NOTES
TO THE CONSOLIDATED FINANCIAL STATEMENTS
NOTE
1 – ORGANIZATION AND DESCRIPTION OF BUSINESS
Q2Earth,
Inc. (hereinafter the “Company”), incorporated in Delaware on August 26, 2004, is currently engaged in the business
of compost and soil manufacturing, and is pursuing a plan of strategic acquisitions in this sector. The Company previously owned
and licensed technology that converts waste fuels and heat to power, technology it sold to a licensee in August 2017. Formerly,
the Company’s name was Q2Power Technologies, Inc., and before that, Anpath Group, Inc. (“Anpath”).
Q2Power
Corp. (the “Subsidiary” or “Q2P”) operated as a renewable power R&D company focused on the conversion
of waste to energy and other valuable “reuse” products since July 2014. The operations of the Company have from the
time of the Merger (described below) until recently been essentially those of the Subsidiary. In 2017, the Company shifted its
focus from technology R&D to the acquisition and operation of facilities that manufacture compost and sustainable soils from
waste resources.
In
May 2016, the Company began exploring other synergistic business lines such as compost and soil manufacturing from waste water
biosolids. The Company began to phase out its R&D activities in mid-2016, and in August 2017, sold its waste-to-power technology
to a licensee. The Company’s current focus is entirely on the business of compost and engineered soils manufacturing and
sales.
NOTE
2 – BASIS OF PRESENTATION AND GOING CONCERN
For the three months
ended March 31, 2018, the Company used cash in operating activities of $187,613. The accumulated deficit since inception is
$9,848,442, which is comprised of operating losses and other expenses. These conditions raise substantial doubt about the Company’s
ability to continue as a going concern. There is no guarantee whether the Company will be able to generate sufficient revenue
and/or raise capital sufficient to support its operations. The ability of the Company to continue as a going concern is dependent
on management’s plans which include implementation of its business model to acquire cash-flowing businesses, grow revenue
and earnings of those companies, and continue to raise funds through debt or equity offerings.
On
March 31, 2017, the Company completed the first $1,050,000 tranche of a convertible bridge note offering (the “Bridge Offering”).
Through the end of 2017, the Company closed an additional $600,000 of follow-on investments in the Bridge Offering. The
proceeds from this offering combined with funds the Company has raised in the subsequent period (see “Note 12: Subsequent
Events”) are expected to provide working capital for the Company through the second quarter of 2018, though there can
be no assurances.
The
consolidated financial statements do not include any adjustments that might result from the outcome of these uncertainties.
NOTE
3 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles
of Consolidation
The
consolidated financial statements include the accounts of the Company and its Subsidiary. All significant inter-company transactions
and balances have been eliminated in consolidation. References herein to the Company include the Company and its Subsidiary, unless
the context otherwise requires.
Cash
The
Company considers cash, short-term deposits, and other investments with original maturities of no more than ninety days when acquired
to be cash and cash equivalents for the purposes of the statement of cash flows. The Company maintains cash balances at two financial
institutions and has experienced no losses with respect to amounts on deposit.
Revenue
Recognition
Revenue
for services from the Company’s compost and soil business includes contracts where the Company is paid to do feasibility
studies, site assessment studies and other similar services in connection with a third party soil or compost manufacturing business.
Revenue from such services is recognized at the date of delivery of deliverables to customers when a formal arrangement exists,
the price is fixed or determinable, the delivery or milestone deliverable is completed, no other significant obligations of the
Company exist, and collectability is reasonably assured. In its review, management identifies that a contract exists with a
customer, identifies the performance obligations in the contract, determines the transaction price, allocates the transaction
price to the performance obligations in the contract, and then recognizes revenue when the Company satisfies specific performance
obligation. Payments received before all of the relevant criteria for revenue recognition are satisfied are recorded as deferred
revenue.
Stock
Based Compensation
The
Company applies the fair value method of Financial Accounting Standards Board (“FASB”) Accounting Standards Codification
(“ASC”) 718, “
Share Based Payment
”, in accounting for its stock-based compensation. This standard
states that compensation cost is measured at the grant date based on the fair value of the award and is recognized over the service
period, which is usually the vesting period. The Company values stock based compensation at the market price for the Company’s
common stock and other pertinent factors at the grant date.
The
Company accounts for transactions in which services are received from non-employees in exchange for equity instruments based on
the fair value of the equity instruments exchanged, in accordance with ASC 505-50, “
Equity Based payments to Non-employees
”.
The Company measures the fair value of the equity instruments issued based on the market price of the Company’s stock at
the time services or goods are provided.
Common
Stock Options
The
Black-Scholes option pricing valuation method is used to determine fair value of these options consistent with ASC 718, “
Share
Based Payment”.
Use of this method requires that the Company make assumptions regarding stock volatility, dividend yields,
expected term of the awards and risk-free interest rates.
Derivatives
Derivatives
were recognized initially at fair value. Subsequent to initial recognition, derivatives were measured at fair value, and changes
are therein generally recognized in profit or loss. In 2017, the Company early adopted Accounting Standards Update (“ASU”)
2017-11,
Earnings Per Share (Topic 260); Distinguishing Liabilities from Equity (Topic 480); Derivatives and Hedging (Topic
815)
which resulted in a reclassification of the Company’s prior year derivative liabilities to equity on January 1,
2017.
Property
and Equipment
Property
and equipment are recorded at cost. Depreciation is computed on the straight-line method, based on the estimated useful lives
of the assets as follows:
|
|
Years
|
Furniture
and equipment
|
|
7
|
Computers
|
|
5
|
Expenditures
for maintenance and repairs are charged to operations as incurred.
Impairment
of Long Lived Assets
The
Company continually evaluates the carrying value of intangible assets and other long-lived assets to determine whether there are
any impairment losses. If indicators of impairment are present and future cash flows are not expected to be sufficient to recover
the assets’ carrying amount, an impairment loss would be charged to expense in the period identified. To date, the Company
has not recognized any impairment charges.
Income
Taxes
Income
taxes are accounted for under the asset and liability method as stipulated by FASB ASC 740, “
Income Taxes
”
(“ASC 740”). Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences
between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating
loss and tax credit carry forwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply
to taxable income in the years in which those temporary differences are expected to be recovered or settled. Under ASC 740, the
effect on deferred tax assets and liabilities or a change in tax rate is recognized in income in the period that includes the
enactment date. Deferred tax assets are reduced to estimated amounts to be realized by the use of a valuation allowance. A valuation
allowance is applied when in management’s view it is more likely than not (50%) that such deferred tax will not be utilized.
In
the event that an uncertain tax position exists in which the Company could incur income taxes, the Company would evaluate whether
there is a probability that the uncertain tax position taken would be sustained upon examination by the taxing authorities. Reserves
for uncertain tax positions would be recorded if the Company determined it is probable that a position would not be sustained
upon examination or if payment would have to be made to a taxing authority and the amount is reasonably estimated. As of March
31, 2018, the Company does not believe it has any uncertain tax positions that would result in the Company having a liability
to the taxing authorities. Interest and penalties related to any unrecognized tax benefits is recognized in the consolidated financial
statements as a component of income taxes.
Basic
and Diluted Income Per Share
Net income per
share is computed by dividing the net income less preferred dividends by the weighted average number of common shares outstanding
during the period. Diluted net income per share is calculated by dividing the net income less preferred dividends
by the weighted average number of common shares outstanding during the period plus any potentially dilutive shares related to
the issuance of stock options, shares from the issuance of stock warrants, shares issued from the conversion of redeemable convertible
preferred stock and shares issued for the conversion of convertible debt. There were 150,000 potentially dilutive shares
from common stock warrants as of March 31, 2018, calculated to have an incremental dilutive effect of 40,909 shares.
There were no potentially dilutive shares as of March 31, 2017.
At March 31, 2018, there
were the following potentially dilutive securities that were excluded from diluted net income per share because their effect would
be anti-dilutive: 6,915,480 shares from common stock options, 3,568,845 shares from common stock warrants, 1,100,000 shares from
the conversion of debentures, 22,387,942 shares that may be converted from the Bridge Round (based upon an assumed conversion
price at March 31, 2018 of $0.094 per share), and 4,000,000 shares from the conversion of redeemable convertible preferred
stock. At March 31, 2017, there were the following potentially dilutive securities that were excluded from diluted net income
per share because their effect would be anti-dilutive: 6,115,480 shares from common stock options, 1,568,845 shares from common
stock warrants, 785,714 shares from the conversion of debentures, and 2,857,142 shares from the conversion of redeemable convertible
preferred stock.
Significant
Estimates
U.S.
Generally Accepted Accounting Principles (“GAAP”) requires the Company to make judgments, estimates and assumptions
that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of
the consolidated financial statements, the reported amounts of revenues and expenses, cash flows and the related footnote disclosures
during the period. On an on-going basis, the Company reviews and evaluates its estimates and assumptions, including, but not limited
to, those that relate to the realizable value of identifiable intangible assets and other long-lived assets, the fair value of
derivative liabilities and convertible bridge notes, and the assessment and recognition of income taxes and contingencies. Actual
results could differ from these estimates.
Recent
Accounting Pronouncements
In
May 2014, the FASB issued ASU 2014-09, “
Revenue from Contracts with Customers (Topic 606)
.” ASU 2014-09 eliminated
transaction- and industry-specific revenue recognition guidance under current GAAP and replaced it with a principle based approach
for determining revenue recognition. ASU 2014-09 requires that companies recognize revenue based on the value of transferred goods
or services as they occur in the contract. The ASU also requires additional disclosure about the nature, amount, timing and uncertainty
of revenue and cash flows arising from customer contracts, including significant judgments and changes in judgments and assets
recognized from costs incurred to obtain or fulfill a contract. In April 2016, the FASB also issued ASU 2016-10, “
Identifying
Performance Obligations and Licensing
,” implementation guidance on principal versus agent, identifying performance obligations,
and licensing. The Company has completed the evaluation of this ASU impact on the results of operations and financial condition.
The Company has concluded, after completing a detailed contract review, that the adoption of the new standard does not have an
impact on the financial results and determined that no material adjustments were necessary to the existing accounting policies.
The Company has adopted the ASU using the modified retrospective method on January 1, 2018.
In
January 2016, the FASB issued ASU No. 2016-01, “
Recognition and Measurement of Financial Assets and Financial Liabilities
”,
requiring management to address certain aspects of recognition, measurement, presentation, and disclosure of financial instruments.
This ASU is effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years.
The Company has assessed the impact of the ASU on its financial position, results of operations and cash flows,
and has determined that such impact, if any, would be insignificant.
In
February 2016, the FASB issued ASU No. 2016-02, “
Leases (Topic 842)
”, requiring management to recognize any
right-to-use-asset and lease liability on the statement of financial position for those leases previously classified as operating
leases. The criteria used to determine such classification is essentially the same as under the previous guidance, but it is more
subjective. The lessee would classify the lease as a finance lease if certain criteria at lease commencement are met. This ASU
is effective for fiscal years beginning after December 15, 2018. The Company is currently assessing the impact of the ASU on its
financial position, results of operations and cash flows.
In
August 2016, the FASB issued ASU No. 2016-15, “
Statement of Cash Flows: Clarification of Certain Cash Receipts and Cash
Payments
” (“ASU 2016-15”), which eliminates the diversity in practice related to the classification of certain
cash receipts and payments in the statement of cash flows, by adding or clarifying guidance on eight specific cash flow issues:
debt prepayment or debt extinguishment costs; settlement of zero-coupon debt instruments or other debt instruments with coupon
interest rates that are insignificant in relation to the effective interest rate of the borrowing; contingent consideration payments
made after a business combination; proceeds from the settlement of insurance claims; proceeds from the settlement of corporate-owned
life insurance policies (including bank-owned life insurance policies); distributions received from equity method investees; beneficial
interests in securitization transactions; and separately identifiable cash flows and application of the predominance principle.
ASU 2016-15 provides for retrospective application for all periods presented. The Company adopted the standard on January 1, 2018.
The adoption of this standard did not have an effect on the Company’s financial position or results of operations.
In
May 2017, the FASB issued ASU 2017-09, “
Compensation - Stock Compensation (Topic 718): Scope of Modification Accounting
“(“ASU 2017-09”). ASU 2017-09 provides clarity and reduces both (i) diversity in practice and (ii) cost
and complexity when applying the guidance in Topic 718, Compensation-Stock Compensation, to a change to the terms or conditions
of a share-based payment award. The amendments in ASU 2017-09 provide guidance about which changes to the terms or conditions
of a share-based payment award require an entity to apply modification accounting in Topic 718. The Company adopted the standard
on January 1, 2018. The adoption of this standard did not have an effect on the Company’s financial position or results
of operations.
In
July 2017, the FASB issued ASU 2017-11, “
Earnings Per Share (Topic 260); Distinguishing Liabilities from Equity
(Topic 480); Derivatives and Hedging (Topic 815).”
The amendment changes the classification of certain
equity-linked financial instruments (or embedded features) with down round features. The amendments also clarify existing
disclosure requirements for equity-classified instruments. When determining whether certain financial instruments (or
embedded features) should be classified as liabilities or equity instruments, under ASU 2017-11, a down round feature no
longer precludes equity classification when assessing whether the instrument (or embedded feature) is indexed to an
entity’s own stock. As a result, a freestanding equity-linked financial instrument (or embedded conversion option) no
longer would be accounted for as a derivative liability at fair value solely as a result of the existence of a down round
feature. The adoption of ASU 2017-11 is effective for annual periods beginning after December 15, 2018. The Company has early
adopted this standard for the year ended December 31, 2017, applying the standard retrospectively by means of a
cumulative-effect adjustment to the opening balance of accumulated deficit in the amount of $388,667 as of January 1, 2017. In
addition, the Company determined that the impact to the income/(loss) per share as a result of the down round features was
not material. The impact to the financial statements for the three-months ended March 31, 2017 is as follows:
|
|
For
the three months ended
|
|
|
|
March
31, 2017
|
|
|
|
As
previously reported
|
|
|
Adjusted
|
|
|
|
|
|
|
|
|
Loss
from operations
|
|
$
|
(140,483
|
)
|
|
$
|
(140,483
|
)
|
|
|
|
|
|
|
|
|
|
Other income (expenses):
|
|
|
|
|
|
|
|
|
Financing
costs including interest
|
|
|
(46,233
|
)
|
|
|
(46,233
|
)
|
Gain
on extinguishment of liabilities
|
|
|
306,262
|
|
|
|
306,262
|
|
Change
in fair value of derivative liabilities
|
|
|
66,477
|
|
|
|
-
|
|
Total
other income
|
|
|
326,506
|
|
|
|
260,029
|
|
|
|
|
|
|
|
|
|
|
Income before income taxes
|
|
|
186,023
|
|
|
|
119,546
|
|
|
|
|
|
|
|
|
|
|
Income
tax
|
|
|
-
|
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
Net income
|
|
|
186,023
|
|
|
|
119,546
|
|
|
|
|
|
|
|
|
|
|
Preferred stock
|
|
|
|
|
|
|
|
|
Series
A convertible contractual dividends
|
|
|
(9,074
|
)
|
|
|
(9,074
|
)
|
|
|
|
|
|
|
|
|
|
Net
income attributable to common stockholders
|
|
$
|
176,949
|
|
|
$
|
110,472
|
|
|
|
|
|
|
|
|
|
|
Net
income attributable to common stockholders: basic and diluted
|
|
$
|
0.01
|
|
|
$
|
0.01
|
|
|
|
|
|
|
|
|
|
|
Weighted average number of common
shares outstanding:
|
|
|
|
|
|
|
|
|
basic
and diluted
|
|
|
35,044,689
|
|
|
|
35,044,689
|
|
Concentration
of Risk
The
Company does not have any off-balance sheet concentrations of credit risk. The Company expects cash to be the asset most likely
to subject the Company to concentrations of credit risk. The Company’s policy is to maintain its cash with high credit quality
financial institutions to limit its risk of loss exposure.
NOTE
4 –PROPERTY AND EQUIPMENT, NET
Property
and equipment, net consists of the following:
|
|
March
31, 2018
|
|
|
December
31, 2017
|
|
Furniture
and computers
|
|
$
|
1,328
|
|
|
$
|
1,328
|
|
Total
|
|
|
1,328
|
|
|
|
1,328
|
|
Accumulated depreciation
|
|
|
(841
|
)
|
|
|
(775
|
)
|
Net property and equipment
|
|
$
|
487
|
|
|
$
|
553
|
|
Depreciation
expense for the three months ended March 31, 2018 and 2017 was $66 and $483 respectively.
The
Company disposed of $4,927 of net property and equipment as part of the transfer of its licensing rights with Cyclone Power Technologies,
Inc. (“Cyclone”) during the year ended December 31, 2017 (see Note 5).
NOTE
5 – CYCLONE SEPARATION, LICENSE RIGHTS AND DEFERRED REVENUE
In
2014, Q2P purchased for $175,000 certain licensing rights to use Cyclone’s patented technology on a worldwide, exclusive
basis for 20 years with two 10-year renewal terms for Q2P’s waste heat and waste-to-power business. This agreement contained
a royalty provision equal to 5% of gross sales payable to Cyclone on sales of engines derived from technology licensed from Cyclone.
Also, as part of a separation agreement with Cyclone, Q2P assumed a license agreement between Cyclone and Phoenix Power Group
(“Phoenix”), which included deferred revenue of $250,000 from payments previously made to Cyclone for undelivered
products. The net balances as of March 31, 2018 and 2017 for the Cyclone licensing rights were $0 and $58,333, respectively; and
the net balances for the Phoenix deferred revenue in the both periods were, which were included as a component of deferred revenue
on the consolidated balance sheets. The licensing rights were amortized over its estimated useful life of 4 years. Amortization
expense for the three months ended March 31, 2018 and 2017 was $0 and $10,938, respectively.
On
January 9, 2017, the Company transferred and assigned to Phoenix its Technology Sales Agreement with MagneGas Corporation (the
“MagneGas Agreement”) to deliver a waste-to-power system to this customer. Under the MagneGas Agreement, the Company
had been paid $90,000 as of the date of transfer, and $68,000 was still due from the customer based on milestones set forth in
the MagneGas Agreement. Phoenix assumed the MagneGas Agreement, including deferred revenue of $50,000, with all rights to receive
the future payments thereunder, and responsibility to perform the services and provide the products to the customer. The Company
has no further responsibility under the MagneGas Agreement. In consideration for this transfer, Phoenix agreed that the Company
had completed and satisfied all financial obligations associated with all past agreements between Phoenix and the Company, specifically:
(1) $150,000 previously paid by Phoenix for durability testing of the Q2P engine, and (2) delivery by the Company of the first
ten (10) Q2P engines at the rate of $10,000 per delivered Engine for $100,000 in total. This deferred revenue in the total amount
of $250,000 was recorded as gain from the extinguishment of liabilities in the consolidated statement of operations for the year
ended December 31, 2017.
On
August 14, 2017, the Company closed a Technology Transfer and Assignment Agreement (the “Transfer Agreement”) with
Phoenix to transfer to Phoenix all of the Company’s technology and materials associated with Q2P’s external combustion
engine, controls and auxiliary systems (the “Q2P Technology”), developed both in conjunction with its license agreement
with Cyclone and such other Q2P Technology developed independently from the license agreement. Pursuant to a consent from Cyclone,
the Company also transferred and assigned the license agreement to Phoenix. In consideration for the transfer and assignment,
which included net property and equipment of $4,927, unamortized license fees to Cyclone of $47,396 and a payment to Cyclone of
$15,000 to consent to the license transfer, Phoenix satisfied and provided releases for $162,500 in past liabilities of Q2P associated
with the development of the Q2P Technology, made certain other payments to the Company’s prior engine manufacturer, and
provided full releases from liability from both Phoenix and Cyclone. The Company recorded a net gain from the extinguishment of
liabilities of $95,178 in the consolidated statement of operations for the year ended December 31, 2017.
In
connection with the separation agreement with Cyclone, the Company also assumed a contract with Clean Carbon of Australia and
a corresponding $10,064 prepayment for services or other value to be provided in the future. This deposit has been presented as
deferred revenue on the March 31, 2018 and 2017 consolidated balance sheets.
NOTE
6 – RELATED PARTY TRANSACTIONS
The
Company currently maintains an executive office in Florida, which is leased by GreenBlock Capital LLC, an investment firm that
the Company’s President serves as a Managing Director but holds no equity or voting rights. The Company has no formal agreement
for this space and pays no rent. The Company also sublets office space in Atlanta, Georgia, where it pays $500 per month on a
month-to-month basis. The lessor is a company that our CEO previously served as a senior executive.
In
March 2017, all outstanding Director accounts payable, accrued expenses and notes payable – related parties with an aggregate
amount of $156,368 were converted into the Company’s Bridge Offering (see Note 7).
In
April 2017, the Company’s President forgave $112,797 of deferred salary. This amount was reclassified from accrued expenses
to additional paid in capital during 2017.
NOTE
7 – NOTES PAYABLE AND DEBENTURES
In
March 2017, the Company entered into a Modification and Extension Agreement with two holders of its Original Issue Discount Senior
Secured Convertible Debentures (the “Debentures”) to extend the maturity date to July 31, 2017, reset the conversion
price from $0.21 to $0.15, and waive any defaults under the Debentures from the expiration of the maturity date or otherwise.
The exercise price of the Warrants that were issued with the Debentures’ exercise price, which had been reset to $0.50 per
verbal agreement of the parties in the third quarter of 2016, was formally documented under this March 2017 modification agreement.
The Debentures do not bear interest, but contained an Original Issue Discount of $20,750. All assets of the Company are secured
under the Debentures, including our Subsidiary and its assets. The Debentures and warrants contain certain anti-dilutive protection
provisions in the instance that the Company issues stock at a price below the stated conversion price of the Debentures, as well
as other standard protections for the holder. As of December 31, 2017 and 2016, the aggregate outstanding principal amount of
the two Debentures was $165,000. In March 2018, the Company and holders extended the maturity date of the Debentures until July
31, 2018 in return for a reduction of the conversion price to $0.10 per share.
On
December 12, 2017, the Company paid-off in full a term loan agreement with one accredited investor in the principal amount of
$150,000, initially issued in March 2016. The loan bore 20% interest with interest payments due monthly. The Company incurred
loan issuance costs of 100,000 shares of common stock valued at $26,000, $3,000 cash and provided a second security interest in
the assets of the Company to the holders. The issuance costs were fully expensed in 2016. On March 22, 2017, prior to repayment,
the Company and the term loan holder entered into an addendum to the loan agreement which extended the maturity date to December
31, 2017, allowed for conversion of the principal amount and accrued interest at the discretion of the holder to common stock
at a price of $0.15 per share, and waived all defaults in return for payment of $30,000 which included a $15,000 late penalty
and $15,000 of accrued but unpaid interest. The Company determined that the new conversion feature had no intrinsic value and
that the amended terms did not result in a significantly different instrument, and, accordingly, accounted for the addendum as
a modification of debt. This debt was repaid in full in December 2017.
On
March 31, 2017, the Company closed the initial $1,050,000 tranche in a Convertible Promissory Note offering (the “Bridge
Offering”). In addition, as part of that initial closing, three of the Company’s directors and one shareholder converted
$168,152 of prior notes and cash advances, including interest thereon, into the Bridge Offering. As of the end of 2017, an additional
$600,000 was raised under the Bridge Offering and $23,756 of additional prior notes were converted into this round.
The
Convertible Promissory Notes (the “Notes”) from the Bridge Offering convert at a 50% discount to the post-funding
valuation of the Company at the closing of its next offering in the minimum amount of $5,000,000 (the “Equity Offering”).
The conversion valuation has a ceiling of $12,000,000, and a “floor” company value of $6,000,000 in the event there
is no Equity Offering before the Notes are able to be converted.
Pursuant
to ASC 825-10-25-1, Fair Value Option, the Company made an irrevocable election at the time of issuance to report the Notes at
fair value, with changes in fair value recorded through the Company’s consolidated statements of operations as other income
(expense) in each reporting period. The fair value recorded as of March 31, 2018 was $2,890,000 (see Note 9) and the principal
amount due was $1,841,908. The change in fair value resulted in a gain in earnings for the three months ended March 31, 2018 of
$446,875.
The
Notes are currently convertible into common stock, or preferred stock if received by investors in the Equity Offering, at the
discretion of each holder based on the conversion formula provided in the Notes. Maturity is 36 months from issuance with 15%
annual interest which will be capitalized each year into the principal of the Notes and paid in kind. There are no warrants issued
in connection with the Offering.
NOTE
8 – FAIR VALUE MEASUREMENT
The
Company measures fair value in accordance with a fair value hierarchy that prioritizes the inputs to valuation techniques used
to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets
or liabilities (Level 1 measurements) and the lowest priority to unobservable inputs (Level 3 measurements). The three levels
of the fair value hierarchy are described below:
|
Level
1
|
Unadjusted
quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities;
|
|
|
|
|
Level
2
|
Quoted
prices in markets that are not active, or inputs that are observable, either directly or indirectly, for substantially the
full term of the asset or liability; and
|
|
|
|
|
Level
3
|
Prices
or valuation techniques that require inputs that are both significant to the fair value measurement and unobservable (supported
by little or no market activity).
|
As
disclosed in Note 7, the Notes are reported at fair value, with changes in fair value recorded through the Company’s consolidated
statements of operations as other income (expense) in each reporting period.
The
following tables set forth the Company’s consolidated financial assets and liabilities measured at fair value by level within
the fair value hierarchy at March 31, 2018 and December 31, 2017. Assets and liabilities are classified in their entirety based
on the lowest level of input that is significant to the fair value measurement.
|
|
Fair
value at
|
|
|
|
|
|
|
|
|
|
|
|
|
March
31, 2018
|
|
|
Level
1
|
|
|
Level
2
|
|
|
Level
3
|
|
Convertible
bridge notes
|
|
$
|
2,890,000
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
2,890,000
|
|
Total
|
|
$
|
2,890,000
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
2,890,000
|
|
|
|
Fair value at
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31, 2017
|
|
|
Level 1
|
|
|
Level 2
|
|
|
Level 3
|
|
Convertible bridge notes
|
|
$
|
3,270,000
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
3,270,000
|
|
Total
|
|
$
|
3,270,000
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
3,270,000
|
|
There
were no transfers between levels during 2017 and through March 31, 2018. However, in accordance with ASU 2017-11, “
Earnings
Per Share (Topic 260); Distinguishing Liabilities from Equity (Topic 480);” Derivatives and Hedging (Topic 815),
the
financial instruments previously classified and fair valued as derivative liabilities due to down round features, have been retrospectively
adjusted by means of a cumulative-effect to the consolidated balance sheet as January 1, 2017. The cumulative change effect of
$388,667 was recognized as an adjustment of the opening balance of accumulated deficit for 2017.
The
following tables present a reconciliation of the beginning and ending balances of items measured at fair value on a recurring
basis that use significant unobservable inputs (Level 3) and the related realized and unrealized gains (losses) recorded in the
consolidated statement of operations during the period. The tables also show the cumulative change effect of the derivative liabilities
that were recorded as an adjustment of the opening balance of accumulated deficit for the year:
|
|
Three
Months Ended
March 31, 2018
|
|
|
|
Convertible
Bridge
Notes
|
|
Fair value, December 31, 2017
|
|
$
|
3,270,000
|
|
Accrued interest
|
|
|
68,125
|
|
Unamortized debt issuance costs
|
|
|
(1,250
|
)
|
Net unrealized
gain on convertible bridge notes
|
|
|
(446,875
|
)
|
Fair value, March 31, 2018
|
|
$
|
2,890,000
|
|
The
Company’s convertible bridge notes are valued by using Monte Carlo Simulation methods and discounted future cash flow models.
Where possible, the Company verifies the values produced by its pricing models to market prices. Valuation models require a variety
of inputs, including contractual terms, market prices, yield curves, credit spreads, measures of volatility and correlations of
such inputs. These convertible bridge notes do not trade in liquid markets, and as such, model inputs cannot generally be verified
and do involve significant management judgment. Such instruments are typically classified within Level 3 of the fair value hierarchy.
The following assumptions were used to value the Company’s convertible bridge notes at March 31, 2018: dividend yield of
-0-%, volatility of 70 – 160%, risk free rate of 2.27% and an expected term of 2.0 years.
NOTE
9 – COMMON STOCK, PREFERRED STOCK AND WARRANTS
Common
Stock
The
Company did not issue any shares of common stock in the first quarter of 2018. During 2017, the Company issued 18,738,195 shares
of common stock valued at $470,279. Details of these issuances are provided below.
On
February 27, 2017, the Company issued an aggregate of 15,000,000 shares of restricted common stock subject to forfeiture to its
CEO and President. The expense of these shares is not recorded until the terms of forfeiture have been satisfied by the respective
employees. Those terms of the stock issuances and forfeitures are materially as follows:
To
fully earn 10,000,000 shares, the Company’s CEO must continue to serve with the Company for a period of at least 12 months
from July 2017, during which 12 month or extended period: (1) the Company must complete at least $3 million in funding and (2)
complete its first strategic acquisition. To fully earn 5,000,000 shares, the Company’s President must continue to serve
the Company as a senior executive on a full-time basis for a period of at least 18 months from December 2016, during which 18
month or extended period: (1) the Company must complete at least $3 million in funding and (2) complete its first strategic acquisition.
If these conditions are not met, the executives may forfeit all of their shares at the discretion of the Board.
In
April 2017, the Company issued 1,738,195 shares of common stock valued at $260,679 as consideration for the payment of accounts
payable and accrued expenses to former employees and vendors. Additionally, the Company paid $85,623 in cash and recognized a
gain on extinguishment of liabilities of $33,313 in the consolidated statement of operations for the year ended December 31, 2017.
On
May 1, 2017, the Company issued 2,000,000 shares of common stock valued at $209,600 to a consultant for investor relations services.
Redeemable
Convertible Preferred Stock
The
Company has 600 shares of Preferred Stock issued and outstanding, which currently are convertible at $0.10 per share of the Company’s
common stock (the “Conversion Price”), as per the terms of a March 2018 Modification and Extension Agreement (the
“2018 Modification”). The Preferred Stock bears a 6% dividend per annum, calculable and payable per quarter in cash
or additional shares of common stock as determined in the Certificate of Designation. The Preferred Stock has no voting rights
until converted to common stock, and has a liquidation preference equal to the aggregate purchase price of $600,000 plus accrued
dividends. In December 2017 and January 2018, the Company was obligated to redeem all of the then outstanding Preferred Stock,
for an amount in cash equal to the Two Year Redemption Amount (such redemption, the “Two Year Redemption”). The Company
extended the redemption date to July 31, 2018, per the 2018 Modification. Each share of Preferred Stock received warrants (the
“Warrants”) equal to one-half of the Purchase Price to purchase common stock in the Company exercisable for five (5)
years following closing at a price of $0.50 per share.
The
Preferred Stock has price protection provisions in the case that the Company issues any shares of stock not pursuant to an “Exempt
Issuance” at a price below the Conversion Price. Exempt Issuances include: (i) shares of Common Stock or common stock equivalents
issued pursuant to the Merger or any funding contemplated by the Merger; (ii) any common stock or convertible securities outstanding
as of the date of closing; (iii) common stock or common stock equivalents issued in connection with strategic acquisitions; (iv)
shares of common stock or equivalents issued to employees, directors or consultants pursuant to a plan, subject to limitations
in amount and price; and (v) other similar transactions. The Certificate of Designation contains restrictive covenants not to
incur certain debt, repurchase shares of common stock, pay dividends or enter into certain transactions with affiliates without
consent of holders of 67% of the Preferred Stock. The holders consented to the Bridge Offering. The unconverted shares of Preferred
Stock must be redeemed on July 31, 2018, per the 2018 Modification.
Management
has determined that the Preferred Stock is more akin to a debt security than equity primarily because it contains a mandatory
2-year redemption at the option of the holder, which only occurs if the Preferred Stock is not converted to common stock. Therefore,
management has presented the Preferred Stock outside of permanent equity as mezzanine equity, which does not factor in to the
totals of either liabilities or equity. In 2016, the proceeds were allocated between the three features of the stock offering:
the embedded conversion feature in the Preferred Stock, the warrants, and the Preferred Stock itself. The fair values of the embedded
conversion feature and warrants were recorded as a discount against the stated value of the Preferred Stock on the date of issuance.
This discount was amortized to interest expense over the term of the redemption period (2 years), which would result in the accretion
of the Preferred Stock to its full redemption value. Unamortized discount as of March 31, 2018 and December 31, 2017 was $0 and
$1,062, respectively. Interest expense related to the preferred stock discount for the three months ended March 31, 2018, and
2017 was $1,062 and $34,661, respectively.
In
accordance with ASU 2017-11, the embedded conversion feature of the Preferred Stock previously classified and fair valued as a
derivative liability has been retrospectively adjusted by means of a cumulative-effect to the consolidated balance sheet as January
1, 2017. The cumulative change effect of $42,925 is recognized as an adjustment of the opening balance of accumulated deficit
for the year. The agreement setting forth the terms of the common stock warrants issued to the holders of the Preferred Stock
also includes an anti-dilution provision that requires a reduction in the warrant’s exercise price, currently $0.50, should
the conversion ratio of the Preferred Stock be adjusted due to anti-dilution provisions. In accordance with ASU 2017-11, these
warrants previously classified and fair valued as a derivative liability have been retrospectively adjusted by means of a cumulative-effect
to the consolidated balance sheet as January 1, 2017. The cumulative change effect of $69,957 is recognized as an adjustment of
the opening balance of accumulated deficit for the year.
The
Preferred Stock also carries a 6% per annum dividend calculated on the stated value of the stock and is cumulative and payable
quarterly beginning July 1, 2016. These dividends are accrued at each reporting period. They add to the redemption value of the
stock; however, as the Company shows an accumulated deficit, the charge has been recognized in additional paid-in capital.
Warrants
The
following is a summary of all outstanding common stock warrants as of March 31, 2018:
|
|
Number
of
Warrants
|
|
|
Exercise
price
per share
|
|
|
Average
remaining
term in years
|
|
Warrants issued in connection
with issuance of Debentures
|
|
|
415,000
|
|
|
$
|
0.50
|
|
|
|
1.50
|
|
Warrants issued in connection with issuance
of Preferred Stock
|
|
|
1,153,845
|
|
|
$
|
0.50
|
|
|
|
2.80
|
|
Warrants issued in connection with a
services contract
|
|
|
1,000,000
|
|
|
$
|
0.20
|
|
|
|
2.23
|
|
Warrants issued in connection with a
services contract
|
|
|
1,000,000
|
|
|
$
|
0.35
|
|
|
|
2.23
|
|
Warrants issued in connection with a
services contract
|
|
|
150,000
|
|
|
$
|
0.04
|
|
|
|
4.75
|
|
NOTE
10 – STOCK OPTIONS AND RESTRICTED STOCK UNITS
On
July 31, 2014, the Board of Directors of Q2P approved the Founders Stock Option Plan (“Founders Plan”) and the 2014
Employee Stock Option Plan (the “2014 Plan”), collectively the “Option Plans”. The Option Plans were developed
to provide a means whereby directors and selected employees, officers, consultants, and advisors of the Company may be granted
incentive or non-qualified stock options to purchase restricted common stock of the Company. On February 25, 2016, to accommodate
the appointment of new Board members and additional incentive stock options and stock grants to key employees of the Company,
the Board approved the 2016 Omnibus Equity Incentive Plan (“2016 Plan”), which allowed for an additional 4 million
shares of common stock, stock options, stock rights (restricted stock units), or stock appreciation rights to be granted by the
Board in its discretion.
In
May 2017, the Company issued 400,000 common stock options under the 2016 Plan to one new Board member and 400,000 common stock
options under the 2016 Plan to one new Board of Advisor Member. The options vest one-half immediately and the balance in 6 months,
with a 10-year term and exercisable at $0.21 per share. The options were valued at $96,800 (pursuant to the Black Scholes valuation
model, and as shown in the table detailing the calculation of fair value below), based on an exercise price of $0.21 per share
and with a maturity life of 5.25 years.
For
the three months ended March 31, 2018, the charge to the consolidated statements of operations for the amortization of stock option
grants awarded under the Option Plans and 2016 Plan and for warrants was $34,579.
A
summary of the common stock options issued under the Option Plans and the 2016 Plan for the period from December 31, 2017
through March 31, 2018 follows:
|
|
Number
Outstanding
|
|
|
Weighted
Avg. Exercise Price
|
|
|
Weighted
Avg. Remaining Contractual Life (Years)
|
|
Balance,
December 31, 2017
|
|
|
6,915,480
|
|
|
$
|
0.21
|
|
|
|
5.6
|
|
Options issued
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
Options exercised
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
Options cancelled
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
Balance, March
31, 2018
|
|
|
6,915,480
|
|
|
$
|
0.21
|
|
|
|
5.3
|
|
The
vested and exercisable options at period end follows:
|
|
Exercisable/
Vested
Options Outstanding
|
|
|
Weighted
Avg.
Exercise Price
|
|
|
Weighted
Avg.
Remaining Contractual
Life (Years)
|
|
Balance,
March 31, 2018
|
|
|
6,828,813
|
|
|
$
|
0.21
|
|
|
|
5.6
|
|
The
fair value of new stock options and warrants granted using the Black-Scholes option pricing model was calculated using the following
assumptions:
|
|
Three
Months
March 31, 2018
|
|
Risk free interest
rate
|
|
|
2.33
|
%
|
Expected volatility
|
|
|
128
|
%
|
Expected
dividend yield
|
|
|
0
|
%
|
Expected term
in years
|
|
|
3.0
|
|
Average value
per options
|
|
$
|
0.066
|
|
Expected
volatility is based on historical volatility of the Company’s own common stock. Short Term U.S. Treasury rates were utilized
as the risk free interest rate. The expected term of the options was calculated using the alternative simplified method codified
as ASC 718 “
Accounting for Stock Based Compensation,
” which defined the expected life as the average of the
contractual term of the options and the weighted average vesting period for all issuances.
NOTE
11 – COMMITMENTS AND CONTINGENCIES
On
April 1, 2017, the Company entered into two Employment Agreements, the first with its Chairman and, as of July 2017, CEO; and
the second with its previous CEO and, as of July 2017, President and General Counsel. The Chairman receives a $12,500 per month
fee starting April 1 and continuing until the Company raises its next round of funding in the minimum amount of $5,000,000, at
which time, his base salary will be increased to $350,000 per year. The President and General Counsel receives a $10,000 per month
fee starting on April 1, and at such time that the Company raises its next round of funding in the minimum amount of $5,000,000,
he will receive a base salary of $220,000 per year. Both agreements have provisions for a 12-month severance in the instance either
executive is terminated without cause or after a change in control; however, the CEO’s severance was extended to 24 months
in the first quarter of 2018 by resolution of the Company’s Compensation Committee.
NOTE
12 - SUBSEQUENT EVENTS
In
May 2018, the Board authorized and the Company commenced a follow-on round to its 2017 Bridge Offering (the “Bridge Follow-On”)
in an amount of up to $300,000. The terms of this Bridge Follow-On round are identical to the 2017 Bridge Offering except the
notes will have a two-year term (instead of three). As of May 15, 2018, the Company raised $40,000 from two
Directors and one Board observer. Funds from this offering will be used for general working capital.