THE ACCOMPANYING NOTES ARE AN INTEGRAL PART
OF THESE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS.
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART
OF THESE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS.
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART
OF THESE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS
SIX MONTHS ENDED NOVEMBER 30, 2016 and 2015
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1.
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DESCRIPTION
OF BUSINESS
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Arkados Group, Inc. (the “Parent”) conducts business
activities principally through its two wholly-owned subsidiaries, Arkados, Inc. (“Arkados”) and Arkados Energy Solutions,
LLC (“AES”) (collectively, the “Company”).
The Company underwent a significant restructuring following December
23, 2010, during which substantially all of its assets were acquired by STMicroelectronics (sometimes referred to hereinafter
as the “Asset Sale”). Settlements reached in connection with the Asset Sale and the fulfillment of obligations in
connection therewith, have been substantially completed.
Following the Asset Sale, the Company shifted its focus towards
the following businesses:
Arkados - Software and hardware design and development of solutions
that enable machine to machine communications for the Internet of Things (“IoT”). Arkados’ solutions are primarily
focused on industrial and commercial applications such as building automation, energy management and predictive maintenance and
are uniquely designed to drive a wide variety of full-featured, cutting edge solutions.
AES - Energy conservation services for commercial and industrial
facilities owners and managers. AES’ services include implementing energy conservation measures such as LED lighting retrofits,
oil to natural gas boiler conversions, co-generation system installation and solar PV system installations. In addition, AES sells
technology solutions designed by Arkados, Inc. and others that serve to improve the effectiveness of the measures and increases
return on investment for the customer.
Effective March 18, 2015, the Company implemented a reverse stock
split of its outstanding common stock at a ratio of 1-for-30 shares. All share figures and results are reflected on a post-split
basis.
The accompanying condensed consolidated financial statements as
of November 30, 2016 (unaudited) and May 31, 2016 and for the three and six months ended November 30, 2016 and 2015 (unaudited)
have been prepared by the Company pursuant to the rules and regulations of the Securities and Exchange Commission including Form
10-Q and Regulation S-X. The information furnished herein reflects all adjustments (consisting of normal recurring accruals and
adjustments) which are, in the opinion of management, necessary to fairly present the operating results for the respective periods.
Certain information and footnote disclosures normally present in annual financial statements prepared in accordance with accounting
principles generally accepted in the United States of America have been omitted pursuant to such rules and regulations. These
financial statements and the information included under the heading “Management’s Discussion and Analysis of Financial
Condition and Results of Operations” should be read in conjunction with the audited financial statements and explanatory
notes for the year ended May 31, 2016 as disclosed in our annual report on Form 10-K for that year. The results of the three and
six months ended November 30, 2016 (unaudited) are not necessarily indicative of the results to be expected for the pending full
year ending May 31, 2017.
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2.
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SUMMARY
OF SIGNIFICANT ACCOUNTING POLICIES
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a.
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Basis
of Presentation - The accompanying condensed consolidated financial statements have been
prepared assuming that the Company will continue as a going concern. The Company has
incurred net losses of approximately $44 million since inception, including a net loss
of $796,125 for the six months ended November 30, 2016. Additionally, the
Company still had both working capital and stockholders’ deficiencies at November
30, 2016 and May 31, 2016 and negative cash flow from operations since inception. These
conditions raise substantial doubt about the Company’s ability to continue as a
going concern. Management expects to incur additional losses in the foreseeable future
and recognizes the need to raise capital to remain viable. The accompanying unaudited condensed consolidated
financial statements do not include any adjustments that might be necessary should the
Company be unable to continue as a going concern.
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The Company’s plan, through
potential acquisitions and the continued promotion of its services to existing and potential
customers, is to generate sufficient revenues to cover our anticipated expenses. The Company is currently exploring several
options to meet its short-term cash requirements, including an equity raise or loan funding from third parties. Although no
assurances can be given as to the Company’s ability to deliver on its revenue plans, or that unforeseen expenses may
arise, the management of the Company believes that the revenue to be generated from operations together with potential bridge
note funding, additional issuances of equity or other potential financing will provide the necessary funding for the Company
to continue as a going concern.
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b.
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Principles of Consolidation - The consolidated financial statements
include the accounts of the Parent, and its wholly-owned subsidiaries, which include AES and Arkados. Intercompany accounts
and transactions have been eliminated in consolidation.
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Arkados
The Company enters into arrangements with end users for
items which may include software license fees, services, maintenance and royalties or various combinations thereof. For each
arrangement, revenues will be recognized when evidence of an agreement has been documented, the fees are fixed or determinable,
collection of fees is probable, delivery of the product has occurred and no other significant obligations remain.
Revenues from software licensing are recognized in accordance
with Accounting Standards Codification (“ASC”) 985-605, “Software Revenue Recognition.” Accordingly, revenue
from software licensing is recognized when all of the following criteria are met: persuasive evidence of an arrangement exists,
delivery has occurred, the fee is fixed or determinable, and collectability is probable.
License revenues are recognized at the time of delivery
of the software and all other revenue recognition criteria discussed above have been met. Deferred revenue represents license
revenues billed but not yet earned. Sales of products are recognized when the products are shipped and the customer takes risk
of ownership and assumes the risk of loss. Royalty income is recognized as it is earned and recorded when reported by the customer.
AES
Sales of products are recognized when the products are
shipped and the customer takes risk of ownership and assumes the risk of loss. Service revenue is recognized when the service
is completed. Deferred revenue represents revenues billed but not yet earned.
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d.
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Cash and Cash Equivalents - The Company considers investments in
highly liquid instruments with a maturity of three months or less to be cash equivalents. The Company did not have any cash
equivalents at both November 30, 2016 and May 31, 2016.
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e.
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Accounts Receivable - Accounts receivable are reported at their
outstanding unpaid principal balances net of allowances for uncollectible accounts. The Company provides for allowances for
uncollectible receivables based on management’s estimate of uncollectible amounts considering age, collection history,
and any other factors considered appropriate. The Company writes off accounts receivable against the allowance for doubtful
accounts when a balance is determined to be uncollectible. At November 30, 2016 and May 31, 2016, the Company determined
that an allowance for doubtful accounts was not needed.
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f.
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Fair Value of Financial Instruments - The carrying value of cash,
accounts receivable, other receivables, accounts payable and accrued expenses approximate their fair values based on the short-term
maturity of these instruments. The carrying amounts of debt were also estimated to approximate fair value. As defined in ASC
820, "Fair Value Measurements and Disclosures," fair value is the price that would be received to sell an asset
or paid to transfer a liability in an orderly transaction between market participants at the measurement date (exit price).
The Company utilizes market data or assumptions that market participants would use in pricing the asset or liability, including
assumptions about risk and the risks inherent in the inputs to the valuation technique. These inputs can be readily observable,
market corroborated, or generally unobservable. ASC 820 establishes a fair value hierarchy that prioritizes the inputs used
to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical
assets or liabilities (level 1 measurement) and the lowest priority to unobservable inputs (level 3 measurement). This fair
value measurement framework applies at both initial and subsequent measurement.
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The three levels of the fair value hierarchy defined by ASC 820
are as follows:
Level 1 – Quoted prices are available in active markets for
identical assets or liabilities as of the reporting date. Active markets are those in which transactions for the asset or liability
occur in sufficient frequency and volume to provide pricing information on an ongoing basis. Level 1 primarily consists of financial
instruments such as exchange-traded derivatives, marketable securities and listed equities.
Level 2 – Pricing inputs are other than quoted prices in
active markets included in Level 1, which are either directly or indirectly observable as of the reported date. Level 2 includes
those financial instruments that are valued using models or other valuation methodologies. These models are primarily industry-standard
models that consider various assumptions, including quoted forward prices for commodities, time value, volatility factors and
current market and contractual prices for the underlying instruments, as well as other relevant economic measures. Substantially
all of these assumptions are observable in the marketplace throughout the full term of the instrument, can be derived from observable
data or are supported by observable levels at which transactions are executed in the marketplace. Instruments in this category
generally include non-exchange-traded derivatives such as commodity swaps, interest rate swaps, options and collars.
Level 3 – Pricing inputs include significant inputs that
are generally less observable from objective sources. These inputs may be used with internally developed methodologies that result
in management’s best estimate of fair value.
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g.
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Earnings (Loss) Per Share (“EPS”) - Basic EPS is computed
by dividing net income (loss) by the weighted average number of shares of common stock outstanding. Diluted EPS includes the
effect from potential issuance of common stock, such as stock issuable pursuant to the exercise of stock options and warrants
and the assumed conversion of convertible notes.
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The following table summarizes the securities that were
excluded from the diluted per share calculation because the effect of including these potential shares was antidilutive even though
the exercise price could be less than the average market price of the common shares.
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Three and six months ended
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November 30,
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2016
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2015
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Convertible notes
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265,401
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117,078
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Stock options
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5,112,500
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3,012,500
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Warrants
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5,078,153
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5,059,320
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Potentially dilutive securities
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10,456,054
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8,188,898
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h.
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Stock Based Compensation - In computing the impact, the fair value
of each option and/or warrant is estimated on the date of grant based on the Black-Scholes options-pricing model utilizing
certain assumptions for a risk-free interest rate; volatility; and expected remaining lives of the awards. The assumptions
used in calculating the fair value of share-based payment awards represent management’s best estimates, but these estimates
involve inherent uncertainties and the application of management judgment. As a result, if factors change and the Company
uses different assumptions, the Company’s stock-based compensation expense could be materially different in the future.
In addition, the Company is required to estimate the expected forfeiture rate and only recognize expense for those shares
expected to vest. In estimating the Company’s forfeiture rate, the Company analyzed its historical forfeiture rate,
the remaining lives of unvested options, and the amount of vested options as a percentage of total options outstanding. If
the Company’s actual forfeiture rate is materially different from its estimate, or if the Company reevaluates the forfeiture
rate in the future, the stock-based compensation expense could be significantly different from what we have recorded in the
current period. During the three and six months ended November 30, 2016, 400,000 shares of the Company’s common stock
were issued for consulting services amounting to $268,000 in stock based compensation. There were no additional issuances
of warrants or options during the three and six months ended November 30, 2016.
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Stock based compensation expense was $451,521 for the three months ended November 30, 2015
and $451,521 for the six months ended November 30, 2015.
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i.
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Use
of Estimates - The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that affect
the reported amounts of assets, liabilities, equity based transactions and disclosure
of contingent liabilities at the date of the financial statements and revenues and expenses
during the reporting period. Actual results could differ from those estimates.
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We believe the following critical accounting policies affect our more significant judgments and estimates used in the preparation
of the financial statements. Significant estimates include the allowance for doubtful accounts, the useful life of plant and
equipment and intangible assets, deferred tax asset and valuation allowance, and assumptions used in Black-Scholes-Merton,
or BSM, valuation methods, such as expected volatility, risk-free interest rate, and expected dividend rate.
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j.
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Inventory
- Inventory, which consists of finished goods and work-in-process (“WIP”)
of AES, is valued at the lower of cost on a first-in, first-out basis or market.
Inventory consists of the following at November 30, 2016 and May 31, 2016.
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November 30,
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May 31,
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2016
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2016
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(unaudited)
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Finished goods
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$
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60,012
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$
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60,012
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Work-in-process (unbilled labor and consulting)
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21,024
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60,398
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$
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81,036
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$
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120,410
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k.
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Property
and Equipment – Property and equipment is recorded at cost. Depreciation
is computed using straight-line and accelerated methods over the estimated useful lives
of the related assets. Expenditures that enhance the useful lives of the assets
are capitalized and depreciated. Maintenance and repairs are expensed as incurred. When
properties are retired or otherwise disposed of, related costs and related accumulated
depreciation are removed from the accounts.
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l.
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Research and Development –All research and development costs
are expensed as incurred.
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m.
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Foreign Currency Transactions – The Company accounts for foreign
currency translation pursuant to ASC 830. The functional currency of the Company is the United States dollar. Under ASC 830,
all assets and liabilities denominated in foreign currencies are translated into United States dollars using the current exchange
rate at the end of each fiscal period. Revenues and expenses are translated using the average exchange rates prevailing throughout
the respective periods. All transaction gains and losses from the measurement of monetary balance sheet items denominated
in foreign currencies are reflected in the statement of operations as gain (loss) on foreign currency transactions.
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n.
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Deferred Financing
Costs-
Costs
incurred in connection with obtaining financing are deferred and amortized on a straight-line
basis over the term of the related loan.
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o.
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Convertible
Instruments-
The Company evaluates
and accounts for conversion options embedded in its convertible instruments in accordance with accounting standards for “Accounting
for Derivative Instruments and Hedging Activities.”
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Accounting
standards generally provides three criteria that, if met, require companies to bifurcate conversion options from their host instruments
and account for them as free standing derivative financial instruments. These three criteria include circumstances in which (a) the
economic characteristics and risks of the embedded derivative instrument are not clearly and closely related to the economic characteristics
and risks of the host contract, (b) the hybrid instrument that embodies both the embedded derivative instrument and the host
contract is not re-measured at fair value under otherwise applicable generally accepted accounting principles with changes in
fair value reported in earnings as they occur, and (c) a separate instrument with the same terms as the embedded derivative
instrument would be considered a derivative instrument. Professional standards also provide an exception to this rule
when the host instrument is deemed to be conventional as defined under professional standards as “The Meaning of Conventional
Convertible Debt Instrument.”
The Company accounts
for convertible instruments (when it has determined that the embedded conversion options should not be bifurcated from their host
instruments) in accordance with professional standards when “Accounting for Convertible Securities with Beneficial Conversion
Features,” as those professional standards pertain to “Certain Convertible Instruments.” Accordingly, the Company
records, when necessary, discounts to convertible notes for the intrinsic value of conversion options embedded in debt instruments
based upon the differences between the fair value of the underlying common stock at the commitment date of the note transaction
and the effective conversion price embedded in the note. Original issue discounts (“OID”) under these arrangements
are amortized over the term of the related debt to their earliest date of redemption. The Company also records when necessary deemed
dividends for the intrinsic value of conversion options embedded in preferred shares based upon the differences between the fair
value of the underlying common stock at the commitment date of the note transaction and the effective conversion price embedded
in the note.
ASC 815-40 provides
that, among other things, generally, if an event is not within the entity’s control could or require net cash settlement,
then the contract shall be classified as an asset or a liability.
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p.
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Reclassifications - Certain reclassifications have been made to conform the prior period data
to the current presentations. The Company has reclassified a $40,000 note payable to Convertible debt. This reclassification
had no impact on reported results of operations.
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q.
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Recent Accounting
Pronouncements
-
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In January 2017, the Financial Accounting Standards
Board (“FASB”) issued an Accounting Standards Update (“ASU”) 2017-01, “Business Combinations (Topic
805) Clarifying the Definition of a Business”. The amendments in this Update is to clarify the definition of a business
with the objective of adding guidance to assist entities with evaluating whether transactions should be accounted for as acquisitions
(or disposals) of assets or businesses. The definition of a business affects many areas of accounting including acquisitions,
disposals, goodwill, and consolidation. The guidance is effective for annual periods beginning after December 15, 2017, including
interim periods within those periods. The Company is currently evaluating the impact of adopting this guidance.
In November 2016, the FASB issued ASU
2016-18, “Statement of Cash Flows (Topic 230) Restricted Cash”. The new guidance requires that the reconciliation of
the beginning-of-period and end-of-period amounts shown in the statement of cash flows include restricted cash and restricted cash
equivalents. If restricted cash is presented separately from cash and cash equivalents on the balance sheet, companies will be
required to reconcile the amounts presented on the statement of cash flows to the amounts on the balance sheet. Companies will
also need to disclose information about the nature of the restrictions. The guidance is effective for fiscal years beginning after
December 15, 2017, and interim periods within those fiscal years. The Company is currently evaluating the impact of adopting this
guidance.
In August 2016,
the FASB issued ASU 2016-15, “Statement of Cash Flows (Topic 230) Classification of Certain Cash Receipts and Cash Payments”.
The new guidance is intended to reduce diversity in practice in how certain transactions are classified in the statement of cash
flows. ASU 2016-15 is effective for the Company beginning in the first quarter of fiscal 2019. Early adoption is permitted, provided
that all of the amendments are adopted in the same period. The guidance requires application using a retrospective transition
method. The Company is currently evaluating the impact of adopting this guidance.
In April 2016, the
FASB issued ASU 2016 – 10 “Revenue from Contract with Customers: identifying Performance Obligations and Licensing”.
The amendments in this Update clarify the two following aspects (a) contracts with customers to transfer goods and services in
exchange for consideration and (b) determining whether an entity’s promise to grant a license provides a customer with either
a right to use the entity’s intellectual property (which is satisfied at a point in time) or a right to access the entity’s
intellectual property (which is satisfied over time). The amendments in this Update are intended to reduce the degree of judgement
necessary to comply with Topic 606. This guidance has no effective date as yet. The Company is currently evaluating the impact
of adopting this guidance.
In March 2016, the FASB issued authoritative
guidance regarding the accounting for share-based payment transactions, including income tax consequences, classification of awards
as either equity or liabilities, and classification on the statement of cash flows. The guidance is to be applied for annual periods
beginning after December 15, 2016 and interim periods within those annual periods, and early adoption is permitted. The guidance
requires companies to apply the requirements retrospectively, modified retrospectively, or prospectively depending on the amendment(s)
applied. The Company is currently evaluating the impact of adopting this guidance.
In February 2016, the FASB issued ASU
2016-02, “Leases” (Topic 842). This guidance will be effective for public entities for fiscal years beginning
after December 15, 2018 including the interim periods within those fiscal years. Early application is permitted. Under the
new provisions, all lessees will report a right-of-use asset and a liability for the obligation to make payments for all leases
with the exception of those leases with a term of 12 months or less. All other leases will fall into one of two categories:
(i) Financing leases, similar to capital leases, which will require the recognition of an asset and liability, measured at the
present value of the lease payments and (ii) Operating leases which will require the recognition of an asset and liability measured
at the present value of the lease payments. Lessor accounting remains substantially unchanged with the exception that no leases
entered into after the effective date will be classified as leveraged leases. For sale leaseback transactions, the sale will only
be recognized if the criteria in the new revenue recognition standard are met. The Company is currently evaluating the impact of
adopting this guidance.
In January 2016, the FASB issued ASU
2016-01, which amends the guidance relating to the classification and measurement of financial instruments. Changes to the current
guidance primarily affect the accounting for equity investments, financial liabilities under the fair value option, and the presentation
and disclosure requirements for financial instruments. In addition, the ASU clarifies guidance related to the valuation allowance
assessment when recognizing deferred tax assets resulting from unrealized losses on available-for-sale debt securities. The new
standard is effective for fiscal years and interim periods beginning after December 15, 2017, and upon adoption, an entity should
apply the amendments by means of a cumulative-effect adjustment to the balance sheet at the beginning of the first reporting period
in which the guidance is effective. Early adoption is not permitted except for the provision to record fair value changes for financial
liabilities under the fair value option resulting from instrument-specific credit risk in other comprehensive income. The Company
is currently evaluating the impact of adopting this guidance.
In August 2015, the FASB issued ASU 2015-14, “Revenue From
Contracts With Customers (Topic 606)”. The amendments in this ASU defer the effective date of ASU 2014-09 “Revenue
From Contracts With Customers (Topic 606)”. Public business entities should apply the guidance in ASU 2014-09 to annual reporting
periods beginning after December 15, 2017, including interim reporting periods within that reporting period. Earlier application
is permitted only as of annual reporting periods beginning after December 15, 2016, including interim reporting periods within
that reporting period. The Company is still evaluating the impact of adopting this guidance.
All newly issued but not yet effective accounting pronouncements
have been deemed to be not applicable or immaterial to the Company.
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3.
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ASSET
SALE AND DEBT SUBJECT TO EQUITY BEING ISSUED
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In December 2010, the Company entered into an agreement to sell
substantially all of the assets (the “Asset Sale”) to STMicroelectronics, Inc. (“ST US”), a subsidiary
of STMicroelectronics N.V. (“ST”). The Asset Sale was predicated on the Company settling its secured debt and a significant
part of its unsecured debt and closed in June, 2011. The Company is negotiating with its remaining unsecured debt holders to compromise,
extend the due date or convert outstanding debt into equity. Debt holders who have agreed to settle through receipt of the Company’s
equity are labeled as “Debt Subject to Equity Being Issued” on the balance sheet. Except as set forth above, there
is no binding commitment on anyone’s part to complete the transactions.
Debt Subject to Equity Being Issued
As a direct result of the Sale of the License and IP Agreements
to ST US and the mandate to obtain debt releases, the Company has been able to reach settlements with its secured creditors and
employees, with cash payments to the secured creditors made as of the December 2010 and June 2011 closings. Nothing further is
owed to the Company’s secured creditors. There remains, however, approximately $179,000 of payments due the former employees
as of November 30, 2016 and May 31, 2016.
As of November 30, 2016 and May 31, 2016, there remained $456,930
of debts that have been settled with debt holders who have agreed to accept equity for their remaining debt.
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4.
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ACCOUNTS
PAYABLE AND ACCRUED EXPENSES
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As of November 30, 2016 and May 31, 2016, accounts payable and
accrued expenses consist of the following amounts:
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November 30,
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May 31,
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2016
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2016
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(Unaudited)
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Accounts payable
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$
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814,018
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$
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782,654
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Accrued interest payable
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136,758
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|
|
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116,035
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Accrued payroll
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11,612
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|
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28,320
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Accrued other
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97,939
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|
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95,373
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|
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$
|
1,060,327
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$
|
1,022,382
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Notes Payable
Notes payable transactions include the following:
FY 2016 (Year Ended May 31, 2016) Transactions:
In January 2016, the Company executed a promissory note for
a loan in the principal amount of $60,000. The promissory note bears interest at 6% per year, compounded quarterly, and
matures on January 15, 2017. The proceeds from this promissory note were used to partially repay two convertible notes as
discussed below. In January 2017, the Company and holder amended this promissory note to extend the maturity date to March
31, 2017.
On January 8, 2016, the Company entered into an Exchange
Agreement with the noteholders of the certain 6% convertible notes (“Convertible Notes”) that were in default. On
January 15, 2016, the Company applied the proceeds of the new promissory note together with the issuance of 50,000 shares of
the Company’s common stock, to the payment of two outstanding Convertible Notes that were in default having the
aggregate outstanding principal amount of $130,000. In exchange for the payment and the shares, the holders of the
outstanding Convertible Notes surrendered their notes, and the Company issued a new 6% Convertible Note to them in the
original principal amount of $40,000 (“Reissued Note”). The Reissued Note bears interest at the rate of 6%
per year, compounded quarterly, and matured on December 31, 2016. In January 2017, the Company agreed to extend the maturity
date of the Reissued Note to March 31, 2017. At any time during the term of the Reissued Note, the holders have the
right to convert any unpaid portion of the Reissued Note and accrued interest into shares of common stock at an original
conversion price of $1.20 per share. The Company has evaluated the conversion terms and determined that a beneficial
conversion feature is not applicable for this exchange transaction. The holders further agreed that their extension of the
maturity of the outstanding Convertible Notes had been effective from October 31, 2015 until January 15, 2016.
On March 31, 2016 and May 6, 2016, the Company executed promissory
notes for loans, each in the amount of $10,000. The promissory notes bear interest at 6% per year, compounded quarterly. Both
notes matured on June 30, 2016. The proceeds from the promissory notes were used to
partially repay two Convertible Notes as discussed above. In January 2017, the Company executed an amendment to the promissory notes to extend the maturity date to March 31, 2017.
The holders further agreed that their extension of the maturity of the outstanding promissory notes had been effective from
June 30, 2016 until January 15, 2017.
FY 2017 (Year Ended May 31, 2017):
In August 2016 the Company issued a promissory note in
the amount of $150,000 with a maturity date in January 2017. The loan bears interest at 10% per annum compounded quarterly.
In January 2017, the Company and holder amended this promissory note to extend the maturity date to
March 31, 2017.
On October 28, 2016 the Company issued a convertible promissory
note for an aggregate principal amount of $38,500 (which includes an Original Issue Discount (“OID”) of $3,500) with
a maturity date of January 30, 2017. The debenture is convertible only upon default after January 30, 2017 at a conversion price
of 65% of the average of the three lowest traded prices occurring during the 25 consecutive trading days immediately preceding
the applicable conversion date. As additional consideration, the Company issued 20,000 shares of common stock upon execution of
this agreement. Accordingly the Company recorded debt discount of $11,793 related to the restricted shares issued, and an original
issue discount of $3,500. The debt discount and OID is amortized on a straight line basis over the term of the loan and amounted
to $5,369 as of November 30, 2016. Net discount and net loan balance amounted to $9,924 and $28,576 respectively, as of November
30, 2016 and is recorded in convertible debentures.
Long term convertible debenture:
On November 11, 2016 the Company entered into a Securities Purchase
Agreement whereas, the buyer wishes to purchase from the Company securities consisting of the Company’s Convertible Debentures
due three years from issuance for an aggregate principal amount of up to $500,000 (which includes an aggregate purchase price of
$450,000 and 10% Original Issue Discount (“OID”) of $50,000). The Debentures are to be issued in three tranches. On
November 11, 2016 the Company issued the first of three debentures amounting to$150,000 of principal, consisting of $135,000 in
proceeds and $15,000 OID. The debenture is convertible at a conversion price of $0.65 up to 150 days after the issuance date and
if no event of default. If an Event of Default has occurred, or 150 days after the Issuance Date, the conversion price is the lesser
of (a) $0.65 or (b) Sixty Five percent (65%) of the lowest closing bid price of the Common Stock for the twenty (20) Trading Days
immediately preceding the date of the date of conversion of the debentures. Accounting for derivatives will be evaluated after 150 days of issuance or upon default, if applicable where at that point
the conversion price becomes variable. As additional consideration, the Company issued 50,000
shares of common stock upon execution of this agreement. In relation to this transaction the Company also incurred deferred financed
costs totaling $6,000 for legal fees and commitment fees. Accordingly the Company recorded debt discount of $38,337 related to
the restricted shares issued, a debt discount of $74,530 related to the beneficial conversion feature, an original issue discount
of $15,000 and deferred finance cost of $6,000. As of November 30, 2016, total straight line amortization for these transactions
amounted to $2,323 which resulted in a net discount of $131,544 and a net loan balance of $18,456 classified as long term debt.
|
6.
|
STOCKHOLDERS’
DEFICIENCY
|
FY 2016 (Year Ended May 31, 2016):
|
a.
|
On
June 25, 2015, the Company issued 108,333 shares of common stock to its chairman/chief
executive officer and 35,000 shares of common stock to an officer/former director for
services rendered to the Company’s board of directors in fiscal 2015. The
shares were valued at $1.75 per share. The value of the shares totaling $250,833
was charged as stock compensation in fiscal 2015.
|
|
b.
|
For the period June 1, 2015 through May 31, 2016, 838,334 shares
of common stock have been subscribed for under the PPO and the Company received proceeds of $503,000. These shares were issued
in July and August 2015.
|
|
c.
|
On January 8, 2016 the Company issued 50,000 shares as part of a
debt conversion and refinance whereby $130,000 of note principle and accrued interest of $11,332 were extinguished and a new
note of $100,000 was issued.
|
|
d.
|
On February 23, 2016, we entered into a consulting agreement with.
LPF Communications under which LPF Communications is to provide certain investor relations services for a period of up to
six months. We have agreed to pay for the services by issuing two tranches of 150,000 shares of our Common Stock each, with
the second tranche becoming issuable only if we do not terminate the consulting agreement on or prior to June 8, 2016. Pursuant
to the agreement, we issued the first tranche of 150,000 shares to the consultant on April 8, 2016.
|
|
e.
|
On April 22, 2016, the Company issued 675,000 shares of common stock
to its key employees, including 500,000 shares to its chairman/chief executive officer, for services rendered to the Company
in fiscal 2016. The shares were valued at $0.51 per share. The value of the shares totaling $344,250
was charged as stock compensation in fiscal 2016.
|
|
f.
|
On April 28, 2016, the Company entered into an asset purchase agreement
pursuant to which the Company purchased intangible assets valued at $249,113 in exchange for 166,667 shares of the Company's
common stock and a warrant to purchase 166,667 shares of the Company's common stock at $2.00 per share. As a result of management's
evaluation, the intangible asset was deemed impaired and thus fully written off to selling, general and administrative expense
of the income statement.
|
FY 2017 (Year Ended May 31, 2017):
|
a.
|
On October 13, 2016, the Company issued 400,000 shares of
its common stock for consulting services to two consulting firms. The shares were valued
at $0.67 at the time resulting in $268,000 in stock based compensation.
|
|
b.
|
On October 28, 2016, the Company issued 20,000 shares of its common stock as part of a promissory note entered
into with an investor (see Note 5).
|
|
c.
|
On November 11, 2016, the Company issued 50,000 shares of its common stock as part of a promissory note entered
into with an investor (see Note 5).
|
|
7.
|
STOCK-BASED COMPENSATION
|
The Company accounted for its stock based compensation in accordance
with the fair value recognition provisions of FASB ASC Topic 718, “Compensation – Stock Compensation”.
A. Options
The Company issued options to purchase an aggregate of 4,100,000
shares of the Company’s common stock in the year ended May 31, 2016, 2,100,000 of which were granted outside of the 2004
Stock Option and Restricted Stock Plan (the “2004 Plan”). There were no options granted during the three or six months
ended November 30, 2016.
Compensation based stock option activity for qualified and unqualified
stock options are summarized as follows:
|
|
|
|
|
Weighted
|
|
|
|
|
|
|
Average
|
|
|
|
Shares
|
|
|
Exercise Price
|
|
Outstanding at May 31, 2015
|
|
|
1,012,500
|
|
|
$
|
1.20
|
|
Granted
|
|
|
4,100,000
|
|
|
|
0.94
|
|
Exercised
|
|
|
-
|
|
|
|
-
|
|
Expired or cancelled
|
|
|
-
|
|
|
|
-
|
|
Outstanding at May 31, 2016
|
|
|
5,112,500
|
|
|
$
|
0.99
|
|
Granted
|
|
|
-
|
|
|
|
-
|
|
Exercised
|
|
|
-
|
|
|
|
-
|
|
Expired or cancelled
|
|
|
-
|
|
|
|
-
|
|
Outstanding at November 30, 2016
|
|
|
5,112,500
|
|
|
$
|
0.99
|
|
The compensation expense attributed to the issuance of the options
will be recognized as they vested/earned. These stock options are exercisable for three to ten years from the grant date.
The employee stock option plan stock options are exercisable for
ten years from the grant date and vest over various terms from the grant date to three years.
B. Warrants
The issuance of warrants to purchase shares of the Company's common
stock including those attributed to debt issuances are summarized as follows:
|
|
|
|
|
Weighted
|
|
|
|
|
|
|
Average
|
|
|
|
Shares
|
|
|
Exercise Price
|
|
Outstanding at May 31, 2015
|
|
|
3,937,986
|
|
|
$
|
1.45
|
|
Granted
|
|
|
1,288,001
|
|
|
|
1.78
|
|
Exercised
|
|
|
-
|
|
|
|
-
|
|
Expired or cancelled
|
|
|
-
|
|
|
|
-
|
|
Outstanding at May 31, 2016
|
|
|
5,225,987
|
|
|
$
|
1.53
|
|
Granted
|
|
|
-
|
|
|
|
-
|
|
Exercised
|
|
|
-
|
|
|
|
-
|
|
Expired or cancelled
|
|
|
(147,833
|
)
|
|
|
3.43
|
|
Outstanding at November 30, 2016
|
|
|
5,078,153
|
|
|
$
|
1.48
|
|
Issuances of warrants to purchase shares of the Company's common
stock were as follows:
FY 2016 (Year Ended May 31, 2016):
|
a
|
As discussed in Note 8, in
addition to common stock, the Company also issued warrants to purchase 833,334 shares of the Company's common stock under the
PPO.
|
|
b
|
In November 2015, a warrant to purchase 250,000 shares of the Company's common stock at $1.00 per share was issued to a vendor as a bonus payment for services rendered in connection with a software development agreement. The warrant issued was valued using the Black Scholes option pricing model under the following assumptions: stock price $ 1.00; strike price $ 1.00; expected volatility 87.54%; risk free interest rate 1.21%; dividend rate 0%; and expected term 3years. The value of the warrant totaling $139,928 was charged as research and development.
|
|
c
|
In November 2015, a warrant to purchase 33,000 shares of the Company's common stock at $1.00 per share was issued to a consultant for services rendered under a consulting contract. The warrant issued was valued using the Black Scholes option pricing model under the following assumptions: stock price $ 1.00; strike price $1.00; expected volatility 87.54%; risk free interest rate 1.21%; dividend rate 0%; and expected term 3years. The value of the warrant totaling $18,471 was charged as consulting. See Note 11.
|
|
d
|
On April 28, 2016, the Company entered into an asset purchase agreement pursuant to which the Company purchased intangible assets in exchange for 166,667 shares of the Company's common stock and a warrant to purchase 166,667 shares of the Company's common stock at $2.00 per share. The warrant issued was valued using the Black Scholes option pricing model under the following assumptions: stock price $ 0.75; strike price $2.00; expected volatility 293%; risk free interest rate .93%; dividend rate 0%; and expected term 3years. The value of the warrant totaling $124,000 was included in the cost of the intangible which was fully impaired as of May 31, 2016.
|
FY 2017 (Year Ended May 31, 2017):
There were no warrants granted during the three or six months ended
November 30, 2016.
The expense attributed to the issuances of the warrants was recognized
as they vested/earned. These warrants are exercisable for three years from the grant date.
Master Agreement – License of (“PEMS-SF”™)
On July 10, 2014, the Company entered into a Master
Agreement to license our Process and Event Management System (“PEMS-SF”™) with Tatung Corporation (“Tatung”).
The basic fee generation structure of the Agreement allows for
(1) a one-time licensing fee for each PEMS-SF-enabled stations or subsystems installed, (2) separate fees of up to 10% of the
software fees for software updates, maintenance and technical support, (3) on-going service fees based on units of products manufactured
utilizing PEMS-SF; and (4) an annual service fee for cloud-based services and data storage.
The Master Agreement has a year-to-year term but
can be terminated by either party upon sixty (60) days’ advance written notice. Upon termination or expiration of this agreement,
we are not required to provide any continuing or ongoing processing of data or other services that, pursuant to a sub-agreement,
are discontinued upon termination, however, the customer shall retain any perpetual rights granted in a sub-agreement or schedule.
The term of any sub-agreements is concomitant and co-terminus with the Master Agreement term.
Revenue recognized under the Master Agreement amounted to $8,764
and $14,793 for the three and six months ended November 30, 2016, respectively. Revenue recognized under the Master Agreement
amounted to $52,000 and $118,000 for the three and six months ended November 30, 2015, respectively.
Agreement – License of Meter Collar and
Bridge Programmable Logic
In October 2014, the Company entered into a year-to-year term agreement
with Tatung to license its meter collar and bridge programmable logic controllers. The license is paid on a per copy (ordered)
fee, and is on a perpetual, worldwide, non-exclusive, transferable basis.
Revenue recognized under the agreement amounted to $0 for both
the three and six months ended November 30, 2016 and $65,000 and $107,000 for the three and six months ended November 30, 2015,
respectively.
In March 2015, the Company entered into a one-year agreement, with
automatic one year renewals until terminated by either party with sixty (60) days’ notice, with Tatung to provide services
in the area of business development and as a representative to sell its products. Tatung will pay a monthly retainer fee for this
service. Revenue recognized under this agreement was $0 and $60,000 for the three and six months ended November 30, 2016, respectively.
Leases
Effective October 1, 2014 as amended on January 15, 2015,
the Company entered a lease for its office space at a total monthly rental of $1,874. The lease expired on January 15, 2016.
The Company renewed this lease until January 15, 2017 at a monthly rental of $2,034. In January 2017, the Company renewed
this lease until January 15, 2018, with an option to renew for one additional year upon its expiration.
Our AES subsidiary leases offices in Jericho, New York. The facility
is approximately 1,850 square feet, occupied pursuant to a lease that commenced on August 1, 2015 and expires September 30, 2018.
The average annual rent over the term of the lease is approximately $57,300. This amount does not include taxes for the premises.
Rent expense for all locations including occupancy costs for the
three months ended November 30, 2016 and 2015 was $20,929 and 21,445, respectively. Rent expense for all locations including occupancy
costs for the six months ended November 30, 2016 and 2015 was $43,706 and 32,211, respectively.
Consulting Agreements
On September 15, 2016, the Company entered into two consulting
agreements with two consultants, pursuant to which the Company agreed to issue 200,000 shares of common stock to each consultant
in exchange for certain consulting services.
|
10.
|
CONCENTRATIONS
OF CREDIT RISK
|
Cash
The Company maintains principally all cash balances in two financial
institutions which, at times, may exceed the amount insured by the Federal Deposit Insurance Corporation. The exposure to the
Company is solely dependent upon daily bank balances and the respective strength of the financial institutions. The Company has
not incurred any losses on these accounts.
Net Sales
Two customers accounted for 86% and 62% of net sales for the three
months ended November 30, 2016 and 2015, respectively, as set forth below:
|
|
Three months ended November 30,
|
|
|
|
2016
|
|
|
2015
|
|
|
|
|
|
|
|
|
Customer 1
|
|
|
74
|
%
|
|
|
36
|
%
|
Customer 2
|
|
|
12
|
%
|
|
|
26
|
%
|
Two customers accounted for 83% and 54% of net sales for the six
months ended November 30, 2016 and 2015 respectively, as set forth below:
|
|
Six months ended November 30,
|
|
|
|
2016
|
|
|
2015
|
|
|
|
|
|
|
|
|
Customer 1
|
|
|
59
|
%
|
|
|
31
|
%
|
Customer 2
|
|
|
24
|
%
|
|
|
23
|
%
|
Accounts Receivable
Two customers accounted for 100% of the accounts receivable as
of November 30, 2016, as set forth below:
|
|
November 30, 2016
|
|
|
May 31, 2016
|
|
|
|
(Unaudited)
|
|
|
|
|
Customer 1
|
|
|
52
|
%
|
|
|
83
|
%
|
Customer 2
|
|
|
48
|
%
|
|
|
11
|
%
|
|
11.
|
RELATED
PARTY TRANSACTIONS
|
There were no related party transactions during the period.
|
12.
|
BUSINESS
SEGMENT INFORMATION
|
As of November 30, 2016, the Company had two operating segments,
Arkados and Arkados Energy Solutions (AES).
The Company’s reportable segments are distinguished by types
of service, customers and methods used to provide their services. The operating results of these business segments are regularly
reviewed by the Company’s chief operating decision maker.
The accounting policies of each of the segments are the same as
those described in the Summary of Significant Accounting Policies. The Company evaluates performance based primarily on income
(loss) from operations
Information about segments is as follows:
|
|
Arkados
|
|
|
AES
|
|
|
Consolidated
|
|
|
|
|
|
|
|
|
|
|
|
Three months ended November 30, 2016
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenues
|
|
$
|
12,064
|
|
|
$
|
377,612
|
|
|
$
|
389,676
|
|
Income (loss) from operations
|
|
$
|
(511,010
|
)
|
|
$
|
27,074
|
|
|
$
|
(503,936
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three months ended November 30, 2015
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenues
|
|
$
|
175,457
|
|
|
$
|
639,762
|
|
|
$
|
815,219
|
|
Loss from operations
|
|
$
|
(254,067
|
)
|
|
$
|
(432,544
|
)
|
|
$
|
(686,611
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Six months ended November 30, 2016
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenues
|
|
$
|
88,947
|
|
|
$
|
725,216
|
|
|
$
|
814,163
|
|
Loss from operations
|
|
$
|
(615,458
|
)
|
|
$
|
(165,803
|
)
|
|
$
|
(781,261
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Six months ended November 30, 2015
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenues
|
|
$
|
282,293
|
|
|
$
|
639,762
|
|
|
$
|
922,055
|
|
Loss from operations
|
|
$
|
(511,804
|
)
|
|
$
|
(695,592
|
)
|
|
$
|
(1,207,396
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total assets
|
|
|
|
|
|
|
|
|
|
|
|
|
November 30, 2016
|
|
$
|
174,997
|
|
|
$
|
254,621
|
|
|
$
|
429,618
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
May 31, 2016
|
|
$
|
236,797
|
|
|
$
|
347,846
|
|
|
$
|
584,643
|
|
On December 31, 2016, the Company entered into a settlement agreement
with one of its vendors, pursuant to which the Company agreed to issue the vendor an aggregate of 33,596 shares of its common
stock in exchange for the cancellation of its outstanding invoice of $20,158 for services rendered.
On December 13, 2016 the Company entered into a one year consulting
agreement for financial advice. As compensation for services the Company will issue 50,000 shares of restricted common stock upon
execution of the agreement.
On January 2017, the Company executed multiple amendments to extend the maturity date of certain promissory notes with an
aggregate principal amount of $270,000, to March 31, 2017. The Company also entered into an agreement to extend its lease
for its office space for an additional year.
On January 19, 2017, the Company entered into a settlement agreement
with one of its former service providers, pursuant to which the Company agreed to issue the service provider an aggregate
of 175,000 shares of its common stock in exchange for the cancellation of its outstanding invoice of $94,617.00 for services
rendered.