WTNW Water Now Inc (CE)

Notes to Condensed Consolidated Financial Statements (unaudited)

September 30, 2019 and 2018

1. Basis of Presentation and Summary of Significant Accounting Policies

The accompanying unaudited financial statements of Water Now, Inc. and subsidiary (collectively, the “Company”) have been prepared in accordance with the rules and regulations of the Securities and Exchange Commission, or the SEC, including the instructions to Regulation S-X. Certain information and note disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles in the United States of America have been omitted from these statements pursuant to such rules and regulations and, accordingly, they do not include all the information and notes necessary for comprehensive financial statements and should be read in conjunction with our audited financial statements for the year ended December 31, 2018.

In the opinion of the management of the Company, all adjustments, which are of a normal recurring nature, necessary for a fair statement of the results for the three-month period have been made. Results for the interim period presented are not necessarily indicative of the results that might be expected for the entire fiscal year. When used in these notes, the terms “Company”, “we”, “us” or “our” mean Water Now, Inc. and subsidiary.

Certain amounts in our Condensed Consolidated Statement of Operations for the period ended September 30, 2018 have been reclassified to conform with the current period presentation.

Fair Value Measurements

ASC Topic 820, “Fair Value Measurement”, requires that certain financial instruments be recognized at their fair values at our balance sheet dates. However, other financial instruments, such as debt obligations, are not required to be recognized at their fair values, but GAAP provides an option to elect fair value accounting for these instruments. GAAP requires the disclosure of the fair values of all financial instruments, regardless of whether they are recognized at their fair values or carrying amounts in our balance sheets. For financial instruments recognized at fair value, GAAP requires the disclosure of their fair values by type of instrument, along with other information, including changes in the fair values of certain financial instruments recognized in income or other comprehensive income. For financial instruments not recognized at fair value, the disclosure of their fair values is provided below under “Financial Instruments.”

Nonfinancial assets, such as property, plant and equipment, and nonfinancial liabilities are recognized at their carrying amounts in the Company’s balance sheets. GAAP does not permit nonfinancial assets and liabilities to be remeasured at their fair values. However, GAAP requires the remeasurement of such assets and liabilities to their fair values upon the occurrence of certain events, such as the impairment of property, plant and equipment. In addition, if such an event occurs, GAAP requires the disclosure of the fair value of the asset or liability along with other information, including the gain or loss recognized in income in the period the remeasurement occurred.

The Company did not have any Level 1 or Level 2 assets and liabilities at September 30, 2019 and 2018.

The Derivative liabilities are Level 3 fair value measurements.

The following is a summary of activity of Level 3 liabilities during the nine months ended September 30, 2019:

At September 30, 2019, the fair value of the derivative liabilities of convertible notes was estimated using the following weighted-average inputs: the price of the Company’s common stock of $0.16, a risk-free interest rate of 1.88%, and expected volatility of the Company’s common stock of 213.76%, and the various estimated reset exercise prices weighted by probability.

Recently Adopted Accounting Pronouncements

Effective January 1, 2019, we adopted the Financial Accounting Standards Board (“FASB”) Accounting Standards Update (“ASU”) 2016-02, Leases, which requires the recognition of lease assets and lease liabilities by lessees for those leases classified as operating leases under previous guidance. The original guidance required application on a modified retrospective basis with the earliest period presented. In August 2018, the FASB issued ASU 2018-11, Targeted Improvements to ASC 842, which included an option to not restate comparative periods in transition and elect to use the effective date of ASC 842, Leases, as the date of initial application of transition, which we elected. As a result of the adoption of ASC 842 on January 1, 2019, we recorded both operating lease right-of-use (“ROU”) assets of $159,433 and lease liabilities of $154,518. The adoption of ASC 842 had an immaterial impact on our Condensed Consolidated Statement of Operations and Condensed Consolidated Statement of Cash Flows for the nine-month period ended September 30, 2019. In addition, we elected the package of practical expedients permitted under the transition guidance within the new standard which allowed us to carry forward the historical lease classification.

Additional information and disclosures required by this new standard are contained in Note 10.

2. Going Concern

At September 30, 2019, the Company had approximately $127,000 in cash and had net working capital deficit of approximately $4,845,000. The Company, which generated a net loss of approximately $7,575,000 and $2,777,000 for the nine months ended September 30, 2019 and 2018, respectively, may not have sufficient cash to fund its current and future operations. There is no assurance that future operations will result in profitability. No assurance can be given that management will be successful in its efforts to raise additional capital. The failure to raise additional capital needed to achieve its business plans will have a material adverse effect on the Company’s financial position, results of operations, and ability to continue as a going concern.

3. Revenues

The Company’s revenues are generated from the sales of water purification products and the sales of hydrocarbons derived from the deployment and operation of Company owned oil recovery systems. The Company obtains purchase orders from its water purification customers for the sale of its products which sets forth the general terms and conditions including line item pricing and payment terms (generally due upon receipt). The Company recognizes revenue when its customers obtain control over the assets (generally when the title passes upon shipment) and it is probable that the Company will collect substantially all the amounts due. Individual promised goods are the Company’s only performance obligation.

The Company earns revenue each month that the oil recovery systems are in place and operating. The Company generally receives 50% of the proceeds of the sales of oil recovered using its systems.

Water purification products that have been sold are not subject to returns unless the product is deemed defective. Credits or refunds are recognized when they are probable and reasonably estimated. The Company’s management reduces revenue to account for estimates of the Company’s credits and refunds.

The Company included shipping and handling fees in net revenues. Shipping and handling costs are associated with outbound freight after control over a product has transferred to a customer. These costs are accounted for as a fulfillment cost and are included in cost of goods sold.

Revenues, as disaggregated by revenue type and reportable segment (see Note 12), are shown below.

4. Distributorship Agreement

On October 31, 2018, the Company entered into an Exclusive Sales Distribution Agreement (the “Agreement”) with African Horizon Technologies (Pty) Ltd (“AHT”) whereby the Company serves as AHT’s exclusive distributor of the Hydraspin Hydro Cyclone technology in the United States of America. The Company was obligated to pay AHT $500,000 and issue AHT 500,000 shares valued at $250,000 based on the closing price of the Company’s shares of $0.50 on the date of the Agreement. In addition, the Company will issue AHT 500,000 shares at the earlier of 24 months from the commencement date of the Agreement or the sale of 50 units to the Company. The Company will also pay AHT a royalty of 2% of total net profits generated by the Company from the sale of oil generated using the Hydraspin units. The term of the Agreement is for five years with an automatic renewal term of five years unless terminated prior to the expiration of the current term. The Company recorded the value of the Agreement of $1,000,000 as an other asset and is amortizing the asset to expense over the life of the Agreement of five years. As of September 30, 2019, $500,000 was paid and the remaining 500,000 shares to be issued is included as an accrued expense.

5. Notes Payable – Stockholders

The Company borrowed $200,000 and $100,000 from two stockholders on March 25, 2019. The notes bear interest at 18% and are payable beginning on April 25, 2019, at which time the entire amount of principal and any accrued interest was due and payable. The notes are unsecured, and the $200,000 note is guaranteed by the Company’s Chief Executive Officer. As of September 30, 2019, the $100,000 note was paid and the $200,000 note remains outstanding.

6. Convertible Notes Payable

The Company borrowed $68,000 from a lender on September 4, 2018. The note bears interest at 8% and matures on September 4, 2019, at which time the entire amount of principal and accrued interest is due and payable. The note is unsecured. The outstanding principal and interest amount is convertible by the holder into shares of the Company’s common stock beginning 170 days after the issuance date and prior to the maturity date at a price per share equal to sixty-five percent of the average of the lowest two trading prices of the Company’s common stock for the twenty trading days prior to the conversion date. This note was paid in full on January 3, 2019 and the Company recorded a gain on extinguishment of this debt of $19,114. The Company has no further obligations with respect to this loan.

The Company borrowed $200,000 from a lender on September 17, 2018. The note does not bear interest and matures September 17, 2021, at which time the entire amount of principal is due and payable. The note is unsecured. The outstanding principal amount is convertible by the holder into shares of the Company’s common stock at any time prior to the maturity date at a price per share equal to $0.75 per share if before 180 days after the issuance date, or if 180 days after the issuance date, the lesser of $0.75 per share or seventy percent of the second lowest trading price of the Company’s common stock for the twenty trading days prior to the conversion date. In addition, the Company granted 60,000 shares of the Company’s common stock valued at $53,400 based on the Company’s share price on the date of the note agreement, paid $34,400 as a discount for interest on the note, and paid $5,000 for debt issuance costs. Through September 30, 2019, the Company paid $142,000 of principal and prepayment penalties of $58,000 recorded as interest expense. The lender converted the remaining $58,000 of principal into 332,500 shares of the Company’s common stock. The Company has no further obligations with respect to this loan.

The Company borrowed $100,000 from a shareholder on August 30, 2018. The note bears interest at 10% and is payable in one lump sum on March 4, 2019, at which time the entire amount of principal and accrued interest is

due and payable. The note is unsecured. The outstanding principal and interest amount is convertible by the holder into shares of the Company’s common stock at any time prior to the maturity date at the conversion price of $0.50 per share.  This note was converted into 200,000 shares of the Company’s common stock on March 28, 2019. The Company has no further obligations with respect to this loan.

The Company borrowed $42,500 from a lender on October 15, 2018. The note bears interest at 8% and is payable in one lump sum on October 15, 2019, at which time the entire amount of principal and accrued interest is due and payable. The note is unsecured. The outstanding principal and interest amount is convertible by the holder into shares of the Company’s common stock beginning 170 days after the issuance date and prior to the maturity date at a price per share equal to sixty-five percent of the average of the lowest two trading prices of the Company’s common stock for the twenty trading days prior to the conversion date. In addition, the Company paid $2,500 for debt issuance costs. This note was paid in full on March 26, 2019 and the Company recorded a loss on extinguishment of this debt of $17,841. The Company has no further obligations with respect to this loan.

The Company borrowed $86,500 from a lender on January 2, 2019. The note bears interest at 8% and is payable in one lump sum on January 2, 2020, at which time the entire amount of principal and accrued interest is due and payable. The note is unsecured. The outstanding principal and interest amount is convertible by the holder into shares of the Company’s common stock beginning 180 days after the issuance date and prior to the maturity date at a price per share equal to sixty-five percent of the average of the lowest two trading prices of the Company’s common stock for the twenty trading days prior to the conversion date. In addition, the Company paid $2,500 for debt issuance costs. This note was paid in full on July 8, 2019 and the Company recorded a loss on extinguishment of this debt of $32,592. The Company has no further obligations with respect to this loan.

The Company borrowed $102,500 from a lender on February 14, 2019. The note bears interest at 8% and is payable in one lump sum on February 14, 2020, at which time the entire amount of principal and accrued interest is due and payable. The note is unsecured. The outstanding principal and interest amount is convertible by the holder into shares of the Company’s common stock beginning 180 days after the issuance date and prior to the maturity date at a price per share equal to sixty-five percent of the average of the lowest two trading prices of the Company’s common stock for the twenty trading days prior to the conversion date. In addition, the Company paid $2,500 for debt issuance costs. This note was paid in full on August 20, 2019 and the Company recorded a gain on extinguishment of this debt of $38,143. The Company has no further obligations with respect to this loan.

The Company borrowed $100,000 from a lender on February 20, 2019. The note bears interest at 10%, and is payable in one lump sum on February 20, 2020, at which time the entire amount of principal and accrued interest is due and payable. The note is unsecured. The outstanding principal amount is convertible by the holder into shares of the Company’s common stock beginning six months after the issuance date and prior to the maturity date at a price per share equal to sixty percent of the lowest trading price of the Company’s common stock for the fifteen trading days prior to the conversion date. The conversion feature meets the definition of a derivative and therefore requires bifurcation and is accounted for as a derivative liability. The Company estimated the aggregate fair value of the conversion feature derivatives embedded in the debenture at the date the debt becomes convertible at $164,490, based on weighted probabilities of assumptions used in the Black Scholes pricing model. The key valuation assumptions used consist, in part, of the price of the Company’s common stock of $0.23, a risk-free interest rate of 2.00% and expected volatility of the Company’s common stock of 178.56%, and the various estimated reset exercise prices weighted by probability. This resulted in the calculated fair value of the debt discount being greater than the face amount of the debt, and the excess amount of $64,490 was immediately expensed as financing costs. In addition, the Company paid $5,000 for debt issuance costs. Through September 30, 2019, the Company paid $85,000 of principal, prepayment penalties and accrued interest totaling $45,000 recorded as interest expense, and recorded a loss on extinguishment of this debt of $42,629. The lender also converted $15,748 of principal and interest into 159,070 shares of the Company’s common stock. The Company has no further obligations with respect to this loan.

The Company borrowed $560,000 from a lender on February 21, 2019. The note bears interest at 12% and is payable in one lump sum on August 21, 2019, at which time the entire amount of principal and accrued interest is due and payable. The note is unsecured. The outstanding principal and interest amount is convertible by the holder into shares of the Company’s common stock beginning 180 days after the issuance date and prior to the maturity

date at a price per share equal to sixty-five percent of the second lowest trade price of the Company’s common stock for the twenty trading days prior to the conversion date. The conversion feature meets the definition of a derivative and therefore requires bifurcation and is accounted for as a derivative liability. The Company estimated the aggregate fair value of the conversion feature derivatives embedded in the debenture at the date the debt becomes convertible at $1,185,397, based on weighted probabilities of assumptions used in the Black Scholes pricing model. The key valuation assumptions used consist, in part, of the price of the Company’s common stock of $0.18, a risk-free interest rate of 1.88% and expected volatility of the Company’s common stock of 213.76%, and the various estimated reset exercise prices weighted by probability. In addition, the Company granted the lender 450,000 shares of the Company’s common stock, paid $56,000 as a discount on the note, and paid $4,000 for debt issuance costs. The shares granted must be returned if the note is fully repaid and satisfied prior to 180 days after the issuance date. The Company recorded the value of the shares at $400,455, based on the Company’s share price on the date of the note agreement, as interest expense. During the third quarter of 2019, in two separate conversions, the holder converted $151,000 of principal and interest into 2,106,044 shares of common stock of the Company. As a result of the conversions the derivative liability related to the debenture was remeasured immediately prior to the conversions with an overall increase in the fair value of $615,000 recognized, with the fair value of the derivative liability related to the converted portion of $287,000 being reclassified to equity. The key valuation assumptions used consist, in part, of the price of the Company’s common stock on the dates of conversion, of $0.20 and $0.23, a risk-free interest rate of 1.88% and expected volatility of the Company’s common stock, of 213.76%, and the various estimated reset exercise prices weighted by probability. The principal balance at September 30, 2019 is $448,000.

The Company borrowed $42,500 from a lender on March 11, 2019. The note bears interest at 8% and is payable in one lump sum on March 11, 2020, at which time the entire amount of principal and accrued interest is due and payable. The note is unsecured. The outstanding principal and interest amount is convertible by the holder into shares of the Company’s common stock beginning 180 days after the issuance date and prior to the maturity date at a price per share equal to sixty-five percent of the average of the lowest two trading prices of the Company’s common stock for the twenty trading days prior to the conversion date. In addition, the Company paid $2,500 for debt issuance costs. This note was paid in full on September 9, 2019 and the Company recorded a loss on extinguishment of this debt of $16,689. The Company has no further obligations with respect to this loan.

The Company borrowed $150,000 from a lender on March 18, 2019. The note bears interest at 12% and is payable in one lump sum on September 18, 2019, at which time the entire amount of principal and accrued interest is due and payable. The note is unsecured. The outstanding principal and interest amount is convertible by the holder into shares of the Company’s common stock beginning 180 days after the issuance date and prior to the maturity date at a price per share equal to sixty-five percent of the second lowest trade price of the Company’s common stock for the twenty trading days prior to the conversion date. The conversion feature meets the definition of a derivative and therefore requires bifurcation and is accounted for as a derivative liability. The Company estimated the aggregate fair value of the conversion feature derivatives embedded in the debenture at the date the debt becomes convertible at $433,000, based on weighted probabilities of assumptions used in the Black Scholes pricing model. The key valuation assumptions used consist, in part, of the price of the Company’s common stock of $0.28, a risk-free interest rate of 1.87% and expected volatility of the Company’s common stock of 167.00%, and the various estimated reset exercise prices weighted by probability. During the third quarter of 2019, the holder converted $56,000 of principal and interest into 1,000,000 shares of common stock of the Company. As a result of the conversions the derivative liability related to the debenture was remeasured immediately prior to the conversion with an overall decrease in the fair value of $91,000 recognized, with the fair value of the derivative liability related to the converted portion, of $99,000 being reclassified to equity. The key valuation assumptions used consist, in part, of the price of the Company’s common stock on the date of conversion, of $0.19; a risk-free interest rate of 1.88% and expected volatility of the Company’s common stock, of 213.76%, and the various estimated reset exercise prices weighted by probability. In addition, the Company granted 115,384 shares of the Company’s common stock and paid $15,000 as a discount on the note. The shares granted must be returned if the note is fully repaid and satisfied prior to 180 days after the issuance date. The Company recorded the value of the shares at $91,153, based on the Company’s share price on the date of the note agreement, as interest expense. The principal balance at September 30, 2019 is $95,650.

The Company borrowed $45,000 from a lender on November 6, 2018. The note bears interest at 8% and is payable

in one lump sum on November 6, 2019, at which time the entire amount of principal and accrued interest is due and payable. The note is unsecured. The outstanding principal and interest amount is convertible by the holder into shares of the Company’s common stock beginning 170 days after the issuance date and prior to the maturity date at a price per share equal to sixty-five percent of the average of the lowest two trading prices of the Company’s common stock for the twenty trading days prior to the conversion date. In addition, the Company paid $2,500 for debt issuance costs. This note was paid in full on April 5, 2019 and the Company recorded a loss on extinguishment of this debt of $15,870. The Company has no further obligations with respect to this loan.

The Company borrowed $82,500 from a shareholder on October 11, 2018. The note bears interest at 8% and is payable in one lump sum on April 11, 2019, at which time the entire amount of principal and accrued interest is due and payable. The note is unsecured. The outstanding principal and interest amount is convertible by the holder into shares of the Company’s common stock at any time prior to the maturity date at the conversion price of $0.50 per share. In addition, the Company paid $13,500 for debt issuance costs. This note was paid in full on April 12, 2019 and the Company recorded additional interest expense of $38,940. The Company has no further obligations with respect to this loan.

The Company borrowed $100,000 from a lender on December 13, 2018. The note bears interest at 10%, and is payable in one lump sum on December 13, 2019, at which time the entire amount of principal and accrued interest is due and payable. The note is unsecured. The outstanding principal and interest amount is convertible by the holder into shares of the Company’s common stock beginning six months after the issuance date and prior to the maturity date at a price per share equal to sixty percent of the lowest trading price of the Company’s common stock for the fifteen trading days prior to the conversion date. The conversion feature meets the definition of a derivative and therefore requires bifurcation and is accounted for as a derivative liability. The Company estimated the aggregate fair value of the conversion feature derivatives embedded in the debenture at the date the debt becomes convertible at $150,000, based on weighted probabilities of assumptions used in the Black Scholes pricing model. The key valuation assumptions used consist, in part, of the price of the Company’s common stock of $0.29, a risk-free interest rate of 2.40% and expected volatility of the Company’s common stock of 156.33%, and the various estimated reset exercise prices weighted by probability. During June and July 2019, in two separate conversions, the holder converted $36,000 of principal and interest into 333,535 shares of common stock of the Company. As a result of the conversions the derivative liability related to the debenture was remeasured immediately prior to the conversions with an overall decrease in the fair value of $32,000 recognized, with the fair value of the derivative liability related to the converted portion, of $117,000 being reclassified to equity. The key valuation assumptions used consist, in part, of the price of the Company’s common stock on the dates of conversion, of $0.32 and $0.22; a risk-free interest rate of 2.00% and expected volatility of the Company’s common stock, of 146.06%, and the various estimated reset exercise prices weighted by probability. In addition, the Company paid $5,000 for debt issuance costs. Through September 30, 2019, the Company paid the remaining $65,745 of principal and prepayment penalties of $29,255 recorded as interest expense. The Company has no further obligations with respect to this loan.

The Company borrowed $77,000 from a lender on October 12, 2018. The note allows borrowing up to $231,000, bears interest at 12%, and is payable in one lump sum on October 12, 2019, at which time the entire amount of principal and accrued interest is due and payable. The note is unsecured. The outstanding principal and interest amount is convertible by the holder into shares of the Company’s common stock prior to the maturity date at a price per share equal to sixty-five percent of the lowest trading price of the Company’s common stock for the twenty trading days prior to the conversion date. If at any time while this note is outstanding, the conversion price is equal to or lower than $0.50, then an additional fifteen percent discount shall be factored into the conversion price until the note is no longer outstanding. The conversion feature meets the definition of a derivative and therefore requires bifurcation and is accounted for as a derivative liability. The Company estimated the aggregate fair value of the conversion feature derivatives embedded in the debenture at the date the debt becomes convertible at $115,000, based on weighted probabilities of assumptions used in the Black Scholes pricing model. The key valuation assumptions used consist, in part, of the price of the Company’s common stock of $0.33, a risk-free interest rate of 2.56% and expected volatility of the Company’s common stock of 172.94%, and the various estimated reset exercise prices weighted by probability. From April through August 2019, in several separate conversions, the holder converted $89,000 of principal and interest into 921,346 shares of common stock of the Company. As a result of the conversions the derivative liability related to the debenture was remeasured

immediately prior to the conversions with an overall decrease in the fair value of $115,000 recognized, with the fair value of the derivative liability related to the converted portion of $150,000 being reclassified to equity. The key valuation assumptions used consist, in part, of the price of the Company’s common stock on the dates of conversion, of $0.27 to $0.40, a risk-free interest rate of 1.88% and expected volatility of the Company’s common stock, of 213.76%, and the various estimated reset exercise prices weighted by probability. In addition, the Company paid $2,000 for debt issuance costs. On May 20, 2019, the Company borrowed an additional $51,500 on this note. The Company estimated the aggregate fair value of the conversion feature derivatives embedded in the debenture at the date the debt becomes convertible at $149,000, based on weighted probabilities of assumptions used in the Black Scholes pricing model. The key valuation assumptions used consist, in part, of the price of the Company’s common stock of $0.40, a risk-free interest rate of 2.37% and expected volatility of the Company’s common stock of 154.69%, and the various estimated reset exercise prices weighted by probability. In addition, the Company paid $1,500 for debt issuance costs. The principal balance at September 30, 2019 is $51,500.

The Company borrowed $80,000 from a lender on December 17, 2018. The note bears interest at 10%, and is payable in one lump sum on December 17, 2019, at which time the entire amount of principal and accrued interest is due and payable. The note is unsecured. The outstanding principal and interest amount is convertible by the holder into shares of the Company’s common stock prior to the maturity date at a price per share equal to sixty-five percent of the lowest trading price of the Company’s common stock for the fifteen trading days prior to the conversion date. The conversion feature meets the definition of a derivative and therefore requires bifurcation and is accounted for as a derivative liability. The Company estimated the aggregate fair value of the conversion feature derivatives embedded in the debenture at the date the debt becomes convertible at $160,000, based on weighted probabilities of assumptions used in the Black Scholes pricing model. The key valuation assumptions used consist, in part, of the price of the Company’s common stock of $0.39, a risk-free interest rate of 2.40% and expected volatility of the Company’s common stock of 156.33%, and the various estimated reset exercise prices weighted by probability. From June through August 2019, in several separate conversions, the holder converted $84,000 of principal and interest into 696,503 shares of common stock of the Company. As a result of the conversions the derivative liability related to the debenture was remeasured immediately prior to the conversions with an overall decrease in the fair value of $91,000 recognized, with the fair value of the derivative liability related to the converted portion, of $101,000 being reclassified to equity. The key valuation assumptions used consist, in part, of the price of the Company’s common stock on the dates of conversion, of $0.19 to $0.35, a risk-free interest rate of 2.00% and expected volatility of the Company’s common stock of 145.37% to 156.33%, and the various estimated reset exercise prices weighted by probability. In addition, the Company paid $4,000 for debt issuance costs. The Company has no further obligations with respect to this loan.

The Company borrowed $175,000 from a lender on April 9, 2019. The note bears interest at 12%, and is payable in one lump sum on January 9, 2020, at which time the entire amount of principal and accrued interest is due and payable. The note is unsecured. The outstanding principal and interest amount is convertible by the holder into shares of the Company’s common stock beginning 180 days after the issuance date and prior to the maturity date at a price per share equal to the lesser of the lowest trading price of the Company’s common stock for the twenty-five trading days prior to the note issuance date, and the variable conversion price equal to fifty-five percent of the lowest trading price of the Company’s common stock for the twenty-five trading days prior to the conversion date. If at any time while this note is outstanding a 3^rd party has the right to convert at a discount to market greater than the conversion price in effect at that time, the lender may utilize such greater discount percentage until the note is no longer outstanding. If at any time while this note is outstanding a 3rd party has a look back period greater than the look back period in effect at that time, the lender may utilize such greater number of look back days until the note is no longer outstanding. In addition, the Company paid $16,250 for debt issuance costs. The principal balance at September 30, 2019 is $175,000.

The Company borrowed $102,500 from a lender on April 10, 2019. The note bears interest at 8% and is payable in one lump sum on April 10, 2020, at which time the entire amount of principal and accrued interest is due and payable. The note is unsecured. The outstanding principal and interest amount is convertible by the holder into shares of the Company’s common stock beginning 180 days after the issuance date and prior to the maturity date at a price per share equal to sixty-five percent of the average of the lowest two trading prices of the Company’s common stock for the twenty trading days prior to the conversion date. The principal balance at September 30, 2019 is $102,500.

The Company borrowed $400,000 from five lenders on May 20, 2019. The notes bear interest at 10% and are payable in one lump sum on May 20, 2020, at which time the entire amount of principal and accrued interest is due and payable. The notes are unsecured. The outstanding principal and interest amount is convertible by the holders into shares of the Company’s common stock at any time after the closing price of the Company’s common stock exceeds $0.75 for 10 consecutive trading days at a price equal to $0.50 per share. There was no value assigned to the beneficial conversion feature on the issuance date of the notes due to the Company’s common stock price being less than $0.75 per share. The principal balance at September 30, 2019 is $400,000.

The Company borrowed $88,500 from a lender on July 8, 2019. The note bears interest at 8% and is payable in one lump sum on July 8, 2020, at which time the entire amount of principal and accrued interest is due and payable. The note is unsecured. The outstanding principal and interest amount is convertible by the holder into shares of the Company’s common stock beginning 180 days after the issuance date and prior to the maturity date at a price per share equal to sixty-five percent of the average of the lowest two trading prices of the Company’s common stock for the twenty trading days prior to the conversion date. The principal balance at September 30, 2019 is $88,500.

The Company borrowed $103,000 from a lender on July 24, 2019. The note bears interest at 10% and is payable in one lump sum on July 24, 2020, at which time the entire amount of principal and accrued interest is due and payable. The note is unsecured. The outstanding principal and interest amount is convertible by the holder into shares of the Company’s common stock beginning 180 days after the issuance date and prior to the maturity date at a price per share equal to the lesser of (1) $0.22 and (2) sixty-five percent of the lowest trading price of the Company’s common stock for the twenty trading days prior to the conversion date. In addition, the Company paid $15,315 for debt issuance costs. The principal balance at September 30, 2019 is $103,000.

The Company borrowed $100,000 from two lenders on July 26, 2019. The notes bear interest at 10% and are payable in one lump sum on May 20, 2020, at which time the entire amount of principal and accrued interest is due and payable. The notes are unsecured. The outstanding principal and interest amount is convertible by the holders into shares of the Company’s common stock at any time after the closing price of the Company’s common stock exceeds $0.75 for 10 consecutive trading days at a price equal to $0.50 per share. There was no value assigned to the beneficial conversion feature on the issuance date of the notes due to the Company’s common stock price being less than $0.75 per share. The principal balance at September 30, 2019 is $100,000.

The Company borrowed $175,000 from a lender on August 26, 2019. The note bears interest at 12% and is payable in one lump sum on February 26, 2020, at which time the entire amount of principal and accrued interest is due and payable. The note is unsecured. The outstanding principal and interest amount is convertible by the holder into shares of the Company’s common stock beginning 180 days after the issuance date and prior to the maturity date at a price per share equal to sixty-five percent of the second lowest trade price of the Company’s common stock for the twenty trading days prior to the conversion date. In addition, the Company granted the lender 625,000 shares of the Company’s common stock, paid $17,500 as a discount on the note, and paid $3,000 for debt issuance costs. The shares granted must be returned if the note is fully repaid and satisfied prior to 180 days after the issuance date. The Company recorded the value of the shares at $81,250, based on the Company’s share price on the date of the note agreement, as debt issuance costs. The principal balance at September 30, 2019 is $175,000.

The Company borrowed $295,000 from a lender on September 4, 2019. The note does not bear interest and matures September 4, 2020, at which time the entire amount of principal is due and payable. The note is unsecured. The outstanding principal amount is convertible by the holder into shares of the Company’s common stock at any time after the closing price of the Company’s common stock exceeds $0.75 for 10 consecutive trading days at a price equal to $0.50 per share. There was no value assigned to the beneficial conversion feature on the issuance date of the notes due to the Company’s common stock price being less than $0.75 per share. The principal balance at September 30, 2019 is $295,000. The Company paid $45,000 as a discount for interest on the note.

The Company borrowed $262,500 from a lender on September 10, 2019. The note bears interest at 10%, and is payable in one lump sum on September 10, 2020, at which time the entire amount of principal and accrued interest

is due and payable. The note is unsecured. The outstanding principal and interest amount is convertible by the holder into shares of the Company’s common stock beginning on the sixth month anniversary of the note and prior to the maturity date at a price per share equal to sixty percent of the lowest trading price of the Company’s common stock for the fifteen trading days prior to the conversion date. The principal balance at September 30, 2019 is $262,500.

7. Advances From Related Parties

The Company has received non-interest bearing advances without a specified maturity date from certain stockholders of the Company. The Company owed approximately $20,000 and $302,000, respectively, at September 30, 2019 and December 31, 2018 to the stockholders.

8. Revenue Sharing Agreements

The Company borrowed $50,000 from a lender on November 29, 2018, whereby the proceeds are to be used to purchase a certain HydraSpin unit in exchange for the lender to receive five percent of the revenues net of costs generated from the HydraSpin unit. On March 3, 2019, the Company cancelled this original agreement and entered into a new agreement whereby the lender is to receive fifty percent of the revenues net of costs and has guaranteed that the lender would receive $150,000 in net revenues by March 3, 2021, or the Company would pay the lender the difference between the $150,000 and the purchase price of $50,000 on or before March 31, 2021. On August 19, 2019, the Company cancelled the March 3, 2019 agreement and entered into a new agreement to borrow an additional $230,000, whereby the proceeds will be used to purchase a certain HydraSpin unit in exchange for the lender to receive fifty percent of the revenues net of costs generated from the HydraSpin unit. The Company has guaranteed that the lender would receive $495,000 in net revenues by November 4, 2021, or the Company would pay the lender the difference between the $495,000 and the purchase price of $330,000 on or before November 30, 2021. For the nine-month period ended September 30, 2019, the Company recorded $27,569 of interest expense related to the value of the revenue sharing liability. The agreement remains in full force and effect until the earlier of (a) the Company is unable to satisfy its obligations under the terms of the agreement and action is brought by the lender to enforce same, (b) the expiration of the operating life of the unit, as confirmed by the manufacturer (five years), or (c) the mutual written agreement of the parties.

The Company borrowed $264,000 from a lender on December 13, 2018, whereby the proceeds are to be used to purchase certain HydraSpin units. On February 27, 2019, the Company cancelled this original agreement and entered into a new agreement to borrow an additional $66,000, whereby the proceeds were used to purchase a certain HydraSpin unit in exchange for the lender to receive fifty percent of the revenues net of costs generated from the HydraSpin unit. The Company has guaranteed that the lender would receive $495,000 in net revenues by March 3, 2021, or the Company would pay the lender the difference between the $495,000 and the purchase price of $330,000 on or before March 31, 2021. For the nine-month period ended September 30, 2019, the Company recorded $42,625 of interest expense related to the value of the revenue sharing liability. The agreement remains in full force and effect until the earlier of (a) the Company is unable to satisfy its obligations under the terms of the agreement and action is brought by the lender to enforce same, (b) the expiration of the operating life of the unit, as confirmed by the manufacturer (five years), or (c) the mutual written agreement of the parties.

The Company borrowed $660,000 from a lender on January 2, 2019, whereby the proceeds were used to purchase certain HydraSpin units in exchange for the lender to receive fifty percent of the revenues net of costs generated from the HydraSpin units. The Company has guaranteed that the lender would receive $990,000 in net revenues by January 2, 2021, or the Company would pay the lender the difference between the $990,000 and the purchase price of $660,000 on or before January 15, 2021. For the nine-month period ended September 30, 2019, the Company recorded $123,750 of interest expense related to the value of the revenue sharing liability. The agreement remains in full force and effect until the earlier of (a) the Company is unable to satisfy its obligations under the terms of the agreement and action is brought by the lender to enforce same, (b) the expiration of the operating life of the units, as confirmed by the manufacturer (five years), or (c) the mutual written agreement of the parties.

The Company borrowed $660,000 from a lender on January 16, 2019, whereby the proceeds were used to purchase certain HydraSpin units in exchange for the lender to receive fifty percent of the revenues net of costs generated

from the HydraSpin units. The Company has guaranteed that the lender would receive $990,000 in net revenues by January 15, 2021, or the Company would pay the lender the difference between the $990,000 and the purchase price of $660,000 on or before January 17, 2021. For the nine-month period ended September 30, 2019, the Company recorded $116,875 of interest expense related to the value of the revenue sharing liability. The agreement remains in full force and effect until the earlier of (a) the Company is unable to satisfy its obligations under the terms of the agreement and action is brought by the lender to enforce same, (b) the expiration of the operating life of the units, as confirmed by the manufacturer (five years), or (c) the mutual written agreement of the parties.

The Company borrowed $330,000 from a lender on January 30, 2019, whereby the proceeds were used to purchase a certain HydraSpin unit in exchange for the lender to receive sixty percent of the revenues net of forty percent of costs generated from the HydraSpin unit until the lender receives revenue equal to 120% of the $330,000 investment, then the lender shall receive fifty percent of the revenues net of costs generated from the HydraSpin unit. The Company has guaranteed that the lender would receive $495,000 in net revenues by January 30, 2021, or the Company would pay the lender the difference between the $495,000 and the purchase price of $330,000 on or before February 6, 2021. For the nine-month period ended September 30, 2019, the Company recorded $55,000 of interest expense related to the value of the revenue sharing liability. The agreement remains in full force and effect until the earlier of (a) the Company is unable to satisfy its obligations under the terms of the agreement and action is brought by the lender to enforce same, (b) the expiration of the operating life of the unit, as confirmed by the manufacturer (five years), or (c) the mutual written agreement of the parties.

The Company borrowed $330,000 from a lender on January 30, 2019, whereby the proceeds were used to purchase a certain HydraSpin unit in exchange for the lender to receive sixty percent of the revenues net of forty percent of costs generated from the HydraSpin unit until the lender receives revenue equal to 120% of the $330,000 investment, then the lender shall receive fifty percent of the revenues net of costs generated from the HydraSpin unit. The Company has guaranteed that the lender would receive $495,000 in net revenues by January 30, 2021, or the Company would pay the lender the difference between the $495,000 and the purchase price of $330,000 on or before February 6, 2021. For the nine-month period ended September 30, 2019, the Company recorded $55,000 of interest expense related to the value of the revenue sharing liability. The agreement remains in full force and effect until the earlier of (a) the Company is unable to satisfy its obligations under the terms of the agreement and action is brought by the lender to enforce same, (b) the expiration of the operating life of the unit, as confirmed by the manufacturer (five years), or (c) the mutual written agreement of the parties.

The Company borrowed $330,000 from a lender on April 1, 2019, whereby the proceeds were used to purchase a certain HydraSpin unit in exchange for the lender to receive fifty percent of the revenues net of costs generated from the HydraSpin unit. The Company has guaranteed that the lender would receive $495,000 in net revenues by April 8, 2021, or the Company would pay the lender the difference between the $495,000 and the purchase price of $330,000 on or before April 30, 2021. For the nine-month period ended September 30, 2019, the Company recorded $41,250 of interest expense related to the value of the revenue sharing liability. The agreement remains in full force and effect until the earlier of (a) the Company is unable to satisfy its obligations under the terms of the agreement and action is brought by the lender to enforce same, (b) the expiration of the operating life of the units, as confirmed by the manufacturer (five years), or (c) the mutual written agreement of the parties.

The Company borrowed $60,000 from a lender on June 25, 2019, whereby the proceeds were used to purchase a certain HydraSpin unit in exchange for the lender to receive fifty percent of the revenues net of costs generated from the HydraSpin unit. The Company has guaranteed that the lender would receive $90,000 in net revenues by June 25, 2021, or the Company would pay the lender the difference between the $90,000 and the purchase price of $60,000 on or before July 25, 2021. On August 15, 2019, the Company borrowed an additional $70,000 from the lender. During the quarter, the lender requested the agreement be terminated and $130,000 be returned to the lender. The Company intends to return the amount borrowed during the period ending December 31, 2019. For the nine-month period ended September 30, 2019, the Company recorded $208 of interest expense related to the value of the revenue sharing liability. The agreement remains in full force and effect until the earlier of (a) the Company is unable to satisfy its obligations under the terms of the agreement and action is brought by the lender to enforce same, (b) the expiration of the operating life of the units, as confirmed by the manufacturer (five years), or (c) the mutual written agreement of the parties.

9. Equity Transactions

From January 1, 2018 to March 31, 2018, the Company issued 1,656,000 shares to investors at $0.50 per share for cash, with total proceeds of $828,000, including subscription receivable of $50,000. In addition, the Company issued 610,000 shares to executives, employees working in research and development at the Company, and consultants. The value of these shares at $0.50 per share was $305,000.

From April 1, 2018 to June 30, 2018, the Company issued 625,000 shares to investors at $0.50 per share for cash, with total proceeds of $312,500. In addition, the Company issued 770,000 shares to executives, employees working in research and development at the Company and consultants. The value of these shares at $0.50 per share was $385,000. The Company had 1,250,000 shares returned during June 2018 as a result of a lawsuit settlement.

From July 1, 2018 to September 30, 2018, the Company issued 660,000 shares to investors at $0.50 per share for cash, with total proceeds of $330,000. In addition, the Company granted 705,000 shares to executives, employees working in research and development at the Company and consultants. The value of these shares at $0.50 per share was $352,500. Also see Note 5 regarding shares issued for debt issuance costs in September 2018.

From January 1, 2019 to March 31, 2019, the Company issued 200,000 shares to a lender upon receipt of a conversion notice. The Company also issued 565,384 shares to lenders for debt issuance costs. See Note 5.

From April 1, 2019 to June 30, 2019, the Company issued 1,289,051 shares to lenders upon receipt of conversion notices. See Note 5. In addition, the Company issued 825,000 shares to employees and consultants valued at the share price on the date the services were performed.

From July 1, 2019 to September 30, 2019, the Company issued 4,183,152 shares to lenders upon receipt of conversion notices. The Company also issued 625,000 shares to a lender for debt issuance costs and 1,502,389 shares to a lender for settlement of a claim. See Note 5. In addition, the Company issued 400,000 shares to employees and consultants valued at the share price on the date the services were performed and issued 1,180,000 shares to investors for total cash proceeds of $294,900.

10. Operating Leases – Right of Use Assets 

The Company has operating leases for office and warehouse space that expires in 2020 and 2023. Below is a summary of the Company’s right of use assets and liabilities as of September 30, 2019:

During the nine months ended September 30, 2019, the Company recognized approximately $164,000 in operating lease costs and are included in selling, general and administrative expenses in our consolidated statement of operations. During the nine months ended September 30, 2019, operating cash flows from operating leases was $144,847.

Approximate future minimum lease payments for the Company’s right of use assets over the remaining lease periods as of September 30, 2019, are as follows:

11. Income Taxes

The Company accounts for income taxes under the liability method. Deferred tax assets and liabilities are recorded based on the differences between the tax bases of assets and liabilities and their carrying amounts for financial reporting purpose, referred to as temporary differences. Deferred tax assets and liabilities at the end of each period are determined using the currently enacted tax rates applied to taxable income in the periods in which the deferred tax assets and liabilities are expected to be settled or realized.

The Company’s tax provision is determined using an estimate of an annual effective tax rate adjusted for discrete items, if any, that are taken into account in the relevant period. The 2019 and 2018 annual effective tax rate was 0% for the U.S. federal and state statutory tax rates. The Company reviews tax uncertainties in light of changing facts and circumstances and adjusts them accordingly. As of September 30, 2019 and December 31, 2018, there were no tax contingencies recorded.

Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities recognized for financial reporting, and the amounts recognized for income tax purposes.

The Company has a net operating loss carry-forward for federal and state tax purposes of approximately $15,549,000 at September 30, 2019, that is potentially available to offset future taxable income. The TCJA (Tax Cut and Jobs Act) changes the rules on NOL carryforwards. The 20-year limitation was eliminated, giving the taxpayer the ability to carry forward losses indefinitely. However, NOL carry forward arising after January 1, 2018, will now be limited to 80 percent of taxable income.

For financial reporting purposes, no deferred tax asset was recognized at September 30, 2019 and December 31, 2018 because management estimates that it is more likely than not that substantially all of the net operating losses will expire unused. As a result, the amount of the deferred tax assets considered realizable was reduced 100% by a valuation allowance. The change in the valuation allowances were approximately $1,590,000 and $583,000 for the nine-months ended September 30, 2019 and 2018, respectively.

12. Segment Information

The Company sells water purification products and operates oil recovery systems. The Company has identified such reportable segments based on management responsibility and the nature of the Company’s products, services, and costs. To date, the Company primarily sells its water purification products internationally and operates its oil recovery systems in the United States. The Company measures segment profit (loss) as income (loss) from operations. Segment assets are those assets controlled by each reportable segment.

Below is the financial information related to the Company’s segments:

General corporate expenses include corporate salaries, health insurance and social security taxes for officers and corporate employees, corporate insurance, legal and accounting fees, and other corporate costs such as transfer agent and travel costs. Management considers these to be non-allocable costs for segment purposes.

13. Subsequent Events

The Company has evaluated all material events or transactions that occurred after September 30, 2019 up to November 19, 2019, the date these financial statements were available to be issued.

On November 12, 2019, the Company, through its HydraSpin subsidiary, signed an Exclusive Distributor Agreement (the “Agreement”) in which the other party to the agreement (the “Distributor”) agrees to become the exclusive distributor of HydraSpin products in certain Texas and New Mexico territories. HydraSpin shall provide the products to the Distributor at no cost but HydraSpin will receive certain net revenues from the sale of hydrocarbons produced by the products. HydraSpin’s share of net revenues will be 92% of Net Revenues, as defined for the first 10 installed products and 85% for the eleventh product installed and those products installed subsequently. In order for the Distributor to maintain the exclusivity granted in the agreement, it must deploy products in 25 new locations during each 12-month period following the effective date and all customer locations in the aggregate must generate an average of 7,500 barrels of water with at least 2% oil content in each per day. If the Agreement is extended beyond the initial term of five years, the number of customer locations to be secured to maintain exclusivity shall be increased to 50 per year.

Stock Issuances

During October 2019 and through November 19, 2019, the Company has converted $123,000 of its convertible debt into 4,927,841 shares of common stock.

Settlement Agreements

On November 15, 2019, the Company reached an amicable resolution of any and all obligations owed by it to Auctus Funds, LLC (“AF”) with respect to the Securities Purchase Agreement dated April 9, 2019 and the related Convertible Promissory Note dated April 9, 2019. The Company has agreed to pay AF $270,000 in three installments. The first payment of $50,000 was paid on November 15, 2019. The second payment of $100,000 will be paid to AF on November 22, 2019. The final payment of $120,000 will be paid to AF on November 29, 2019.

On November 15, 2019, the Company reached an amicable resolution of any and all obligations owed by it to Crown Bridge Partners, LLC (“CBP”) with respect to that certain securities purchase agreement and outstanding convertible note with CBP. The Company made a payment of $120,000 to CBP on November 15, 2019, thereby fulfilling any and all obligations to CBP.