NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
NOTE 1 BUSINESS ORGANIZATION, NATURE OF OPERATIONS
Business Description
Notis Global, Inc, (formerly Medbox, Inc.)
which is incorporated in the state of Nevada (the Company), provides specialized services to the hemp and marijuana industry, owns independently and through affiliates, real property and licenses that it leases and assigns or sublicenses
to partner cultivators and operators in return for a percentage of revenues or profits from sales and operations, distributes hemp product processed by contractual partners and sells associated vaporization devices. Prior to 2016, through its
consulting services, Company worked with clients who seek to enter the medical and cultivation marijuana markets in those states where approved. In 2015, the Company expanded into hemp cultivation with the acquisition of a 320 acre farm in Colorado
by the Companys wholly owned subsidiary, EWSD 1, LLC. The farm is operated by an independent farming partner. In addition, through its wholly owned subsidiary, Vaporfection International, Inc. (VII), the Company sold a line of
vaporizer and accessory products online and through distribution partners. On March 28, 2016, the Company sold the assets of VII and exited the vaporizer and accessory business. The Company is headquartered in Los Angeles, California.
Effective January 28, 2016, the Company changed its legal corporate name from Medbox, Inc., to Notis Global, Inc. The name change was effected through a
parent/subsidiary short-form merger pursuant to Section 92A.180 of the Nevada Revised Statutes. Notis Global, Inc., the Companys wholly-owned Nevada subsidiary formed solely for the purpose of the name change, was merged with and into the
Company, with Notis Global, Inc. as the surviving entity. The merger had the effect of amending the Companys Certificate of Incorporation to reflect the new legal name of the Company. There were no other changes to the Companys
Certificate of Incorporation. The Companys Board of Directors approved the merger.
Notis Global, Inc., operates the business directly and through
the utilization of 5 primary operating subsidiaries, as follows:
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EWSD I, LLC, an Arizona corporation that owns property in Colorado.
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Prescription Vending Machines, Inc., a California corporation, d/b/a Medicine Dispensing Systems in the State of California (MDS), which distributes our Medbox
product and provides related consulting services described further below.
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Vaporfection International, Inc., a Florida corporation through which we distributed our medical vaporizing products and accessories. (all the assets of which were sold during the three months ended March 31, 2016, see
Note 6)
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Medbox Property Investments, Inc., a California corporation specializing in real property acquisitions and leases for dispensaries and cultivation centers.
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MJ Property Investments, Inc., a Washington corporation specializing in real property acquisitions and leases for dispensaries and cultivation centers in the state of Washington.
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San Diego Sunrise, LLC, a California corporation to hold San Diego, California dispensary operations.
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On
March 3, 2014, in order to obtain the license for one of the Companys clients, the Company registered an affiliated nonprofit corporation Allied Patient Care, Inc, in the State of Oregon. Additionally, on April 21, 2014, the Company
registered an affiliated nonprofit corporation Alternative Health Cooperative, Inc. in the State of California.
NOTE 2 SUMMARY OF SIGNIFICANT
ACCOUNTING POLICIES
Going Concern
The condensed
consolidated financial statements were prepared on a going concern basis. The going concern basis assumes that the Company will continue in operation for the foreseeable future and will be able to realize its assets and discharge its liabilities in
the normal course of business. During the three months ended March 31, 2016, the Company had net income of approximately $1.2 million, negative cash flow from operations of $1.4 million and negative working capital of $28.7 million. During
the year ended December 31, 2015, the Company had a net loss of approximately $50.5 million, negative cash flow from operations of $9.6 million and negative working capital of $32.9 million. The Company will need to raise capital in order
to fund its operations. The Company is also in the process of obtaining final approval on a settlement agreement in their Class action and Derivative lawsuits (Note 11) and recently received a Wells Notice from the SEC (Note 11) in connection with
misstatements by prior management in the Companys financial statements for 2012, 2013 and the first three quarters of 2014. The Company is unable to predict the outcome of these matters, however, a rejection of the settlement agreements or
adverse action of the SEC could have a material adverse effect on the financial condition,
5
results of operations and/or cash flows of the Company and their ability to raise funds in the future. These factors, among others, raise substantial doubt about the Companys ability to
continue as a going concern. The ability to continue as a going concern is dependent on the Companys ability to raise additional capital and implement its business plan. The condensed consolidated financial statements do not include any
adjustments that might be necessary if the Company is unable to continue as a going concern.
Managements plans include:
On April 13, 2016, Notis Global, Inc. entered into a note purchase agreement with an accredited investor pursuant to which the Company agreed to sell, and the
investor agreed to purchase, a convertible promissory note in the aggregate principal amount of $225,000. The Company also expects that the acquisition of EWSD I, LLC (EWSD) (Note 3), who owns a 320-acre farm in Pueblo, Colorado, will
generate recurring revenues for the Company through farming hemp, extracting CBD oil and controlling the full production cycle to ensure consistent quality. Lastly, management is actively seeking additional financing over the next few months to fund
operations.
The Company will continue to execute on its business model by attempting to raise additional capital through the sales of debt or equity
securities or other means. However, there is no guarantee that such financing will be available on terms acceptable to the Company, or at all. It is uncertain whether the Company can obtain financing to fund operating deficits until
profitability is achieved. This need may be adversely impacted by: unavailability of financing, uncertain market conditions, timing for and possible delays in approval of dispensary and cultivation sites and timing for and possible delays in
obtaining licenses from regulatory bodies for the operation of cultivation centers and dispensaries, and adverse operating results. The outcome of these matters cannot be predicted at this time.
Principles of Consolidation
The consolidated financial
statements include the accounts of Notis Global, Inc. and its wholly owned subsidiaries, as named in Note 1 above. All intercompany transactions have been eliminated in consolidation.
Use of Estimates
The preparation of condensed
consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the
disclosure of contingent liabilities at the date of the condensed consolidated financial statements as well as the reported expenses during the reporting periods. The Companys significant estimates and assumptions include accounts receivable
and note receivable collectability, inventory reserves, advances on investments, the valuation of restricted stock and warrants received from customers, the amortization and recoverability of capitalized patent costs and useful lives and
recoverability of long-lived assets, the derivative liability, and income tax expense. Some of these judgments can be subjective and complex, and, consequently, actual results may differ from these estimates. Although the Company believes that its
estimates and assumptions are reasonable, they are based upon information available at the time the estimates and assumptions were made. Actual results could differ from these estimates.
Reclassification
The Company has reclassified certain
prior fiscal year amounts in the accompanying condensed consolidated financial statements to be consistent with the current fiscal year presentation.
Concentrations of Credit Risk
The Company maintains cash
balances at several financial institutions in the Los Angeles, California area, Iowa, Illinois and Florida. Accounts at each institution are insured by the Federal Deposit Insurance Corporation up to $250,000. The Company has not experienced
any losses in such accounts and periodically evaluates the credit worthiness of the financial institutions and has determined the credit exposure to be negligible.
Advertising and Marketing Costs
Advertising and
marketing costs are expensed as incurred. The Company incurred advertising and marketing costs of approximately $39,000 and $0 for the three months ended March 31, 2016 and 2015, respectively.
6
Fair Value of Financial Instruments
Pursuant to ASC No. 825,
Financial Instruments
, the Company is required to estimate the fair value of all financial instruments included on its
balance sheets. The carrying value of cash, accounts receivable, other receivables, inventory, accounts payable and accrued expenses, notes payable, related party notes payable, customer deposits, provision for customer refunds and short term loans
payable approximate their fair value due to the short period to maturity of these instruments.
Embedded derivative - The Companys convertible notes
payable include embedded features that require bifurcation due to a reset provision and are accounted for as a separate embedded derivative (see Note 7).
As of December 31, 2015, and for new issuances of convertible debentures during the fourth quarter of fiscal 2015, the Company estimated the fair value of the
conversion feature derivatives embedded in the convertible debentures based on a Monte Carlo Simulation model (MCS). The MCS model was used to simulate the stock price of the Company from the valuation date through to the maturity date
of the related debenture and to better estimate the fair value of the derivative liability due to the complex nature of the convertible debentures and embedded instruments. Management believes that the use of the MCS model compared to the black
Scholes model as previously used would provide a better estimate of the fair value of these instruments. Beginning in the fourth quarter of 2015, using the MCS model, the Company valued these embedded derivatives using a with-and-without
method, where the value of the Convertible Debentures including the embedded derivatives, is defined as the with, and the value of the Convertible Debentures excluding the embedded derivatives, is defined as the
without. This method estimates the value of the embedded derivatives by observing the difference between the value of the Convertible Debentures with the embedded derivatives and the value of the Convertible Debentures without the
embedded derivatives. The Company believes the with-and-without method results in a measurement that is more representative of the fair value of the embedded derivatives.
For each simulation path, the Company used the Geometric Brownian Motion (GBM) model to determine future stock prices at the maturity date. The
inputs utilized in the application of the GBM model included a starting stock price, an expected term of each debenture remaining from the valuation date to maturity, an estimated volatility, and a risk-free rate.
For the three months ended March 31, 2016, the Company estimated the fair value of the conversion feature derivatives embedded in the convertible debentures
based on an internally calculated adjustment to the MCS valuation determined at December 31, 2015. This adjustment took into consideration the changes in the assumptions, such as market value and expected volatility of the Companys common
stock, and the discount rate used in the December 31, 2015 valuation as compared to March 31, 2016. The Company believes this methodology results in a reasonable fair value of the embedded derivatives for the interim period.
For the three months ended March 31, 2015, the Company estimated the fair value of the conversion feature derivatives embedded in the convertible
debentures based on weighted probabilities of assumptions used in the Black Scholes pricing model. The key valuation assumptions used consists, in part, of the price of the Companys common stock, a risk free interest rate based on the average
yield of a Treasury note and expected volatility of the Companys common stock all as of the measurement dates, and the various estimated reset exercise prices weighted by probability.
Warrants
The Company reexamined the determination made
as of December 31, 2015 that they did not have sufficient authorized shares available for all of their outstanding warrants to be classified in equity at March 31, 2016, and concluded there still were insufficient authorized shares (Note 7).
Therefore, the Company recognized a Warrant liability as of March 31, 2016. The Company estimated the fair value of the warrant liability based on a Black Scholes valuation model. The key assumptions used consist of the price of the
Companys stock, a risk free interest rate based on the average yield of a two or three year Treasury note (based on remaining term of the related warrants), and expected volatility of the Companys common stock over the remaining life of
the warrants.
A three-tier fair value hierarchy is used to prioritize the inputs in measuring fair value as follows:
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Level 1
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Quoted prices in active markets for identical assets or liabilities.
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Level 2
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Quoted prices for similar assets or liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active, or other inputs that are observable, either directly or
indirectly.
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Level 3
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Significant unobservable inputs that cannot be corroborated by market data.
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7
The assets or liabilities fair value measurement within the fair value hierarchy is based upon the lowest
level of any input that is significant to the fair value measurement. The following table provides a summary of the relevant assets and liabilities that are measured at fair value on a recurring basis.
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Total
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Quoted Prices
in Active
Markets for
Identical
Assets or
Liabilities
(Level 1)
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Quoted Prices
for Similar
Assets or
Liabilities in
Active
Markets
(Level 2)
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Significant
Unobservable
Inputs
(Level 3)
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March 31, 2016
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Marketable securities
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$
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12,544
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$
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6,712
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$
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$
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5,832
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Warrant liability
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426,027
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426,027
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Derivative liability
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12,579,271
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12,579,271
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Total
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$
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13,017,842
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$
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6,712
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$
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$
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13,011,130
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Total
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Quoted Prices
in Active
Markets for
Identical
Assets or
Liabilities
(Level 1)
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Quoted Prices
for Similar
Assets or
Liabilities in
Active
Markets
(Level 2)
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Significant
Unobservable
Inputs
(Level 3)
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December 31, 2015
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Marketable securities
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$
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9,410
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$
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5,629
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$
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$
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3,781
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Warrant liability
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940,000
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940,000
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Derivative liability
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19,246,594
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19,246,594
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Total
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$
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20,196,004
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$
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5,629
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$
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$
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20,190,375
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8
The following table sets forth a summary of the changes in the fair value of the Companys Level 3 financial
liabilities that are measured at fair value on a recurring basis:
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For the three
months ended
March 31, 2016
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Total
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Beginning balance
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$
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20,186,594
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Initial recognition of conversion feature
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3,976,843
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Change in fair value of conversion feature
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(8,879,586
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)
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Reclassified to equity upon conversion
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(1,764,580
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)
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Additions to warrant liability
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42,000
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Change in fair value of warrant liability
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(555,973
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)
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Ending Balance
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$
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13,005,298
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Revenue Recognition
Prior to 2015, the Company entered into transactions with clients who are interested in being granted the right to have the Company engage exclusively with
them in certain territories (which are described as territory rights) to obtain the necessary licenses to operate a dispensary or cultivation center for the location, and to consult in daily operations of the dispensary or cultivation center.
Terms for each transaction are varied and, prior to 2015, sales arrangements typically included the delivery of our dispensing technology and dispensary
location build-out and/or consultation on the location, licensing, build out and operation of a cultivation center. Prior to 2015, the Companys standard contracts had a five year term, calling for an upfront, non-refundable consulting
fee, and containing options including acquiring a Medbox dispensary machine and having the Company perform the build-outs for the location, at set prices. The up-front fees under these contracts are recognized over the five year term, and are
included in Deferred revenue. The Company has determined these optional purchases each constituted a separate purchasing decision, and therefore are considered a separate arrangement for revenue recognition purposes. Revenue on each of these options
are evaluated for recognition when and if the customer decides to enter into the arrangement.
In 2015 and 2016, the Company concentrated on revenue
generating transactions to develop and set up dispensaries, including obtaining the conditional use permits (CUP) that grant the dispensary the authorization to operate, as well as cultivation centers. The Company enters into joint
ventures and operating agreements, whereby separate unrelated party controls the operations of the dispensary or cultivation center, and the Company receives an agreed upon percentage of the revenue or profits of the operating entity.
Based on these contracts, and other auxiliary agreements, our current revenue model consists of the following income streams:
Consulting fee revenues and build-outs
Prior to 2015,
Consulting fee revenues were a consistent component of our revenues and were negotiated at the time the Company entered into a contract. Consulting revenue consisted of providing ongoing consulting services over the life of the contract, to the
established business in the areas of regulatory compliance, security, operations and other matters to operate the dispensary. The majority of the consulting fees from prior to 2015 arose from the upfront, non-refundable consulting fee in the
Companys standard contract, and were recognized using the straight line method over the life of the contract. Consulting fee revenue is only recognized when the following four criteria are met: 1) persuasive evidence of an arrangement exists,
2) delivery has occurred or services have been rendered, 3) sales price is fixed and determinable and 4) collectability is reasonably assured. Consulting fee revenue continues to be recognized in our income statement over the life of the
aforementioned contracts.
Due to the uncertainties inherent in the emerging industry, the Company deferred recognition of revenue for sale of completed
dispensaries with licenses until the issuance of a certificate of occupancy by the municipality. The certificate of occupancy is the final approval to open a dispensary in the customers community, at which time all criteria for revenue
recognition, including delivery and acceptance, has been met. Additionally, at the time of the issuance of the certificate of occupancy, under the contract terms, all payments owed by the customer have been received by the Company. Similarly,
recognition of revenue for the sale of a completed cultivation center is deferred until all licensing and permitting is completed and approved.
Unbilled
costs and associated fees related to the build-outs are recorded in inventory and are subject to valuation testing at each quarter end for net realizable value (lower of cost or market) and collectability. None of these costs were included in
Inventory as of March 31, 2016.
9
Revenues from Operating Agreements
The Company enters into operating agreements with independent parties, giving the operator the rights to control the operations of a dispensary or cultivation
center during the term of the agreement. In exchange, the Company earns a fee based on a percentage of the revenue or profit of the dispensary or cultivation center. The Company has determined they are not the principal in the revenue
sharing agreements and recognizes revenue under these agreements on a net basis as the fees are earned and it has been concluded that collectability is reasonably assured.
Cost of Revenue
Cost of revenue consists primarily of
expenses associated with the delivery and distribution of our products and services. We only begin capitalizing costs when we have obtained a license and a site for operation of a customer dispensary or cultivation center. The previously
capitalized costs are charged to cost of revenue in the same period that the associated revenue is earned. In the case where it is determined that previously inventoried costs are in excess of the projected net realizable value of the sale of the
licenses, then the excess cost above net realizable value is written off to cost of revenues. Cost of revenues also includes the rent expense on master leases held in the Companys name, which are subleased to the Companys
operators. In addition, cost of revenue related to our vaporizer line of products consists of direct procurement cost of the products along with costs associated with order fulfillment, shipping, inventory storage and inventory management
costs.
Inventory
Inventory is stated at the lower
of cost or market value. Cost is determined on a cost basis that approximates the first-in, first-out (FIFO) method.
Work in process and related
capitalized costs includes costs to build out a dispensary in Portland, Oregon that opened in the second quarter of 2015. Costs included tenant improvements to the facility, furniture, fixtures and Medbox dispensary units to be used by the licensed
operator. The costs related to the Portland dispensary have been classified in deferred costs and are amortized straight-line over remaining term of the lease.
Basic and Diluted Net Loss Per Share
Basic net
income/loss per share is computed by dividing net income (loss) available to common stockholders by the weighted average number of shares of common stock outstanding during the period. Diluted net income per share includes the effects of any
outstanding options, warrants and other potentially dilutive securities.
As of March 31, 2015, the Company had 3,000,000 shares of Series A
preferred stock outstanding with par value of $0.001 that could have been converted into 15,000,000 shares of the Companys common stock. On August 24, 2015, 2 million shares of Series A preferred stock was cancelled,
leaving 1 million shares outstanding, which were converted into common shares on November 16, 2015. There are no Series A preferred stock outstanding at March 31, 2016. Additionally, the Company had approximately 50,119,000 and
338,000 warrants to purchase common stock outstanding as of March 31, 2016 and 2015, respectively, which were not included in the computation of diluted loss per share, as based on their exercise prices they would all have an anti-dilutive
effect on net loss per share. The Company also had approximately $7,661,000 and $3,300,000 in convertible debentures outstanding at March 31, 2016 and 2015, respectively, that are convertible at the holders option at a conversion price of
the lower of $0.75 or 51% to 60% of either the lowest trading price or the VWAP over the last 20 to 30 days prior to conversion (subject to reset upon a future dilutive financing), whose underlying shares resulted in an additional 5,746,769,206
dilutive shares being included in the computation of diluted net income per share.
Accounts Receivable and Allowance for Bad Debts
The Company is subject to credit risk as it extends credit to our customers for work performed as specified in individual contracts. The Company extends credit
to its customers, mostly on an unsecured basis after performing certain credit analyses. Prior to 2015, our typical terms required the customer to pay a portion of the contract price up front and the rest upon certain agreed milestones. The
Companys management periodically reviews the creditworthiness of its customers and provides for probable uncollectible amounts through a charge to operations and a credit to an allowance for doubtful accounts based on our assessment of the
current status of individual accounts. Accounts still outstanding after the Company has used reasonable collection efforts are written off through a charge to the allowance for doubtful accounts. As of March 31, 2016, the Companys
management considered all accounts outstanding fully collectible.
Property and Equipment
Property and equipment are recorded at cost. Expenditures for major additions and improvements are capitalized and minor replacements, maintenance, and repairs
are charged to expense as incurred. When property and equipment are retired or otherwise
10
disposed of, the cost and accumulated depreciation are removed from the accounts and any resulting gain or loss is included in the results of operations for the respective
period. Depreciation is provided over the estimated useful lives of the related assets using the straight-line method for financial statement purposes. The Company uses accelerated depreciation methods for tax purposes where
appropriate. The estimated useful lives for significant property and equipment categories are as follows:
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Vehicles
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5 years
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Furniture and Fixtures
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3 - 5 years
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Office equipment
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3 years
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Machinery
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2 years
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Buildings
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10 - 39 years
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Income Taxes
The Company
accounts for income taxes under the asset and liability method. The Company recognizes deferred tax liabilities and assets for the expected future tax consequences of events that have been included in the consolidated financial statements or
tax returns. Under this method, deferred tax liabilities and assets are determined based on the difference between the financial statement and tax bases of assets and liabilities using enacted tax rates in effect for the year in which the
differences are expected to reverse. The components of the deferred tax assets and liabilities are classified as current and non-current based on their characteristics. A valuation allowance is provided for certain deferred tax assets if
it is more likely than not that the Company will not realize tax assets through future operations.
In addition, the Companys management performs an
evaluation of all uncertain income tax positions taken or expected to be taken in the course of preparing the Companys income tax returns to determine whether the income tax positions meet a more likely than not standard of being
sustained under examination by the applicable taxing authorities. This evaluation is required to be performed for all open tax years, as defined by the various statutes of limitations, for federal and state purposes.
Commitments and Contingencies
Certain conditions may
exist as of the date the consolidated financial statements are issued, which may result in a loss to the Company but which will only be resolved when one or more future events occur or fail to occur. The Companys management and its legal
counsel assess such contingent liabilities, and such assessment inherently involves an exercise of judgment. In assessing loss contingencies related to legal proceedings that are pending against the Company or unasserted claims that may result
in such proceedings, the Companys legal counsel evaluates the perceived merits of any legal proceedings or unasserted claims as well as the perceived merits of the amount of relief sought or expected to be sought therein.
If the assessment of a contingency indicates that it is probable that a material loss has been incurred and the amount of the liability can be estimated, then
the estimated liability would be accrued in the Companys consolidated financial statements. If the assessment indicates that a potentially material loss contingency is not probable, but is reasonably possible, or is probable but cannot be
estimated, then the nature of the contingent liability, together with an estimate of the range of possible loss if determinable and material, would be disclosed.
Loss contingencies considered remote are generally not disclosed unless they involve guarantees, in which case the nature of the guarantee would be disclosed.
The Company accrues all legal costs expected to be incurred per event. For legal matters covered by insurance, the Company accrues all legal costs
expected to be incurred per event up to the amount of the deductible.
Recent Accounting Pronouncements
In May 2014, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2014-09,
Revenue from Contracts with Customers, which requires an entity to recognize the amount of revenue to which it expects to be entitled for the transfer of promised goods or services to customers. ASU 2014-09 will replace most existing
revenue recognition guidance in U.S. GAAP when it becomes effective. The new standard is effective for annual reporting periods for public business entities beginning after December 15, 2017, including interim periods within that reporting
period. The new standard permits the use of either the retrospective or cumulative effect transition method. The Company is currently evaluating the effect that ASU 2014-09 will have on its financial statements and related disclosures. The Company
has not yet selected a transition method nor determined the effect of the standard on its ongoing financial reporting.
11
On July 22, 2015, the Financial Accounting Standards Board (FASB) issued a new standard that
requires entities to measure most inventory at the lower of cost and net realizable value, thereby simplifying the current guidance under which an entity must measure inventory at the lower of cost or market. The new standard will not
apply to inventories that are measured by using either the last-in, first-out (LIFO) method or the retail inventory method. The new standard will be effective for fiscal years beginning after December 15, 2016, and interim periods in fiscal
years beginning after December 15, 2016. The Company is in the process of evaluating the impact of adoption on its consolidated financial statements.
In April 2015, the FASB issued a new standard that requires an entity to determine whether a cloud computing arrangement contains a software license. If
the arrangement contains a software license, the entity would account for the fees related to the software license element in a manner consistent with how the acquisition of other software licenses is accounted for. If the arrangement does not
contain a software license, the customer would account for the arrangement as a service contract. The new standard will be effective for fiscal years beginning after December 15, 2015, and interim periods in fiscal years beginning after
December 15, 2016. The Company is in the process of evaluating the impact of adoption on its consolidated financial statements.
In
February 2016, the FASB issued Leases (Topic 842) (ASU 2016-02). This update amends leasing accounting requirements. The most significant change will result in the recognition of lease assets and lease liabilities by lessees for
those leases classified as operating leases under current guidance. The new guidance will also require significant additional disclosures about the amount, timing and uncertainty of cash flows from leases. ASU 2016-02 is effective for fiscal years
and interim periods beginning after December 15, 2018, which for the Company is December 31, 2018, the first day of its 2019 fiscal year. Upon adoption, entities are required to recognize and measure leases at the beginning of the earliest
period presented using a modified retrospective approach. Early adoption is permitted, and a number of optional practical expedients may be elected to simplify the impact of adoption. The Company is currently evaluating the impact of adopting this
guidance. The overall impact is that assets and liabilities arising from leases are expected to increase based on the present value of remaining estimated lease payments at the time of adoption.
Managements Evaluation of Subsequent Events
The
Company evaluates events that have occurred after the balance sheet date of March 31, 2016, through the date which the consolidated financial statements were issued. Based upon the review, other than described in Note 18 Subsequent
Events, the Company did not identify any recognized or non-recognized subsequent events that would have required adjustment or disclosure in the consolidated financial statements.
NOTE 3 ASSET ACQUISITION
On July 24, 2015,
the Company entered into an Agreement of Purchase and Sale of Membership Interest (the Acquisition Agreement) with East West Secured Development, LLC (the Seller) to purchase 100% of the membership interest of EWSD I, LLC
(EWSD) which has entered into an agreement with Southwest Farms, Inc. (Southwest) to purchase certain real property comprised of 320-acres of agricultural land in Pueblo, Colorado (the Acquired Property or
the Farm).
The purchase price to acquire EWSD consisted of (i) $500,000 paid by the Company as a deposit into the escrow for the
Acquired Property, and (ii) the Companys future payments to Seller of a royalty of 3% of the adjusted gross revenue, if any, from operation of the Acquired Property (including sale of any portion of or interest in the Acquired Property
less any applicable expenses) for the three-year period beginning on January 1, 2016. Such royalty payments shall be payable 50% in cash and 50% in Company common stock (the Royalty Payment). The Company determined that the royalty
payments could not be estimated at the time of acquisition, and, therefore, the contingent payments have not been recognized as part of the acquisition price. The contingent consideration will be re-measured to fair value each subsequent period
until the contingency is resolved, in this case, for the three year period beginning on January 1, 2016, with any changes in fair value recognized in earnings. Per the terms of the agreement, the closing is deemed to have occurred when the
Special Warranty Deed is recorded (which occurred on August 7, 2015) and all terms of the purchase agreement for the Farm have been complied with, including the Farm closing, which also took place on August 7, 2015. Therefore, the
acquisition date has been determined to be August 7, 2015. There were no assets or liabilities of EWSD on the acquisition date.
In connection with
EWSDs purchase of the Acquired Property, EWSD entered into a secured promissory note (the Note) with Southwest in the principal amount of $3,670,000 (Note 8). Interest on the outstanding principal balance of the Note shall accrue
at the rate of five percent per annum. The Note shall be payable by EWSD in thirty-five payments of principal and interest, which shall be calculated based upon an amortization period of thirty years, commencing on September 1, 2015 and
continuing thereafter on the first day of each calendar month through and including July 1, 2018; and one final balloon payment of all unpaid principal and accrued but unpaid interest on August 1, 2018. The Note is secured by a deed of
trust, security agreement, assignment of rents and financing statement encumbering the Acquired Property.
12
EWSD also entered into an unsecured promissory note (the Unsecured Note) in the principal amount of
$830,000 with the Seller (Note 8), in respect of payments previously made by Seller to Southwest in connection with acquiring the Farm. Interest on the outstanding principal balance of the Unsecured Note shall accrue at the rate of six
percent per annum. The Unsecured Note shall be payable by EWSD in thirty-five payments of principal and interest, which shall be calculated based upon an amortization period of thirty years, commencing on September 1, 2015 and continuing
thereafter on the first day of each calendar month through and including July 1, 2018; and one final balloon payment of all unpaid principal and accrued but unpaid interest on August 1, 2018.
Farming Agreement
On December 18, 2015, the Company
and its subsidiary EWSD I, LLC (EWSD), entered into a Farming Agreement (the Farming Agreement) with Whole Hemp Company (Whole Hemp now known as Folium Biosciences), pursuant to which Folium
Biosciences would manufacture products from hemp and cannabis crops it would grow on EWSD farmland, and the Company would build greenhouses for such activities up to an aggregate size of 200,000 square feet. Folium Biosciences would pay all
preapproved costs of such construction on or before September 30, 2017 as partial consideration for a revocable license to use the greenhouses and a separate 10 acre plot of EWSD farmland (the 10 Acres). EWSD would retain ownership of
the greenhouses. For the first growing season commencing October 1, 2016, the Company would receive a percentage of gross sales of all Folium Biosciences products on a monthly basis, and the Companys share would increase incrementally
based on the extent of crops planted on EWSD farmland according to a mutually agreed schedule. In addition, the Company would receive 50% of Folium Biosciencess gross profits from the farming activities on the 10 Acres. The Company planned to
recognize all revenue from the Farming Agreement at the net amount received when it has been earned and determined collectable.
Pursuant to the Farming
Agreement, the Company also granted Folium Biosciences a warrant to purchase 4,000,000 shares of Company common stock at an exercise price of $0.50 per share, exercisable at any time within 5 years. The warrants were valued at $76,000, using a Black
Scholes Merton Model, with key valuation assumptions used that consist of the price of the Companys stock at settlement date, a risk free interest rate based on the average yield of a 5 year Treasury note and expected volatility of the
Companys common stock all as of the measurement date. The fair value of the warrants is included in Deferred costs and will be recognized over the life of the Farming Agreement.
On March 11, 2016, the Company and EWSD entered into a First Amended and Restated Farming Agreement with Whole Hemp, amending and restating in certain
respects the Farming Agreement. The First Amended and Restated Farming Agreement clarifies that EWSD, rather than the Company, would be responsible for the building of greenhouses to be utilized by Whole Hemp for growing hemp and cannabis crops
pursuant to the agreement, and that EWSD would be the recipient of all payments by Whole Hemp (including all revenue sharing arrangements) under the agreement.
Since May 7, 2016, we believe Folium Biosciences has been in default, principally because they abandoned their obligation to provide farming activities
under the First Amended and Restated Farming Agreement. On May 13, 2016, EWSD notified Folium Biosciences of its defaults under the First Amended and Restated Farming Agreement and EWSDs election to terminate the First Amended and
Restated Farming Agreement.
By its terms, the First Amended and Restated Farming Agreement may be terminated at any time by either party, if the other
party was in material breach of any obligation under the First Amended and Restated Farming Agreement, which breach continued uncured for 30 days following written notice thereof.
Growers Distributor Agreement
On December 18,
2015, the Company also entered into a Growers Agent Agreement with Folium Biosciences, which was amended on March 11, 2016, to change the name of the agreement to Growers Distributor Agreement, (Distributor Agreement) as well
clarify some terms. Pursuant to the Distributor Agreement, the Company would provide marketing, sales, and related services on behalf of Folium Biosciences in connection with the sale of its Cannabidiol oil product, from which the Company would
receive a percentage of gross revenues (other than the sale of such product generated from the EWSD 10 Acres and the Folium Biosciences 40 acre plot subject to the Farming Agreement). The Growers Agent Agreement was effective until September
30, 2025. The Company would sell the product on behalf of Folium Biosciences on a commission basis. The Company may not act as agent of any other grower, distributor or manufacturer of the same product unless such other party agrees.
On March 11, 2016, the Company and EWSD entered into a First Amended and Restated Growers Distributor Agreement with Whole Hemp, amending and
restating in certain respects the Growers Agent Agreement, including by substituting EWSD as a party in-place of the Company.
Because we believe
Folium Biosciences is in default, principally because they abandoned their obligation to provide farming activities under the First Amended and Restated Farming Agreement since May 7, 2016, EWSD notified Whole Hemp on May 13, 2016 of its
election to terminate the Restated Growers Distributor Agreement.
By its terms, the Restated Growers Distributor Agreement could be
terminated at any time by either party, if the other party was in material breach of any obligation under the Restated Growers Distributor Agreement, which breach continued uncured for 30 days following written notice thereof.
As we continue to navigate the nascent world of hemp and CBD growing, cultivation, production and sales, it became clear that controlling all aspects of the
business is the best strategy to ensure that we are meeting all of our goals. Again, we are taking action now to protect the investment all the stakeholders have all made in Notis Global.
NOTE 4 INVENTORY
Inventory is stated at the lower
of cost or market value. Cost is determined on a standard cost basis that approximates the first-in, first-out (FIFO) method.
Inventory at
March 31, 2016 and December 31, 2015 consists of the following:
|
|
|
|
|
|
|
|
|
|
|
March 31, 2016
|
|
|
December 31, 2015
|
|
Vaporizers and accessories
|
|
$
|
|
|
|
$
|
81,934
|
|
|
|
|
CBD Oil
|
|
|
32,300
|
|
|
|
35,889
|
|
Light Bulbs for cultivation centers
|
|
|
|
|
|
|
33,000
|
|
|
|
|
|
|
|
|
|
|
Total inventory, net
|
|
$
|
32,300
|
|
|
$
|
150,823
|
|
|
|
|
|
|
|
|
|
|
The Company did not write down any slow moving or obsolete inventory during the three months ended March, 31, 2016 and
2015.
13
NOTE 5 DISPENSARIES
Portland
The Company holds the license to operate a
dispensary in Portland, Oregon, and a master lease on the property in which the dispensary is located. In April 2015, the Company entered into an Operating Agreement (Original Agreement) with an unrelated party (the
Operator) in which the Operator was to manage and operate the Dispensary. The Original Agreement also included an annual Licensor Fee of 5% of the annual Gross Revenues, which would have begun after the additional fees related to the
startup of the new venture had been paid in full.
On December 3, 2015 the Company replaced the original operator of the Portland dispensary with
another operator under a new Operator Agreement (the Agreement). Per the terms of the Agreement, the Dispensary was under the exclusive supervision and control of Operator, which shall be responsible for the proper and efficient
operation of the Dispensary. The term of the Agreement includes an initial term of five years, and a renewal term for an additional five years. The renewal term is at the discretion of the Operator. There is a License fee, which is based on a
flat 10% of Gross Revenues. The Companys management has determined that under this Agreement they do not hold the controlling financial interest in the Dispensary and are not the primary beneficiary, and therefore did not consolidate the
Dispensary in their consolidated financial statements.
Sunrise Property Investments, LLC
On December 3, 2015, the Company entered into an Operating Agreement with PSM Investment Group, LLC (PSM), for the governance of Sunrise
Property Investments, LLC (Sunrise). Pursuant to the agreement, each of the two members contributed 50% of the capital of Sunrise. The Companys contribution to the investment was the conditional use permit for the location,
which was determined to have a zero cost basis, based on its carrying value in the Companys financial statements. Sunrise acquired the property on which a dispensary will be located in San Diego on December 31, 2015. The Company has
determined it should not consolidate the financial position and results of operations in its consolidated financial statements as it does not hold greater than 50% voting interest or is able to exercise influence over the operations and management
in Sunrise. Instead, the Company accounts for Sunrise as an equity method investment. No income or loss has been recognized from Sunrise for the year ending December 31, 2015.
Alternative Health Cooperative, Inc. (Alternative) is a not-for-profit corporation, managed by an employee of Notis Global, which holds the
conditional user permit (CUP) to run the dispensary. On January 1, 2016, Sunrise entered into an Operator Agreement with Alternative for Sunrise to operate the dispensary located on the Sunrise property. The Operator
Agreement engages Sunrise to supervise, direct and control the management of the dispensary. The Agreement also states that the operation of the dispensary shall be under the exclusive supervision and control of Sunrise which shall
be responsible for the proper and efficient operation of the dispensary. The Company had determined that under the operating agreement neither it nor Alternative hold the controlling financial interest in the dispensary, but that Sunrise is the
controlling entity. Therefore, the Company did not consolidate the dispensary in its consolidated financial statements.
The Company incorporated a
new wholly owned subsidiary, San Diego Sunrise, LLC (San Diego Sunrise), on February 22, 2016, in order to enter into a partnership agreement with PSM Investments to create an entity which would control the dispensary operations.
Thereafter, Sunrise Dispensary LLC (Dispensary) was incorporated by PSM Investments and San Diego Sunrise on February 24, 2016, with each party holding a 50% ownership interest in the new entity. Immediately after which, Sunrise
assigned the Operating Agreement with Alternative to Dispensary. The Company therefore indirectly held a 50% interest in the Sunrise Dispensary, through its subsidiary, San Diego Sunrise.
In February 2016, the Company sold 70% of its ownership interest in San Diego Sunrise for approximately $299,000. As of March 31, 2016, the Company owned
50% of Sunrise and 30% of San Diego Sunrise. These investments are accounted for under the equity method, with the Companys proportionate share of the income or losses of the investments reflected in the Companys financial
statements. There has been no activity, aside from the sale of the Companys ownership interests, in these investees as of, and for the three months ended, March 31, 2016.
Sunrise Delivery
On November 24, 2015, the Company
entered into a Management Agreement (the Agreement) with Rise Industries (the Operator) for a delivery service to be called Sunrise Delivery, operating under the conditional use permit awarded to the Sunrise
Dispensary. The delivery service began operations on December 19, 2015 and, due to the short period between commencement of operations and the year end, the results of operations were not material for the year ended December 31, 2015.
Under the Agreement, the Operator is fully and solely responsible to collect all revenue and pay all expenses arising from the delivery service,
including acquisition of inventory. The Companys name is not being used in connection with any advertising, marketing, product or delivery services provided by the Operator. The Company determined that under the Agreement they do not
hold the controlling financial interest in the delivery service and the Operator is the controlling entity. Therefore, the Company did not consolidate Sunrise Delivery in their financial statements. The Company also evaluated whether the
revenue earned from the delivery service should be recognized at the gross or net amount. As the Company meets the three indicators of being an agent, the Company will report the earnings or losses from the delivery service on a net basis,
under the equity method of accounting.
14
On December 9, 2015, the Company provided a $60,000 loan to Sunrise Delivery for working capital, with interest
at prime and payable in one year and added an additional advance of $10,000 in the first quarter of 2016. In connection with the decision to sell 70% of their interests in the San Diego dispensary, the Company wrote off the loans totaling
$70,000 as uncollectible at the end of the first quarter of 2016.
Washington
In the course of seeking licenses for new locations, the Company has to enter into real estate purchase agreements in order to secure the sites to be developed
for clients dispensaries and cultivation centers. During the second quarter of 2014, one of the Companys subsidiaries entered into a real estate purchase agreement for a property in the State of Washington. The purchase transaction was
closed during the third quarter of 2014 for a total purchase price of $399,594, partially financed by a promissory note for $249,000. The note was due January 30, 2015 and bore interest at twelve percent (12%). The Company did not repay the
note on its maturity date, and therefore began incurring interest at the default interest rate of eighteen percent (18%) per annum. On September 30, 2015, the Company, through its subsidiary MJ Property Investments, and the seller of the
property entered into an amendment to the Note Payable, whereby the maturity date was extended to April 1, 2017, and the interest rate returned to twelve percent (12%) per annum (see Note 8).
NOTE 6 VAPORFECTION INTERNATIONAL, INC.
The
Company acquired certain intangible assets with its purchase of 100% of the outstanding common stock of Vaporfection International Inc. (VII) on April 1, 2013. The Company accounts for intangible assets acquired in a business
combination, if any, under the purchase method of accounting at their estimated fair values at the date of acquisition. Intangibles are either amortized over their estimated lives, if a definite life is determined, or are not amortized if their
life is considered indefinite.
On December 31, 2015, the Company re-evaluated the future value of the intangible assets and determined none of the
carrying value of the intangible assets were recoverable, and its carrying value exceeded its fair value. Therefore, the Company recognized an impairment loss on Intangibles of $586,000.
On December 31, 2015, the Company also performed the first step of the Goodwill impairment test, and, based on the same conclusions as above, determined
there were indications of impairment of the Goodwill and they had to perform the second step of the impairment test, which compares the carrying value of the Goodwill to the implied Goodwill. The Company re-evaluated the fair value of all the
associated assets of VII at December 31, 2015 and determined that there was no implied Goodwill. As there is no implied Goodwill, the impairment loss recognized was be the entire carrying value of Goodwill, approximately $1,260,000.
In light of these impairments, as discussed above, the Company wrote down all other assets related to the business, such as fixed assets and costs to develop
the website as of December 31, 2015, resulting in a impairment of approximately $80,000. The Company also wrote down the Inventory of VII to its estimated fair value of $82,000.
The Board made a decision the last week of January 2016, to sell the assets of Vaporfection and exit the vaporizer business and sell the remaining
inventory and related assets during the first half of 2016. The Company analyzed if Vaporfection should be presented as a Discontinued Operation under the guidance of ASC 205, Presentation of Financial Statements, 20, Discontinued Operations,
(ASC 205-20), and determined the decision to exit the Vaporfection business was not a strategic shift in the Companys business, as the Board and management did not consider the strategy for the business to be built around the sale
of vape machines or peripherals.
On March 28, 2016, the Company sold the assets of the subsidiary for $70,000, which is payable $35,000 at the closing
and with a 6% Note Payable, due September 30, 2016. The Company recognized approximately $6,000 as a gain on sale of the assets of their subsidiary for the three months ended March 31, 2016.
NOTE 7 CONVERTIBLE NOTES PAYABLE AND DERIVATIVE LIABILITY
July and September 2014 Debentures
On
July 21, 2014, as amended on September 19, 2014 and October 20, 2014, the Company entered into a Securities Purchase Agreement whereby the Company agreed to issue convertible debentures (July 2014 Debentures) in the
aggregate principal amount of $3,500,000, in five tranches. The July 2014 Debentures bore interest at the rate of 10% per year. The debt was due July 21, 2015.
15
Also on September 19, 2014, as amended on October 20, 2014, the Company entered into a securities
purchase agreement pursuant to which it agreed to issue convertible debentures (September 2014 Debentures) in the aggregate principal amount of $2,500,000, in two tranches. The September 2014 Debentures bore interest at the
rate of 5% per year. The debt was due September 19, 2015.
Both the original July 2014 Purchase Agreement Debentures and
September 2014 Debentures, prior to subsequent amendment, share the following significant terms:
All amounts are convertible at any time, in whole
or in part, at the option of the holders into shares of the Companys common stock at a conversion price. The Notes were initially convertible into shares of the Companys common stock at the initial Fixed Conversion Price of $11.75 per
share. The Fixed Conversion Price is subject to adjustment for stock splits, combinations or similar events. If the Company makes any subsequent equity sales (subject to certain exceptions), under which an effective price per share is lower than the
Fixed Conversion Price, then the conversion price will be reduced to equal such price. The Company may make the amortization payments on the debt in cash, prompting a 30% premium or, subject to certain conditions, in shares of common stock valued at
70% of the lowest volume weighted average price of the common stock for the 20 prior trading days.
The conversion feature of the July 2014 Debenture
and the September 2014 Debenture meets the definition of a derivative and due to the reset provision to occur upon subsequent sales of securities at a price lower than the fixed conversion price, requires bifurcation and is accounted for as a
derivative liability, with a discount created on the Debentures that would be amortized over the life of the Debentures using the effective interest rate method. The fair value of the embedded derivative is measured and recognized at fair value each
subsequent reporting period and the changes in fair value are recognized in the Statement of Operations as Change in fair value of derivative liability. See Note 2 Fair value of financial instruments for additional information on the fair value and
gains or losses on the embedded derivative.
In connection with each of the purchase agreements, the Company entered into a registration rights agreement
with the respective investors, pursuant to which the Company agreed to file a registration statement for the resale of the shares of common stock issuable upon conversion of, or payable as principal and interest on, the respective debentures, within
45 days of the initial closing date under each agreement, and to have such registration statements declared effective within 120 days of the initial closing dates of each purchase agreement. Through subsequent modifications of the July 2014
Debentures and September 2014 Debentures, the required date to file the registration statement and the effective date of the registration statement were modified, and the registration statement filed on April 9, 2015, and became
effective on June 11, 2015.
On January 30, 2015, the Company and certain of the Investors entered into an Amendment, Modification and
Supplement to the Purchase Agreement (the Purchase Agreement Amendment or the Modification) pursuant to which the Investors agreed to purchase an additional $1,800,000 in seven Modified Closings. The Modification also
eliminated the amortization payments discussed above, and provided for accrued and unpaid interest to be payable upon conversion or maturity rather than on specified payment dates. The Company was also required to open a new dispensary in Portland,
Oregon through a licensed operator during the first calendar quarter of 2015 (which was later modified to April 30, 2015). The Company also had to file the Registration Statement by March 8, 2015 (later amended), and it had to be declared
effective by June 15, 2015 in order to avoid default and acceleration under the Amended and Restated Debenture. As noted above, the Registration Statement was filed on April 9, 2015, and became effective June 11, 2015.
As part of the January 30, 2015 Modification, the parties entered into a Modified Debenture Agreement for the $200,000 that was funded at the Closing and
agreed to use the same form of Modified Debenture for each of the other foregoing Modified Closings (collectively, the Modified Debentures). The fixed conversion price of the Modified Debenture on January 30, 2015 was the lower of $5.00
or 51% of the lowest volume weighted average price for the 20 consecutive trading days prior to the applicable conversion date. This new fixed conversion price was a dilutive issuance to the outstanding July 2014 and September 2014
Debentures, thereby triggering a reset of the older fixed conversion price. As a result of the reset to the conversion price, at January 30, 2015, the derivative liability was re-measured to a fair value of approximately $2,690,000, using a
weighted probability model as estimated by management. A decrease in fair value of the derivative liability of approximately $1,072,000 was recognized as a gain on the Statement of Consolidated Comprehensive Loss, in the three months ended March 31,
2015.
The additional Modified Debentures under the July 2014 Debentures as of closing dates had a fixed conversion price of the lower of $1.83 or
51% of the VWAP for the last 20 days prior to the conversion. This new fixed conversion price was a dilutive issuance to the outstanding July 2014 and September 2014 Debentures, thereby triggering a reset of the previous $5 fixed
conversion price. This reset resulted in the derivative liability being revalued at February 27, 2015, using a weighted probability model for a fair value of $2,720,000.
The additional Modified Debentures under the September 2014 Debentures closed on January 29, 2015 in the amount of $100,000 and February 24,
2015 in the amount of $100,000. These Modified Debentures have a fixed conversion price of the lower of $5.00 or 51%
16
of the VWAP for the last 20 days prior to the conversion. This new fixed conversion price was a dilutive issuance to the outstanding September 2014 Debentures, thereby triggering a reset of
the previous $5.00 fixed conversion price. The resulting reset and re-measurement of the fair value of the derivative liability is included in the amounts of the change to fair value discussed above.
The April 17, 2015 closing under the July 2014 Modified Debentures contained a fixed conversion price of the lower of $0.88 or 51% of the VWAP for
the last 40 days prior to the conversion. This new fixed conversion price was a dilutive issuance to the outstanding July 2014 and September 2014 Debentures, thereby triggering a reset of the previous $1.83 fixed conversion price. This
reset resulted in the derivative liability being revalued at April 17, 2015, using a weighted probability model for a fair value of $3,287,000, for a increase in fair value of approximately $1,764,000, recognized as a loss on the Statement of
Consolidated Comprehensive Loss.
There was additional funding of $1,300,000 of the September 2014 Modified Debentures under the closing schedule
detailed above. These Modified Debentures all have a fixed conversion price of the lower of $0.88 or 51% of the VWAP for the last 40 days prior to the conversion.
The Directors convertible debentures required under the March 23, 2015 Modification, issued in the first quarter of 2015, total $150,000, and have
a three year term and an interest rate of 8% per annum. They were originally convertible at a fixed conversion price of the lower of $1.83 or 51% of the VWAP for the last 20 days prior to conversion. As with the Modified Debentures, the
debentures included a reset provision, which resulted in the conversion feature being bifurcated and accounted for as a derivative liability, with an initial fair value of $132,175. The directors convertible debentures also reset on
February 27, 2015 and April 17, 2015, with the changes to fair value included in the amounts disclosed above. The Directors debentures were all converted during the third quarter of 2015.
The Modified Debentures also included a warrant instrument granting the Investor the right to purchase shares of common stock of the Company equal to the
principal amount of the applicable Modified Debenture divided by a price equal to 120% of the last reported closing price of the common stock on the applicable closing date of the Modified Debenture, with a three year term.
August 2015 Debentures
On August 14,
2015, the Company entered into a Securities Purchase Agreement whereby they agreed to issue convertible debentures in the aggregate principal amount of up to $3,979,877 to certain Investors. The initial closing in the aggregate principal amount of
$650,000 occurred on August 14, 2015. An additional 11 payments were made in the total amount of $2,434,143 through December 31, 2015. The August 2015 Debentures bear interest at the rate of 10% per year. During the first
quarter of 2016, an additional approximately $895,000 was funded.
On August 20, 2015, the Company also entered into a Securities Purchase Agreement
with another Investor in the aggregate principal amount of up to $1,500,000 (collectively the August 2015 Debentures), which was amended on September 19, 2015, to increase the principal by an additional $200,000..
The August 2015 Debentures contain the following significant terms:
The debentures all mature in one year from the date of each individual closing.
All amounts are convertible at any time, in whole or in part, at the option of the holders into shares of the Companys common stock at a fixed
conversion price. The conversion price is the lower of (a) $0.75, or (b) a 49% discount to the lowest daily VWAP (as reported by Bloomberg) of the Common Stock during the 30 trading days prior to the conversion date. The Fixed Conversion
Price is subject to adjustment for stock splits, combinations or similar events. If the Company makes any subsequent equity sales (subject to certain exceptions), under which an effective price per share is lower than the Fixed Conversion Price,
then the conversion price will be reset to equal such price. The Company may prepay the Debentures in cash, prompting a 30% premium or, subject to certain conditions, in shares of common stock valued at 51% of the lowest volume weighted average
price of the common stock of the Company for the 30 prior trading days. The premium will be recognized at such time as the Company may choose to prepay the Debentures.
In connection with each of the purchase agreements, the Company entered into a registration rights agreement with the respective Investors pursuant to which
the Company agreed to file a registration statement for the resale of the shares of common stock issuable upon conversion of, or payable as principal and interest on, the respective debentures, within 45 days of the initial closing date under
each agreement, and to have such registration statements declared effective within 120 days of the initial closing dates of each purchase agreement. The pre-effective registration statement was filed with the SEC on October 16, 2015.
The conversion feature of the August 2015 Debenture meets the definition of a derivative and due to the reset provision to occur upon subsequent sales of
securities at a price lower than the fixed conversion price, requires bifurcation and is accounted for as a derivative
17
liability. The derivatives related to all closings on the August 2015 debentures were initially recognized at estimated fair values of approximately $11,205,000 and created a discount on the
Debentures that will be amortized over the life of the Debentures using the effective interest rate method. The fair value of the embedded derivative is measured and recognized at fair value each subsequent reporting period and the changes in fair
value are recognized in the Statement of Comprehensive Income (Loss) as Change in fair value of derivative liability. For the year ended December 31, 2014, and the interim periods through September 30, 2015, the Company estimated the fair
value of the conversion feature derivatives embedded in the convertible debentures based on weighted probabilities of assumptions used in the Black Scholes pricing model. The key valuation assumptions used consists, in part, of the price of the
Companys common stock, ranging from $8.81 down to $0.05; a risk free interest rate ranging from 0.41% to 0.12% and expected volatility of the Companys common stock, ranging from 196.78% to 106.38%, and the various estimated reset
exercise prices weighted by probability.
As of December 31, 2015, and for new issuances of convertible debentures during the fourth quarter of
fiscal 2015, the Company estimated the fair value of the conversion feature derivatives embedded in the convertible debentures based on a Monte Carlo Simulation model (MCS). The MCS model was used to simulate the stock price of the
Company from the valuation date through to the maturity date of the related debenture and to better estimate the fair value of the derivative liability due to the complex nature of the convertible debentures and embedded instruments. Management
believes that the use of the MCS model compared to the black Scholes model as previously used would provide a better estimate of the fair value of these instruments. Beginning in the fourth quarter of 2015, using the MCS model, the Company valued
these embedded derivatives using a with-and-without method, where the value of the Convertible Debentures including the embedded derivatives, is defined as the with, and the value of the Convertible Debentures excluding the
embedded derivatives, is defined as the without. This method estimates the value of the embedded derivatives by observing the difference between the value of the Convertible Debentures with the embedded derivatives and the value of the
Convertible Debentures without the embedded derivatives. The Company believes the with-and-without method results in a measurement that is more representative of the fair value of the embedded derivatives.
For each simulation path, the Company used the Geometric Brownian Motion (GBM) model to determine future stock prices at the maturity date. The
inputs utilized in the application of the GBM model included a starting stock price ranging from $0.03 to $0.10, an expected term of each debenture remaining from the valuation date to maturity ranging from .24 years to 1.04 years, an
estimated volatility of ranging from 193% to 219%, and a risk-free rate ranging from .20% to .70%. See Note 2 Fair value of financial instruments for additional information on the fair value and gains or losses on the embedded derivative.
For the three months ended March 31, 2016, the Company estimated the fair value of the conversion feature derivatives embedded in the convertible debentures
based on an internally calculated adjustment to the MCS valuation determined at December 31, 2015. This adjustment took into consideration the changes in the assumptions, such as market value and expected volatility of the Companys common
stock, and the discount rate used in the December 31, 2015 valuation as compared to March 31, 2016. The Company believes this methodology results in a reasonable fair value of the embedded derivatives for the interim period.
Entry into Security Agreement
In connection with
entry into the August 20 Purchase Agreement and August 14 Purchase Agreement, the Investors and the Company entered into a Security Agreement, dated August 21, 2015, securing the amounts underlying the August 14 Debentures and
the August 20 Debentures. The Security Agreement grants a security interest in all assets and personal property of the Company, subject to certain excluded real property assets. The security interests under the Security Agreement terminated
following the date that the registration statement registering the shares underlying the Convertible Debentures was declared effective, which occurred on December 15, 2015.
July 2015 Debenture
On July 10, 2015,
another accredited Investor and affiliate of the July 2014 Investor (the July 2015 Investor) purchased a separate Convertible Debenture (the July 2015 Debenture) in the aggregate principal amount of $500,000,
that closed in five weekly tranches between July 10 and August 15, 2015. The July 2015 Debenture is in substantially the same form as the August 14 Debentures, and does not include issuance of warrants. As such, the conversion
feature was also determined to require bifurcation and derivative accounting. All amounts related to the July 2015 derivative liability are included in amounts disclosed above for the August 2015 debentures.
18
On October 14, 2015, the August 2015 Investor assigned the right to purchase August 2015
Debentures in the principal amount of $100,000 to the July 2015 Investor and the July 2015 Investor purchased such August 2015 Debentures on the same day.
October 2015 Debentures
On October 14,
2015, the Company issued seven debentures in the aggregate of $2,000,000 to a service provider (the October 2015 Investor) as consideration for services previously rendered to the Company on the same terms as the August 14
Debentures and August 14 Purchase Agreement (the October 2015 Debentures and October 2015 Purchase Agreement, respectively) except that the October 2015 Purchase Agreement does not provide for registration
rights to the October 2015 Investor with regard to the shares underlying the October 2015 Debentures. The service provider has agreed with the Company not to convert the October 2015 Debentures for any amount in excess of fees payable
for services previously rendered to the Company at the time of conversion. To the extent that the sale of shares underlying the October 2015 Debentures do not satisfy outstanding amounts payable to the service provider, such amounts will remain
payable to the service provider by the Company. In the three months ending March 31, 2016, funding closed on $425,000 of the October 2015 debentures.
December 28, 2015 Amendment and Restriction Agreement
On December 28, 2015, the Company, the August 14 Investor and the August 20 Investor entered into a Debenture Amendment and Restriction
Agreement (the Agreement), pursuant to which (1) the August 14 Investor agreed to be restricted from converting any of its convertible debentures into common stock until February 21, 2016, subject to certain limitations set
forth below (the Restriction) and (2) the August 14 Investor agreed to assign, as of the effective date of the Agreement approximately $390,000 of its convertible debentures to the August 20 Investor in exchange for the amount
of principal outstanding under such debenture plus a premium in cash from the August 20 Investor (the Assigned Debentures). The accrued and unpaid interest under the Assigned Debentures remained payable by the Company to the
August 14 Investor.
The August 14 Investor also agreed to amend the terms of each of its debentures (other than the debentures that were
assigned) such that the debenture is convertible at a 40% discount to the lowest trading price of the Companys common stock during the 30 consecutive prior trading days rather than at a 49% discount to the lowest volume weighted-average
price during the 30 consecutive prior trading days. This was not considered to be a modification of the terms of the conversion feature, requiring evaluation of the debenture to determine if it was modified or extinguished, as the conversion
feature is separately accounted for as a derivative, and is outside of the scope of the guidance on debt modifications. The change in the conversion price will be reflected in its fair value under derivative accounting.
As consideration for entering into the Agreement, the August 14 Investor was issued a promissory note from the Company in the principal amount of
$700,000 (the Promissory Note). The Promissory Note has a term of ten months, accrues interest at a rate of 10% per annum, and outstanding principal and accrued interest under the Promissory Note may be pre-paid at any time by the
Company without penalty. The Promissory Note is not convertible other than in an event of default, in which case it is convertible on the terms of the other debentures held by the August 14 Investor. This conversion feature was considered to be
a contingent conversion feature, and therefore the conversion feature would not be bifurcated and accounted for as a derivative, as are the conversion features of all other debentures, until such time as and if the Company is in an event of default.
The Promissory Note is being accounted for as a finance expense of the December 28, 2015 transaction, similar to a debt discount, and will be amortized to financing expense over the ten month life of the note (Note 8).
19
The August 20 Investor shall also acquire from the August 14 Investor an additional $650,000 of the
convertible debentures held by the August 14 Investor (1) upon the declaration of effectiveness of a post-effective amendment (the POSAM) to the Companys Registration Statement on Form S-1 originally filed by the Company on
October 16, 2015 and declared effective by the Securities and Exchange Commission on December 15, 2015 (the Registration Statement) reflecting the terms of the Agreement, or (2) at the option of the August 20 Investor (the
Option), at an earlier time. The August 14 Investor exercised the Option on January 25, 2016. The POSAM was declared effective on February 3, 2016.
At March 31, 2016, the Company had not paid the principal due of $9,600 on a convertible debenture which was due on March 27, 2016. The Company was in
default and obtained a waiver from the lender on May 11, 2016 waiving all rights relating to the nonpayment and extending the maturity date of the convertible debenture to August 1, 2016. In the same waiver agreement, the terms of five
additional convertible debentures with maturity dates in May and June of 2016 totaling $122,084 were also extended to a maturity date of August 1, 2016.
February 10, 2016 Financing
On
February 10, 2016, the Company entered into a Note Purchase Agreement (the Purchase Agreement) with an accredited investor (the Investor), pursuant to which the Company agreed to sell, and the Investor agreed to
purchase, a promissory note (the Note) in the aggregate principal amount of $275,000. The closing occurred on February 11, 2016.
The
Investor deducted a commitment fee in the amount of $25,000 at the closing. The Note bears interest at the rate of 10% per year and matures on October 31, 2016. The Company may prepay all or any part of the outstanding balance of the Note at
any time without penalty. In the event that the Company or any of its subsidiaries becomes subject to bankruptcy, insolvency, liquidation, or similar proceedings or takes certain related corporate actions, all outstanding principal and accrued
interest under the Note will immediately and automatically become due and payable. In addition, the Note identifies certain other events of default, the occurrence of which would entitle the Investor to declare the outstanding principal and accrued
interest immediately due and payable or to convert the Note, in whole or in part, into shares of the Companys common stock at a conversion price that is the lower of (a) $0.75, or (b) a 51% discount to the lowest daily volume weighted average
price of the Companys common stock during the 20 trading days prior to the conversion date.
This conversion feature was considered to be a
contingent conversion feature, and therefore the conversion feature would not be bifurcated and accounted for as a derivative, as are the conversion features of all other debentures, until such time as and if the Company is in an event of
default. The balance of this note is included with Notes Payable on the accompanying condensed consolidated Balance Sheet (Note 8).
February 18, 2016 Financing
On
February 18, 2016, the Company entered into a securities purchase agreement (the Purchase Agreement) with an accredited investor (the Investor) pursuant to which the Company agreed to sell, and the Investor agreed to
purchase, convertible debentures (the Debentures) in the aggregate principal amount of $420,000, in two tranches.
The initial closing in the
aggregate principal amount of $210,000 occurred on February 18, 2016. The second closing in the amount of $210,000 occurred on March 18, 2016 ($125,000) and March 22, 2016 ($85,000). The Debentures bear interest at the rate of 10% per
year and mature after one year and are subject to a financing fee of 5%.
Each of the Debentures are convertible at the option of the holders into shares
of the common stock of the Company at a conversion price that is lower of (a) $0.75, or (b) a 40% discount to the lowest traded price of the common stock of the Company during the 30 trading days prior to the conversion date. The Company may
prepay the Debentures in cash, prompting a 30% premium.
The conversion feature of the Debentures meets the definition of a derivative and due to the
reset provision to occur upon subsequent sales of securities at a price lower than the fixed conversion price, requires bifurcation and is accounted for as a derivative liability.
The derivatives related to both the February 18, 2016 convertible debentures and the additional closings on the August 2015 and October 2015 debentures, were
initially recognized at their estimated fair values as described previously, which amounted to approximately $4,082,000 in the three months ended March 31, 2016 and $1,885,000 for the same period of 2015. The resulting debt discount is
amortized as over the life of the convertible debenture, or until conversion if earlier, which resulted in amortization expense of $1,868,000 and $1,820,000, for the three months ended March 31, 2016 and 2015, respectively. Additionally, the
current year closings to convertible debentures resulted in the calculated fair value of the debt being greater than the face amounts of the debt by approximately $2,302,000, with this excess amount being immediately expensed as Financing
costs. Financing costs for the three months ended March 31, 2015, were approximately $525,000. The fair value of the embedded derivative consisting of all related convertible debentures is measured and recognized at fair value each
subsequent reporting period and the changes in fair value for all derivatives for three months ended March 31, 2016 and 2015, resulted in a gain of approximately $8,880,000 and $2,239,000, respectively, which are recognized in the condensed
consolidated Statement of Comprehensive Income (Loss) as Change in fair value of derivative liability.
20
March 15 2016 Financing
The Company entered into a Note Purchase Agreement, effective as of March 14, 2016 (the Effective Date), with an Investor (the March 15
Investor) pursuant to which the March 15 Investor purchased and the Company issued and sold a promissory note in the original principal amount of $140,000 (the First Promissory Note). Upon satisfaction of certain conditions
set forth in the Note Purchase Agreement, the Company will issue and sell a second promissory note in the original principal amount of $137,500 (the Second Promissory Note). Each Promissory Note matures six (6) months after the date
of its issuance. The First Promissory Note carries an original issue discount of $12,500 (the First Promissory Note OID). In addition, Company agreed to pay $5,000 towards the March 15 Investors legal fees incurred in
connection with the purchase and sale of the First Promissory Note and the Second Promissory Note, $2,500 of which was paid to the March 15 Investor prior to the Effective Date and $2,500 of which amount (the Carried Transaction Expense
Amount) is included in the initial principal balance of the First Promissory Note. The purchase price of the First Promissory Note was $125,000, computed as follows: $140,000 initial principal balance, less the First Promissory Note OID, less
the Carried Transaction Expense Amount. The Second Promissory Note, if issued, also carries an original issue discount of $12,500 (the Second Promissory Note OID). The purchase price of the Second Promissory Note shall be $125,000,
computed as follows: $137,500 initial principal balance, less the Second Promissory Note OID (the Second Promissory Note Purchase Price).
On
March 15, 2016, the Company issued and sold the First Promissory Note to the March 15 Investor. Upon satisfaction of the terms (the Mandatory Second Promissory Note Conditions), the Company shall issue and sell the Second
Promissory Note to the March 15 Investor. The Mandatory Second Promissory Note Conditions means that each of the following conditions has been satisfied on or before the date that is ninety (90) days from the Effective Date: (i) the
Share Reserve (as defined in the First Promissory Note) for the First Promissory Note shall have been established; (ii) no Event of Default (as defined in the First Promissory Note) shall have occurred under the First Promissory Note;
(iii) the median daily dollar volume of the Common Stock on its principal market for the nineteen (19) Trading Days (as defined in the First Promissory Note) immediately preceding the Share Reserve Date is greater than $75,000 per Trading
Day; and (iv) the Company has notified Investor in writing that it has elected to require that Investor pay the Second Promissory Note Purchase Price. If the Mandatory Second Promissory Note Conditions are not satisfied as of the date that is
ninety (90) days from the Effective Date, then the March 15 Investor shall not be obligated to pay the Second Promissory Note Purchase Price and the Second Promissory Note shall not be considered a valid, binding, or enforceable obligation
of the Company, and, thereafter, the Second Promissory Note shall only be issued and the Second Promissory Note Purchase Price will only be payable upon the mutual written agreement of Company and the March 15 Investor. The First Promissory
Note and/or the Second Promissory Note may be prepaid at any time by the Company in the sole discretion of the Company at a 25% premium to the outstanding balance under the applicable Promissory Note.
In the event that the First Promissory Note and/or the Second Promissory Note is not paid in full on or before maturity by the Company, then the March 15
Investor shall have the right at any time thereafter until such time as the First Promissory Note and/or the Second Promissory Note is paid in full, at the March 15 Investors election, to convert (each instance of conversion being a
Conversion) all or any part of the outstanding balance into shares (Conversion Shares) of fully paid and non-assessable Common Stock of the Company as per the following conversion formula: the number of Conversion Shares
equals the amount being converted divided by 50% multiplied by the lowest daily volume weighted average price of the Common Stock in the twenty (20) Trading Days immediately preceding the applicable Conversion. At any time and from time to time
after the March 15 Investor becoming aware of the occurrence of any event of default, the March 15 Investor may accelerate the First Promissory Note and/or the Second Promissory by written notice to the Company, with the outstanding
balance of the respective Note becoming immediately due and payable in cash at 125% of the outstanding balance.
This conversion feature was considered to
be a contingent conversion feature, and therefore the conversion feature would not be bifurcated and accounted for as a derivative, as are the conversion features of all other debentures, until such time as and if the Company is in an event of
default. The balance of the First Promissory Note is included with Notes Payable on the accompanying condensed consolidated Balance Sheet (Note 8).
Related Party Financing
One of the directors on
the Companys Board, entered into three separate subordinated convertible promissory notes convertible at $0.01 with the Company on March 4, 2016, March 10, 2016 and March 15, 2016, respectively, each in the principal amount
of $25,000, for a total of $75,000. Also on March 15, 2016, another of the Companys directors entered into a subordinated convertible promissory note convertible at $0.01 with the Company in the principal amount of $25,000, and two other of
the Companys directors each entered into a subordinated convertible promissory note convertible at $0.01 with the Company in the principal amount of $2,500. All of the foregoing convertible promissory notes have three year terms and an
interest rate of 8% per annum. The debentures were evaluated to determine if the conversion feature fell within the guidance for derivative accounting, and as the debentures are convertible at a fixed conversion price, and do not include a the
reset provision to occur upon subsequent sales of securities at a price lower than the fixed conversion price, the Company concluded the conversion feature did not qualify as a derivative.
21
In connection with their funding of the Notes (collectively the Notes), the directors each receive a
warrant, exercisable for a period of three (3) years from the date of Notes, to purchase an amount of Company Common Stock equal to 50% of the principal sum under each of the director notes, at an exercise price equal to 200% of the applicable
Conversion Price. The exercise price of the Warrants is $0.02. The warrants were determined to have a fair value of $42,000, calculated with the Black Sholes Merton model, with key valuation assumptions used that consist of the price of the
Companys stock at settlement date, a risk free interest rate based on the average yield of a 3 year Treasury note and expected volatility of the Companys common stock all as of the measurement date.
Conversions
During the three months ended March
31, 2016 and 2015, respectively, $928,000 and $1,400,000 of principal and approximately $8,000 and $25,000, of accrued interest were converted into approximately 151,824,000 and 1,919,000 of the Companys common shares at an average price of
$0.01 and $0.74, based on 51% of the calculated VWAP. Upon conversion, the derivative fair value for the amounts converted were re-measured through the date of conversion, with the conversion date fair value reclassified to equity, amounting to
approximately $1,765,000 in the three months ended March 31, 2016. As a result of the conversions, the resulting decrease of fair value of approximately $1,512,000 of the related debt discount was recognized on the Statement of Consolidated
Comprehensive Income (Loss).
Warrants
The
warrants issued under all debentures are summarized below:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Date issued
|
|
Number of
warrants
|
|
|
Exercise
price
|
|
|
December 18,
2015 re-price
|
|
|
Fair Value at issuance
|
|
July 2014 Modified Debentures
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
January 30, 2015
|
|
|
40,552
|
|
|
|
4.93
|
|
|
|
.06
|
|
|
$
|
159,601
|
|
February 26, 2015
|
|
|
45,537
|
|
|
|
2.20
|
|
|
|
.06
|
|
|
|
79,904
|
|
March 13, 2015
|
|
|
21,151
|
|
|
|
2.36
|
|
|
|
.06
|
|
|
|
39,965
|
|
March 16, 2015
|
|
|
10,575
|
|
|
|
2.36
|
|
|
|
.06
|
|
|
|
19,981
|
|
|
|
|
|
|
March 20, 2015
|
|
|
41,946
|
|
|
|
1.79
|
|
|
|
.06
|
|
|
|
59,942
|
|
|
|
|
|
|
March 27, 2015
|
|
|
75,758
|
|
|
|
1.98
|
|
|
|
.06
|
|
|
|
119,888
|
|
|
|
|
|
|
April 2, 2015
|
|
|
60,386
|
|
|
|
1.66
|
|
|
|
.06
|
|
|
|
74,025
|
|
|
|
|
|
|
April 2, 2015
|
|
|
30,193
|
|
|
|
1.66
|
|
|
|
.06
|
|
|
|
37,012
|
|
|
|
|
|
|
April 10, 2015
|
|
|
107,914
|
|
|
|
1.39
|
|
|
|
.06
|
|
|
|
112,460
|
|
|
|
|
|
|
April 17, 2015
|
|
|
41,667
|
|
|
|
1.20
|
|
|
|
.06
|
|
|
|
37,680
|
|
|
|
|
|
|
April 24, 2015
|
|
|
127,119
|
|
|
|
1.18
|
|
|
|
.06
|
|
|
|
112,635
|
|
|
|
|
|
|
April 24, 2015
|
|
|
21,186
|
|
|
|
1.18
|
|
|
|
.06
|
|
|
|
18,772
|
|
May 1, 2015
|
|
|
156,250
|
|
|
|
.96
|
|
|
|
.06
|
|
|
|
113,133
|
|
May 7, 2015
|
|
|
134,615
|
|
|
|
.78
|
|
|
|
.06
|
|
|
|
79,234
|
|
May 8, 2015
|
|
|
42,000
|
|
|
|
.75
|
|
|
|
.06
|
|
|
|
23,768
|
|
May 15, 2015
|
|
|
200,000
|
|
|
|
.75
|
|
|
|
.06
|
|
|
|
113,365
|
|
May 22, 2015
|
|
|
250,000
|
|
|
|
.60
|
|
|
|
.06
|
|
|
|
113,366
|
|
May 29, 2015
|
|
|
258,621
|
|
|
|
.58
|
|
|
|
.06
|
|
|
|
112,537
|
|
June 5, 2015
|
|
|
288,462
|
|
|
|
.52
|
|
|
|
.06
|
|
|
|
120,738
|
|
June 12, 2015
|
|
|
930,233
|
|
|
|
.43
|
|
|
|
.06
|
|
|
|
303,246
|
|
June 19, 2015
|
|
|
3,448,276
|
|
|
|
.29
|
|
|
|
.06
|
|
|
|
751,159
|
|
|
|
|
|
|
September 2014 Modified Debentures
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
January 28, 2015
|
|
|
18,038
|
|
|
|
5.54
|
|
|
|
.06
|
|
|
|
80,156
|
|
February 13, 2015
|
|
|
57,870
|
|
|
|
1.73
|
|
|
|
.06
|
|
|
|
96,689
|
|
April 2, 2015
|
|
|
181,159
|
|
|
|
1.66
|
|
|
|
.06
|
|
|
|
222,109
|
|
April 24, 2015
|
|
|
90,579
|
|
|
|
1.10
|
|
|
|
.06
|
|
|
|
80,548
|
|
May 15, 2015
|
|
|
200,000
|
|
|
|
.75
|
|
|
|
.06
|
|
|
|
113,365
|
|
22
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Date issued
|
|
Number of
warrants
|
|
|
Exercise
price
|
|
|
December 18,
2015 re-price
|
|
|
Fair Value at issuance
|
|
June 12, 2015
|
|
|
1,744,186
|
|
|
|
.43
|
|
|
|
.06
|
|
|
|
570,248
|
|
|
|
|
|
|
August 2015 Debentures
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
August 24, 2015
|
|
|
6,666,667
|
|
|
|
.06
|
|
|
|
|
|
|
|
321,757
|
|
September 18, 2015
|
|
|
588,235
|
|
|
|
.17
|
|
|
|
|
|
|
|
82,804
|
|
October 28, 2015
|
|
|
4,166,667
|
|
|
|
.12
|
|
|
|
|
|
|
|
363,306
|
|
November 16, 2015
|
|
|
1,785,714
|
|
|
|
.07
|
|
|
|
|
|
|
|
92,798
|
|
November 23, 2015
|
|
|
2,083,333
|
|
|
|
.06
|
|
|
|
|
|
|
|
68,988
|
|
November 30,2015
|
|
|
2,500,000
|
|
|
|
.05
|
|
|
|
|
|
|
|
81,988
|
|
December 7, 2015
|
|
|
6,250,000
|
|
|
|
.02
|
|
|
|
|
|
|
|
163,382
|
|
December 17, 2015
|
|
|
10,000,000
|
|
|
|
.02
|
|
|
|
|
|
|
|
76,376
|
|
|
|
|
|
|
Directors
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
January 5, 2015
|
|
|
129,305
|
|
|
|
.40
|
|
|
|
|
|
|
|
39,901
|
|
January 30, 2015
|
|
|
129,250
|
|
|
|
.40
|
|
|
|
|
|
|
|
39,916
|
|
February 2, 2015
|
|
|
237,778
|
|
|
|
.22
|
|
|
|
|
|
|
|
16,619
|
|
March 4, 2016
|
|
|
1,250,000
|
|
|
|
.02
|
|
|
|
|
|
|
|
10,000
|
|
March 10, 2016
|
|
|
1,250,000
|
|
|
|
.02
|
|
|
|
|
|
|
|
10,000
|
|
March 15, 2016
|
|
|
1,250,000
|
|
|
|
.02
|
|
|
|
|
|
|
|
10,000
|
|
March 15, 2016
|
|
|
1,250,000
|
|
|
|
.02
|
|
|
|
|
|
|
|
10,000
|
|
March 15, 2016
|
|
|
125,000
|
|
|
|
.02
|
|
|
|
|
|
|
|
1,000
|
|
March 15, 2016
|
|
|
125,000
|
|
|
|
.02
|
|
|
|
|
|
|
|
1,000
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
|
48,411,222
|
|
|
|
|
|
|
|
|
|
|
$
|
5,155,361
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Effective September 18, 2015, the holder of the September 2014 Debentures and the Company agreed to amend its September 2014
Warrants, to reduce the exercise price of the warrants to purchase an aggregate of 2,291,832 shares of the Companys common stock to six cents per share. Additionally, the holder of the July 2014 Debentures and the Company agreed to amend its
July 2014 Warrants, to reduce the exercise price of the warrants to purchase an aggregate of 6,332,441 shares of Common Stock to six cents per share. As a result of the amendment, the fair value of the warrants was remeasured as of September 18,
2015, for an additional fair value of approximately $38,000 recognized as a financing expense. During the year ended December 31, 2015, approximately 2,292,000 warrants were exercised for cash proceeds of $137,510 at an average exercise price
of $0.06.
During the three months ended March 31, 2016 and 2015, there were no warrants exercised.
The Company determined at issuance that the warrants were properly classified in equity as there is no cash settlement provision and the warrants have a fixed
exercise price and, therefore, result in an obligation to deliver a known number of shares.
The Company adopted a sequencing policy that reclassifies
contracts, with the exception of stock options, from equity to assets or liabilities for those with the earliest inception date first. Any future issuance of securities, as well as period-end reevaluations, will be evaluated as to reclassification
as a liability under our sequencing policy of earliest inception date first until all of the convertible debentures are either converted or settled.
The
Company reevaluated the warrants as of March 31, 2016 and determined that they did not have a sufficient number of authorized and unissued shares to settle all existing commitments, and the fair value of the warrants for which there was
insufficient authorized shares, were reclassified out of equity to a liability. Under the sequencing policy, of the approximately 50,120,000 warrants outstanding at March 31, 2016, it was determined there was not sufficient authorized shares for
approximately 49,625,000 of the outstanding warrants. The fair value of these warrants was re-measured on March 31, 2016 using the Black Scholes Merton Model, with key valuation assumptions used that consist of the price of the Companys
stock on March 31, 2016, a risk free interest rate based on the average yield of a 2 or 3 year Treasury note and expected volatility of the Companys common stock, resulting in the fair value for the Warrant liability of $426,000.
23
NOTE 8 NOTES PAYABLE
Notes payable consists of:
|
|
|
|
|
|
|
|
|
|
|
March 31,
2016
|
|
|
December 31,
2015
|
|
Southwest Farms (Note 3)
|
|
$
|
3,635,704
|
|
|
$
|
3,645,163
|
|
East West Secured Development (Note 3)
|
|
|
520,065
|
|
|
|
675,093
|
|
Washington Property (Note 6)
|
|
|
199,000
|
|
|
|
208,605
|
|
Investment funds
|
|
|
1,115,000
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
5,469,769
|
|
|
|
4,528,861
|
|
|
|
|
Less discounts
|
|
|
(530,000
|
)
|
|
|
|
|
Plus premium
|
|
|
13,333
|
|
|
|
16,667
|
|
|
|
|
|
|
|
|
|
|
|
|
|
4,953,102
|
|
|
|
4,545,528
|
|
Less current maturities
|
|
|
683,337
|
|
|
|
256,897
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
4,269,765
|
|
|
$
|
4,288,631
|
|
|
|
|
|
|
|
|
|
|
Maturities on Notes Payable are as follows:
|
|
|
|
|
Years ending:
|
|
|
|
|
December 31, 2016
|
|
$
|
1,177,576
|
|
December 31, 2017
|
|
|
287,647
|
|
December 31, 2018
|
|
|
4,004,546
|
|
|
|
|
|
|
|
|
$
|
5,469,769
|
|
|
|
|
|
|
NOTE 9 SHARE BASED AWARDS, RESTRICTED STOCK AND RESTRICTED STOCK UNITS (RSUs)
The Board resolved that, beginning with the fourth calendar quarter of 2015, the Company shall pay each member of the Companys Board of Directors, who is
not also an employee of the Company, for each calendar quarter during which such member continues to serve on the Board compensation in the amount of $15,000 in cash and 325,000 shares of Company common stock. The 975,000 shares issued to all
the directors for the three months ended March 31, 2016 were valued at the market price of the Companys common stock on March 31, 2016, for total compensation expense of $9,750. On March 31, 2016, the Board awarded the Chairman a
cash bonus of approximately $89,000 and following the increase in the Companys authorized shares of common stock during the second quarter of 2016 the Board intended to issue to the Chairman determined that, 2,230,000 shares of Company common
stock for his service in the three months ended March 31, 2016, which at the time of such determination was at the market price of the Companys common stock on such date.
The Board also voted on November 20, 2015, to increase the shares available for grant under the 2014 Equity Incentive Plan to 32,000,000. The
Company intends to file a Form S-8 regarding the increased shares available for grant now that the increase in authorized shares has been approved.
24
A summary of the activity related to RSUs for the three months ended March 31, 2016 and 2015 is presented
below:
|
|
|
|
|
|
|
Restricted stock units (RSUs)
|
|
Total shares
|
|
|
Grant date fair
value
|
RSUs non-vested at January 1, 2016
|
|
|
152,823
|
|
|
$0.51 - $1.88
|
RSUs granted
|
|
|
|
|
|
$
|
RSUs vested
|
|
|
(49,020
|
)
|
|
$0.51
|
RSUs forfeited
|
|
|
|
|
|
$
|
|
|
|
|
|
|
|
|
|
|
RSUs non-vested March 31, 2016
|
|
|
103,803
|
|
|
$0.51 - $1.88
|
|
|
|
|
|
|
|
|
|
|
Restricted stock units (RSUs)
|
|
Total shares
|
|
|
Grant date fair
value
|
RSUs non-vested at January 1, 2015
|
|
|
199,584
|
|
|
$10.70
|
RSUs granted
|
|
|
177,633
|
|
|
$1.88 - $6.70
|
|
|
|
RSUs vested
|
|
|
(135,135
|
)
|
|
$1.88 - $6.70
|
RSUs forfeited
|
|
|
|
|
|
$
|
|
|
|
|
|
|
|
|
|
|
RSUs non-vested March 31, 2015
|
|
|
242,082
|
|
|
$1.88 - $11.00
|
|
|
|
|
|
|
|
A summary of the expense related to restricted stock, RSUs and stock option awards for the quarter ended March 31, 2016
is presented below:
|
|
|
|
|
|
|
Three months ended
March 31, 2016
|
|
Restricted Stock
|
|
$
|
390,000
|
|
RSUs
|
|
|
154,048
|
|
Stock options
|
|
|
|
|
Common stock
|
|
|
32,050
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
576,098
|
|
|
|
|
|
|
NOTE 10 RELATED PARTY TRANSACTIONS
During the first quarter of 2015, the Company issued two convertible notes to one of its directors in the aggregate principal amount of $100,000 and one
convertible note to another of its director in the aggregate principal amount of $50,000. These notes were all converted to common stock during the third quarter of 2015.
During the first quarter of 2016, the Company issued three convertible notes to one of its directors in the aggregate principal amount of $75,000 and one
convertible note to another of its director in the aggregate principal amount of $25,000, plus a convertible note to each of its other two directors, in the amount of $2,500 each. See Note 7 for a description of these notes.
NOTE 11 COMMITMENTS AND CONTINGENCIES
The Company
leases property for its day to day operations and facilities for possible retail dispensary locations and cultivation locations as part of the process of applying for retail dispensary and cultivation licenses.
25
Office Leases
On August 1, 2011, the Company entered into a lease agreement for office space located in West Hollywood, California through June 30, 2017 at a
current monthly rate of $14,828 per month. The Company moved to new offices in Los Angeles, CA in April 2015. The sublease on the new office has a term of 18 months with monthly rent of $7,486.
The landlord for the West Hollywood space has filed a suit against the Company and independent guarantors on the West Hollywood lease. The Company has
expensed all lease payments due under the West Hollywood lease. The Companys liability for the West Hollywood lease will be adjusted, if required, upon settlement of the suit with the landlord.
Total rent expense under operating leases for the quarters ended March 31, 2016 and 2015 was approximately $289,000 and $45,000, respectively.
Retail/Cultivation facility leases
The
Companys business model of acquiring retail dispensary and cultivation licenses often requires us to acquire real estate either through lease arrangements or through purchase agreements in order to secure a possible license. Deposits in escrow
consist of amounts paid to open escrow accounts for the purchase of multiple properties to be used to develop retail dispensary or product cultivation facilities.
The following table is a summary of our material contractual lease commitments as of March 31, 2016:
|
|
|
|
|
|
|
|
|
Year Ending
|
|
Office Rent
|
|
|
Retail/Cultivation
Facility Lease
|
|
2016
|
|
$
|
44,916
|
|
|
$
|
66,600
|
|
2017
|
|
|
|
|
|
|
88,800
|
|
2018
|
|
|
|
|
|
|
88,800
|
|
2019
|
|
|
|
|
|
|
29,600
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
44,916
|
|
|
$
|
273,800
|
|
|
|
|
|
|
|
|
|
|
Litigation
On
May 22, 2013, Medbox initiated litigation in the United States District Court in the District of Arizona against three shareholders of MedVend Holdings LLC (Medvend) in connection with a contemplated transaction that Medbox entered
into for the purchase of an approximate 50% ownership stake in Medvend for $4.1 million. The lawsuit alleges fraud and related claims arising out of the contemplated transaction during the quarter ended June 30, 2013. The litigation is pending
and Medbox has sought cancellation due to a fraudulent sale of the stock because the selling shareholders lacked the power or authority to sell their ownership stake in MedVend, and their actions were a breach of representations made by them in the
agreement. On November 19, 2013 the litigation was transferred to United States District Court for the Eastern District of Michigan. MedVend recently joined the suit pursuant to a consolidation order executed by a new judge assigned to the
matter. In the litigation, the selling shareholder defendants seek alternatively to have the transaction performed, or to have it unwound and be awarded damages and allege breach of the agreement by Medbox and that $600,000 was wrongfully retained
by the Company. Medbox has denied liability with respect to any and all such counterclaims. A new litigation schedule was recently issued setting trial for September 2015. On June 5, 2014, the Company entered into a purchase and sale agreement
(the Medvend PSA) with PVM International, Inc. (PVMI) concerning this matter. Pursuant to the Medvend PSA, the Company sold to PVMI the Companys rights and claims attributable to or controlled by the Company against
those three certain stockholders of Medvend, known as Kaplan, Tartaglia and Kovan (the Medvend Rights and Claims), in exchange for the return by PVMI to the Company of 30,000 shares of the Companys common stock. PVMI is owned by
Vincent Mehdizadeh, formerly the Companys largest stockholder. On December 17, 2015, the Company entered into a revocation of the Medvend PSA, which provided that from that date forward, Medbox would take over the litigation and be
responsible for the costs and attorneys fees associated with the Medvend Litigation from December 17, 2015 forward. All costs and attorneys fees through December 16, 2015 will be borne by PVMI. After the filing of a motion
for substitution of Medbox n/k/a Notis Global, Inc. for PVMI, Defendants agreed, via a stipulated order, to permit the substitution. The Court entered the order substituting Notis Global, Inc. for PVMI on February 17, 2016. The case
is in the discovery stage, and, at this time, the Company cannot determine whether the likelihood of an unfavorable outcome of the dispute is probable or remote, nor can they reasonably estimate a range of potential loss, should the outcome be
unfavorable.
On February 20, 2015, Michael A. Glinter, derivatively and on behalf of nominal defendants Medbox, Inc. the Board and certain executive
officers (Pejman Medizadeh, Matthew Feinstein, Bruce Bedrick, Thomas Iwanskai, Guy Marsala, J. Mitchell Lowe, Ned Siegel, Jennifer Love, and C. Douglas Mitchell) filed a suit in the Superior Court of the State of California for the County of Los
26
Angeles. The suit alleges breach of fiduciary duties and abuse of control by the defendants. Relief is sought awarding damages resulting from breach of fiduciary duty and to direct the Company
and the defendants to take all necessary actions to reform and improve its corporate governance and internal procedures to comply with applicable law. This action has been stayed pending the outcome of the actions filed in the United States District
Court for the District of Nevada (Calabrese and Gray). The Company has entered into a Stipulation and Agreement of Settlement on October 16, 2015. See more detailed discussion below under
Class Settlement
and
Derivative
Settlements
.
On January 21, 2015, Josh Crystal on behalf of himself and of all others similarly situated filed a class action lawsuit in the
U.S. District Court for Central District of California against Medbox, Inc., and certain past and present members of the Board (Pejman Medizadeh, Bruce Bedrick, Thomas Iwanskai, Guy Marsala, and C. Douglas Mitchell). The suit alleges that the
Company issued materially false and misleading statements regarding its financial results for the fiscal year ended December 31, 2013 and each of the interim financial periods that year. The plaintiff seeks relief of compensatory damages and
reasonable costs and expenses or all damages sustained as a result of the wrongdoing. On April 23, 2015, the Court issued an Order consolidating the three related cases in this matter: Crystal v. Medbox, Inc., Gutierrez v. Medbox, Inc., and
Donnino v. Medbox, Inc., and appointing a lead plaintiff. On July 27, 2015 Plaintiffs filed a Consolidated Amended Complaint. The Company must file a responsive pleading on or before December 4, 2015. The Company has entered into a
Stipulation and Agreement of Settlement on October 16, 2015. See more detailed discussion below under
Class Settlement
and
Derivative Settlements
.
On January 18, 2015, Ervin Gutierrez filed a class action lawsuit in the U.S. District Court for the Central District of California. The suit alleges
violations of federal securities laws through public announcements and filings that were materially false and misleading when made because they misrepresented and failed to disclose that the Company was recognizing revenue in a manner that violated
US GAAP. The plaintiff seeks relief for compensatory damages and reasonable costs and expenses or all damages sustained as a result of the wrongdoing. On April 23, 2015, the Court issued an Order consolidating the three related cases in this
matter: Crystal v. Medbox, Inc., Gutierrez v. Medbox, Inc., and Donnino v. Medbox, Inc., and appointing a lead plaintiff. On July 27, 2015 Plaintiffs filed a Consolidated Amended Complaint. The Company must file a responsive pleading on or
before December 4, 2015. The Company intends to vigorously defend against this suit. The Company has entered into a Stipulation and Agreement of Settlement on October 16, 2015. See more detailed discussion below under
Class
Settlement
and
Derivative Settlements
.
On January 29, 2015, Matthew Donnino filed a class action lawsuit in the U.S. District Court for
Central District of California. The suit alleges that the Company issued materially false and misleading statements regarding its financial results for the fiscal year ended December 31, 2013 and each of the interim financial periods that year.
The plaintiff seeks relief for compensatory damages and reasonable costs and expenses or all damages sustained as a result of the wrongdoing. On April 23, 2015, the Court issued an Order consolidating the three related cases in this matter:
Crystal v. Medbox, Inc., Gutierrez v. Medbox, Inc., and Donnino v. Medbox, Inc., and appointing a lead plaintiff. On July 27, 2015 Plaintiffs filed a Consolidated Amended Complaint. The Company must file a responsive pleading on or before
December 4, 2015. The Company intends to vigorously defend against this suit. The Company has entered into a Stipulation and Agreement of Settlement on October 16, 2015. See more detailed discussion below under
Class Settlement
and
Derivative Settlements
.
On February 12, 2015, Jennifer Scheffer, derivatively on behalf of Medbox, Guy Marsala, Ned Siegel, Mitchell Lowe
and C. Douglas Mitchell filed a lawsuit in the Eighth Judicial District Court of Nevada seeking damages for breaches of fiduciary duty regarding the issuance and dissemination of false and misleading statements and regarding allegedly improper and
unfair related party transactions, unjust enrichment and waste of corporate assets. On April 17, 2015, Ned Siegel and Mitchell Lowe filed a Motion to Dismiss. On April 20, 2015, the Company filed a Joinder in the Motion to Dismiss. On
July 27, 2015, the Court held a hearing on and granted the Motion to Dismiss without prejudice. The Company has entered into a Stipulation and Agreement of Settlement on October 16, 2015. See more detailed discussion below under
Class Settlement
and
Derivative Settlements
.
On March 10, 2015 Robert J. Calabrese, derivatively and on behalf of nominal defendant
Medbox, Inc., filed a suit in the United States District Court for the District of Nevada against certain Company officers and/or directors (Ned L. Siegel, Guy Marsala, J. Mitchell Lowe, Pejman Vincent Mehdizadeh, Bruce Bedrick, and Jennifer S.
Love). The suit alleges breach of fiduciary duties and gross mismanagement by issuing materially false and misleading statements regarding the Companys financial results for the fiscal year ended December 31, 2013 and each of the interim
financial periods. Specifically the suit alleges that defendants caused the Company to overstate the Companys revenues by recognizing revenue on customer contracts before it had been earned. The plaintiff seeks relief for compensatory damages
and reasonable costs and expenses for all damages sustained as a result of the alleged wrongdoing. The Company has entered into a Stipulation and Agreement of Settlement on October 16, 2015. See more detailed discussion below under
Class
Settlement
and
Derivative Settlements
.
On March 27, 2015 Tyler Gray, derivatively and on behalf of nominal defendant Medbox, Inc., filed
a suit in the United States District Court for the District of Nevada against the Companys Board of Directors and certain executive officers (Pejman Vincent Mehdizadeh, Matthew Feinstein, Bruce Bedrick, Thomas Iwanski, Guy Marsala, J. Mitchell
Lowe, Ned Siegel, Jennifer S. Love, and C. Douglas Mitchell). The suit alleges breach of fiduciary duties and abuse of control. The plaintiff seeks relief for compensatory damages and reasonable costs and expenses for all damages sustained as a
result of the alleged wrongdoing. Additionally the plaintiff
27
seeks declaratory judgments that plaintiff may maintain the action on behalf of the Company, that the plaintiff is an adequate representative of the Company, and that the defendants have breached
and/or aided and abetted the breach of their fiduciary duties to the Company. Lastly the plaintiff seeks that the Company be directed to take all necessary actions to reform and improve its corporate governance and internal procedures to comply with
applicable law. The Company has entered into a Stipulation and Agreement of Settlement on October 16, 2015. See more detailed discussion below under
Class Settlement
and
Derivative Settlements
.
On May 20, 2015 Patricia des Groseilliers, derivatively and on behalf of nominal defendant Medbox, Inc., filed a suit in the United States District Court
for the District of Nevada against the Companys Board of Directors and certain executive officers (Pejman Vincent Mehdizadeh, Ned Siegel, Guy Marsala, J. Mitchell Lowe, Bruce Bedrick, Jennifer S. Love, Matthew Feinstein, C. Douglas Mitchell,
and Thomas Iwanski). The suit alleges breach of fiduciary duties and unjust enrichment. The plaintiff seeks relief for compensatory damages and reasonable costs and expenses for all damages sustained as a result of the alleged wrongdoing.
Additionally the plaintiff seeks declaratory judgments that plaintiff may maintain the action on behalf of the Company, that the plaintiff is an adequate representative of the Company, and that the defendants have breached and/or aided and abetted
the breach of their fiduciary duties to the Company. Lastly the plaintiff seeks that the Company be directed to take all necessary actions to reform and improve its corporate governance and internal procedures to comply with applicable law. The
Company has entered into a Stipulation and Agreement of Settlement on October 16, 2015. On April 22, 2016, the Court issued an Order granting, without a hearing, shareholder Richard Merritts Motion to Intervene in the lawsuit titled
Mike Jones v. Guy Marsala, et al.
, in order to conduct limited discovery. The Order granting the Motion to Intervene also continued the final fairness hearing, previously scheduled for May 16, 2016, at 1:30 p.m., to August 15, 2016,
at 1:30 p.m. See more detailed discussion below under
Class Settlement
and
Derivative Settlements
.
On June 3, 2015 Mike Jones,
derivatively and on behalf of nominal defendant Medbox, Inc., filed a suit in the U.S. District Court for Central District of California against the Companys Board of Directors and certain executive officers (Guy Marsala, J. Mitchell Lowe, Ned
Siegel, Jennifer S. Love, C. Douglas Mitchell, Pejman Vincent Mehdizadeh, Matthew Feinstein, Bruce Bedrick, and Thomas Iwanski). The suit alleges breach of fiduciary duties, abuse of control, and breach of duty of honest services. The plaintiff
seeks relief for compensatory damages and reasonable costs and expenses for all damages sustained as a result of the alleged wrongdoing. Additionally the plaintiff seeks declaratory judgments that plaintiff may maintain the action on behalf of the
Company, that the plaintiff is an adequate representative of the Company, and that the defendants have breached and/or aided and abetted the breach of their fiduciary duties to the Company. Lastly the plaintiff seeks that the Company be directed to
take all necessary actions to reform and improve its corporate governance and internal procedures to comply with applicable law. On July 20, 2015, the Court issued an Order consolidating this litigation with those previously consolidated in the
Central District (Crystal, Gutierrez, and Donnino). The Company has entered into a Stipulation and Agreement of Settlement on October 16, 2015. On March 25, 2016, shareholder Richard Merritts, who filed a derivative lawsuit against the
Companys Board of Directors and certain executive officers on October 27, 2015, filed a Motion to Intervene in the case. By his Motion, Merritts seeks limited intervention in the Jones shareholder derivative action in order to seek
confirmatory information and discovery regarding the Stipulation and Agreement of Settlement preliminarily approved by the Court on February 3, 2016. On April 4, 2016, Plaintiff Jones and the Company separately filed oppositions to the Motion to
Intervene. The hearing on the Motion to Intervene is set for April 25, 2016. See more detailed discussion below under
Class Settlement
and
Derivative Settlements
.
On July 20, 2015 Kimberly Freeman, derivatively and on behalf of nominal defendant Medbox, Inc., filed a suit in the Eighth Judicial District Court of
Nevada against the Companys Board of Directors and certain executive officers (Pejman Vincent Mehdizadeh, Guy Marsala, Ned Siegel, J. Mitchell Lowe, Jennifer S. Love, C. Douglas Mitchell, and Bruce Bedrick). The suit alleges breach of
fiduciary duties and unjust enrichment. The plaintiff seeks relief for compensatory damages and reasonable costs and expenses for all damages sustained as a result of the alleged wrongdoing. Additionally the plaintiff seeks declaratory judgments
that plaintiff may maintain the action on behalf of the Company, that the plaintiff is an adequate representative of the Company, and that the defendants have breached and/or aided and abetted the breach of their fiduciary duties to the Company.
Lastly the plaintiff seeks that the Company be directed to take all necessary actions to reform and improve its corporate governance and internal procedures to comply with applicable law. The Company has entered into a Stipulation and Agreement of
Settlement on October 16, 2015. See more detailed discussion below under
Class Settlement
and
Derivative Settlements
.
On
October 16, 2015, solely to avoid the costs, risks, and uncertainties inherent in litigation, the parties to the class actions and derivative lawsuits named above entered into settlements that collectively effect a global settlement of all
claims asserted in the class actions and the derivative actions. The global settlement provides, among other things, for the release and dismissal of all asserted claims. The global settlement is contingent on final court approval, respectively, of
the settlements of the class actions and derivative actions. If the global settlement does not receive final court approval, it could have a material adverse effect on the financial condition, results of operations and/or cash flows of the Company
and their ability to raise funds in the future.
Class Settlement
On December 1, 2015, Medbox and the class plaintiffs in Josh Crystal v. Medbox, Inc., et al., Case No. 2:15-CV-00426-BRO (JEMx), pending
before the United States District Court for the Central District of California (the Court) notified the Court of the settlement. The Court stayed the action pending the Courts review of the settlement and directed the parties to
file a stipulation of settlement. On December 18, 2015, plaintiffs filed the Motion for Preliminary Approval of Class Action Settlement that included the stipulation of settlement. On February 3, 2016, the Court issued an Order granting
preliminary approval of the settlement. The settlement provides for notice to be given to the class, a period for opt outs and a final approval hearing. The Court originally scheduled the Final Settlement Approval Hearing to be held on May 16,
2016 at 1:30 p.m., but continued it to August 15, 2016 at 1:30 p.m. to be heard at the same time as the Final Settlement Approval Hearing for the derivative actions, discussed below. The principal terms of the settlement are:
|
|
A cash payment to a settlement escrow account in the amount of $1,850,000 of which $150,000 will be paid by the Company and $1,700,000 will be paid by the Companys insurers;
|
28
|
|
A transfer of 2,300,000 shares of Medbox common stock to the settlement escrow account, of which 2,000,000 shares would be contributed by Medbox and 300,000 shares by Bruce Bedrick;
|
|
|
The net proceeds of the settlement escrow, after deduction of Court-approved administrative costs and any Court-approved attorneys fees and costs would be distributed to the Class;
|
|
|
Releases of claims and dismissal of the action.
|
By entering into the settlement, the settling parties have
resolved the class claims to their mutual satisfaction. However, the final determination is subject to approval by the Federal Courts. Defendants have not admitted the validity of any claims or allegations and the settling plaintiffs have not
admitted that any claims or allegations lack merit or foundation.
The Company has accrued the amounts per the terms of the settlement that are their
responsibility in Accrued settlement and severance expense on the accompanying consolidated balance sheet. This consists of the $150,000 cash payment, and the fair value of 2,000,000 of the Companys stock, based on the fair value as of
December 31, 2015 of $0.03, approximately $52,000.
Derivative Settlements
As previously announced on October 22, 2015, on October 16, 2015, the Company, in its capacity as a nominal defendant, entered into a memorandum of
understanding of settlement (the Settlement) in the following shareholder derivative actions: (1) Mike Jones v. Guy Marsala, et al., in the U.S. District Court for Central District of California; (2) Jennifer Scheffer v. P. Vincent
Mehdizadeh, et al., in the Eighth Judicial District Court of Nevada; (3) Kimberly Y. Freeman v. Pejman Vincent Mehdizadeh, et al., in the Eighth Judicial District Court of Nevada; (4) Tyler Gray v. Pejman Vincent Mehdizadeh, et al., in the U.S.
District Court for the District of Nevada; (5) Robert J. Calabrese v. Ned L. Siegel, et al., in the U.S. District Court for the District of Nevada; (6) Patricia des Groseilliers v. Pejman Vincent Mehdizadeh, et al., in the U.S. District Court for
the District of Nevada; (7) Michael A. Glinter v. Pejman Vincent Mehdizadeh, et al., in the Superior Court of the State of California for the County of Los Angeles (the Shareholder Derivative Lawsuits). In addition to the Company, Pejman
Vincent Mehdizadeh, Matthew Feinstein, Bruce Bedrick, Thomas Iwanski, Guy Marsala, J. Mitchell Lowe, Ned Siegel, and C. Douglas Mitchell were named as defendants in all of the lawsuits, and Jennifer S. Love was named in all of the lawsuits but the
Scheffer action (the Individual Defendants).
On December 3, 2015, the parties in the Jones v. Marsala action advised the Court of the
settlements in the Shareholder Derivative Lawsuits and that the parties would be submitting the settlement to the Court in the Jones action for approval. The Court thereafter issued an order vacating all pending dates in the action and ordered
Plaintiff to file the Stipulation and Agreement of Settlement for the Courts approval. On December 18, 2015, plaintiffs filed the Motion for Preliminary Approval of Derivative Settlement that included the Stipulation and Agreement of
Settlement. On February 3, 2016, the Court issued an Order granting preliminary approval of the settlement.
The Court originally scheduled a final
Settlement Hearing to be held on May 16, 2016 at 1:30 p.m., but subsequently continued that hearing to August 15, 2016 at 1:30. By the terms of the settlement, a final Court approval would provide for a release of the claims in the Shareholder
Derivative Actions and a bar against continued prosecution of all claims covered by the release. By entering into the Settlement, the settling parties have resolved the derivative claims to their mutual satisfaction. The Individual Defendants have
not admitted the validity of any claims or allegations and the settling plaintiffs have not admitted that any claims or allegations lack merit or foundation.
Under the terms of the Settlement, the Company agrees to adopt and adhere to certain corporate governance processes in the future. In addition to these
corporate governance measures, the Companys insurers, on behalf of the Individual Defendants, will make a payment of $300,000 into the settlement escrow account and Messrs. Mehdizadeh and Bedrick will deliver 2,000,000 and 300,000 shares,
respectively, of their Medbox, Inc. common stock into the settlement escrow account. Subject to Court approval, the funds and common stock in the settlement escrow account will be paid as attorneys fees and expenses, or as service awards to
plaintiffs.
The Settlement remains subject to approval by the Court. The Court must determine whether (1) the terms and conditions of the Settlement are
fair, reasonable, and adequate in the best interest of the Company and its stockholders, (2) if the judgment, as provided for in the Settlement, should be entered, and (3) if the request of plaintiffs counsel for an award of attorneys
fees and reimbursement of expenses should be granted.
The Companys responsibilities as to the proposed settlements have been accrued and included
in Accrued settlement and severance expenses on the accompanying consolidated balance sheet as of December 31, 2015. If the Class or Derivative settlements do not receive final court approval, it could have a material adverse effect on the financial
condition, results of operations and/or cash flows of the Company and their ability to raise funds in the future.
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On October 27, 2015, separate from the above lawsuits and settlement, Richard Merritts, derivatively and on
behalf of nominal defendant Medbox, Inc., filed a suit in the Superior Court of the State of California for the County of Los Angeles against the Board and certain executive officers (Guy Marsala, J. Mitchell Lowe, Ned Siegel, Jennifer S. Love, C.
Douglas Mitchell, Pejman Vincent Mehdizadeh, Matthew Feinstein, Bruce Bedrick, Jeff Goh, and Thomas Iwanski). The suit alleges breach of fiduciary duties by the defendants. Relief is sought awarding damages resulting from breach of fiduciary duty
and to direct the Company and the defendants to take all necessary actions to reform and improve its corporate governance and internal procedures to comply with applicable law. On February 16, 2016, the court issued an order staying the
litigation pending final court approval of the settlement of the other pending derivative actions involving Medbox, Inc., as nominal defendant, and former and current officers and directors. The settlement of the other derivative actions has been
preliminarily approved by the court in Jones v. Marsala, et al., Case No. 15-cv-4170 BRO (JEMx), in the U.S. District Court for the Central District of California. On March 25, 2016, Merritts filed a Motion to Intervene in the case
filed by Mike Jones in the U.S. District Court for the Central District of California. By his Motion, Merritts seeks limited intervention in the Jones shareholder derivative action in order to seek confirmatory information and discovery regarding
the Stipulation and Agreement of Settlement preliminarily approved by the Court on February 3, 2016. On April 4, 2016, Plaintiff Jones and the Company separately filed oppositions to the Motion to Intervene. On April 22, 2016, the Court
issued an Order granting, without a hearing, shareholder Richard Merritts Motion to Intervene in the lawsuit titled
Mike Jones v. Guy Marsala, et al.
, in order to conduct limited discovery. The Order granting the Motion to Intervene
also continued the final fairness hearing, previously scheduled for May 16, 2016, at 1:30 p.m., to August 15, 2016, at 1:30 p.m.
Other litigation
On December 26, 2014, Medicine Dispensing Systems, a wholly-owned subsidiary of Medbox, filed a suit against Kind Meds, Inc. to collect fees of
approximately $550,000 arising under a contract to establish a dispensary. Kind Meds, Inc. filed a cross complaint against Medicine Dispensing Systems for breach of contract and breach of implied covenant of good faith and fair dealing, claiming
damages of not less than $500,000. On November 14, 2015, the parties entered into a Confidential Settlement and Release Agreement wherein the matter was resolved, and the complaint and cross complaint were subsequently dismissed with no amounts
owing by the Company, and the complaint and cross complaint were subsequently dismissed.
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The Company commenced arbitration proceedings against a former employee on June 13, 2013 related to
employment claims asserted by the employee. Thereafter, the employee filed a suit in Los Angeles County Superior Court. The suit was stayed pending the outcome of the arbitration and thereafter dismissed without prejudice. The Company obtained a
favorable arbitration award. The Company then filed an Application to Confirm the Arbitration Award in Arizona Superior Court, Maricopa County. After being unable to serve the employee, the Company performed service by publication and filed proofs
of publication for service on the employee on February 27, 2015 and March 2, 2015. On November 13, 2015, the parties entered into a Confidential Settlement and Release Agreement wherein the matter was resolved with no amounts owing by
the Company, and the suit was dismissed with prejudice.
The lease for the former office at 8439 West Sunset Blvd. in West Hollywood, CA has been
partially subleased. The Company plans to sublease the remainder of the office in West Hollywood, CA and continues to incur rent expense while the space is being marketed. The landlord for the prior lease filed a suit in Los Angeles Superior Court
in April 2015 against the Company for damages they allege have been incurred from unpaid rent and otherwise. In January 2016, the landlord filed a first amended complaint adding the independent guarantors under the lease as co-defendents and
specifying damages claim of approximately $300,000. A trial date has been set in November 2016. The Company is presently unable to determine whether the likelihood of an unfavorable outcome of the dispute is probable or remote, nor can it reasonably
estimate a range of potential loss, should the outcome be unfavorable.
SEC MATTER
In October 2014, the Board of Directors of the Company appointed a special board committee (the Special Committee) to investigate a federal
grand jury subpoena pertaining to the Companys financial reporting which was served upon the Companys predecessor independent registered public accounting firm as well as certain alleged wrongdoing raised by a former employee of the
Company. The Company was subsequently served with two SEC subpoenas in early November 2014. The Company is fully cooperating with the grand jury and the SEC. In connection with its investigation of these matters, the Special Committee in
conjunction with the Audit Committee initiated an internal review by management and by an outside professional advisor of certain prior period financial reporting of the Company. The outside professional advisor reviewed the Companys revenue
recognition methodology for certain contracts for the third and fourth quarters of 2013. As a result of certain errors discovered in connection with the review by management and its professional advisor, the Audit Committee, upon managements
recommendation, concluded on December 24, 2014 that the consolidated financial statements for the year ended December 31, 2013 and for the third and fourth quarters therein, as well as for the quarters ended June 30,
2014, June 30, 2014 and September 30, 2014, should no longer be relied upon and would be restated to correct the errors. On March 6, 2015 the audit committee determined that the consolidated financial statements for the year
ended December 31, 2012, together with all three, six and nine month financial information contained therein, and the quarterly information for the first two quarters of the 2013 fiscal year should also be restated. On March 11, 2015, the
Company filed its restated Form 10 Registration Statement with the SEC with restated financial information for the years ended December 31, 2012 and December 31, 2013, and on March 16, 2015, the Company filed amended and restated
quarterly reports on Form 10-Q, with restated financial information for the periods ended March 31, June 30 and September 30, 2014, respectively.
The staff of the Los Angeles Regional Office of the U.S. Securities and Exchange Commission recently advised counsel for the Company in a
telephone conversation, followed by a written Wells notice, that it is has made a preliminary determination to recommend that the Commission file an enforcement action against the Company in connection with misstatements by prior
management in the Companys financial statements for 2012, 2013 and the first three quarters of 2014. A Wells Notice is neither a formal allegation of wrongdoing nor a finding that any violations of law have occurred. Rather, it provides the
Company with an opportunity to respond to issues raised by the Staff and offer its perspective prior to any SEC decision to institute proceedings. These proceedings could result in the Company being subject to an injunction and cease and desist
order from further violations of the securities laws as well as monetary penalties of disgorgement, pre-judgment interest and a civil penalty. The Company has responded in writing to the Wells notice. Under current management, the
Company restated the relevant financial statements and took other remedial action, and has been cooperating with the SECs investigation since November 2014, including the appointment of a Special Committee of the Board to investigate the
conduct of prior management and disclose this conduct to the SEC. The Company has also produced documents to the SEC and has made witnesses available, both voluntarily and for sworn testimony pursuant to subpoena. The Company is unable to predict
the outcome of the investigation, any potential enforcement actions or any other impact on the Company that may arise as a result of such investigation. The Company has not established a liability for this matter, because it believes that the
probability of loss related to this matter and an estimate of the amount of loss, if any, are not determinable at this time. An adverse judgment or action of the SEC could have a material adverse effect on the financial condition, results of
operations and/or cash flows of the Company and their ability to raise funds in the future.
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NOTE 12 SUBSEQUENT EVENTS
On April 15, 2016, at a special meeting of the shareholders of the Company, the shareholders of the Company holding a majority of the total shares of
outstanding common stock of the Company voted to amend the Companys Articles of Incorporation to increase the number of authorized shares of common stock of the Company from 400,000,000 to 10,000,000,000 (the Certificate of
Amendment). The Certificate of Amendment was filed with the Nevada Secretary of State and was declared effective on April 18, 2016.
Sale
of Equity method investments
On April 6, 2016, the Company sold its remaining 30% interest in San Diego Sunrise, as well as all of its interest in
Sunrise Property Investments, LLC, the entity that owns underlying real estate related to the San Diego dispensary, for net proceeds of $331,000.
April 2016 Financing
On April 13, 2016, the
Company entered into a note purchase agreement (the Purchase Agreement) with an accredited investor (the Investor) pursuant to which the Company agreed to sell, and the Investor agreed to purchase, a convertible promissory
note (the Note) in the aggregate principal amount of $225,000.
The Note bears interest at the rate of 5% per year and matures on July 13,
2016. The Note is convertible at any time, in whole or in part, at the option of the holders into shares of the common stock of the Company at a conversion price that is the lower of (a) $0.75, or (b) a 49% discount to the lowest traded price of the
common stock of the Company during the 20 trading days prior to the conversion date. The Company may prepay the Note in cash, prompting a 30% premium.
The Company will, within thirty (30) days, grant a security interest to the Investor and its affiliates over the Companys assets, including its stock
ownership in its subsidiary, ESWD I, LLC (but not the assets of ESWD I, LLC). Furthermore, in connection with the next $1.5 million of equity capital raised by the Company, the Company shall use one third of such funds to make principal repayment of
amounts owed to the Investor, plus a redemption premium of 30% of such amounts.
March 15, 2016 Financing Second Promissory Note
On or about April 20, 2016 it was mutually determined by the parties involved that the median daily dollar volumes requirement of the Mandatory Second
Promissory Note Conditions was not met and the Second Promissory Note would not be issued.
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