 3.26 years, respectively.
The following table presents the common stock warrant activity during the six months ended June 30, 2015:
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Warrants
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Weighted Average Exercise Price
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Outstanding - December 31, 2014
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Outstanding - June 30, 2015
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Exercisable - June 30, 2015
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The weighted average remaining life of the outstanding common stock warrants as of June 30, 2015 and December 31, 2014 was 0.92 and 0.48 years, respectively.
Note 4—RELATED PARTY TRANSACTIONS
In July 2013, we entered into a consulting agreement with an affiliate of Mr. Basloe. The agreement provides for consulting on marketing-related services for use in our business operations. The amounts paid under this agreement in the six months ended June 30, 2015 and June 30, 2014 were $36,000 and $35,875, respectively.
In January 2015, we entered into a services agreement with a family member of Mr. Basloe. The agreement provided for consultation services related to the Colorado recreational and medical marijuana marketplace and onsite retail operations studies in Boulder, CO and Denver, CO. The consultant was granted 250,000 common shares under the agreement which vest after six months. The fair value of the award was determined to be $1,750, of which $1,750 was recognized during the six months ended June 30, 2015 as stock-based compensation. The shares will be issued upon vesting.
In connection with the investments in Harris Lee Holdings, LLC and MA & Associates, LLC the Company issued Series B and Series C Preferred shares to two current board members, Mr. Del Hierro and Mr. Lierberthal. Mr. Del Hierro was issued 150,000 shares of Series B Preferred shares valued at $150 and 140,000 shares of Series C Preferred shares valued at $204,400. Mr. Lieberthal was issued 150,000 shares of Series B Preferred shares valued at $150 and 140,000 shares of Series C Preferred shares valued at $204,400.
Note 5—EQUITY METHOD INVESTMENTS AND ACQUISITIONS
MA & Associates, LLC
Equity method investees are all entities over which the Company has significant influence, but not control. Significant influence is presumed with a shareholding of between 20% and 50% of the voting rights. Investments in equity method investees are accounted for using the equity method of accounting and are initially recognized at cost. As of June 30, 2015, the Company has control of MA & Associates, LLC.
On April 8, 2014 the Company entered into a Limited Liability Company Membership Interest Purchase Agreement with MA & Associates, LLC (“MA”) under which the Company agreed to acquire a 40% equity interest in MA for two testing locations in exchange for a purchase price of $2,000,000 and 150,000 shares of the Company’s Series C Preferred Stock. MA was formed to become a marijuana testing laboratory within the State of Nevada. In 2014 the Company paid an aggregate of $542,780 of the cash portion of the purchase price. This equity method investment was fully impaired during 2014. In 2015, the Company paid an additional $778,639 of the $2,000,000 cash portion of the purchase price and issued 100,000 of the 150,000. The $778,639 equity method investment was fully impaired in 2015. The fair value of the 100,000 Series C shares was determined to be $146,000 and it was recognized as compensation expense to the sellers of MA. In addition, there are 60,000 additional Series C shares to be issued for compensation upon achieving certain milestones in 2015 of which 30,000 were issued valued and expensed at $43,800.
On June 3, 2015, the Company entered into an agreement to acquire the remaining 60% interest in MA & Associates, LLC for 1,000,000 shares of Series C preferred stock. 500,000 of the shares were issued and valued at $500,000. The remaining 500,000 shares under the 60% agreement and the remaining 50,000 shares under the 40% agreement will be issued in the future after the testing laboratory is operational. The fair value of the additional 550,000 shares was determined to be $550,000 as of the date of this acquisition and this fair value, along with the remaining cash payments due under the 40% acquisition, were recognized as a contingent consideration liability of $1,228,581. In accounting for this step-acquisition, the Company estimated the fair value of the previous equity method investment to be $666,667 as of the date control was obtained. This resulted in a loss on the change in fair value of equity method investment of $61,914 as the carrying value of the equity method investment was $728,581.
In accordance with the purchase agreement to acquire MA & Associates, LLC, ICPI is entitled to 500,000 Series C shares of which 300,000 were issued valued and expensed at $438,000. The remaining 200,000 shares will be issued upon achieving certain milestones in 2015.
The aggregate purchase price for the business acquisition was approximately $1.7 million consisting of 1,000,000 shares of Series C valued at $1,000,000 and the fair value of the previously held equity method investment of $666,667. The acquisitions were accounted for using the purchase method and accordingly, the purchase price was allocated based on the estimated fair market values of the assets acquired and liabilities assumed on the date of each acquisition. As of the date of acquisition we felt that the entire acquisition cost should be impaired as MA & Associates, LLC had not yet begun its testing operations and it is uncertain when the testing operations would begin. The goodwill from the transaction was $1,128,442. The fair value of the assets acquired and liabilities assumed for this acquisition is as follows:
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$
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4,866
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In-process research & development
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117,329
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100,000
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327,796
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$
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549,991
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$
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(11,756
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)
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(10
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)
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Total liabilities assumed
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$
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(11,766
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)
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$
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538,225
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Unaudited pro forma results of operations data for the three and six months ended June 30, 2015 and 2014 are shown below as if the Company and the entities described above had been combined on January 1, 2014. The pro forma results include estimates and assumptions which management believes are reasonable. However, pro forma results do not include any anticipated cost savings or other effects of the planned integration of these entities, and are not necessarily indicative of the results that would have occurred if the business combinations had been in effect on the dates indicated, or which may result in the future.
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Unaudited Pro Forma Results of Operations
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Three Months Ended June 30,
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Six Months Ended June 30,
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2015
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2014
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2015
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2014
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(Restated)
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(Restated)
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$
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1,399
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$
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34,093
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$
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21,632
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$
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51,419
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(748,828
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)
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(458,632
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)
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(2,095,098
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)
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(783,433
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)
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$
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(3,430,804
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)
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$
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(503,249
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)
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$
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(5,355,332
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)
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$
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(1,132,733
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)
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Harris Lee Holdings, LLC
At December 31, 2014, the Company owned 45% of Harris Lee Holdings, LLC (“Harris Lee”). Pursuant to an October 2014 agreement, during the first quarter of 2015, the company acquired an additional 10% interest in Harris Lee in exchange for 150,000 shares of the Company’s Series C Preferred stock to be issued based on a series of milestone events.
In January 2015, the Company acquired the remaining 45% of Harris Lee in exchange for 450,000 shares of the Company’s Series B Preferred Stock.
The aggregate fair value of the 450,000 Series B and the 150,000 Series C shares was determined to be $219,450 and it was recognized as compensation expense to the sellers of Harris Lee. Harris Lee is now consolidated in the Company’s financial results.
During the quarter ended June 30, 2015, Harris Lee was not operating and its impact on the Company’s Statement of Operations was zero as it was determined to be nominal.
As of the date of acquisition we felt that the entire acquisition cost should be impaired as Harris Lee Holdings, LLC had not yet begun its testing operations and it is uncertain when the testing operations would begin.
Note 6—CONVERTIBLE NOTES
During the six months ended June 30, 2015, the Company recorded discounts of $912,981 on the notes of which $855,101 resulted from derivative liabilities and $57,880 resulted from original issue discounts. During the six months ended June 30, 2015, the Company recognized a total of $137,470 in losses on true-up of convertible notes of which $44,383 related to additional principal and $93,087 related to additional shares issued. Aggregate amortization of debt discounts was $1,111,453 for the six months ended June 30, 2015.
The following table summarizes the changes in the convertible notes for the six months ending June 30, 2015:
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Short Term
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Long Term
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Total
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Balance as of December 31, 2014 - Net
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$
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911,899
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$
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15,607
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$
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927,496
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Add back: unamortized discount
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(500,673
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)
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(696,893
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)
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(1,197,566
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)
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Balance as of December 31, 2014 - Gross
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$
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1,412,562
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$
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712,500
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$
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2,125,062
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970,287
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280,000
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1,250,287
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179,302
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-
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179,302
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(350,000
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)
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-
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(350,000
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)
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(833,425
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)
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(55,556
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)
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(888,981
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)
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57,880
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-
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57,880
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1,436,606
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936,944
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2,373,550
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Less: unamortized discount
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(284,366
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)
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(838,596
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)
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(1,122,962
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)
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Balance as of June 30, 2015
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$
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1,152,240
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$
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98,348
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$
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1,250,588
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(a) The Statement of Cash Flows reflects $14,051 for accrued rent and $165,251 for true up of shares.
(b) The Statement of Cash Flows reflects $1,016,943 which consists of $888,982 in principal plus $127,961 in interest. Both were converted into common shares.
The Company uses the Black Scholes Option Pricing Model to value its convertible debt and warrant derivative liabilities based upon the following assumptions during the three months ended June 30, 2015:
Note 7—DERIVATIVE LIABILITIES
The following table summarizes the changes in the derivative liabilities during the period ending June 30, 2015:
Balance as of December 31, 2014
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Original issuance discount
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Ending balance as of June 30, 2015
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Note 8—FAIR VALUE MEASUREMENTS AND DERIVATIVE LIABILITY
The Company evaluates all of it 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 as charges or credits to income. For option-based derivative financial instruments, the Company uses the Black-Scholes option-pricing model to value the derivative instruments at inception and subsequent valuation dates. The classification of derivative instruments, including whether such instruments should be recorded as liabilities or as equity, is re-assessed 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.
Under ASC-815 the conversion options embedded in the notes payable described in Note 5 require liability classification because they do not contain an explicit limit to the number of shares that could be issued upon settlement.
As defined in FASB ASC 820, fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (exit price). The Company utilized the market data of similar entities in its industry or assumptions that market participants would use in pricing the asset or liability, including assumptions about risk and the risks inherent in the inputs to the valuation technique. These inputs can be readily observable, market corroborated, or generally unobservable. The Company classifies fair value balances based on the observability of those inputs. FASB ASC 820 establishes a fair value hierarchy that prioritizes the inputs 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 measurement) and the lowest priority to unobservable inputs (level 3 measurement).
The three levels of the fair value hierarchy are as follows:
Level 1 – Quoted prices are available in active markets for identical assets or liabilities as of the reporting date. Active markets are those in which transactions for the asset or liability occur in sufficient frequency and volume to provide pricing information on an ongoing basis. Level 1 primarily consists of financial instruments such as exchange-traded derivatives, marketable securities and listed equities.
Level 2 – Pricing inputs are other than quoted prices in active markets included in level 1, which are either directly or indirectly observable as of the reported date.
Level 3 – Pricing inputs include significant inputs that are generally less observable from objective sources. These inputs may be used with internally developed methodologies that result in management’s best estimate of fair value.
The following table sets forth by level within the fair value hierarchy the Company’s financial assets and liabilities that were accounted for at fair value at the period ending June 30, 2015.
Recurring Fair Value Measurements
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Level 1
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Level 2
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Level 3
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Total
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Derivative liabilities – June 30, 2015
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Derivative liabilities – December 31, 2014
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Note 9—SUBSEQUENT EVENTS
In accordance with FASB ASC 855-10-50-1 we evaluated our subsequent events through August 19, 2015. During this period, we entered into the following debt and equity transactions:
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●
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Investors converted $97,405 of Convertible Promissory Notes into 36,208,656 common shares.
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●
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Investors converted 200,000 Convertible Preferred Series A Stock into 20,000,000 shares of common stock.
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●
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The Company borrowed one Convertible Note of $125,000 under convertible notes with the following terms: 8.0% interest, maturity date of 4/14/16, and a conversion price calculated at 50% discount to the lowest trading price of the previous 15 days.
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●
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The Company took an investment of $125,000 in exchange for Convertible Series C Stock which converts to 12,500,000 common shares. The Company has not yet issued any shares as a result of this agreement and no cash has been received.
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●
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On July 24, 2015, the Company entered into a revolving loan agreement whereby the Company will act as Lender to Harris Lee Colorado, LLC. The maximum principal of the loan is $2,500,000, of which $0 is outstanding as of this date. The maturity date for the loan is January 24, 2023 and has an interest rate of the higher of 1.77% per annum or LIBOR + 50 bps, but not to exceed 4.0% per annum.
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●
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The Company issued a total of 4,500,000 warrant exercise shares less 166,387 exercise shares in cashless exercise.
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