NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
NOTE
1 - BUSINESS ORGANIZATION, NATURE OF OPERATIONS
Business
Description
Notis
Global, Inc., (formerly Medbox, Inc.) which is incorporated in the state of Nevada (the “Company”), provides specialized
services to the hemp and marijuana industry, distributes hemp product processed by contractual partners and through September
30, 2016, owned independently and through affiliates, real property and licenses that it leased and assigned or sublicensed to
partner cultivators and operators in return for a percentage of revenues or profits from sales and operations (Note 5). Prior
to 2016, through its consulting services, Company worked with clients who sought to enter the medical and cultivation marijuana
markets in those states where approved. In 2015, the Company expanded into hemp cultivation with the acquisition of a 320 acre
farm in Colorado by the Company’s wholly owned subsidiary, EWSD 1, LLC. The farm was operated by an independent farming
partner until the relationship was terminated in May 2016 (Note 3). In addition, through its wholly owned subsidiary, Vaporfection
International, Inc. (“VII”), the Company sold a line of vaporizer and accessory products online and through distribution
partners. On March 28, 2016, the Company sold the assets of VII and exited the vaporizer and accessory business. As of September
30, 2016, the Company was headquartered in Los Angeles, California. As of the date of filing of this Quarterly Report, the Company
was headquartered in Middletown, New Jersey.
Effective
January 28, 2016, the Company changed its legal corporate name from Medbox, Inc., to Notis Global, Inc. The name change was effected
through a parent/subsidiary short-form merger pursuant to Section 92A.180 of the Nevada Revised Statutes. Notis Global, Inc.,
the Company’s wholly-owned Nevada subsidiary formed solely for the purpose of the name change, was merged with and into
the Company, with Notis Global, Inc. as the surviving entity. The merger had the effect of amending the Company’s Certificate
of Incorporation to reflect the new legal name of the Company. There were no other changes to the Company’s Articles of
Incorporation. The Company’s Board of Directors approved the merger.
Notis
Global, Inc. operates the business directly and through the utilization of 5 primary operating subsidiaries, as follows:
|
●
|
EWSD
I, LLC, a Delaware corporation that owns property in Colorado.
|
|
●
|
Pueblo
Agriculture Supply and Equipment, LLC, a Delaware corporation that was established to own extraction equipment
|
|
●
|
Prescription
Vending Machines, Inc., a California corporation, d/b/a Medicine Dispensing Systems in the State of California (“MDS”),
which previously distributed our Medbox product and provided related consulting services.
|
|
●
|
Vaporfection
International, Inc., a Florida corporation through which we distributed our medical vaporizing products and accessories. (All
the assets of which were sold during the three months ended March 31, 2016). (See Note 6)
|
|
●
|
Medbox
Property Investments, Inc., a California corporation specializing in real property acquisitions and leases for dispensaries
and cultivation centers. This corporation currently owns no real property.
|
|
●
|
MJ Property
Investments, Inc., a Washington corporation specializing in real property acquisitions and leases for dispensaries and cultivation
centers in the state of Washington. This corporation currently owns no real property. (See Note 5)
|
|
●
|
San
Diego Sunrise, LLC, a California corporation to hold San Diego, California dispensary operations. (as of June 30, 2016, the
Company has sold its interest in San Diego Sunrise, LLC, see Note 5)
|
On
March 3, 2014, in order to obtain the license for one of the Company’s clients, the Company registered an affiliated nonprofit
corporation Allied Patient Care, Inc., in the State of Oregon. Additionally, on April 21, 2014, the Company registered an affiliated
nonprofit corporation Alternative Health Cooperative, Inc. in the State of California. As a result of our sale of the Sunset and
Portland dispensaries and related rights and assets, the Company no longer owns the rights to these nonprofit corporations. (Note
5)
On
April 15, 2016, at a special meeting of the stockholders of the Company, the stockholders of the Company holding a majority of
the total shares of outstanding common stock of the Company voted to amend the Company’s Articles of Incorporation to increase
the number of authorized shares of common stock of the Company from 400,000,000 to 10,000,000,000 (the “Certificate of Amendment”).
The Certificate of Amendment was filed with the Nevada Secretary of State and was declared effective on April 18, 2016.
NOTE
2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Going
Concern
The
condensed consolidated financial statements were prepared on a going concern basis. The going concern basis assumes that the Company
will continue in operation for the foreseeable future and will be able to realize its assets and discharge its liabilities in
the normal course of business. During the nine months ended September 30, 2016, the Company had a net loss from operations of
approximately $8.1 million, negative cash flow from operations of $4.1 million and negative working capital of $22.5 million.
During the year ended December 31, 2015, the Company had a net loss of approximately $50.5 million, negative cash flow from operations
of $9.6 million and negative working capital of $32.9 million. The Company will need to raise capital in order to fund its operations.
On September 22, 2016, the Company received notice of an Event of Default and Acceleration from one of its lenders regarding a
Promissory Note issued on March 14, 2016. (See Item 1A. Risk Factors elsewhere in this document) As of the date of this filing,
the Company is in technical default on all notes outstanding. The Company is unable to predict the outcome of these matters, however,
legal action taken by the Company’s lenders could have a material adverse effect on the financial condition, results of
operations and/or cash flows of the Company and their ability to raise funds in the future. These factors, among others, raise
substantial doubt about the Company’s ability to continue as a going concern. The ability to continue as a going concern
is dependent on the Company’s ability to raise additional capital and implement its business plan. The condensed consolidated
financial statements do not include any adjustments that might be necessary if the Company is unable to continue as a going concern.
Management’s
plans include:
The Company has received approximately $1.9
million, in additional closings under the September 30, 2016 funding (Note 7 & Note 8), subsequent to September 30, 2016. In
connection with the September 30, 2016 financing, all outstanding principal and accrued interest owing to the Company’s largest
investor were exchanged for one new convertible debenture (“Exchange Agreement”), with an extended maturity date of
June 30, 2017.
Additionally,
on October 10, 2016, the Company entered into a Note Purchase Agreement with an investor for a secured convertible promissory
note in the aggregate principal amount of $53,000. (Note 12).
The
Company also expects that the acquisition of EWSD I, LLC (“EWSD”) (Note 3), who owns a 320-acre farm in Pueblo, Colorado,
will generate recurring revenues for the Company through farming hemp, extracting and selling CBD oil, and collecting fees from
production related to extracting CBD oil for other farmers, while controlling the full production cycle to ensure consistent quality.
Lastly, management is actively seeking additional financing over the next few months to fund operations.
The
Company will continue to execute on its business model by attempting to raise additional capital through the sales of debt or
equity securities or other means. However, there is no guarantee that such financing will be available on terms acceptable to
the Company, or at all. It is uncertain whether the Company can obtain financing to fund operating deficits until profitability
is achieved. This need may be adversely impacted by: unavailability of financing, uncertain market conditions, the success of
the crop growing season, the demand for CBD oil, the ability of the Company to obtain financing for the equipment and labor needed
to cultivate hemp and extract the CBD oil, and adverse operating results. The outcome of these matters cannot be predicted at
this time.
On
May 24, 2016, the Company received a notice from the OTC Markets Group, Inc. (“OTC Markets”) that the Company’s
bid price is below $0.01 and does not meet the Standards for Continued Eligibility for OTCQB as per the OTCQB Standards. If the
bid price has not closed at or above $0.01 for ten consecutive trading days by November 20, 2016, the Company will be moved to
the OTC Pink marketplace. Additionally, on September 9, 2016, the Company received notice from the OTC that OTC Markets would
move the Company’s listing from the OTCQB market to OTC Pink Sheets market, if the Company had not filed this Quarterly
Report on Form 10-Q for the period ended June 30, 2016 by September 30, 2016. On or about October 1, 2016, the Company moved to
the OTC Pink Sheets market. These actions might also impact the Company’s ability to obtain funding.
Principles
of Consolidation
The
condensed consolidated financial statements include the accounts of Notis Global, Inc. and its wholly owned subsidiaries, as named
in Note 1 above. All intercompany transactions have been eliminated in consolidation.
Use
of Estimates
The
preparation of condensed consolidated financial statements in conformity with accounting principles generally accepted in the
United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and
liabilities and the disclosure of contingent liabilities at the date of the condensed consolidated financial statements as well
as the reported expenses during the reporting periods. The Company’s significant estimates and assumptions include accounts
receivable and note receivable collectability, inventory reserves, advances on investments, the valuation of restricted stock
and warrants received from customers, the amortization and recoverability of capitalized patent costs and useful lives and recoverability
of long-lived assets, the derivative liability, and income tax expense. Some of these judgments can be subjective and complex,
and, consequently, actual results may differ from these estimates. Although the Company believes that its estimates and assumptions
are reasonable, they are based upon information available at the time the estimates and assumptions were made. Actual results
could differ from these estimates.
Reclassification
The
Company has reclassified certain prior fiscal year amounts in the accompanying condensed consolidated financial statements to
be consistent with the current fiscal year presentation.
Concentrations
of Credit Risk
The
Company maintains cash balances at several financial institutions in the Los Angeles, California area and Iowa. Accounts at each
institution are insured by the Federal Deposit Insurance Corporation up to $250,000. The Company has not experienced any losses
in such accounts and periodically evaluates the credit worthiness of the financial institutions and has determined the credit
exposure to be negligible.
Advertising
and Marketing Costs
Advertising
and marketing costs are expensed as incurred. The Company did not incur any advertising and marketing costs for the three months
ended September 30, 2016 and 2015, respectively and for the nine months ended September 30, 2016 and 2015, respectively.
Fair
Value of Financial Instruments
Pursuant
to ASC No. 825,
Financial Instruments
, the Company is required to estimate the fair value of all financial instruments
included on its balance sheets. The carrying value of cash, accounts receivable, other receivables, inventory, accounts payable
and accrued expenses, notes payable, related party notes payable, customer deposits, provision for customer refunds and short
term loans payable approximate their fair value due to the short period to maturity of these instruments.
Embedded
derivative - The Company’s convertible notes payable include embedded features that require bifurcation due to a reset provision
and are accounted for as a separate embedded derivative (see Note 7).
As
of December 31, 2015, and for new issuances of convertible debentures during the fourth quarter of fiscal 2015, the Company estimated
the fair value of the conversion feature derivatives embedded in the convertible debentures based on a Monte Carlo Simulation
model (“MCS”). The MCS model was used to simulate the stock price of the Company from the valuation date through to
the maturity date of the related debenture and to better estimate the fair value of the derivative liability due to the complex
nature of the convertible debentures and embedded instruments. Management believes that the use of the MCS model compared to the
black Scholes model as previously used would provide a better estimate of the fair value of these instruments. Beginning in the
fourth quarter of 2015, using the MCS model, the Company valued these embedded derivatives using a “with-and-without method,”
where the value of the Convertible Debentures including the embedded derivatives, is defined as the “with”, and the
value of the Convertible Debentures excluding the embedded derivatives, is defined as the “without.” This method estimates
the value of the embedded derivatives by observing the difference between the value of the Convertible Debentures with the embedded
derivatives and the value of the Convertible Debentures without the embedded derivatives. The Company believes the “with-and-without
method” results in a measurement that is more representative of the fair value of the embedded derivatives.
For
each simulation path, the Company used the Geometric Brownian Motion (“GBM”) model to determine future stock prices
at the maturity date. The inputs utilized in the application of the GBM model included a starting stock price, an expected term
of each debenture remaining from the valuation date to maturity, an estimated volatility, and a risk-free rate.
For
the nine months ended September 30, 2016, the Company estimated the fair value of the conversion feature derivatives embedded
in the convertible debentures based on an internally calculated adjustment to the MCS valuation determined at December 31, 2015.
This adjustment took into consideration the changes in the assumptions, such as market value and expected volatility of the Company’s
common stock, and the discount rate used in the December 31, 2015 valuation as compared to September 30, 2016. The valuation also
took into consideration the term in the debentures which limits the amounts converted to not result in the investor owning more
than 4.99% of the outstanding common stock of the Company, after giving effect to the converted shares. The Company believes this
methodology results in a reasonable fair value of the embedded derivatives for the interim period.
For
the nine months ended September 30, 2015, the Company estimated the fair value of the conversion feature derivatives embedded
in the convertible debentures based on weighted probabilities of assumptions used in the Black Scholes pricing model. The key
valuation assumptions used consists, in part, of the price of the Company’s common stock, a risk free interest rate based
on the average yield of a Treasury note and expected volatility of the Company’s common stock all as of the measurement
dates, and the various estimated reset exercise prices weighted by probability.
Warrants
The
Company reexamined the determination made as of December 31, 2015 that they did not have sufficient authorized shares available
for all of their outstanding warrants to be classified in equity at September 30, 2016, and concluded there still were insufficient
authorized shares (Note 7). Therefore, the Company recognized a Warrant liability as of September 30, 2016. The Company estimated
the fair value of the warrant liability based on a Black Scholes valuation model. The key assumptions used consist of the price
of the Company’s stock, a risk free interest rate based on the average yield of a two or three year Treasury note (based
on remaining term of the related warrants), and expected volatility of the Company’s common stock over the remaining life
of the warrants.
A
three-tier fair value hierarchy is used to prioritize the inputs in measuring fair value as follows:
|
Level
1
|
Quoted
prices in active markets for identical assets or liabilities.
|
|
Level
2
|
Quoted
prices for similar assets or liabilities in active markets, quoted prices for identical or similar assets or liabilities in
markets that are not active, or other inputs that are observable, either directly or indirectly.
|
|
Level
3
|
Significant
unobservable inputs that cannot be corroborated by market data.
|
The
assets or liabilities’ fair value measurement within the fair value hierarchy is based upon the lowest level of any input
that is significant to the fair value measurement. The following table provides a summary of the relevant assets and liabilities
that are measured at fair value on a recurring basis:
|
|
Total
|
|
|
Quoted Prices
in Active
Markets for
Identical
Assets or
Liabilities
(Level 1)
|
|
|
Quoted Prices
for Similar
Assets or
Liabilities in
Active
Markets
(Level 2)
|
|
|
Significant
Unobservable
Inputs
(Level 3)
|
|
September 30, 2016
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Marketable securities
|
|
$
|
16,010
|
|
|
$
|
5,370
|
|
|
$
|
—
|
|
|
$
|
10,640
|
|
Total assets
|
|
$
|
16,010
|
|
|
$
|
5,370
|
|
|
$
|
—
|
|
|
$
|
10,640
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Warrant liability
|
|
|
101,577
|
|
|
|
|
|
|
|
|
|
|
|
101,577
|
|
Derivative liability
|
|
|
3,761,508
|
|
|
|
—
|
|
|
|
—
|
|
|
|
3,761,508
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total liabilities
|
|
$
|
3,863,085
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
3,863,085
|
|
|
|
Total
|
|
|
Quoted Prices
in Active
Markets for
Identical
Assets or
Liabilities
(Level 1)
|
|
|
Quoted Prices
for Similar
Assets or
Liabilities in
Active
Markets
(Level 2)
|
|
|
Significant
Unobservable
Inputs
(Level 3)
|
|
December 31, 2015
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Marketable securities
|
|
$
|
9,410
|
|
|
$
|
5,629
|
|
|
$
|
—
|
|
|
$
|
3,781
|
|
Total assets
|
|
$
|
9,410
|
|
|
$
|
5,629
|
|
|
$
|
—
|
|
|
$
|
3,781
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Warrant liability
|
|
|
940,000
|
|
|
|
|
|
|
|
|
|
|
|
940,000
|
|
Derivative liability
|
|
|
19,246,594
|
|
|
|
—
|
|
|
|
—
|
|
|
|
19,246,594
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total liabilities
|
|
$
|
20,186,594
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
20,186,594
|
|
The
following table sets forth a summary of the changes in the fair value of the Company’s Level 3 financial liabilities that
are measured at fair value on a recurring basis:
|
|
For the nine
months ended
September 30, 2016
|
|
|
|
Total
|
|
Beginning balance, December 31, 2015
|
|
$
|
20,186,594
|
|
Initial recognition of conversion feature
|
|
|
4,932,162
|
|
Change in fair value of conversion feature
|
|
|
(18,819,893
|
)
|
Reclassified to equity upon conversion
|
|
|
(3,199,797
|
)
|
Additions to warrant liability
|
|
|
62,673
|
|
Change in fair value of warrant liability
|
|
|
(997,121
|
)
|
|
|
|
|
|
Ending Balance, September 30, 2016
|
|
$
|
2,164,618
|
|
Revenue
Recognition
Prior
to 2015, the Company entered into transactions with clients who are interested in being granted the right to have the Company
engage exclusively with them in certain territories (which are described as territory rights) to obtain the necessary licenses
to operate a dispensary or cultivation center for the location, and to consult in daily operations of the dispensary or cultivation
center.
Terms
for each transaction are varied and, prior to 2015, sales arrangements typically included the delivery of our dispensing technology
and dispensary location build-out and/or consultation on the location, licensing, build out and operation of a cultivation center.
Prior to 2015, the Company’s standard contracts had a five year term, calling for an upfront, non-refundable consulting
fee, and containing options including acquiring a Medbox dispensary machine and having the Company perform the build-outs for
the location, at set prices. The up-front fees under these contracts are recognized over the five year term, and are included
in deferred revenue. The Company has determined these optional purchases each constituted a separate purchasing decision, and
therefore are considered a separate arrangement for revenue recognition purposes. Revenue on each of these options are evaluated
for recognition when and if the customer decides to enter into the arrangement.
In
2015 and the first quarter of 2016, the Company concentrated on revenue generating transactions to develop and set up dispensaries,
including obtaining the conditional use permits (“CUP”) that grant the dispensary the authorization to operate, as
well as cultivation centers. The Company entered into joint ventures and operating agreements, whereby separate unrelated party
controls the operations of the dispensary or cultivation center, and the Company receives an agreed upon percentage of the revenue
or profits of the operating entity. The revenue in the second quarter of 2016 consisted mainly of the recognition of previously
deferred revenue and the sale of CBD oil.
Based
on these contracts, and other auxiliary agreements, our revenue model consisted of the following income streams:
Consulting
fee revenues and build-outs
Prior
to 2015, consulting fee revenues were a consistent component of our revenues and were negotiated at the time the Company entered
into a contract. Consulting revenue consisted of providing ongoing consulting services over the life of the contract, to the established
business in the areas of regulatory compliance, security, operations and other matters to operate the dispensary. The majority
of the consulting fees from prior to 2015 arose from the upfront, non-refundable consulting fee in the Company’s standard
contract, and were recognized using the straight line method over the life of the contract. Consulting fee revenue is only recognized
when the following four criteria are met: 1) persuasive evidence of an arrangement exists, 2) delivery has occurred or services
have been rendered, 3) sales price is fixed and determinable and 4) collectability is reasonably assured. Consulting fee revenue
continues to be recognized in our income statement over the life of the aforementioned contracts.
Due
to the uncertainties inherent in the emerging industry, the Company deferred recognition of revenue for sale of completed dispensaries
with licenses until the issuance of a certificate of occupancy by the municipality. The certificate of occupancy is the final
approval to open a dispensary in the customer’s community, at which time all criteria for revenue recognition, including
delivery and acceptance, has been met. Additionally, at the time of the issuance of the certificate of occupancy, under the contract
terms, all payments owed by the customer have been received by the Company. Similarly, recognition of revenue for the sale of
a completed cultivation center is deferred until all licensing and permitting is completed and approved.
Revenues
from Operating Agreements
Under
the foregoing business model, the Company entered into operating agreements with independent parties, giving the operator the
rights to control the operations of a dispensary or cultivation center during the term of the agreement. In exchange, the Company
earns a fee based on a percentage of the revenue or profit of the dispensary or cultivation center. The Company has determined
they are not the principal in the revenue sharing agreements and recognizes revenue under these agreements on a net basis as the
fees are earned and it has been concluded that collectability is reasonably assured.
Revenues
from Cannabidiol oil product
The
Company recognizes revenue from the sale of Cannabidiol oil products (“CBD oil”) upon shipment, when title passes,
and when collectability is reasonably assured.
Cost
of Revenue
Cost
of revenue consists primarily of expenses associated with the delivery and distribution of our products and services. Under our
prior business model, we only began capitalizing costs when we have obtained a license and a site for operation of a customer
dispensary or cultivation center. The previously capitalized costs are charged to cost of revenue in the same period that the
associated revenue is earned. In the case where it is determined that previously inventoried costs are in excess of the projected
net realizable value of the sale of the licenses, then the excess cost above net realizable value is written off to cost of revenues.
Cost of revenues also includes the rent expense on master leases held in the Company’s name, which are subleased to the
Company’s operators. In addition, cost of revenue related to our vaporizer line of products consists of direct procurement
cost of the products along with costs associated with order fulfillment, shipping, inventory storage and inventory management
costs.
Inventory
Inventory
is stated at the lower of cost or market value. Cost is determined on a cost basis that approximates the first-in, first-out (FIFO)
method.
Capitalized
agricultural costs
Pre-harvest
agricultural costs, including irrigation, fertilization, seeding, laboring, and other ongoing crop and land maintenance activities,
are accumulated and capitalized as inventory and cease to be accumulated when the crops reach maturity and is ready to be harvested.
All costs incurred subsequent to the crops reaching maturity will be expensed as incurred. The Company has reflected the capitalized
agriculture costs as a current asset as the growing cycle of the crops are estimated to be approximately six months.
Basic
and Diluted Net Income/Loss Per Share
Basic
net income/loss per share is computed by dividing net income (loss) available to common stockholders by the weighted average number
of shares of common stock outstanding during the period. The Company did not consider any potential common shares in the computation
of diluted loss per share for the three months ending September 30, 2016 and for the three and nine months ending September 30,
2015, due to the net loss, as they would have an anti-dilutive effect on EPS.
As
of June 30, 2015, the Company had 3,000,000 shares of Series A preferred stock outstanding with par value of $0.001 that could
have been converted into 15,000,000 shares of the Company’s common stock. On August 24, 2015, 2,000,000 shares of Series
A preferred stock were cancelled, leaving 1,000,000 shares outstanding, which were converted into common shares on November 16,
2015. There were no shares of Series A preferred stock outstanding at September 30, 2016. Additionally, the Company had approximately
69,758,000 and 14,084,000 warrants to purchase common stock outstanding as of September 30, 2016 and 2015, respectively, which
were not included in the computation of diluted loss per share, as based on their exercise prices they would all have an anti-dilutive
effect on net loss per share. The Company also had outstanding at September 30, 2016 and 2015 approximately $7,465,000 and $4,994,000
in convertible debentures, respectively, that are convertible at the holders’ option at a conversion price of the lower
of $0.75 or 51% to 60% of either the lowest trading price or the VWAP over the last 20 to 30 days prior to conversion (subject
to reset upon a future dilutive financing), whose underlying shares resulted in an additional 10,506,777,999 dilutive shares being
included in the computation of diluted net income per share for the nine months ended September 30, 2016.
Accounts
Receivable and Allowance for Bad Debts
The
Company is subject to credit risk as it extends credit to our customers for work performed as specified in individual contracts.
The Company extends credit to its customers, mostly on an unsecured basis after performing certain credit analyses. Prior to 2015,
our typical terms required the customer to pay a portion of the contract price up front and the rest upon certain agreed milestones.
The Company’s management periodically reviews the creditworthiness of its customers and provides for probable uncollectible
amounts through a charge to operations and a credit to an allowance for doubtful accounts based on our assessment of the current
status of individual accounts. Accounts still outstanding after the Company has used reasonable collection efforts are written
off through a charge to the allowance for doubtful accounts. As of September 30, 2016, the Company’s management considered
all accounts outstanding fully collectible.
Property
and Equipment
Property
and equipment are recorded at cost. Expenditures for major additions and improvements are capitalized and minor replacements,
maintenance, and repairs are charged to expense as incurred. When property and equipment are retired or otherwise disposed of,
the cost and accumulated depreciation are removed from the accounts and any resulting gain or loss is included in the results
of operations for the respective period. Depreciation is provided over the estimated useful lives of the related assets using
the straight-line method for financial statement purposes. The Company uses accelerated depreciation methods for tax purposes
where appropriate. The estimated useful lives for significant property and equipment categories are as follows:
Vehicles
|
|
5 years
|
Furniture
and Fixtures
|
|
3 - 5 years
|
Office
equipment
|
|
3 years
|
Machinery
|
|
2 years
|
Buildings
|
|
10 - 39 years
|
Income
Taxes
The
Company accounts for income taxes under the asset and liability method. The Company recognizes deferred tax liabilities and assets
for the expected future tax consequences of events that have been included in the consolidated financial statements or tax returns.
Under this method, deferred tax liabilities and assets are determined based on the difference between the financial statement
and tax bases of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to
reverse. The components of the deferred tax assets and liabilities are classified as current and non-current based on their characteristics.
A valuation allowance is provided for certain deferred tax assets if it is more likely than not that the Company will not realize
tax assets through future operations.
In
addition, the Company’s management performs an evaluation of all uncertain income tax positions taken or expected to be
taken in the course of preparing the Company’s income tax returns to determine whether the income tax positions meet a “more
likely than not” standard of being sustained under examination by the applicable taxing authorities. This evaluation is
required to be performed for all open tax years, as defined by the various statutes of limitations, for federal and state purposes.
Commitments
and Contingencies
Certain
conditions may exist as of the date the consolidated financial statements are issued, which may result in a loss to the Company
but which will only be resolved when one or more future events occur or fail to occur. The Company’s management and its
legal counsel assess such contingent liabilities, and such assessment inherently involves an exercise of judgment. In assessing
loss contingencies related to legal proceedings that are pending against the Company or unasserted claims that may result in such
proceedings, the Company’s legal counsel evaluates the perceived merits of any legal proceedings or unasserted claims as
well as the perceived merits of the amount of relief sought or expected to be sought therein.
If
the assessment of a contingency indicates that it is probable that a material loss has been incurred and the amount of the liability
can be estimated, then the estimated liability would be accrued in the Company’s consolidated financial statements. If the
assessment indicates that a potentially material loss contingency is not probable, but is reasonably possible, or is probable
but cannot be estimated, then the nature of the contingent liability, together with an estimate of the range of possible loss
if determinable and material, would be disclosed.
Loss
contingencies considered remote are generally not disclosed unless they involve guarantees, in which case the nature of the guarantee
would be disclosed.
The
Company accrues all legal costs expected to be incurred per event. For legal matters covered by insurance, the Company accrues
all legal costs expected to be incurred per event up to the amount of the deductible.
Recent
Accounting Pronouncements
In
May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”)
No. 2014-09, “Revenue from Contracts with Customers,” which requires an entity to recognize the amount of revenue
to which it expects to be entitled for the transfer of promised goods or services to customers. ASU 2014-09 will replace most
existing revenue recognition guidance in U.S. GAAP when it becomes effective. The new standard is effective for annual reporting
periods for public business entities beginning after December 15, 2017, including interim periods within that reporting period.
The new standard permits the use of either the retrospective or cumulative effect transition method. The Company is currently
evaluating the effect that ASU 2014-09 will have on its financial statements and related disclosures. The Company has not yet
selected a transition method nor determined the effect of the standard on its ongoing financial reporting.
On
July 22, 2015, the Financial Accounting Standards Board (“FASB”) issued a new standard that requires entities to measure
most inventory “at the lower of cost and net realizable value,” thereby simplifying the current guidance under which
an entity must measure inventory at the lower of cost or market. The new standard will not apply to inventories that are measured
by using either the last-in, first-out (LIFO) method or the retail inventory method. The new standard will be effective for fiscal
years beginning after December 15, 2016, and interim periods in fiscal years beginning after December 15, 2016. The Company is
in the process of evaluating the impact of adoption on its consolidated financial statements.
In
April 2015, the FASB issued a new standard that requires an entity to determine whether a cloud computing arrangement contains
a software license. If the arrangement contains a software license, the entity would account for the fees related to the software
license element in a manner consistent with how the acquisition of other software licenses is accounted for. If the arrangement
does not contain a software license, the customer would account for the arrangement as a service contract. The new standard will
be effective for fiscal years beginning after December 15, 2015, and interim periods in fiscal years beginning after December
15, 2016. The Company is in the process of evaluating the impact of adoption on its consolidated financial statements.
In
February 2016, the FASB issued “Leases (Topic 842)” (ASU 2016-02). This update amends leasing accounting requirements.
The most significant change will result in the recognition of lease assets and lease liabilities by lessees for those leases classified
as operating leases under current guidance. The new guidance will also require significant additional disclosures about the amount,
timing and uncertainty of cash flows from leases. ASU 2016-02 is effective for fiscal years and interim periods beginning after
December 15, 2018, which for the Company is December 31, 2018, the first day of its 2019 fiscal year. Upon adoption, entities
are required to recognize and measure leases at the beginning of the earliest period presented using a modified retrospective
approach. Early adoption is permitted, and a number of optional practical expedients may be elected to simplify the impact of
adoption. The Company is currently evaluating the impact of adopting this guidance. The overall impact is that assets and liabilities
arising from leases are expected to increase based on the present value of remaining estimated lease payments at the time of adoption.
In
March 2016, the FASB issued ASU 2016-09,
Improvements to Employee Share-Based Payment Accounting
, which amends Accounting
Standards Codification (“ASC”) Topic 718,
Compensation - Stock Compensation
. ASU 2016-09 simplifies several
aspects of the accounting for share-based payment transactions, including the income tax consequences, classification of awards
as either equity or liabilities, and classification on the statement of cash flows. ASU 2016-09 is effective for fiscal years
beginning after December 15, 2016, and interim periods within those fiscal years and early adoption is permitted. The Company
is in the process of evaluating the impact of adoption on its consolidated financial statements.
Management’s
Evaluation of Subsequent Events
The
Company evaluates events that have occurred after the balance sheet date of September 30, 2016, through the date which the condensed
consolidated financial statements were issued. Based upon the review, other than described in Note 12 - Subsequent Events, the
Company did not identify any recognized or non-recognized subsequent events that would have required adjustment or disclosure
in the condensed consolidated financial statements.
NOTE
3 - ASSET ACQUISITION
On
July 24, 2015, the Company entered into an Agreement of Purchase and Sale of Membership Interest (the “Acquisition Agreement”)
with East West Secured Development, LLC (the “Seller”) to purchase 100% of the membership interest of EWSD I, LLC
(“EWSD”) which has entered into an agreement with Southwest Farms, Inc. (“Southwest”) to purchase certain
real property comprised of 320-acres of agricultural land in Pueblo, Colorado (the “Acquired Property” or “the
Farm”).
The
purchase price to acquire EWSD consisted of (i) $500,000 paid by the Company as a deposit into the escrow for the Acquired Property,
and (ii) the Company’s future payments to Seller of a royalty of 3% of the adjusted gross revenue, if any, from operation
of the Acquired Property (including sale of any portion of or interest in the Acquired Property less any applicable expenses)
for the three-year period beginning on January 1, 2016. Such royalty payments shall be payable 50% in cash and 50% in Company
common stock (the “Royalty Payment”). The Company determined that the royalty payments could not be estimated at the
time of acquisition, and, therefore, the contingent payments have not been recognized as part of the acquisition price. The contingent
consideration will be re-measured to fair value each subsequent period until the contingency is resolved, in this case, for the
three year period beginning on January 1, 2016, with any changes in fair value recognized in earnings. Per the terms of the agreement,
the closing is deemed to have occurred when the Special Warranty Deed is recorded (which occurred on August 7, 2015) and all terms
of the purchase agreement for the Farm have been complied with, including the Farm closing, which also took place on August 7,
2015. Therefore, the acquisition date has been determined to be August 7, 2015. There were no assets or liabilities of EWSD on
the acquisition date.
In
connection with EWSD’s purchase of the Acquired Property, EWSD entered into a secured promissory note (the “Note”)
with Southwest in the principal amount of $3,670,000 (Note 8). Interest on the outstanding principal balance of the Note shall
accrue at the rate of five percent per annum. The Note shall be payable by EWSD in thirty-five payments of principal and interest,
which shall be calculated based upon an amortization period of thirty years, commencing on September 1, 2015 and continuing thereafter
on the first day of each calendar month through and including July 1, 2018; and one final balloon payment of all unpaid principal
and accrued but unpaid interest on August 1, 2018. The Note is secured by a deed of trust, security agreement, assignment of rents
and financing statement encumbering the Acquired Property.
EWSD
also entered into an unsecured promissory note (the “Unsecured Note”) in the principal amount of $830,000 with the
Seller (Note 8), in respect of payments previously made by Seller to Southwest in connection with acquiring the Farm. Interest
on the outstanding principal balance of the Unsecured Note shall accrue at the rate of six percent per annum. The Unsecured Note
shall be payable by EWSD in thirty-five payments of principal and interest, which shall be calculated based upon an amortization
period of thirty years, commencing on September 1, 2015 and continuing thereafter on the first day of each calendar month through
and including July 1, 2018; and one final balloon payment of all unpaid principal and accrued but unpaid interest on August 1,
2018.
Farming
Agreement
On
December 18, 2015, the Company and its subsidiary EWSD I, LLC (“EWSD”), entered into a Farming Agreement (the “Farming
Agreement”) with Whole Hemp Company (“Whole Hemp” now known as “Folium Biosciences”), pursuant to
which Folium Biosciences would manufacture products from hemp and cannabis crops it would grow on EWSD farmland, and the Company
would build greenhouses for such activities up to an aggregate size of 200,000 square feet. Folium Biosciences would pay all preapproved
costs of such construction on or before September 30, 2017 as partial consideration for a revocable license to use the greenhouses
and a separate 10 acre plot of EWSD farmland (the “10 Acres”). EWSD would retain ownership of the greenhouses. For
the first growing season commencing October 1, 2016, the Company would receive a percentage of gross sales of all Folium Bioscience’s
products on a monthly basis, and the Company’s share would increase incrementally based on the extent of crops planted on
EWSD farmland according to a mutually agreed schedule. In addition, the Company would receive 50% of Folium Biosciences gross
profits from the farming activities on the 10 Acres. The Company planned to recognize all revenue from the Farming Agreement at
the net amount received when it has been earned and determined collectable.
Pursuant
to the Farming Agreement, the Company also granted Folium Biosciences a warrant to purchase 4,000,000 shares of Company common
stock at an exercise price of $0.50 per share, exercisable at any time within 5 years. The warrants were valued at $76,000, using
a Black Scholes Merton Model, with key valuation assumptions used that consist of the price of the Company’s stock at settlement
date, a risk free interest rate based on the average yield of a 5 year Treasury note and expected volatility of the Company’s
common stock all as of the measurement date. The fair value of the warrants is included in deferred costs and will be recognized
over the life of the Farming Agreement. Due to the termination of the Farming and Growers Distribution Agreements, as discussed
below, as of September 30, 2016, this amount has been fully amortized.
On
March 11, 2016, the Company and EWSD entered into a First Amended and Restated Farming Agreement with Whole Hemp, amending and
restating in certain respects the Farming Agreement. The First Amended and Restated Farming Agreement clarifies that EWSD, rather
than the Company, would be responsible for the building of greenhouses to be utilized by Whole Hemp for growing hemp and cannabis
crops pursuant to the agreement, and that EWSD would be the recipient of all payments by Whole Hemp (including all revenue sharing
arrangements) under the agreement.
On
or about May 7, 2016, the Company determined that Folium Biosciences was in default of the Farming Agreement, principally because
they abandoned their obligation to provide farming activities under the First Amended and Restated Farming Agreement. On May 13,
2016, EWSD notified Folium Biosciences of its defaults under the First Amended and Restated Farming Agreement and EWSD’s
election to terminate the First Amended and Restated Farming Agreement.
By
its terms, the First Amended and Restated Farming Agreement may be terminated at any time by either party, if the other party
was in material breach of any obligation under the First Amended and Restated Farming Agreement, which breach continued uncured
for 30 days following written notice thereof.
On
June 1, 2016, a complaint was filed by Whole Hemp on this matter, naming Notis Global, Inc. and EWSD I, LLC, as defendants. See
Whole Hemp Complaint, below.
Growers’
Distributor Agreement
On
December 18, 2015, the Company also entered into a Growers’ Agent Agreement with Folium Biosciences, which was amended
on March 11, 2016, to change the name of the agreement to Growers’ Distributor Agreement, (“Distributor
Agreement”) and to clarify some terms. Pursuant to the Distributor Agreement, the Company would provide marketing,
sales, and related services on behalf of Folium Biosciences in connection with the sale of its Cannabidiol oil product
(“CBD oil”), from which the Company would receive a percentage of gross revenues (other than the sale of such
product generated from the EWSD 10 Acres and the Folium Biosciences 40 acre plot subject to the Farming Agreement). The
Growers’ Agent Agreement was effective until September 30, 2025. The Company would sell the product on behalf of Folium
Biosciences on a commission basis. The Company may not act as agent of any other grower, distributor or manufacturer of the
same product unless such other party agrees.
On
March 11, 2016, the Company and EWSD entered into a First Amended and Restated Grower’s Distributor Agreement with Whole
Hemp, amending and restating in certain respects the Grower’s Agent Agreement, including by substituting EWSD as a party
in-place of the Company.
Because
the Company believes Folium Biosciences is in default, principally because they abandoned their obligation to provide farming
activities under the First Amended and Restated Farming Agreement since May 7, 2016, EWSD notified Whole Hemp on May 13, 2016
of its election to terminate the Restated Grower’s Distributor Agreement.
By
its terms, the Restated Grower’s Distributor Agreement could be terminated at any time by either party, if the other party
was in material breach of any obligation under the Restated Grower’s Distributor Agreement, which breach continued uncured
for 30 days following written notice thereof.
As
the Company continued to navigate the nascent world of hemp and CBD growing, cultivation, production and sales, it became clear
that controlling all aspects of the business is the best strategy to ensure that the Company’s goals are met. Again, the
Company is taking action now to protect the investment all the stakeholders have made in Notis Global.
Whole
Hemp complaint
A
complaint was filed by Whole Hemp Company, LLC d/b/a Folium Biosciences (“Whole Hemp”) on June 1, 2016, naming Notis
Global, Inc. and EWSD I, LLC (collectively, “Notis”), as defendants in Pueblo County, CO district court. The complaint
alleges five causes of action against Notis: misappropriation of trade secrets, civil theft, intentional interference with prospective
business advantage, civil conspiracy, and breach of contract. All claims concern contracts between Whole Hemp and Notis for the
Farming Agreement and the Distributor Agreement.
The
court entered an
ex parte
temporary restraining order on June 2, 2016, and a modified temporary restraining order on July
14, 2016, enjoining Notis from disclosing, using, copying, conveying, transferring, or transmitting Whole Hemp’s trade secrets,
including Whole Hemp’s plants. On June 13, 2016, the court ordered that all claims be submitted to arbitration, except for
the disposition of the temporary restraining order.
On
August 12, 2016, the court ordered that all of Whole Hemp’s plants in Notis’ possession be destroyed, which occurred
by August 24, 2016, at which time the temporary restraining order was dissolved and the parties were expected to file a motion
to dismiss the district court action.
In
light of the Whole Hemp plants all being destroyed per the court order, the Company has immediately expensed all Capitalized agricultural
costs as of June 30, 2016, as all costs as of that date related to Whole Hemp plants.
Notis
commenced arbitration in Denver, CO on August 2, 2016, seeking injunctive relief and alleging breaches of the contracts between
the parties. Whole Hemp filed an Answer and counterclaims on September 6, 2016, asserting similar allegations that were asserted
to the court.
On
September 30, 2016, the arbitrator held an initial status conference and agreed to allow EWSD and Notis to file a motion to dismiss
some or all of Whole Hemp’s claims by no later than October 28, 2016. The parties were also ordered to make initial disclosures
of relevant documents and persons with knowledge of relevant information by October 21, 2016.
On
or about July 19, 2016, EWSD initiated arbitration before JAMS (Case ID: 18657). Effective June 20, 2017, as a result of a
mediation held in Colorado, the parties entered into a Confidential Settlement and Mutual Release Agreement (the “Release
Agreement”), pursuant to which we and Whole Hemp dismissed with prejudice all of our respective claims or counterclaims
against each other, as asserted in the Arbitration, and we mutually released each other from all claims. The Release Agreement
specifically provides that neither its execution nor implementation is, or will be deemed to be or construed as, an admission
by any party of any liability, act, or matter.
NOTE
4 - INVENTORY
Inventory
is stated at the lower of cost or market value. Cost is determined on a standard cost basis that approximates the first-in, first-out
(FIFO) method.
Inventory
at September 30, 2016 and December 31, 2015 consists of the following:
|
|
September
30, 2016
|
|
|
December
31, 2015
|
|
Vaporizers
and accessories
|
|
$
|
—
|
|
|
$
|
81,934
|
|
CBD
Oil
|
|
|
32,300
|
|
|
|
35,889
|
|
Light
Bulbs for cultivation centers
|
|
|
—
|
|
|
|
33,000
|
|
|
|
|
|
|
|
|
|
|
Total
inventory, net
|
|
$
|
32,300
|
|
|
$
|
150,823
|
|
The
Company did not write down any slow moving or obsolete inventory during the nine months ended September 30, 2016 and 2015.
NOTE
5 - DISPENSARIES
Portland
The
Company held a license to operate a dispensary in Portland, Oregon, and a master lease on the property in which the dispensary
is located. In April 2015, the Company entered into an Operating Agreement (“Original Agreement”) with an unrelated
party (the “Operator”) in which the Operator was to manage and operate the Dispensary. The Original Agreement also
included an annual Licensor Fee of 5% of the annual Gross Revenues, which would have begun after the additional fees related to
the startup of the new venture had been paid in full.
On
December 3, 2015 the Company replaced the original operator of the Portland dispensary with another operator under a new Operator
Agreement (the “Agreement”). Per the terms of the Agreement, the Dispensary was “under the exclusive supervision
and control of Operator, which shall be responsible for the proper and efficient operation of the Dispensary”. The term
of the Agreement includes an initial term of five years, and a renewal term for an additional five years. The renewal term is
at the discretion of the Operator. There is a License fee, which is based on a flat 10% of Gross Revenues. The Company’s
management has determined that under this Agreement they do not hold the controlling financial interest in the Dispensary and
are not the primary beneficiary, and therefore did not consolidate the Dispensary in their consolidated financial statements.
On
June 30, 2016, the Company entered into an Assignment Agreement whereby they sold and assigned all of their rights in the Operating
Agreement, including but not limited to the assets and liabilities the Company held in relation to the Portland Dispensary, including
the license to operate a dispensary in Portland, Oregon. The assets consisted mainly of tenant improvements and other capitalized
costs incurred in connection with the Portland dispensary, categorized as Deferred Costs on the Company’s condensed consolidated
Balance Sheet, at a carrying value of approximately $270,000. The gross consideration paid for the assets and liabilities as stated
in the agreement was $150,000, with approximately $58,000 of this amount paid to the State of Oregon for outstanding sales taxes,
resulting in net proceeds of approximately $92,000, providing for a net loss of $178,000 on sale of assets.
Sunrise
Property Investments, LLC
On
December 3, 2015, the Company entered into an Operating Agreement with PSM Investment Group, LLC (“PSM”), for the
governance of Sunrise Property Investments, LLC (“Sunrise”). Pursuant to the agreement, each of the two members contributed
50% of the capital of Sunrise. The Company’s contribution to the investment was the conditional use permit for the location,
which was determined to have a zero cost basis, based on its carrying value in the Company’s financial statements. Sunrise
acquired the property on which a dispensary will be located in San Diego on December 31, 2015. The Company has determined it should
not consolidate the financial position and results of operations in its consolidated financial statements as it does not hold
greater than 50% voting interest or is able to exercise influence over the operations and management in Sunrise. Instead, the
Company accounts for Sunrise as an equity method investment. No income or loss has been recognized from Sunrise for the year ending
December 31, 2015.
Alternative
Health Cooperative, Inc. (“Alternative”) is a not-for-profit corporation, managed by an employee of Notis Global,
which holds the conditional user permit (“CUP”) to run the dispensary. On January 1, 2016, Sunrise entered into an
Operator Agreement with Alternative for Sunrise to operate the dispensary located on the Sunrise property. The Operator Agreement
engages Sunrise to “supervise, direct and control the management of the dispensary”. The Agreement also states that
the operation of the dispensary shall be under the exclusive supervision and control of Sunrise which shall be responsible for
the proper and efficient operation of the dispensary. The Company had determined that under the operating agreement neither it
nor Alternative hold the controlling financial interest in the dispensary, but that Sunrise is the controlling entity. Therefore,
the Company did not consolidate the dispensary in its consolidated financial statements.
The
Company incorporated a new wholly owned subsidiary, San Diego Sunrise, LLC (“San Diego Sunrise”), on February 22,
2016, in order to enter into a partnership agreement with PSM Investments to create an entity which would control the dispensary
operations. Thereafter, Sunrise Dispensary LLC (“Dispensary”) was incorporated by PSM Investments and San Diego Sunrise
on February 24, 2016, with each party holding a 50% ownership interest in the new entity. Immediately after which, Sunrise assigned
the Operating Agreement with Alternative to Dispensary. The Company therefore indirectly held a 50% interest in the Sunrise Dispensary,
through its subsidiary, San Diego Sunrise.
In
February 2016, the Company sold 70% of its ownership interest in San Diego Sunrise for approximately $299,000. As of September
30, 2016, the Company owned 50% of Sunrise and 30% of San Diego Sunrise. These investments are accounted for under the equity
method, with the Company’s proportionate share of the income or losses of the investments reflected in the Company’s
financial statements.
On
April 6, 2016, the Company sold its remaining 30% interest in San Diego Sunrise, as well as all of its interest in Sunrise Property
Investments, LLC, the entity that owns underlying real estate related to the San Diego dispensary, for net proceeds of $331,000.
There had been no activity, in these investees, aside from the sale of the Company’s ownership interests, while held by
the Company
Sunrise
Delivery
On
November 24, 2015, the Company entered into a Management Agreement (“the Agreement”) with Rise Industries (“the
Operator”) for a delivery service to be called Sunrise Delivery, operating under the conditional use permit awarded to the
Sunrise Dispensary. The delivery service began operations on December 19, 2015 and, due to the short period between commencement
of operations and the year end, the results of operations were not material for the year ended December 31, 2015.
Under
the Agreement, the Operator is fully and solely responsible to collect all revenue and pay all expenses arising from the delivery
service, including acquisition of inventory. The Company’s name is not being used in connection with any advertising, marketing,
product or delivery services provided by the Operator. The Company determined that under the Agreement they do not hold the controlling
financial interest in the delivery service and the Operator is the controlling entity. Therefore, the Company did not consolidate
Sunrise Delivery in their financial statements. The Company also evaluated whether the revenue earned from the delivery service
should be recognized at the gross or net amount. As the Company meets the three indicators of being an agent, the Company will
report the earnings or losses from the delivery service on a net basis, under the equity method of accounting.
On
December 9, 2015, the Company provided a $60,000 loan to Sunrise Delivery for working capital, with interest at prime and payable
in one year and added an additional advance of $10,000 in the first quarter of 2016. In connection with the sale of their interests
in the San Diego dispensary, the Company wrote off the loans totaling $70,000 as uncollectible at the end of the first quarter
of 2016.
Washington
In
the course of seeking licenses for new locations, the Company has to enter into real estate purchase agreements in order to secure
the sites to be developed for clients’ dispensaries and cultivation centers. During the second quarter of 2014, one of the
Company’s subsidiaries entered into a real estate purchase agreement for a property in the State of Washington. The purchase
transaction was closed during the third quarter of 2014 for a total purchase price of $399,594, partially financed by a promissory
note for $249,000. The note was due January 30, 2015 and bore interest at twelve percent (12%). The Company did not repay the
note on its maturity date, and therefore began incurring interest at the default interest rate of eighteen percent (18%) per annum.
On September 30, 2015, the Company, through its subsidiary MJ Property Investments, and the seller of the property entered into
an amendment to the Note Payable, whereby the maturity date was extended to April 1, 2017, and the interest rate returned to twelve
percent (12%) per annum (see Note 8). The Company did not make their May or June interest payments, and on July 26, 2016 they
were notified they were in default on the note, which resulted in the Company incurring interest at the default interest rate
of 18%, beginning in May 2016.
On
September 27, 2016, the Company entered into a default settlement with the noteholder, whereby the note was settled by conveying
the property to the noteholder, recognizing a loss on the default settlement of approximately $168,000.
NOTE
6 - VAPORFECTION INTERNATIONAL, INC.
The
Company acquired certain intangible assets with its purchase of 100% of the outstanding common stock of Vaporfection International
Inc. (“VII”) on April 1, 2013. The Company accounts for intangible assets acquired in a business combination, if any,
under the purchase method of accounting at their estimated fair values at the date of acquisition. Intangibles are either amortized
over their estimated lives, if a definite life is determined, or are not amortized if their life is considered indefinite.
On
December 31, 2015, the Company re-evaluated the future value of the intangible assets and determined none of the carrying value
of the intangible assets were recoverable, and its carrying value exceeded its fair value. Therefore, the Company recognized an
impairment loss on Intangibles of $586,000.
On
December 31, 2015, the Company also performed the first step of the Goodwill impairment test, and, based on the same conclusions
as above, determined there were indications of impairment of the Goodwill and they had to perform the second step of the impairment
test, which compares the carrying value of the Goodwill to the implied Goodwill. The Company re-evaluated the fair value of all
the associated assets of VII at December 31, 2015 and determined that there was no implied Goodwill. As there is no implied Goodwill,
the impairment loss recognized was the entire carrying value of Goodwill, approximately $1,260,000.
In
light of these impairments, as discussed above, the Company wrote down all other assets related to the business, such as fixed
assets and costs to develop the website as of December 31, 2015, resulting in an impairment of approximately $80,000. The Company
also wrote down the Inventory of VII to its estimated fair value of $82,000.
The
Board made a decision the last week of January 2016, to sell the assets of Vaporfection and exit the vaporizer business and sell
the remaining inventory and related assets during the first half of 2016. The Company analyzed if Vaporfection should be presented
as a Discontinued Operation under the guidance of ASC 205, Presentation of Financial Statements, 20, Discontinued Operations,
(“ASC 205-20”), and determined the decision to exit the Vaporfection business was not a strategic shift in the Company’s
business, as the Board and management did not consider the strategy for the business to be built around the sale of vape machines
or peripherals.
On
March 28, 2016, the Company sold the assets of the subsidiary for $70,000, which was payable $35,000 at the closing and with a
6% Note Payable, due September 30, 2016. The Company recognized approximately $6,000 as a gain on sale of the assets of their
subsidiary for the nine months ended September 30, 2016.
NOTE
7 - CONVERTIBLE NOTES PAYABLE AND DERIVATIVE LIABILITY
July
and September 2014 Debentures
On
July 21, 2014, as amended on September 19, 2014 and October 20, 2014, the Company entered into a Securities Purchase Agreement
with an Investor (“Investor #1”) whereby the Company agreed to issue convertible debentures (“July 2014 Debentures”)
in the aggregate principal amount of $3,500,000, in five tranches. The July 2014 Debentures bore interest at the rate of 10% per
year. The debt was due July 21, 2015.
Also
on September 19, 2014, as amended on October 20, 2014, the Company entered into a securities purchase agreement with another investor
(“Investor #2) pursuant to which it agreed to issue convertible debentures (“September 2014 Debentures”) in
the aggregate principal amount of $2,500,000, in two tranches. The September 2014 Debentures bore interest at the rate of 5% per
year. The debt was due September 19, 2015. All amounts due under the September 2014 Debentures have been fully converted,
Both
the original July 2014 Purchase Agreement Debentures and September 2014 Debentures, prior to subsequent amendment, share the following
significant terms:
All
amounts are convertible at any time, in whole or in part, at the option of the holders into shares of the Company’s common
stock at a conversion price. The Notes were initially convertible into shares of the Company’s common stock at the initial
Fixed Conversion Price of $11.75 per share. The Fixed Conversion Price is subject to adjustment for stock splits, combinations
or similar events. If the Company makes any subsequent equity sales (subject to certain exceptions), under which an effective
price per share is lower than the Fixed Conversion Price, then the conversion price will be reduced to equal such price. The Company
may make the amortization payments on the debt in cash, prompting a 30% premium or, subject to certain conditions, in shares of
common stock valued at 70% of the lowest volume weighted average price of the common stock for the 20 prior trading days.
The
conversion feature of the July 2014 Debenture and the September 2014 Debenture meets the definition of a derivative and due to
the reset provision to occur upon subsequent sales of securities at a price lower than the fixed conversion price, requires bifurcation
and is accounted for as a derivative liability, with a discount created on the Debentures that would be amortized over the life
of the Debentures using the effective interest rate method. The fair value of the embedded derivative is measured and recognized
at fair value each subsequent reporting period and the changes in fair value are recognized in the Statement of Operations as
Change in fair value of derivative liability. See Note 2 Fair value of financial instruments for additional information on the
fair value and gains or losses on the embedded derivative.
In
connection with each of the purchase agreements, the Company entered into a registration rights agreement with the respective
investors, pursuant to which the Company agreed to file a registration statement for the resale of the shares of common stock
issuable upon conversion of, or payable as principal and interest on, the respective debentures, within 45 days of the initial
closing date under each agreement, and to have such registration statements declared effective within 120 days of the initial
closing dates of each purchase agreement. Through subsequent modifications of the July 2014 Debentures and September 2014 Debentures,
the required date to file the registration statement and the effective date of the registration statement were modified, and the
registration statement filed on April 9, 2015, and became effective on June 11, 2015.
On
January 30, 2015, the Company and Investor #1 entered into an Amendment, Modification and Supplement to the Purchase Agreement
(the “Purchase Agreement Amendment” or the “Modification”) pursuant to which Investor #1 agreed to purchase
an additional $1,800,000 in seven Modified Closings. The Modification also eliminated the amortization payments discussed above,
and provided for accrued and unpaid interest to be payable upon conversion or maturity rather than on specified payment dates.
The Company was also required to open a new dispensary in Portland, Oregon through a licensed operator during the first calendar
quarter of 2015 (which was later modified to April 30, 2015). The Company also had to file the Registration Statement by March
8, 2015 (later amended), and it had to be declared effective by June 15, 2015 in order to avoid default and acceleration under
the Amended and Restated Debenture. As noted above, the Registration Statement was filed on April 9, 2015, and became effective
June 11, 2015.
As
part of the January 30, 2015 Modification, the parties entered into a Modified Debenture Agreement for the $200,000 that was funded
at the Closing and agreed to use the same form of Modified Debenture for each of the other foregoing Modified Closings (collectively,
the “Modified Debentures”). The fixed conversion price of the Modified Debenture on January 30, 2015 was the lower
of $5.00 or 51% of the lowest volume weighted average price for the 20 consecutive trading days prior to the applicable conversion
date. This new fixed conversion price was a dilutive issuance to the outstanding July 2014 and September 2014 Debentures, thereby
triggering a reset of the older fixed conversion price. As a result of the reset to the conversion price, at January 30, 2015,
the derivative liability was re-measured to a fair value of approximately $2,690,000, using a weighted probability model as estimated
by management. A decrease in fair value of the derivative liability of approximately $1,072,000 was recognized as a gain on the
Statement of Consolidated Comprehensive Loss, in the three months ended March 31, 2015.
The
additional Modified Debentures under the July 2014 Debentures as of closing dates had a fixed conversion price of the lower of
$1.83 or 51% of the VWAP for the last 20 days prior to the conversion. This new fixed conversion price was a dilutive issuance
to the outstanding July 2014 and September 2014 Debentures, thereby triggering a reset of the previous $5 fixed conversion price.
This reset resulted in the derivative liability being revalued at February 27, 2015, using a weighted probability model for a
fair value of $2,720,000.
The
April 17, 2015 closing under the July 2014 Modified Debentures contained a fixed conversion price of the lower of $0.88 or 51%
of the VWAP for the last 40 days prior to the conversion. This new fixed conversion price was a dilutive issuance to the outstanding
July 2014 and September 2014 Debentures, thereby triggering a reset of the previous $1.83 fixed conversion price. This reset resulted
in the derivative liability being revalued at April 17, 2015, using a weighted probability model for a fair value of $3,287,000,
for an increase in fair value of approximately $1,764,000, recognized as a loss on the Statement of Consolidated Comprehensive
Loss.
There
was additional funding of $1,300,000 of the September 2014 Modified Debentures under the closing schedule detailed above. These
Modified Debentures all have a fixed conversion price of the lower of $0.88 or 51% of the VWAP for the last 40 days prior to the
conversion.
The
Directors’ convertible debentures required under the March 23, 2015 Modification, issued in the first quarter of 2015, total
$150,000, and have a three year term and an interest rate of 8% per annum. They were originally convertible at a fixed conversion
price of the lower of $1.83 or 51% of the VWAP for the last 20 days prior to conversion. As with the Modified Debentures, the
debentures included a reset provision, which resulted in the conversion feature being bifurcated and accounted for as a derivative
liability, with an initial fair value of $132,175. The director’s convertible debentures also reset on February 27, 2015
and April 17, 2015, with the changes to fair value included in the amounts disclosed above. The Directors debentures were all
converted during the third quarter of 2015.
The
Modified Debentures also included a warrant instrument granting the Investor the right to purchase shares of common stock of the
Company equal to the principal amount of the applicable Modified Debenture divided by a price equal to 120% of the last reported
closing price of the common stock on the applicable closing date of the Modified Debenture, with a three year term.
August
2015 Debentures
On
August 14, 2015, the Company entered into a Securities Purchase Agreement whereby they agreed to issue convertible debentures
in the aggregate principal amount of up to $3,979,877 to Investor #1. The initial closing in the aggregate principal amount of
$650,000 occurred on August 14, 2015. An additional 11 payments were made in the total amount of $2,434,143 through December 31,
2015. The August 2015 Debentures bear interest at the rate of 10% per year. During the first quarter of 2016, an additional approximately
$895,000 was funded.
On
August 20, 2015, the Company also entered into a Securities Purchase Agreement with Investor #2 in the aggregate principal amount
of up to $1,500,000 (collectively the “August 2015 Debentures”), which was amended on September 19, 2015, to increase
the principal by an additional $200,000.
The
August 2015 Debentures contain the following significant terms:
The
debentures all mature in one year from the date of each individual closing.
All
amounts are convertible at any time, in whole or in part, at the option of the holders into shares of the Company’s common
stock at a fixed conversion price. The conversion price is the lower of (a) $0.75, or (b) a 49% discount to the lowest daily VWAP
(as reported by Bloomberg) of the Common Stock during the 30 trading days prior to the conversion date. The Fixed Conversion Price
is subject to adjustment for stock splits, combinations or similar events. If the Company makes any subsequent equity sales (subject
to certain exceptions), under which an effective price per share is lower than the Fixed Conversion Price, then the conversion
price will be reset to equal such price. The Company may prepay the Debentures in cash, prompting a 30% premium or, subject to
certain conditions, in shares of common stock valued at 51% of the lowest volume weighted average price of the common stock of
the Company for the 30 prior trading days. The premium will be recognized at such time as the Company may choose to prepay the
Debentures.
In
connection with each of the purchase agreements, the Company entered into a registration rights agreement with the respective
Investors pursuant to which the Company agreed to file a registration statement for the resale of the shares of common stock issuable
upon conversion of, or payable as principal and interest on, the respective debentures, within 45 days of the initial closing
date under each agreement, and to have such registration statements declared effective within 120 days of the initial closing
dates of each purchase agreement. The registration statement was deemed effective on December 15, 2015.
The
conversion feature of the August 2015 Debenture meets the definition of a derivative and due to the reset provision to occur upon
subsequent sales of securities at a price lower than the fixed conversion price, requires bifurcation and is accounted for as
a derivative liability. The derivatives related to all closings on the August 2015 debentures were initially recognized at estimated
fair values of approximately $11,205,000 and created a discount on the Debentures that will be amortized over the life of the
Debentures using the effective interest rate method. The fair value of the embedded derivative is measured and recognized at fair
value each subsequent reporting period and the changes in fair value are recognized in the Statement of Comprehensive Income (Loss)
as Change in fair value of derivative liability. For the year ended December 31, 2014, and the interim periods through September
30, 2015, the Company estimated the fair value of the conversion feature derivatives embedded in the convertible debentures based
on weighted probabilities of assumptions used in the Black Scholes pricing model. The key valuation assumptions used consists,
in part, of the price of the Company’s common stock, ranging from $8.81 down to $0.05; a risk free interest rate ranging
from 0.41% to 0.12% and expected volatility of the Company’s common stock, ranging from 196.78% to 106.38%, and the various
estimated reset exercise prices weighted by probability.
As
of December 31, 2015, and for new issuances of convertible debentures during the fourth quarter of fiscal 2015, the Company estimated
the fair value of the conversion feature derivatives embedded in the convertible debentures based on a Monte Carlo Simulation
model (“MCS”). The MCS model was used to simulate the stock price of the Company from the valuation date through to
the maturity date of the related debenture and to better estimate the fair value of the derivative liability due to the complex
nature of the convertible debentures and embedded instruments. Management believes that the use of the MCS model compared to the
black Scholes model as previously used would provide a better estimate of the fair value of these instruments. Beginning in the
fourth quarter of 2015, using the MCS model, the Company valued these embedded derivatives using a “with-and-without method,”
where the value of the Convertible Debentures including the embedded derivatives, is defined as the “with”, and the
value of the Convertible Debentures excluding the embedded derivatives, is defined as the “without.” This method estimates
the value of the embedded derivatives by observing the difference between the value of the Convertible Debentures with the embedded
derivatives and the value of the Convertible Debentures without the embedded derivatives. The Company believes the “with-and-without
method” results in a measurement that is more representative of the fair value of the embedded derivatives.
For
each simulation path, the Company used the Geometric Brownian Motion (“GBM”) model to determine future stock prices
at the maturity date. The inputs utilized in the application of the GBM model included a starting stock price ranging from $0.03
to $0.10, an expected term of each debenture remaining from the valuation date to maturity ranging from .24 years to 1.04 years,
an estimated volatility of ranging from 193% to 219%, and a risk-free rate ranging from .20% to .70%. See Note 2 Fair value of
financial instruments for additional information on the fair value and gains or losses on the embedded derivative.
For
the nine months ended September 30, 2016, the Company estimated the fair value of the conversion feature derivatives embedded
in the convertible debentures based on an internally calculated adjustment to the MCS valuation determined at December 31, 2015.
This adjustment took into consideration the changes in the assumptions, such as market value and expected volatility of the Company’s
common stock, and the discount rate used in the December 31, 2015 valuation as compared to September 30, 2016. The valuation also
took into consideration the term in the debentures which limits the amounts converted to not result in the investor owning more
than 4.99% of the outstanding common stock of the Company, after giving effect to the converted shares. The Company believes this
methodology results in a reasonable fair value of the embedded derivatives for the interim period.
Entry
into Security Agreement
In
connection with entry into the August 20 Purchase Agreement and August 14 Purchase Agreement, the Investors and the Company entered
into a Security Agreement, dated August 21, 2015, securing the amounts underlying the August 14 Debentures and the August 20 Debentures.
The Security Agreement grants a security interest in all assets and personal property of the Company, subject to certain excluded
real property assets. The security interests under the Security Agreement terminated following the date that the registration
statement registering the shares underlying the Convertible Debentures was declared effective, which occurred on December 15,
2015.
July
2015 Debenture
On
July 10, 2015, another accredited Investor and affiliate of the Investor #1 (the “July 2015 Investor”) purchased a
separate Convertible Debenture (the “July 2015 Debenture”) in the aggregate principal amount of $500,000, that closed
in five weekly tranches between July 10 and August 15, 2015. The July 2015 Debenture is in substantially the same form as the
August 14 Debentures, and does not include issuance of warrants. As such, the conversion feature was also determined to require
bifurcation and derivative accounting. All amounts related to the July 2015 derivative liability are included in amounts disclosed
above for the August 2015 debentures.
On
October 14, 2015, Investor #1 assigned the right to purchase August 2015 Debentures in the principal amount of $100,000 to the
July 2015 Investor and the July 2015 Investor purchased such August 2015 Debentures on the same day. The outstanding balance of
these Debentures as of September 30, 2016 were included in the Exchange Agreement, discussed below in connection with the September
30, 2016 financing.
October
2015 Debentures
On
October 14, 2015, the Company issued seven debentures in the aggregate of $2,000,000 to a service provider (the “October
2015 Investor”) as consideration for services previously rendered to the Company on the same terms as the August 14 Debentures
and August 14 Purchase Agreement (the “October 2015 Debentures” and “October 2015 Purchase Agreement”,
respectively) except that the October 2015 Purchase Agreement does not provide for registration rights to the October 2015 Investor
with regard to the shares underlying the October 2015 Debentures. The service provider has agreed with the Company not to convert
the October 2015 Debentures for any amount in excess of fees payable for services previously rendered to the Company at the time
of conversion. To the extent that the sale of shares underlying the October 2015 Debentures do not satisfy outstanding amounts
payable to the service provider, such amounts will remain payable to the service provider by the Company. In the nine months ending
September 30, 2016, funding closed on $525,000 of the October 2015 debentures. The outstanding balance of this debenture as of
September 30, 2016 was included in the Exchange Agreement, discussed below in connection with the September 30, 2016 financing.
December
28, 2015 Amendment and Restriction Agreement
On
December 28, 2015, the Company, Investor #1 (the “August 14 Investor”), and Investor #2 (the “August 20 Investor”)
entered into a Debenture Amendment and Restriction Agreement (the “Agreement”), pursuant to which (1) the August 14
Investor agreed to be restricted from converting any of its convertible debentures into common stock until February 21, 2016,
subject to certain limitations set forth below (the “Restriction”) and (2) the August 14 Investor agreed to assign,
as of the effective date of the Agreement approximately $390,000 of its convertible debentures to the August 20 Investor in exchange
for the amount of principal outstanding under such debenture plus a premium in cash from the August 20 Investor (the “Assigned
Debentures”). The accrued and unpaid interest under the Assigned Debentures remained payable by the Company to the August
14 Investor.
The
Investor #1 also agreed to amend the terms of each of its debentures (other than the debentures that were assigned) such that
the debentures are convertible at a 40% discount to the lowest trading price of the Company’s common stock during the 30
consecutive prior trading days rather than at a 49% discount to the lowest ‘volume weighted-average price’ during
the 30 consecutive prior trading days. This was not considered to be a modification of the terms of the conversion feature, requiring
evaluation of the debenture to determine if it was modified or extinguished, as the conversion feature is separately accounted
for as a derivative, and is outside of the scope of the guidance on debt modifications. The change in the conversion price will
be reflected in its fair value under derivative accounting. The outstanding balance of these debentures as of September 30, 2016
was included in the Exchange Agreement, discussed below in connection with the September 30, 2016 financing.
As
consideration for entering into the Agreement, the August 14 Investor was issued a promissory note from the Company in the principal
amount of $700,000 (the “Promissory Note”). The Promissory Note has a term of ten months, accrues interest at a rate
of 10% per annum, and outstanding principal and accrued interest under the Promissory Note may be pre-paid at any time by the
Company without penalty. The Promissory Note is not convertible other than in an event of default, in which case it is convertible
on the terms of the other debentures held by the August 14 Investor. This conversion feature was considered to be a contingent
conversion feature, and therefore the conversion feature would not be bifurcated and accounted for as a derivative, as are the
conversion features of all other debentures, until such time as and if the Company is in an event of default. The Promissory Note
is being accounted for as a finance expense of the December 28, 2015 transaction, similar to a debt discount, and will be amortized
to financing expense over the ten month life of the note (Note 8). The outstanding balance of this promissory note as of September
30, 2016 was included in the Exchange Agreement, discussed below in connection with the September 30, 2016 financing.
The
August 20 Investor also acquired from the August 14 Investor an additional $650,000 of the convertible debentures held by the
August 14 Investor (1) upon the declaration of effectiveness of a post-effective amendment (the “POSAM”) to the Company’s
Registration Statement on Form S-1 originally filed by the Company on October 16, 2015 and declared effective by the Securities
and Exchange Commission on December 15, 2015 (the “Registration Statement”) reflecting the terms of the Agreement,
or (2) at the option of the August 20 Investor (the “Option”), at an earlier time. The POSAM was declared effective
on February 3, 2016.
At
March 31, 2016, the Company had not paid the principal due of $9,600 on a convertible debenture which was due on March 27, 2016.
The Company was in default and obtained a waiver from the lender on May 11, 2016 waiving all rights relating to the nonpayment
and extending the maturity date of the convertible debenture to August 1, 2016. In the same waiver agreement, the terms of five
additional convertible debentures with maturity dates in May and June of 2016 totaling $122,084 were also extended to a maturity
date of August 1, 2016.
At
June 30, 2016, the Company had not paid the total principal due of $225,700 on convertible debentures which was due on July 10,
2016. The Company was in default and obtained a waiver from the lender on August 3, 2016 waiving all rights relating to the nonpayment
and extending the maturity date of the convertible debenture to October 31, 2016. In the same waiver agreement, the terms of thirteen
additional convertible debentures with maturity dates in July and August of 2016 totaling approximately $1,260,000 were also extended
to a maturity date of October 31, 2016. (Note 12) Approximately, $1,115,000 of these principal balances were included in the Exchange
Agreement, discussed below in connection with the September 30, 2016 financing.
At
September 30, 2016, the Company was in default on all the convertible debentures with Investor #2 as to sufficient common shares
reserved for the conversion and obtained a waiver from the lender on May 11, 2016 waiving all default terms. In the same waiver
agreement, the terms of fifteen additional convertible debentures with maturity dates in October through December of 2016 totaling
approximately $2,606,000 were also extended to a maturity date of December 31, 2016.
February
10, 2016 Financing
On
February 10, 2016, the Company entered into a Note Purchase Agreement (the “Purchase Agreement”) with Investor #2,
pursuant to which the Company agreed to sell, and the Investor agreed to purchase, a promissory note (the “Note”)
in the aggregate principal amount of $275,000. The closing occurred on February 11, 2016.
The
Investor deducted a commitment fee in the amount of $25,000 at the closing. The Note bears interest at the rate of 10% per year
and matures on October 31, 2016. The Company may prepay all or any part of the outstanding balance of the Note at any time without
penalty. In the event that the Company or any of its subsidiaries becomes subject to bankruptcy, insolvency, liquidation, or similar
proceedings or takes certain related corporate actions, all outstanding principal and accrued interest under the Note will immediately
and automatically become due and payable. In addition, the Note identifies certain other events of default, the occurrence of
which would entitle the Investor to declare the outstanding principal and accrued interest immediately due and payable or to convert
the Note, in whole or in part, into shares of the Company’s common stock at a conversion price that is the lower of (a)
$0.75, or (b) a 51% discount to the lowest daily volume weighted average price of the Company’s common stock during the
20 trading days prior to the conversion date.
This
conversion feature was considered to be a contingent conversion feature, and therefore the conversion feature would not be bifurcated
and accounted for as a derivative, as are the conversion features of all other debentures, until such time as and if the Company
is in an event of default. The balance of this note is included with Notes Payable on the accompanying condensed consolidated
Balance Sheet (Note 8).
February
18, 2016 Financing
On
February 18, 2016, the Company entered into a securities purchase agreement (the “Purchase Agreement”) with an Investor
#1 pursuant to which the Company agreed to sell, and the Investor agreed to purchase, convertible debentures (the “Debentures”)
in the aggregate principal amount of $420,000, in two tranches.
The
initial closing in the aggregate principal amount of $210,000 occurred on February 18, 2016. The second closing in the amount
of $210,000 occurred on March 18, 2016 ($125,000) and March 22, 2016 ($85,000). The Debentures bear interest at the rate of 10%
per year and mature after one year and are subject to a financing fee of 5%.
Each
of the Debentures are convertible at the option of the holders into shares of the common stock of the Company at a conversion
price that is lower of (a) $0.75, or (b) a 40% discount to the lowest traded price of the common stock of the Company during the
30 trading days prior to the conversion date. The Company may prepay the Debentures in cash, prompting a 30% premium.
The
conversion feature of the Debentures meets the definition of a derivative and due to the reset provision to occur upon subsequent
sales of securities at a price lower than the fixed conversion price, requires bifurcation and is accounted for as a derivative
liability.
March
15, 2016 Financing
The
Company entered into a Note Purchase Agreement, effective as of March 14, 2016 (the “Effective Date”), with an investor
(the “Investor #3” or “March 15 Investor”) pursuant to which the March 15 Investor purchased and the Company
issued and sold a promissory note in the original principal amount of $140,000 (the “First Promissory Note”), which
matures on September 14, 2016. Upon satisfaction of certain conditions set forth in the Note Purchase Agreement, the Company will
issue and sell a second promissory note in the original principal amount of $137,500 (the “Second Promissory Note”).
Each Promissory Note matures six (6) months after the date of its issuance. The First Promissory Note carries an original issue
discount of $12,500 (the “First Promissory Note OID”). In addition, Company agreed to pay $5,000 towards Investor
#3’s legal fees incurred in connection with the purchase and sale of the First Promissory Note and the Second Promissory
Note. The purchase price of the First Promissory Note was $125,000, computed as follows: $140,000 initial principal balance, less
the First Promissory Note OID, and less legal fees. The First Promissory Note and/or the Second Promissory Note may be prepaid
at any time by the Company in the sole discretion of the Company at a 25% premium to the outstanding balance under the applicable
Promissory Note.
On
or about April 20, 2016 it was mutually determined by the parties involved that the median daily dollar volumes requirement of
the Mandatory Second Promissory Note Conditions was not met and the Second Promissory Note would not be issued.
In
the event that the First Promissory Note is not paid in full on or before maturity by the Company, then the March 15 Investor
shall have the right at any time thereafter until such time as the First Promissory Note is paid in full, at the March 15 Investor’s
election, to convert (each instance of conversion being a “Conversion”) all or any part of the outstanding balance
into shares (“Conversion Shares”) of fully paid and non-assessable Common Stock of the Company as per the following
conversion formula: the number of Conversion Shares equals the amount being converted divided by 50% multiplied by the lowest
daily volume weighted average price of the Common Stock in the twenty (20) Trading Days immediately preceding the applicable Conversion.
At any time and from time to time after the March 15 Investor becoming aware of the occurrence of any event of default, the March
15 Investor may accelerate the First Promissory Note by written notice to the Company, with the outstanding balance of the respective
Note becoming immediately due and payable in cash at 125% of the outstanding balance.
This
conversion feature was considered to be a contingent conversion feature, and therefore the conversion feature would not be bifurcated
and accounted for as a derivative, as are the conversion features of all other debentures, until such time as and if the Company
is in an event of default. The balance of the First Promissory Note was included with Notes Payable on the condensed consolidated
Balance Sheet as of June 30, 2016. (Note 8)
On
September 22, 2016, the Company received notice of an Event of Default and Acceleration (the “Notice Letter “) in
connection with the promissory note (the “Note”), dated March 14, 2016. Pursuant to the Notice Letter, (1) beginning
on September 14, 2016, the maturity date of the Note, the Note began to accrue interest at a default rate of 22% per annum (the
“ Default Rate Adjustment “), (2) the noteholder declared all unpaid principal, accrued interest and other amounts
due and payable at 125% of the outstanding balance of the Note (the “ Mandatory Default Amount “), and (3) the noteholder
declared the outstanding balance of the Note immediately due and payable (the “ Acceleration Payment “). As the Note
has been placed in default, the Note is now convertible at the holder’s option, and is presented in Convertible Debentures
balance on the accompanying condensed consolidated balance sheet, as of September 30, 2016.
As a result
of the application of the Mandatory Default Amount formula, the outstanding balance of the Note increased to $184,022 from $147,217.
(See Item 1A. Risk Factors elsewhere in this document)
As
a result of the effect of the Notice Letter, other of the Company’s lenders could issue similar notices of events of default
or acceleration or penalties due to the Company’s Event of Default set forth in the Notice Letter.
April
2016 Financing
On
April 13, 2016, the Company entered into a note purchase agreement with Investor #2 pursuant to which the Company agreed to sell,
and Investor #2 agreed to purchase, a convertible promissory note (the “Note”) in the aggregate principal amount of
$225,000.
The
Note bears interest at the rate of 5% per year and matures on July 13, 2016. The Note is convertible at any time, in whole or
in part, at the option of the holders into shares of the common stock of the Company at a conversion price that is the lower of
(a) $0.75, or (b) a 49% discount to the lowest traded price of the common stock of the Company during the 20 trading days prior
to the conversion date. The Company may prepay the Note in cash, prompting a 30% premium.
The
Company will, within thirty (30) days, grant a security interest to the Investor and its affiliates over the Company’s assets,
including its stock ownership in its subsidiary, ESWD I, LLC (but not the assets of ESWD I, LLC). Furthermore, in connection with
the next $1.5 million of equity capital raised by the Company, the Company shall use one third of such funds to make principal
repayment of amounts owed to the Investor, plus a redemption premium of 30% of such amounts.
May
2016 Financings
The
Company received an additional $100,000 through the issuance of two convertible debentures of $50,000 each, on May 13, 2016 and
May 20, 2016. The Notes bears interest at the rate of 10% per year and mature on July 13, 2016 and July 20, 2016, respectively.
The Notes are convertible at any time, in whole or in part, at the option of the holders into shares of the common stock of the
Company at a conversion price that is the lower of (a) $0.75, or (b) a 40% discount to the lowest traded price of the common stock
of the Company during the 20 trading days prior to the conversion date. The remaining terms of the debentures are the same as
all other convertible debentures, and have also been determined to require derivative accounting. The Company may prepay the Note
in cash, prompting a 30% premium.
June
22, 2016 Financing
Entry
into Securities Purchase Agreement and Equity Purchase Agreement
On
June 22, 2016, the Company entered into a securities purchase agreement with Investor #1 pursuant to which the Company agreed
to sell, and Investor #1 agreed to purchase, convertible debentures in the aggregate principal amount of $240,000, in two tranches.
The initial closing in the aggregate principal amount of $120,000 occurred on June 22, 2016, and the second closing in the aggregate
principal amount of $120,000 was scheduled to occur on July 8, 2016. As of the date these consolidated financial statements were
issued, the second closing has not occurred.
The
Convertible Commitment Debenture and the Convertible Bridge Debenture accrue interest at a rate of 10% per annum. Each of the
debentures are convertible at any time, in whole or in part, at the option of the holders into shares of the Company’s common
stock at a conversion price that is the lower of (a) $0.75, or (b) a 40% discount to the lowest traded price of the Company’s
common stock during the 30 trading days prior to the conversion date.
The
Company and the Investor also entered into an Equity Purchase Agreement (the “Equity Purchase Agreement”, “EQP”),
pursuant to which, following the filing and declaration of effectiveness of a registration statement by the Company (the “Registration
Statement”) and the availability of authorized stock, the Company may “put” its shares of common stock to the
Investor at a 20% discount to lowest traded price over the prior 10 trading days for up to the higher of $50,000 or 300% of the
average daily trading volume over the previous 10 trading days, for up to an aggregate of $5,000,000 in aggregates “puts”.
In
connection with the Equity Purchase Agreement, the Company entered into a registration rights agreement (the “Registration
Rights Agreement”) with the Investors, pursuant to which the Company agreed to file the Registration Statement for the resale
of shares of common stock put to the Investor under the Equity Purchase Agreement, within 30 days of the closing date of the Equity
Purchase Agreement, and to have such registration statements become effective within 60 days of the closing date of the Purchase
Agreement.
The
Investor shall have a right of first refusal to participate in future equity financings of the Company on the same terms as any
new investors for a period of twelve months from the closing of the last Convertible Bridge Debenture. The Company also shall
not enter into other variable rate transactions other than with pre-existing investors, so long as the Investors hold more than
$2,000,000 in debentures of the Company, including pre-existing debentures. The Company also may not enter into any equity line
of credit with any other investor during the term of the Equity Purchase Agreement, which expires on December 22, 2017.
No
amounts have been funded under the Equity Purchase Agreement to date. The Company and the Investor have entered into a verbal
agreement to terminate the EQP, and the parties are working on finalized a formal termination agreement.
To
induce the Investor to purchase the Equity Purchase Agreement (described below), the Company issued an additional $100,000 convertible
debenture, on the same terms of the Convertible Bridge Debentures to the Investor (the “Convertible Commitment Debenture”).
The Company will not receive any cash for the Convertible Commitment Debentures.
The
Company entered into a Convertible Debenture with the above Investor for an additional $10,000 on June 14, 2016. The convertible
debenture is due on June 14, 2017 and accrues interest at a rate of 10% per annum. The debenture is convertible at any time, in
whole or in part, at the option of the holder into shares of the Company’s common stock at a conversion price that is the
lower of (a) $0.75, or (b) a 40% discount to the lowest traded price of the Company’s common stock during the 30 trading
days prior to the conversion date.
June
30, 2016 Financing
On
June 30, 2016, the Company entered into a securities purchase agreement with Investor #1 pursuant to which two wholly-owned subsidiaries
of the Company, EWSD I, LLC (“EWSD I”) and Pueblo Agriculture Supply and Equipment, LLC (“Pueblo”, and
together with EWSD I, the ‘Subsidiaries”) agreed to jointly sell, and the Investors agreed to purchase, convertible
debentures (the “Convertible Debentures”) in the aggregate principal amount of $1,500,000, in six tranches over the
following 90-day period. The Company guaranteed the issuance of the Convertible Debentures and, upon notice from the Investor,
the Convertible Debentures are convertible in to the Common Stock of the Company. The initial closing in the aggregate principal
amount of $125,000 occurred on June 30, 2016, with additional closings of approximately $1,266,000, net, received through September
30, 2016. The Company agreed to pay an aggregate of the Investor’s legal fees of $40,000 ($10,000 per tranche) in connection
with the closing of each of tranches three through six. The June 30, 2016 financing was subsequently assigned to a new investor
(Note 12).
The
Company and the Subsidiaries also entered into a Security Agreement (the “Security Agreement”) and Parent Guarantee
(the “Guarantee”), securing a lien for the Investor on EWSD I’s assets on a secondary basis to the primary lien
holder and securing a lien for the Investor on Pueblo’s assets on a primary basis and with the Company guaranteeing all
obligations of EWSD I and Pueblo to the Investor. Pursuant to the Security Agreement, the Company agreed to, within 14 calendar
days, negotiate and enter into an Intercreditor Agreement among the other secured creditors of the Company and EWSD I. The Company
subsequently entered into a Subordination Agreement, which replaced the Intercreditor Agreement, on August 23, 2016.
The
Convertible Debentures accrue interest at a rate of 10% per annum. Each of the debentures are convertible at any time into shares
of common stock of the Company, in whole or in part, at the option of the holders into shares of the Company’s common stock
at a conversion price that is the lower of (a) $0.75, or (b) a 40% discount to the lowest traded price of the Company’s
common stock during the 30 trading days prior to the conversion date.
The
Investor shall have a right of first refusal to participate in future equity financings of the Company on the same terms as any
new investors for a period of twelve months from the closing of the last Convertible Debenture. The Company and the Subsidiaries
also shall not enter into other variable rate transactions other than with pre-existing investors, so long as the Investors hold
more than $2,000,000 in debentures of the Company, including pre-existing debentures.
The
conversion feature of the Debentures meets the definition of a derivative and due to the reset provision to occur upon subsequent
sales of securities at a price lower than the fixed conversion price, requires bifurcation and is accounted for as a derivative
liability.
The
derivatives related to the above convertible debentures were initially recognized at their estimated fair values as described
previously, which amounted to approximately $4,932,000 in the nine months ended September 30, 2016 and $1,885,000 for the same
period of 2015. The resulting debt discount is amortized as over the life of the convertible debenture, or until conversion if
earlier, which resulted in amortization expense of $2,086,000 and $6,050,000, for the nine months ended September 30, 2016 and
2015, respectively. Additionally, the current year closings to convertible debentures resulted in the calculated fair value of
the debt being greater than the face amounts of the debt by approximately $2,627,000, with this excess amount being immediately
expensed as financing costs. Financing costs for the nine months ended September 30, 2015, were approximately $3,061,000. The
fair value of the embedded derivative consisting of all related convertible debentures is measured and recognized at fair value
each subsequent reporting period and the changes in fair value for all derivatives for nine months ended September 30, 2016 and
2015, resulted in a gain of approximately $9,320,000 and $3,053,000, respectively, which are recognized in the condensed consolidated
Statement of Comprehensive Income (Loss) as Change in fair value of derivative liability.
Letter
agreements
On
August 3, 2016, Notis Global, Inc. executed letter agreements with each of the Company’s two largest investors (the “First
Investor” and the “Second Investor”, respectively).
First
Investor Letter Agreement:
Pursuant
to the letter agreement with the First Investor (the “First Investor Letter Agreement”), the First Investor agreed
to waive, until October 31, 2016, any defaults relating to the requirement to reserve shares of common stock in excess of shares
presently held in the First Investor’s reserve with the Company’s transfer agent, as required pursuant to all securities
purchase agreements between the Company and the First Investor, debentures issued by the Company to the First Investor and promissory
notes issued by the Company to the First Investor (collectively, the “First Investor Credit Agreements”). The First
Investor Letter Agreement also extended the maturity dates of certain debentures issued to the First Investor dated July 10, 2015,
August 24, 2015, August 28, 2015, May 13, 2016 and May 20, 2016 from their original maturity dates (occurring between July 10,
2016 and August 28, 2016) to October 31, 2016.
Additionally,
the parties to the First Investor Letter Agreement agreed that any payments made to the First Investor pursuant to Section 4.16
(Profit Sharing) of that certain Stock Purchase Agreement among the First Investor, the Company, EWSD I LLC, a subsidiary of the
Company (“EWSD”), and Pueblo Agriculture Supply and Equipment, LLC, a subsidiary of the Company (“PASE”)
dated as of June 30, 2016 (the “EWSD SPA”) (Note 7), shall be applied as repayments of any redemption premium, accrued
and unpaid interest, and outstanding principal owed to the First Investor under the First Investor Credit Agreements, and that
the provisions of Section 4.16 of the EWSD SPA are only applicable until the First Investor has been repaid required principal,
interest, fees and premiums under the EWSD SPA and any related debentures issued by the Company pursuant thereto.
Second
Investor Letter Agreement:
Pursuant
to the letter agreement with the Second Investor (the “Second Investor Letter Agreement”), the Second Investor (on
behalf of itself and its affiliates) also agreed to waive, until October 31, 2016, any defaults relating to the requirement to
reserve shares of common stock in excess of shares presently held in the Second Investor’s reserve with the Company’s
transfer agent, as required pursuant to all securities purchase agreements between the Company and the Second Investor, debentures
issued by the Company to the Second Investor and promissory notes issued by the Company to the Second Investor (collectively,
the “Second Investor Credit Agreements”). The Second Investor Letter Agreement also extended the maturity dates of
certain debentures issued (or assigned) to the Second Investor (or its affiliates) dated August 24, 2015, March 27, 2015, May
7, 2015, May 15, 2015, May 22, 2015 and August 14, 2015 from their original maturity dates (occurring between July 10, 2016 and
August 24, 2016) to October 31, 2016.
Pursuant
to the Second Investor Letter Agreement, the Company agreed to pay the Second Investor within five (5) days of the end of each
fiscal quarter, (i) 20% of all distributed cash flow from PASE and EWSD to the Company after taking into account amounts owed
to First Investor pursuant to Section 4.16 (Profit Sharing) of the EWSD SPA, and (ii) 20% of any money raised at either EWSD or
PASE that is distributable or paid to the Company. Such payments will be credited as repayments of amounts owed to the Second
Investor under all securities purchase agreements between the Company and the Second Investor, debentures issued by the Company
to the Second Investor and promissory notes issued by the Company to the Second Investor (collectively, the “Second Investor
Credit Agreements”) including towards any redemption, premium accrued and unpaid interest, and outstanding principal thereunder,
and such payments shall only occur until the Second Investor has been repaid the sum of $500,000 of principal under the Second
Investor Credit Agreements, plus a 30% premium on such amount.
Related
Party Financing
One
of the directors on the Company’s Board entered into three separate subordinated convertible promissory notes convertible
at $0.01 with the Company on March 4, 2016, March 10, 2016 and March 15, 2016, respectively, each in the principal amount of $25,000,
for a total of $75,000. Also on March 15, 2016, another of the Company’s directors entered into a subordinated convertible
promissory note convertible at $0.01 with the Company in the principal amount of $25,000, and two other of the Company’s
directors each entered into a subordinated convertible promissory note convertible at $0.01 with the Company in the principal
amount of $2,500. All of the foregoing convertible promissory notes have three year terms and an interest rate of 8% per annum.
The debentures were evaluated to determine if the conversion feature fell within the guidance for derivative accounting, and as
the debentures are convertible at a fixed conversion price, and do not include a the reset provision to occur upon subsequent
sales of securities at a price lower than the fixed conversion price, the Company concluded the conversion feature did not qualify
as a derivative.
In
connection with their funding of the Notes (collectively the “Notes”), the directors each receive a warrant, exercisable
for a period of three (3) years from the date of Notes, to purchase an amount of Company Common Stock equal to 50% of the
principal sum under each of the director notes, at an exercise price equal to 200% of the applicable Conversion Price. The exercise
price of the warrants is $0.02. The warrants were determined to have a fair value of $42,000, calculated with the Black Sholes
Merton model, with the following key valuation assumptions: estimated term of three years, annual risk-free rate of 0.93%, and
annualized expected volatility of 172%.
Conversions
During
the nine months ended September 30, 2016 and 2015, respectively, approximately $2,148,000 and $6,130,000 (plus $150,000 related
to directors’ debentures) of principal and approximately $20,000 and $49,000, of accrued interest were converted into approximately
6,838,208,000 and 67,475,000 of the Company’s common shares at an average price of $0.0003 and $0.09, based on 51% of the
calculated VWAP. Upon conversion, the derivative fair value for the amounts converted were re-measured through the date of conversion,
with the conversion date fair value reclassified to equity, amounting to approximately $3,566,000 and $4,519,000 in the nine months
ended September 30, 2016 and 2015, respectively. As a result of the conversions, the resulting decrease of fair value of approximately
$1,318,000 and $1,719,000 of the related debt discount was recognized on the Condensed Consolidated Statement of Comprehensive
Income (Loss).
Warrants
The
warrants issued under all debentures, and other agreements, are summarized below:
Date issued
|
|
Number of
warrants
|
|
|
Exercise
price
|
|
|
December 18,
2015
re-price
|
|
|
Fair
Value at
issuance
|
|
July 2014 Modified Debentures
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
January 30, 2015
|
|
|
40,552
|
|
|
|
4.93
|
|
|
|
.06
|
|
|
$
|
159,601
|
|
February 26, 2015
|
|
|
45,537
|
|
|
|
2.20
|
|
|
|
.06
|
|
|
|
79,904
|
|
March 13, 2015
|
|
|
21,151
|
|
|
|
2.36
|
|
|
|
.06
|
|
|
|
39,965
|
|
March 16, 2015
|
|
|
10,575
|
|
|
|
2.36
|
|
|
|
.06
|
|
|
|
19,981
|
|
March 20, 2015
|
|
|
41,946
|
|
|
|
1.79
|
|
|
|
.06
|
|
|
|
59,942
|
|
March 27, 2015
|
|
|
75,758
|
|
|
|
1.98
|
|
|
|
.06
|
|
|
|
119,888
|
|
April 2, 2015
|
|
|
60,386
|
|
|
|
1.66
|
|
|
|
.06
|
|
|
|
74,025
|
|
April 2, 2015
|
|
|
30,193
|
|
|
|
1.66
|
|
|
|
.06
|
|
|
|
37,012
|
|
April 10, 2015
|
|
|
107,914
|
|
|
|
1.39
|
|
|
|
.06
|
|
|
|
112,460
|
|
April 17, 2015
|
|
|
41,667
|
|
|
|
1.20
|
|
|
|
.06
|
|
|
|
37,680
|
|
April 24, 2015
|
|
|
127,119
|
|
|
|
1.18
|
|
|
|
.06
|
|
|
|
112,635
|
|
April 24, 2015
|
|
|
21,186
|
|
|
|
1.18
|
|
|
|
.06
|
|
|
|
18,772
|
|
May 1, 2015
|
|
|
156,250
|
|
|
|
.96
|
|
|
|
.06
|
|
|
|
113,133
|
|
May 7, 2015
|
|
|
134,615
|
|
|
|
.78
|
|
|
|
.06
|
|
|
|
79,234
|
|
May 8, 2015
|
|
|
42,000
|
|
|
|
.75
|
|
|
|
.06
|
|
|
|
23,768
|
|
May 15, 2015
|
|
|
200,000
|
|
|
|
.75
|
|
|
|
.06
|
|
|
|
113,365
|
|
May 22, 2015
|
|
|
250,000
|
|
|
|
.60
|
|
|
|
.06
|
|
|
|
113,366
|
|
May 29, 2015
|
|
|
258,621
|
|
|
|
.58
|
|
|
|
.06
|
|
|
|
112,537
|
|
June 5, 2015
|
|
|
288,462
|
|
|
|
.52
|
|
|
|
.06
|
|
|
|
120,738
|
|
June 12, 2015
|
|
|
930,233
|
|
|
|
.43
|
|
|
|
.06
|
|
|
|
303,246
|
|
June 19, 2015
|
|
|
3,448,276
|
|
|
|
.29
|
|
|
|
.06
|
|
|
|
751,159
|
|
September 2014 Modified Debentures
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
January 28, 2015
|
|
|
18,038
|
|
|
|
5.54
|
|
|
|
.06
|
|
|
|
80,156
|
|
February 13, 2015
|
|
|
57,870
|
|
|
|
1.73
|
|
|
|
.06
|
|
|
|
96,689
|
|
April 2, 2015
|
|
|
181,159
|
|
|
|
1.66
|
|
|
|
.06
|
|
|
|
222,109
|
|
April 24, 2015
|
|
|
90,579
|
|
|
|
1.10
|
|
|
|
.06
|
|
|
|
80,548
|
|
May 15, 2015
|
|
|
200,000
|
|
|
|
.75
|
|
|
|
.06
|
|
|
|
113,365
|
|
Date issued
|
|
Number of
warrants
|
|
|
Exercise
price
|
|
|
December 18,
2015
re-price
|
|
|
Fair
Value at
issuance
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
June 12,
2015
|
|
|
1,744,186
|
|
|
|
.43
|
|
|
|
.06
|
|
|
|
570,248
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
August 2015 Debentures
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
August 24, 2015
|
|
|
6,666,667
|
|
|
|
.06
|
|
|
|
|
|
|
|
321,757
|
|
September 18, 2015
|
|
|
588,235
|
|
|
|
.17
|
|
|
|
|
|
|
|
82,804
|
|
October 28, 2015
|
|
|
4,166,667
|
|
|
|
.12
|
|
|
|
|
|
|
|
363,306
|
|
November 16, 2015
|
|
|
1,785,714
|
|
|
|
.07
|
|
|
|
|
|
|
|
92,798
|
|
November 23, 2015
|
|
|
2,083,333
|
|
|
|
.06
|
|
|
|
|
|
|
|
68,988
|
|
November 30,2015
|
|
|
2,500,000
|
|
|
|
.05
|
|
|
|
|
|
|
|
81,988
|
|
December 7, 2015
|
|
|
6,250,000
|
|
|
|
.02
|
|
|
|
|
|
|
|
163,382
|
|
December 17, 2015
|
|
|
10,000,000
|
|
|
|
.02
|
|
|
|
|
|
|
|
76,376
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Directors
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
January 5, 2015
|
|
|
129,305
|
|
|
|
.40
|
|
|
|
|
|
|
|
39,901
|
|
January 30, 2015
|
|
|
129,917
|
|
|
|
.40
|
|
|
|
|
|
|
|
39,916
|
|
February 2, 2015
|
|
|
237,778
|
|
|
|
.22
|
|
|
|
|
|
|
|
16,619
|
|
March 4, 2016
|
|
|
1,250,000
|
|
|
|
.02
|
|
|
|
|
|
|
|
10,000
|
|
March 10, 2016
|
|
|
1,250,000
|
|
|
|
.02
|
|
|
|
|
|
|
|
10,000
|
|
March 15, 2016
|
|
|
1,250,000
|
|
|
|
.02
|
|
|
|
|
|
|
|
10,000
|
|
March 15, 2016
|
|
|
1,250,000
|
|
|
|
.02
|
|
|
|
|
|
|
|
10,000
|
|
March 15, 2016
|
|
|
125,000
|
|
|
|
.02
|
|
|
|
|
|
|
|
1,000
|
|
March 15, 2016
|
|
|
125,000
|
|
|
|
.02
|
|
|
|
|
|
|
|
1,000
|
|
April 20, 2016
|
|
|
1,041,663
|
|
|
|
.02
|
|
|
|
|
|
|
|
4,000
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
June 8, 2016
|
|
|
5,000,000
|
|
|
|
.01
|
|
|
|
|
|
|
|
4,425
|
|
June 8, 2016
|
|
|
2,691,250
|
|
|
|
.01
|
|
|
|
|
|
|
|
2,381
|
|
June 8, 2016
|
|
|
1,500,000
|
|
|
|
.01
|
|
|
|
|
|
|
|
1,327
|
|
June 8, 2016
|
|
|
3,343,750
|
|
|
|
.01
|
|
|
|
|
|
|
|
2,959
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other Agreements
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 18, 2015
|
|
|
4,000,000
|
|
|
|
.50
|
|
|
|
|
|
|
|
76,000
|
|
April 13, 2016
|
|
|
500,000
|
|
|
|
.03
|
|
|
|
|
|
|
|
3,869
|
|
May 5, 2016
|
|
|
590,625
|
|
|
|
.01
|
|
|
|
|
|
|
|
3,477
|
|
June 8, 2016
|
|
|
2,678,571
|
|
|
|
.01
|
|
|
|
|
|
|
|
2,265
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
|
69,757,748
|
|
|
|
|
|
|
|
|
|
|
$
|
5,256,064
|
|
Effective
September 18, 2015, the holder of the September 2014 Debentures and the Company agreed to amend its September 2014 Warrants, to
reduce the exercise price of the warrants to purchase an aggregate of 2,291,832 shares of the Company’s common stock to
six cents per share. Additionally, the holder of the July 2014 Debentures and the Company agreed to amend its July 2014 Warrants,
to reduce the exercise price of the warrants to purchase an aggregate of 6,332,441 shares of Common Stock to six cents per share.
As a result of the amendment, the fair value of the warrants was remeasured as of September 18, 2015, for an additional fair value
of approximately $38,000 recognized as a financing expense. During the year ended December 31, 2015, approximately 2,292,000
warrants were exercised for cash proceeds of $137,510 at an average exercise price of $0.06.
There
were no warrants granted during the three months ended September 30, 2016.
During
the three and nine months ended September 30, 2016 and 2015, there were no warrants exercised.
The
Company adopted a sequencing policy that reclassifies contracts, with the exception of stock options, from equity to assets or
liabilities for those with the earliest inception date first. Any future issuance of securities, as well as period-end reevaluations,
will be evaluated as to reclassification as a liability under the sequencing policy of earliest inception date first until all
of the convertible debentures are either converted or settled.
For
warrants issued in 2015, the Company determined that the warrants were properly classified in equity as there is no cash settlement
provision and the warrants have a fixed exercise price and, therefore, result in an obligation to deliver a known number of shares.
The
Company reevaluated the warrants as of September 30, 2016 and determined that they did not have a sufficient number of authorized
and unissued shares to settle all existing commitments, and the fair value of the warrants for which there was insufficient authorized
shares, were reclassified out of equity to a liability. Under the sequencing policy, of the approximately 67,466,000 warrants
outstanding at September 30, 2016, it was determined there was not sufficient authorized shares for approximately 59,595,000 of
the outstanding warrants. The fair value of these warrants was re-measured on September 30, 2016 using the Black Scholes Merton
Model, with key valuation assumptions used that consist of the price of the Company’s stock on September 30, 2016, a risk
free interest rate based on the average yield of a 2 or 3 year Treasury note and expected volatility of the Company’s common
stock, resulting in the fair value for the Warrant liability of approximately $102,000. The resulting change in fair value of
approximately $96,000 and $(835,000) for the three and nine months ended September 30, 2016, respectively, was recognized as a
gain/(loss) in the Condensed consolidated statement of comprehensive income(loss).
NOTE
8 - NOTES PAYABLE
Notes
payable consists of:
|
|
September 30,
2016
|
|
|
December 31,
2015
|
|
Southwest Farms (Note 3)
|
|
$
|
3,608,852
|
|
|
$
|
3,645,163
|
|
East West Secured Development (Note 3)
|
|
|
512,727
|
|
|
|
675,093
|
|
Washington Property (Note 6)
|
|
|
—
|
|
|
|
208,605
|
|
Investor #2 (Note 7)
|
|
|
275,000
|
|
|
|
—
|
|
Investor #3
|
|
|
142,500
|
|
|
|
—
|
|
Investor #4
|
|
|
2,665,963
|
|
|
|
—
|
|
Financial Freedom, LLC
|
|
|
—
|
|
|
|
—
|
|
|
|
|
7,205,041
|
|
|
|
4,528,861
|
|
Less discounts
|
|
|
(803,025
|
)
|
|
|
—
|
|
Plus premium
|
|
|
—
|
|
|
|
16,667
|
|
|
|
|
|
|
|
|
|
|
|
|
|
6,402,016
|
|
|
|
4,545,528
|
|
Less current maturities
|
|
|
2,372,599
|
|
|
|
256,897
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
4,029,417
|
|
|
$
|
4,288,631
|
|
Maturities
on Notes Payable are as follows:
Years ending:
|
|
|
December 31, 2016
|
|
|
$
|
296,471
|
|
December 31, 2017
|
|
|
|
2,896,683
|
|
December 31, 2018
|
|
|
|
4,011,887
|
|
|
|
|
$
|
7,205,041
|
|
The
Company entered into a Securities Purchase Agreement dated May 20, 2016 (the “SPA”) with Investor #3, pursuant
to which it issued to the Investor a Convertible Promissory Note (the “Note”) in the principal amount of $1,242,500
that matures on July 20, 2017 and earns interest at the rate of 10% per annum. The Note carries an original issuance
discount of $112,500 and the Company agreed to pay $5,000 in legal fees for the Investor. In exchange for the Note, the Investor
(1) paid to the Company $125,000 less $6,250 in broker fees paid by the Company, and (2) issued to the Company eight
(8) secured promissory notes in the principal amount of $125,000 each (each, a “Investor Note” and collectively
the “Investor Notes”). This amount is included with Investment funds in schedule above.
The
Company must begin repaying principal and interest on funded portions of the Note beginning 180 days after the date of the Note,
and each month thereafter for a total period of 10 months, in fixed amounts of $124,250 per month. The Company has a right to
prepay the total outstanding balance of the Note at any time (so long as it is not in default under the Note) in cash equal to
125% of the outstanding balance of the Note. Furthermore, for a period of sixty days from the date of entry into the Note, a third
party has the right to prepay the outstanding balance of the Note in cash equal to 130% of the outstanding balance of the Note.
The
notes become convertible into commons shares of the Company’s stock upon an Event of Default, as set forth in the terms of the
SPA. The conversion price shall be 50% of the lowest closing bid price during the twenty trading days immediately preceding the
conversion. This conversion feature was considered to be a contingent conversion feature, and therefore the conversion feature
would not be bifurcated and accounted for as a derivative, until such time as and if the Company is in an event of default.
In
connection with any Event of Default by the Company, Investor #3 may accelerate the Note with the outstanding balance becoming
immediately due and payable in cash at 125% of the outstanding balance. Furthermore, Investor #3 may elect to increase the outstanding
balance by applying a 125% “default effect” (up to two applications for two defaults) without accelerating the outstanding
balance, in which event the outstanding balance shall be increased as of the date of the occurrence of the applicable event of
default. Furthermore, following the occurrence of an event of default interest shall accrue on the outstanding balance beginning
on the date the applicable event of default occurring at an interest rate equal to the lesser of 22% per annum or the maximum
rate permitted under applicable law.
In
connection with entry into the SPA, the Company agreed to reserve 300% of the shares into which the Note can be converted for
the Investor.
Investor
#3 may, with the Company’s consent, prepay, without penalty, all or any portion of the outstanding balance of the Investor
Notes at any time prior to the Investor Note Maturity Date. Notwithstanding the foregoing, beginning on the date that is 90 days
from the date of the issuance of the Note, and then on the 6-month anniversary of the date of entry into the Note and monthly
thereafter for a total of eight payments, Investor #3 shall be obligated to prepay one of the eight Investor Notes at each such
occurrence, if at the time of such occurrence: (a) no event of default under the Note has occurred; (b) the average
daily dollar volume of the Common Stock on its principal market for the twenty (20) trading days is greater than $55,000;
(c) the market capitalization of the Common Stock on the date of the occurrence is greater than $3,000,000; and (d) the
share reserve described below remains in place at the required thresholds.
The
Company also made extensive representations and warranties relating to the transaction.
To
date, no amounts have been received by the Company against the eight Investor Notes.
March 15
2016 Financing
As
detailed above (Note 7), on September 22, 2016, the Company received notice of an Event of Default and Acceleration (the “Notice
Letter”) in connection with another Note with Investor #3, dated March 14, 2016, in the original principal amount of $140,000.
This note was determined to have a contingent conversion feature, and as such was included with the notes payable balance upon
issuance. As the Note has been placed in default, the Note is now convertible at the holder’s option, and has been reclassed into
the Convertible Debentures balance on the accompanying condensed consolidated balance sheet, as of September 30, 2016.
April
6, 2016 Note Payable
On
April 6, 2016, the Company entered into a Promissory note for $85,000, which was issued with a $2,500 premium, and bears interest
at 0.0%. The proceeds were to be used by the Farm, to pay for water usage. Additionally, the Company issued 600,000 of the Company’s
restricted common stock to the holder. The shares were valued at the market value of the common shares of the Company on the date
of the issuance of the note. The payment terms called for $40,000 to be paid on or before April 21, 2016, $20,000 to be paid on
or before May 6, 2016, and the final $27,500 to also be paid on or before May 6, 2016. The Note also allowed for the extension
of the maturity date by 30 days, at the Company’s request, in exchange for an additional $2,500 payment. The note and the $2,500
extension payment were paid during July, 2016.
Entry
into Note Purchase Agreement, Exchange Agreement, and Security Agreement
On
September 30, 2016, the Company entered into a securities purchase agreement (the “Securities Purchase Agreement”)
with a new investor (“Investor #4”) pursuant to which two wholly-owned subsidiaries of the Company, EWSD and Pueblo
Agriculture Supply and Equipment, LLC (“Pueblo”, and together with EWSD, the “Subsidiaries”) agreed to
jointly sell, and the Investor agreed to purchase, an aggregate of up to $3,349,599 in subscription amount of convertible secured
promissory notes (plus the Investor Subscription Amount of $1,431,401, described below, which was tendered with the first tranche
of the Securities Purchase Agreement) (collectively, the “New Notes”) in seven tranches (each, a “Closing”).
Investor
#4’s commitment to purchase the New Notes may, at the option of Investor #4, be reduced by up to $700,000 for monies raised by
the Company or the Subsidiaries. The Investor Note Subscription Amount refers to $1,431,401 of 10% convertible notes of the Company
previously issued to the Company’s major investor (“First Investor”) pursuant to that certain Securities Purchase Agreement
dated on or about June 30, 2016 (the “July SPA”) (Note 7). The debentures issued pursuant to the July SPA were subsequently
assigned to the Investor and were tendered for cancellation to the Company for the Investor Subscription Amount portion of the
New Notes.
The
New Notes accrue interest at a rate of 5% per annum and are issued at a 40% discount to purchase price. Therefore, if each of
the seven tranches described below are fully funded, the Company would receive cash in the aggregate of $1,983,599 in exchange
for the issuance of New Notes with a face value of $3,349,599 in principal to be repaid to the Investor. The first New Note issued
in the first tranche under the Securities Purchase Agreement was for an original purchase price of $1,881,401 (representing the
Investor Note Subscription Amount of $1,431,401 plus $450,000 funded purchase price) and an original principal amount of $2,633,961.
The New Notes may be prepaid inclusive of interest of the greater of one year or the current amount of time that the New Note
has been outstanding.
The funding of New Notes under the Securities
Purchase Agreement are as follows: The first tranche of up to $539,306 plus the Investor Note Subscription Amount, the second tranche
of up to $100,000 being closed upon on or about October 1, 2016, the third tranche of up to $208,424 being closed upon on or about
October 17, 2016, the fourth tranche of up to $100,000 being closed upon on or about November 1, 2016, the fifth tranche of up
to $188,818 being closed upon on or about November 15, 2016, the sixth tranche of up to $182,051 being closed upon on or about
December 15, 2016, and the seventh tranche of up to $665,000, the closing of which is contingent upon, among other things, the
purchase of that certain parcel of land located at 212 39th Ln, Pueblo CO 81006 referred to as “Farm #2”, upon terms
and conditions that are satisfactory to the Investor and the assignment of a 20% ownership interest in that certain 320-acres of
agricultural land in Pueblo, Colorado (the “Farm”) and Farm #2 to the Investor. As of the date of this filing, the
new investor has funded approximately $1.9 million in cash for New Notes with the total face value of approximately $3.2 million,
excluding the Investor Note Subscription Amount.
Upon
retirement of the New Notes, the Company or its Subsidiaries or affiliates as applicable, shall assign twenty percent (20%) of
their respective ownership interest in the Farm and Farm #2 to the Investor. As the assignment is not triggered until all performance
obligations under this agreement are met, the twenty percent ownership interest is not due until a future contingent date, and
therefore there is no accounting recognition at this time.
The
Company and Ned Siegel, Jeffrey Goh, and Clinton Pyatt, each an executive officer of the Company or member of the Company’s
Board, shall enter into management contracts with the Company upon terms and subject to conditions that are reasonably acceptable
to the Investor.
Furthermore,
the Company shall pay to the Investor as partial repayment of the New Notes or other indebtedness at the end of each calendar
month:
(a)
Out of the first $1,000,000 in the aggregate of combined revenues received from all sources, including, without
limitation, any revenue from any legal settlement, judgment, or other legal proceeding (collectively, a “Legal Matter”),
received of the Company and all of its Subsidiaries net of any payments to an ‘outside farmer’ (collectively, the
“Combined Revenues”), 80% of the Combined Revenues, except to the extent the Combined Revenues are from a Legal Matter,
in which event, the percentage shall be 50% (collectively, the “Combined Net Revenues”).
(b)
Out of the second $1,000,000 in the aggregate of Combined Revenues, 70% of the Combined Net Revenues, except
to the extent the Combined Revenues are from a Legal Matter, in which event, the percentage shall be 50%.
(c)
Out of any Combined Revenues in excess of $2,000,000, 60% of the Combined Net Revenues, except to the
extent the Combined Revenues are from a Legal Matter, in which event, the percentage shall be 50%.
(d)
Upon full satisfaction of the New Notes, 60% of the Combined Net Revenues shall be used to redeem any
outstanding indebtedness owed to the Investor.
(e)
The foregoing amounts may, at the Investor’s option, be reduced to allow EWSD to meet its overhead
not to exceed $120,000 per month plus a maximum of $100,000 per month to the Company beginning January 15, 2017.
(f)
The Company shall be permitted to enter into one or more agreements with third parties to allocate
to such third parties up to no more than 20% of the Combined Net Revenues. Any such agreements shall reduce the percentage of
the Combined Net Revenues to be paid by the Companies to the Investor.
In
connection with the Securities Purchase Agreement, the Company shall pay Investor #4 an annual collateral management fee of $239,050,
which shall be due and payable in equal monthly installments of $19,921, commencing October 3, 2016 and continuing each successive
month until the New Notes have been satisfied in full. Upon an event of default, the Collateral Management Fee shall increase
to $478,100 per year until such event of default has been cured. The Collateral Management Fee is guaranteed for the first 12
months following the issuance of the New Notes.
The
Company agreed to use commercially reasonable efforts to amend the Subordination Agreement (referred to above) to reflect the
issuance of New Notes to the Investor within 14 days of the date of the Securities Purchase Agreement. The First Investor and
the Investor are affiliates of one another.
The
Company and the Subsidiaries also entered into an Exchange Agreement with Investor #1, pursuant to which the Investor #1 agreed
to exchange each of the Company’s outstanding convertible debentures issued in their favor, in the principal outstanding
balance amount of approximately $5,882,242, plus accrued interest (the “Original Debentures”), for certain 10% Convertible
Debentures issued by the Subsidiaries, due June 30, 2017, on substantially the same terms as the Original Debentures. As the conversion
features, as discussed previously, were concluded to require bifurcation and accounted for as derivatives, debt extinguishment
or modification guidance does not apply. It was therefore concluded that the Exchange Agreement would be accounted for as a modification,
covered instead by derivative accounting, which requires any change in conversion feature to be reflected in the derivative valuation.
The
Company and the Subsidiaries also entered into a Security Agreement (the “Security Agreement”), securing a lien for
the Investor on the Farm (subject to the rights of the primary lien holder in the Farm pursuant to the Subordination Agreement
(as defined above)) and securing a lien for the Investor on Subsidiaries’ other assets on a primary basis. Pursuant to the
Security Agreement, the Company agreed to, within 14 calendar days, negotiate and enter into an amendment to the Subordination
Agreement to reflect the rights of the Investor set forth in the Security Agreement. The Company also intends to negotiate related
waivers with its other creditors.
In
the instance of an Event of Default, as such term is defined in the New Note, the Investor has the right to convert all or any
portion of principal and/or interest of the New Notes into shares of Common Stock of the Company in accordance with the terms
of the form of 10% Convertible Debenture dated as of June 30, 2016 issued under the July SPA. This conversion feature was considered
to be a contingent conversion feature, and therefore the conversion feature would not be bifurcated and accounted for as a derivative,
until such time as and if the Company is in an event of default.
The
Investor shall have a right of first refusal to participate in future equity financings of the Company on the same terms as any
new investors for a period of twelve months from the closing of the last Convertible Debenture.
Grant
of Second Deed of Trust and Assignment of Rents
On
September 30, 2016, EWSD,, a wholly-owned subsidiary of the Company granted a junior lender (the “
Junior Lender
”) a Second Deed of Trust, Security Agreement and Financing Statement (the “
Second Trust Deed
”) and
an Assignment of Rents and Leases (the “
Assignment of Rents
”). The Second Trust Deed and the Assignment of
Rents encumber the Farm, and the rents payable by tenants under any current and future leases of and from the Farm. The Second
Trust Deed and the Assignment of Rents secure the payment of all obligations of EWSD I pursuant to any debentures issued to the
Junior Lender in accordance with the Securities Purchase Agreement dated June 30, 2016 by and among EWSD I, Junior Lender, and
Company (the “
Securities Purchase Agreement
”).
The
security granted to the Junior Lender pursuant to the Second Trust Deed and the Assignment of Rents is subordinate to the rights
of Southwest Farms, Inc. (the “
Senior Lender
”) as set forth in the Deed of Trust, Security Agreement and
Financing Statement dated as of August 7, 2015 granted by EWSD in favor of Senior Lender and the Assignment of Rents and Leases
by and between EWSD and Senior Lender dated as of August 7, 2015. Such subordination is documented in a Subordination Agreement
dated as of August 23, 2016 by and among Senior Lender, Junior Lender, Company, EWSD, and Pueblo Agriculture Supply and Equipment,
LLC, another wholly-owned subsidiary of the Company, as amended by a First Amendment to Subordination Agreement dated as of September
19, 2016 (collectively, the “
Subordination Agreement
”) pursuant to which Senior Lender consented to the Second
Trust Deed and the Assignment of Rents. The Subordination Agreement also provides that the Junior Lender may not increase the
principal amount of indebtedness pursuant to the Securities Purchase Agreement beyond $1,500,000.
Notes
payable, related parties, consists of:
|
|
September 30,
2016
|
|
|
December 31,
2015
|
|
Directors’ Notes
|
|
$
|
289,866
|
|
|
$
|
—
|
|
|
|
|
|
|
|
|
|
|
Less discounts
|
|
|
(6,000
|
)
|
|
|
—
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
283,866
|
|
|
$
|
—
|
|
Maturities
on Notes payable, related parties, are as follows:
Years ending:
|
|
|
|
|
December 31, 2016
|
|
|
$
|
39,166
|
|
December 31, 2017
|
|
|
|
250,700
|
|
|
|
|
$
|
289,866
|
|
On
June 8, 2016, the Company issued Promissory Notes (the “Directors Notes”), in the amount of $250,700, to all the directors
in exchange for various amounts outstanding for fees and reimbursements incurred during December 2015 and April 2016. The Notes
have a term of six months and bear interest at 8% until the note is paid in full. The Directors Notes were each issued with a
warrant for fifty percent of the face amount of the note, with an exercise price of $0.01 and exercisable for three years. The
Company estimated the fair value of the warrants based on a Black Scholes valuation model. The warrants were determined to have
a fair value of $12,000, calculated with the Black Sholes Merton model, with the following key valuation assumptions: estimated
term of three years, annual risk-free rate of .93%, and annualized expected volatility of 172%. The $12,000 fair value was recognized
as a debt discount and is being amortized over the six month term of the Directors Notes.
NOTE
9 - SHARE BASED AWARDS, RESTRICTED STOCK AND RESTRICTED STOCK UNITS (“RSUs”)
The
Board resolved that, beginning with the fourth calendar quarter of 2015, the Company shall pay each member of the Company’s
Board of Directors, who is not also an employee of the Company, for each calendar quarter during which such member continues to
serve on the Board compensation in the amount of $15,000 in cash and 325,000 shares of Company common stock. The 975,000
shares issued to all the directors for the three months ended March 31, 2016 were valued at the market price of the Company’s
common stock on March 31, 2016, for total compensation expense of $9,750. On March 31, 2016, the Board awarded the Chairman
a cash bonus of approximately $89,000 and, 2,230,000 shares of Company common stock for his service in the three months ended
March 31, 2016.
The
Board authorized grants of approximately 2,761,000 shares of the Company common stock during the second quarter of 2016, which
were valued at the market price of the Company’s common stock on date of grant, for total compensation expense of approximately
$13,000. On June 8, 2016, the Board also awarded the Chairman a cash bonus of approximately $89,200 and 6,027,000 shares of Company
common stock, valued at approximately $8,000.
The
Board also voted on June 8, 2016, to increase the shares available for grant under the 2014 Equity Incentive Plan to 125,000,000. The
Company intends to file a Form S-8 regarding the increased shares available for grant now that the increase in authorized
shares has been approved.
A
summary of the activity related to RSUs for the nine months ended September 30, 2016 and 2015 is presented below:
Restricted stock units (RSU’s)
|
|
Total shares
|
|
|
Grant date
fair
value
|
|
RSU’s non-vested
at January 1, 2016
|
|
|
152,823
|
|
|
$0.51 - $1.88
|
|
RSU’s granted
|
|
|
14,285,714
|
|
|
$0.007
|
|
RSU’s vested
|
|
|
(125,431
|
)
|
|
$0.51- $1.88
|
|
RSU’s forfeited
|
|
|
—
|
|
|
$-
|
|
|
|
|
|
|
|
|
|
RSU’s non-vested September 30, 2016
|
|
|
14,313,106
|
|
|
$0.51 - $1.88
|
|
Restricted stock units (RSU’s)
|
|
Total shares
|
|
|
Grant date fair
value
|
|
RSU’s non-vested
at January 1, 2015
|
|
|
199,584
|
|
|
$10.70
|
|
RSU’s granted
|
|
|
177,633
|
|
|
$1.88 - $6.70
|
|
RSU’s vested
|
|
|
(135,135
|
)
|
|
$1.88 - $6.70
|
|
RSU’s forfeited
|
|
|
—
|
|
|
$-
|
|
|
|
|
|
|
|
|
|
RSU’s non-vested September 30, 2015
|
|
|
242,082
|
|
|
$1.88 - $11.00
|
|
A
summary of the expense related to restricted stock, RSUs and stock option awards for the three and nine months ended September
30, 2016 is presented below:
|
|
Three months ended
September 30, 2016
|
|
|
Nine months ended
September 30, 2016
|
|
Restricted Stock
|
|
$
|
—
|
|
|
$
|
390,000
|
|
RSU’s
|
|
|
38,144
|
|
|
|
192,192
|
|
Stock options
|
|
|
—
|
|
|
|
—
|
|
Common stock
|
|
|
30,281
|
|
|
|
62,331
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
68,425
|
|
|
$
|
644,523
|
|
NOTE
10 - RELATED PARTY TRANSACTIONS
During
the first quarter of 2015, the Company issued two convertible notes to one of its directors in the aggregate principal amount
of $100,000 and one convertible note to another of its director in the aggregate principal amount of $50,000. These notes were
all converted to common stock during the third quarter of 2015.
During
the first quarter of 2016, the Company issued three convertible notes to one of its directors in the aggregate principal amount
of $75,000 and one convertible note to another of its director in the aggregate principal amount of $25,000, plus a convertible
note to each of its other two directors, in the amount of $2,500 each. See Note 7 for a description of these notes.
In
the second quarter of 2016, the Company issued promissory notes to all of the directors, in exchange for past unpaid cash bonuses,
board compensation and expenses. See Note 8 for a description of these notes
NOTE
11 - COMMITMENTS AND CONTINGENCIES
The
Company previously leased property for its day to day operations and facilities for possible retail dispensary locations and cultivation
locations as part of the process of applying for retail dispensary and cultivation licenses.
Entry
into Agreement to Acquire Real Property
On June 17, 2016, EWSD , a wholly owned subsidiary
of the Company, entered into a Contract to Buy and Sell Real Estate (the “Acquisition Agreement”) with Tammy J. Sciumbato
and Donnie J. Sciumbato (collectively, the “Sellers”) to purchase certain real property comprised of 116-acres of agricultural
land, a barn and a farmhouse in Pueblo, Colorado (the “Property”). The closing of the Acquisition Agreement is scheduled
to occur on or about September 22, 2016 (the “Closing”), with possession of the land and barn occurring twelve (12)
days after the Closing and possession of the farm house occurring on or before January 1, 2017. The Sellers will were to rent back
the farm house from the Company until January 1, 2017. The purchase price to acquire the Property is $650,000, including $10,000
paid by the Company as a deposit into the escrow for the Property. During the third quarter of 2017 the Acquisition Agreement was
cancelled and the deposit was forfeited.
Office
Leases
On
August 1, 2011, the Company entered into a lease agreement for office space located in West Hollywood, California through
June 30, 2017 at a current monthly rate of $14,828 per month. The Company moved to new offices in Los Angeles, CA in April 2015.
The sublease on the new office has a term of 18 months with monthly rent of $7,486.
The
landlord for the West Hollywood space has filed a suit against the Company and independent guarantors on the West Hollywood lease.
The Company has expensed all lease payments due under the West Hollywood lease. The Company’s liability for the West Hollywood
lease will be adjusted, if required, upon settlement of the suit with the landlord. On September 8, 2016, the court approved the
landlord’s application for writ of attachment in the State of California in the amount of $374,402 against Prescription Vending
Machines, Inc. (“PVM”). A trial date has been set for May 2017 (Note 12). On July 18, 2017, plaintiff filed a Request
for Dismissal with Prejudice of the litigation in respect of PVM.
Total
rent expense under operating leases for the three months ended September 30, 2016 and 2015 was $23,000 and $66,000, respectively.
Rent expense for the nine months ended September 30, 2016 and 2015 was approximately $376,000 and $110,000, respectively.
Consulting
Agreements
On
December 7, 2015, the Company entered into a consulting agreement for marketing and PR services, for a term of six months, which
was subsequently extended through August 30, 2016. Compensation under this agreement through May 30, 2016 was $25,000 per month,
with twenty percent, or $5,000, of this amount to be paid in shares of the Company’s common stock. Per the terms of the agreement,
the number of shares issued is determined at the end of each quarter. Upon extension, the terms were adjusted to $15,000 per month
for services, with $5,000 to be paid in shares of the Company’s common stock.
On
March 1, 2016, the Company entered into a consulting agreement for corporate financial advisory services, for a term of twelve
months, which is cancellable anytime with thirty days written notice after the first ninety days. Compensation under this agreement
consists of a retainer of $3,500 per month, plus 1,500,000 shares of common stock issuable in 375,000 share tranches on a quarterly
basis.
Litigation
On
May 22, 2013, Medbox (now known as Notis Global, Inc.) initiated litigation in the United States District Court in the District
of Arizona against three stockholders of MedVend Holdings LLC (“MedVend”) in connection with a contemplated transaction
that Medbox entered into for the purchase of an approximate 50% ownership stake in MedVend for $4.1 million. The lawsuit alleges
fraud and related claims arising out of the contemplated transaction during the quarter ended June 30, 2013. The litigation is
pending and Medbox has sought cancellation due to a fraudulent sale of the stock because the selling stockholders lacked the power
or authority to sell their ownership stake in MedVend, and their actions were a breach of representations made by them in the
agreement. On November 19, 2013 the litigation was transferred to United States District Court for the Eastern District of Michigan.
MedVend recently joined the suit pursuant to a consolidation order executed by a new judge assigned to the matter. In the litigation,
the selling stockholder defendants and MedVend seek to have the transaction performed, or alternatively be awarded damages for
the alleged breach of the agreement by Medbox. MedVend and the stockholder defendants seek $4.55 million in damages, plus costs
and attorneys’ fees. Medbox has denied liability with respect to all such claims. On June 5, 2014, the Company entered into
a purchase and sale agreement (the “MedVend PSA”) with PVM International, Inc. (“PVMI”) concerning this
matter. Pursuant to the MedVend PSA, the Company sold to PVMI the Company’s rights and claims attributable to or controlled
by the Company against those three certain stockholders of MedVend, known as Kaplan, Tartaglia and Kovan (the “MedVend Rights
and Claims”), in exchange for the return by PVMI to the Company of 30,000 shares of the Company’s common stock. PVMI
is owned by Vincent Mehdizadeh, formerly the Company’s largest stockholder. On December 17, 2015, the Company entered into
a revocation of the MedVend PSA, which provided that from that date forward, Medbox would take over the litigation and be responsible
for the costs and attorneys’ fees associated with the MedVend Litigation from December 17, 2015 forward. All costs and attorneys’
fees through December 16, 2015 will be borne by PVMI. After the filing of a motion for substitution of Medbox n/k/a Notis Global,
Inc. for PVMI, Defendants’ agreed, via a stipulated order, to permit the substitution. The Court entered the order substituting
Notis Global, Inc. for PVMI on February 17, 2016. A new litigation schedule was recently issued which resulted in an adjournment
of the trial. A new trial date will be set by the court following its ruling on a motion for summary judgment filed by Defendants
and MedVend, which is set for hearing on November 16, 2016. At this time, the Company cannot determine whether the likelihood
of an unfavorable outcome of the dispute is probable or remote, nor can they reasonably estimate a range of potential loss, should
the outcome be unfavorable. In January 2017, we entered into a Settlement Agreement with the three stockholders, pursuant to which
we agreed to pay to them $375,000 in six payments commencing August 2017 and concluding on or before February 2020. In connection
with the settlement, we executed a Consent Judgment in the amount of $937,000 in their favor. We did not make the first payment
and the Consent Judgment was recorded against us on August 25, 2017. Plaintiffs have attempted to collect on the judgment and,
in November 2017, garnished approximately $10,000 from our bank account.
On
February 20, 2015, Michael A. Glinter, derivatively and on behalf of nominal defendants Medbox, Inc. the Board and certain executive
officers (Pejman Medizadeh, Matthew Feinstein, Bruce Bedrick, Thomas Iwanskai, Guy Marsala, J. Mitchell Lowe, Ned Siegel, Jennifer
Love, and C. Douglas Mitchell), filed a suit in the Superior Court of the State of California for the County of Los Angeles. The
suit alleges breach of fiduciary duties and abuse of control by the defendants. Relief is sought awarding damages resulting from
breach of fiduciary duty and to direct the Company and the defendants to take all necessary actions to reform and improve its
corporate governance and internal procedures to comply with applicable law. The Company has entered into a Stipulation and Agreement
of Settlement on October 16, 2015. See more detailed discussion below under
Derivative Settlements
.
On
January 21, 2015, Josh Crystal on behalf of himself and of all others similarly situated filed a class action lawsuit in the U.S.
District Court for Central District of California against Medbox, Inc., and certain past and present members of the Board (Pejman
Medizadeh, Bruce Bedrick, Thomas Iwanskai, Guy Marsala, and C. Douglas Mitchell). The suit alleges that the Company issued materially
false and misleading statements regarding its financial results for the fiscal year ended December 31, 2013 and each of the interim
financial periods that year. The plaintiff seeks relief of compensatory damages and reasonable costs and expenses or all damages
sustained as a result of the wrongdoing. On April 23, 2015, the Court issued an Order consolidating the three related cases in
this matter: Crystal v. Medbox, Inc., Gutierrez v. Medbox, Inc., and Donnino v. Medbox, Inc., and appointing a lead plaintiff.
On July 27, 2015, Plaintiffs filed a Consolidated Amended Complaint. The Company has entered into a Stipulation and Agreement
of Settlement on October 16, 2015. See more detailed discussion below under
Class Settlement
.
On
January 18, 2015, Ervin Gutierrez filed a class action lawsuit in the U.S. District Court for the Central District of California.
The suit alleges violations of federal securities laws through public announcements and filings that were materially false and
misleading when made because they misrepresented and failed to disclose that the Company was recognizing revenue in a manner that
violated US GAAP. The plaintiff seeks relief for compensatory damages and reasonable costs and expenses or all damages sustained
as a result of the wrongdoing. On April 23, 2015, the Court issued an Order consolidating the three related cases in this matter:
Crystal v. Medbox, Inc., Gutierrez v. Medbox, Inc., and Donnino v. Medbox, Inc., and appointing a lead plaintiff. On July 27,
2015, Plaintiffs filed a Consolidated Amended Complaint. The Company has entered into a Stipulation and Agreement of Settlement
on October 16, 2015. See more detailed discussion below under
Class Settlement
.
On
January 29, 2015, Matthew Donnino filed a class action lawsuit in the U.S. District Court for Central District of California.
The suit alleges that the Company issued materially false and misleading statements regarding its financial results for the fiscal
year ended December 31, 2013 and each of the interim financial periods that year. The plaintiff seeks relief for compensatory
damages and reasonable costs and expenses or all damages sustained as a result of the wrongdoing. On April 23, 2015, the Court
issued an Order consolidating the three related cases in this matter: Crystal v. Medbox, Inc., Gutierrez v. Medbox, Inc., and
Donnino v. Medbox, Inc., and appointing a lead plaintiff. On July 27, 2015 Plaintiffs filed a Consolidated Amended Complaint.
The Company has entered into a Stipulation and Agreement of Settlement on October 16, 2015. See more detailed discussion
below under
Class Settlement
.
On February 12, 2015, Jennifer
Scheffer, derivatively on behalf of Medbox, Guy Marsala, Ned Siegel, Mitchell Lowe and C. Douglas Mitchell filed a lawsuit in
the Eighth Judicial District Court of Nevada seeking damages for breaches of fiduciary duty regarding the issuance and dissemination
of false and misleading statements and regarding allegedly improper and unfair related party transactions, unjust enrichment and
waste of corporate assets. On April 17, 2015, Ned Siegel and Mitchell Lowe filed a Motion to Dismiss. On April 20, 2015, the Company
filed a Joinder in the Motion to Dismiss. On July 27, 2015, the Court held a hearing on and granted the Motion to Dismiss without
prejudice. The Company has entered into a Stipulation and Agreement of Settlement on October 16, 2015. See more detailed
discussion below under
Derivative Settlements
.
On
March 10, 2015, Robert J. Calabrese, derivatively and on behalf of nominal defendant Medbox, Inc., filed a suit in the United
States District Court for the District of Nevada against certain Company officers and/or directors (Ned L. Siegel, Guy Marsala,
J. Mitchell Lowe, Pejman Vincent Mehdizadeh, Bruce Bedrick, and Jennifer S. Love). The suit alleges breach of fiduciary duties
and gross mismanagement by issuing materially false and misleading statements regarding the Company’s financial results
for the fiscal year ended December 31, 2013 and each of the interim financial periods. Specifically, the suit alleges that defendants
caused the Company to overstate the Company’s revenues by recognizing revenue on customer contracts before it had been earned.
The plaintiff seeks relief for compensatory damages and reasonable costs and expenses for all damages sustained as a result of
the alleged wrongdoing. The Company has entered into a Stipulation and Agreement of Settlement on October 16, 2015. See more detailed
discussion below under
Derivative Settlements
.
On
March 27, 2015, Tyler Gray, derivatively and on behalf of nominal defendant Medbox, Inc., filed a suit in the United States District
Court for the District of Nevada against the Company’s Board of Directors and certain executive officers (Pejman Vincent
Mehdizadeh, Matthew Feinstein, Bruce Bedrick, Thomas Iwanski, Guy Marsala, J. Mitchell Lowe, Ned Siegel, Jennifer S. Love, and
C. Douglas Mitchell). The suit alleges breach of fiduciary duties and abuse of control. The plaintiff seeks relief for compensatory
damages and reasonable costs and expenses for all damages sustained as a result of the alleged wrongdoing. Additionally, the plaintiff
seeks declaratory judgments that plaintiff may maintain the action on behalf of the Company, that the plaintiff is an adequate
representative of the Company, and that the defendants have breached and/or aided and abetted the breach of their fiduciary duties
to the Company. Lastly the plaintiff seeks that the Company be directed to take all necessary actions to reform and improve its
corporate governance and internal procedures to comply with applicable law. The Company has entered into a Stipulation and Agreement
of Settlement on October 16, 2015. See more detailed discussion below under
Derivative Settlements
.
On
May 20, 2015, Patricia des Groseilliers, derivatively and on behalf of nominal defendant Medbox, Inc., filed a suit in the United
States District Court for the District of Nevada against the Company’s Board of Directors and certain executive officers
(Pejman Vincent Mehdizadeh, Ned Siegel, Guy Marsala, J. Mitchell Lowe, Bruce Bedrick, Jennifer S. Love, Matthew Feinstein, C.
Douglas Mitchell, and Thomas Iwanski). The suit alleges breach of fiduciary duties and unjust enrichment. The plaintiff seeks
relief for compensatory damages and reasonable costs and expenses for all damages sustained as a result of the alleged wrongdoing.
Additionally, the plaintiff seeks declaratory judgments that plaintiff may maintain the action on behalf of the Company, that
the plaintiff is an adequate representative of the Company, and that the defendants have breached and/or aided and abetted the
breach of their fiduciary duties to the Company. Lastly the plaintiff seeks that the Company be directed to take all necessary
actions to reform and improve its corporate governance and internal procedures to comply with applicable law. The Company has
entered into a Stipulation and Agreement of Settlement on October 16, 2015. See more detailed discussion below under
Derivative
Settlements
.
On
June 3, 2015, Mike Jones, derivatively and on behalf of nominal defendant Medbox, Inc., filed a suit in the U.S. District Court
for Central District of California against the Company’s Board of Directors and certain executive officers (Guy Marsala,
J. Mitchell Lowe, Ned Siegel, Jennifer S. Love, C. Douglas Mitchell, Pejman Vincent Mehdizadeh, Matthew Feinstein, Bruce Bedrick,
and Thomas Iwanski). The suit alleges breach of fiduciary duties, abuse of control, and breach of duty of honest services. The
plaintiff seeks relief for compensatory damages and reasonable costs and expenses for all damages sustained as a result of the
alleged wrongdoing. Additionally the plaintiff seeks declaratory judgments that plaintiff may maintain the action on behalf of
the Company, that the plaintiff is an adequate representative of the Company, and that the defendants have breached and/or aided
and abetted the breach of their fiduciary duties to the Company. Lastly the plaintiff seeks that the Company be directed to take
all necessary actions to reform and improve its corporate governance and internal procedures to comply with applicable law. On
July 20, 2015, the Court issued an Order consolidating this litigation with those previously consolidated in the Central District
(Crystal, Gutierrez, and Donnino). On October 7, 2015, the Court issued an Order modifying the July 20, 2015 Order consolidating
the litigation so that the matters remain consolidated for the purposes of pretrial only. The Company has entered into a Stipulation
and Agreement of Settlement on October 16, 2015. See more detailed discussion below under
Derivative Settlement
s.
On
July 20, 2015, Kimberly Freeman, derivatively and on behalf of nominal defendant Medbox, Inc., filed a suit in the Eighth Judicial
District Court of Nevada against the Company’s Board of Directors and certain executive officers (Pejman Vincent Mehdizadeh,
Guy Marsala, Ned Siegel, J. Mitchell Lowe, Jennifer S. Love, C. Douglas Mitchell, and Bruce Bedrick). The suit alleges breach
of fiduciary duties and unjust enrichment. The plaintiff seeks relief for compensatory damages and reasonable costs and expenses
for all damages sustained as a result of the alleged wrongdoing. Additionally, the plaintiff seeks declaratory judgments that
plaintiff may maintain the action on behalf of the Company, that the plaintiff is an adequate representative of the Company, and
that the defendants have breached and/or aided and abetted the breach of their fiduciary duties to the Company. Lastly, the plaintiff
seeks that the Company be directed to take all necessary actions to reform and improve its corporate governance and internal procedures
to comply with applicable law. The Company has entered into a Stipulation and Agreement of Settlement on October 16, 2015. See
more detailed discussion below under
Derivative Settlement
s.
On
October 16, 2015, solely to avoid the costs, risks, and uncertainties inherent in litigation, the parties to the class actions
and derivative lawsuits named above entered into settlements that collectively effect a global settlement of all claims asserted
in the class actions and the derivative actions. The global settlement provides, among other things, for the release and dismissal
of all asserted claims. The global settlement is contingent on final court approval, respectively, of the settlements of the class
actions and derivative actions. If the global settlement does not receive final court approval, it could have a material adverse
effect on the financial condition, results of operations and/or cash flows of the Company and their ability to raise funds in
the future.
On
October 27, 2015, separate from the above lawsuits and settlement, Richard Merritts, derivatively and on behalf of nominal defendant
Medbox, Inc., filed a suit in the Superior Court of the State of California for the County of Los Angeles against the Board and
certain executive officers (Guy Marsala, J. Mitchell Lowe, Ned Siegel, Jennifer S. Love, C. Douglas Mitchell, Pejman Vincent Mehdizadeh,
Matthew Feinstein, Bruce Bedrick, Jeff Goh, and Thomas Iwanski). The suit titled
Merritts v. Marsala, et al.
, Case No.
BC599159 (the “Merritts Action”), alleges breach of fiduciary duties by the defendants. Relief is sought awarding
damages resulting from breach of fiduciary duty and to direct the Company and the defendants to take all necessary actions to
reform and improve its corporate governance and internal procedures to comply with applicable law. On February 16, 2016,
the court issued an order staying the litigation pending final court approval of the settlement of the other pending derivative
actions involving Medbox, Inc., as nominal defendant, and former and current officers and directors. The settlement of the
other derivative actions has been preliminarily approved by the court in
Jones v. Marsala, et al
., Case No. 15-cv-4170
BRO (JEMx), in the U.S. District Court for the Central District of California. On March 25, 2016, Merritts filed a Motion to Intervene
in the case filed by Mike Jones in the U.S. District Court for the Central District of California. By his Motion, Merritts seeks
limited intervention in the Jones stockholder derivative action in order to seek confirmatory information and discovery regarding
the Stipulation and Agreement of Settlement preliminarily approved by the Court on February 3, 2016. On April 4, 2016,
Plaintiff Jones and the Company separately filed oppositions to the Motion to Intervene. On April 22, 2016, the Court issued an
Order granting, without a hearing, stockholder Richard Merritts’ Motion to Intervene in the lawsuit titled
Mike Jones
v. Guy Marsala, et al.
, in order to conduct limited discovery. On September 16, 2016, solely to avoid the costs, risks, and
uncertainties inherent in litigation, the parties entered into a settlement regarding Merritts’ claims. See more detailed
discussion below under
Derivative Settlements
.
Class
Settlement
On
December 1, 2015, Medbox and the class plaintiffs in Josh Crystal v. Medbox, Inc., et al., Case No. 2:15-CV-00426-BRO (JEMx),
pending before the United States District Court for the Central District of California (the “Court”) notified the
Court of the settlement. The Court stayed the action pending the Court’s review of the settlement and directed the parties
to file a stipulation of settlement. On December 18, 2015, plaintiffs filed the Motion for Preliminary Approval of Class Action
Settlement that included the stipulation of settlement. On February 3, 2016, the Court issued an Order granting preliminary approval
of the settlement. The settlement provides for notice to be given to the class, a period for opt outs and a final approval hearing.
The Court originally scheduled the Final Settlement Approval Hearing to be held on May 16, 2016 at 1:30 p.m., but continued it
to August 15, 2016 at 1:30 p.m. to be heard at the same time as the Final Settlement Approval Hearing for the derivative actions,
discussed below. The principal terms of the settlement are:
|
•
|
a
cash payment to a settlement escrow account in the amount of $1,850,000 of which $150,000 will be paid by the Company and
$1,700,000 will be paid by the Company’s insurers;
|
|
•
|
a
transfer of 2,300,000 shares of Medbox common stock to the settlement escrow account, of which 2,000,000 shares would be contributed
by Medbox and 300,000 shares by Bruce Bedrick;
|
|
•
|
the
net proceeds of the settlement escrow, after deduction of Court-approved administrative costs and any Court-approved attorneys’
fees and costs would be distributed to the Class; and
|
|
•
|
releases
of claims and dismissal of the action.
|
By
entering into the settlement, the settling parties have resolved the class claims to their mutual satisfaction. However, the final
determination is subject to approval by the Federal Courts. Defendants have not admitted the validity of any claims or allegations
and the settling plaintiffs have not admitted that any claims or allegations lack merit or foundation. If the global settlement
does not receive final court approval, it could have a material adverse effect on the financial condition, results of operations
and/or cash flows of the Company and their ability to raise funds in the future.
Derivative
Settlements
As
previously announced on October 22, 2015, on October 16, 2015, the Company, in its capacity as a nominal defendant, entered into
a memorandum of understanding of settlement (the “Settlement”) in the following stockholder derivative actions: (1)
Mike Jones v. Guy Marsala, et al., in the U.S. District Court for Central District of California; (2) Jennifer Scheffer v. P.
Vincent Mehdizadeh, et al., in the Eighth Judicial District Court of Nevada; (3) Kimberly Y. Freeman v. Pejman Vincent Mehdizadeh,
et al., in the Eighth Judicial District Court of Nevada; (4) Tyler Gray v. Pejman Vincent Mehdizadeh, et al., in the U.S. District
Court for the District of Nevada; (5) Robert J. Calabrese v. Ned L. Siegel, et al., in the U.S. District Court for the District
of Nevada; (6) Patricia des Groseilliers v. Pejman Vincent Mehdizadeh, et al., in the U.S. District Court for the District of
Nevada; (7) Michael A. Glinter v. Pejman Vincent Mehdizadeh, et al., in the Superior Court of the State of California for the
County of Los Angeles (the “Stockholder Derivative Lawsuits”). In addition to the Company, Pejman Vincent Mehdizadeh,
Matthew Feinstein, Bruce Bedrick, Thomas Iwanski, Guy Marsala, J. Mitchell Lowe, Ned Siegel, and C. Douglas Mitchell were named
as defendants in all of the lawsuits, and Jennifer S. Love was named in all of the lawsuits but the Scheffer action (the “Individual
Defendants”).
On
December 3, 2015, the parties in the Jones v. Marsala action advised the Court of the settlements in the Stockholder Derivative
Lawsuits and that the parties would be submitting the settlement to the Court in the Jones action for approval. The Court thereafter
issued an order vacating all pending dates in the action and ordered Plaintiff to file the Stipulation and Agreement of Settlement
for the Court’s approval. On December 18, 2015, plaintiffs filed the Motion for Preliminary Approval of Derivative Settlement
that included the Stipulation and Agreement of Settlement. On February 3, 2016, the Court issued an Order granting preliminary
approval of the settlement.
The
Court originally scheduled a final Settlement Hearing to be held on May 16, 2016, but subsequently continued that hearing to October
17, 2016. By the terms of the settlement, a final Court approval would provide for a release of the claims in the Stockholder
Derivative Actions and a bar against continued prosecution of all claims covered by the release. By entering into the Settlement,
the settling parties have resolved the derivative claims to their mutual satisfaction. The Individual Defendants have not admitted
the validity of any claims or allegations and the settling plaintiffs have not admitted that any claims or allegations lack merit
or foundation.
The
final Settlement Hearing was held on October 17, 2016, and the Court has taken the settlement under review.
Under
the terms of the Settlement, the Company agrees to adopt and adhere to certain corporate governance processes in the future. In
addition to these corporate governance measures, the Company’s insurers, on behalf of the Individual Defendants, will make
a payment of $300,000 into the settlement escrow account and Messrs. Mehdizadeh and Bedrick will deliver 2,000,000 and 300,000
shares, respectively, of their Medbox, Inc. common stock into the settlement escrow account. Subject to Court approval, the funds
and common stock in the settlement escrow account will be paid as attorneys’ fees and expenses, or as service awards to
plaintiffs.
On
September 16, 2016, solely to avoid the costs, risks, and uncertainties inherent in litigation, the parties entered into a settlement
regarding the Merritts Action. The settlement provides, among other things, for the release and dismissal of all asserted claims.
Under the terms of the settlement, the Company agrees to adopt and to adhere to certain corporate governance processes in the
future. In addition to these corporate governance measures, the Company will make a payment of $135,000 in cash to be used to
pay Merritts’ counsel for any attorneys’ fees and expenses, or as service awards to plaintiff Merritts, that are approved
and awarded by the Court. The settlement is contingent on final court approval. The final Settlement Hearing was held on October
17, 2016, at the same date and time as the final Settlement Hearing for the Stockholder Derivative Lawsuits. The Court has taken
the settlement under review.
The
Settlements remain subject to approval by the Court. The Court must determine whether (1) the terms and conditions of the Settlements
are fair, reasonable, and adequate in the best interest of the Company and its stockholders, (2) if the judgment, as provided
for in the Settlements, should be entered, and (3) if the request of plaintiff’s counsel for an award of attorneys’
fees and reimbursement of expenses should be granted.
The
Company’s responsibilities as to the proposed settlements of the Class Action and the Stockholder Derivative Lawsuits have
been accrued and included in Accrued settlement and severance expenses on the accompanying consolidated balance sheet as of December
31, 2015. If the settlements of the Class Action, the Stockholder Derivative Lawsuits, or the Merritts Action do not receive final
court approval, it could have a material adverse effect on the financial condition, results of operations and/or cash flows of
the Company and their ability to raise funds in the future.
SEC
Investigation
In
October 2014, the Board of Directors of the Company appointed a special board committee (the “Special Committee”)
to investigate issues arising from a federal grand jury subpoena pertaining to the Company’s financial reporting which was
served upon the Company’s predecessor independent registered public accounting firm as well as certain alleged wrongdoing
raised by a former employee of the Company. The Company was subsequently served with two SEC subpoenas in early November 2014.
The Company is fully cooperating with the grand jury and SEC investigations. In connection with its investigation of these matters,
the Special Committee in conjunction with the Audit Committee initiated an internal review by management and by an outside professional
advisor of certain prior period financial reporting of the Company. The outside professional advisor reviewed the Company’s
revenue recognition methodology for certain contracts for the third and fourth quarters of 2013. As a result of certain errors
discovered in connection with the review by management and its professional advisor, the Audit Committee, upon management’s
recommendation, concluded on December 24, 2014 that the consolidated financial statements for the year ended December 31, 2013
and for the third and fourth quarters therein, as well as for the quarters ended March 31, 2014, June 30, 2014 and September
30, 2014, should no longer be relied upon and would be restated to correct the errors. On March 6, 2015 the audit committee determined
that the consolidated financial statements for the year ended December 31, 2012, together with all three, six and nine month financial
information contained therein, and the quarterly information for the first two quarters of the 2013 fiscal year should also be
restated. On March 11, 2015, the Company filed its restated Form 10 Registration Statement with the SEC with restated financial
information for the years ended December 31, 2012 and December 31, 2013, and on March 16, 2015, the Company filed amended and
restated quarterly reports on Form 10-Q, with restated financial information for the periods ended March 31, June 30
and September 30, 2014, respectively.
In March 2016, the staff of the Los Angeles
Regional Office of the U.S. Securities and Exchange Commission advised counsel for the Company in a telephone conversation, followed
by a written “Wells” notice, that it is has made a preliminary determination to recommend that the Commission file
an enforcement action against the Company in connection with misstatements by prior management in the Company’s financial
statements for 2012, 2013 and the first three quarters of 2014. A Wells Notice is neither a formal allegation of wrongdoing nor
a finding that any violations of law have occurred. Rather, it provides the Company with an opportunity to respond to issues raised
by the Staff and offer its perspective prior to any SEC decision to institute proceedings.
In
March 2017, the SEC and the Company settled this matter. The Company consented to the entry of a final judgment permanently enjoining
it from violations of Sections 5(a), 5(c), and 17(a) of the Securities Act of 1933 (Securities Act) and Sections 10(b), 13(a),
13(b)(2)(A), and 13(b)(2)(B) of the Securities Exchange Act of 1934 (Exchange Act) and Rules 10b-5, 12b-20, 13a-11, and 13a-13
thereunder. In connection with the settlement, the Company did not have any monetary sanctions or penalties assessed against it.
Other
litigation
Whole
Hemp complaint
A
complaint was filed by Whole Hemp Company, LLC d/b/a Folium Biosciences (“Whole Hemp”) on June 1, 2016, naming Notis
Global, Inc. and EWSD (collectively, “Notis”), as defendants in Pueblo County, CO district court. The complaint
alleges five causes of action against Notis: misappropriation of trade secrets, civil theft, intentional interference with
prospective business advantage, civil conspiracy, and breach of contract. All claims concern contracts between Whole Hemp
and Notis for the Farming Agreement and the Distributor Agreement.
The
court entered an
ex parte
temporary restraining order on June 2, 2016, and a modified temporary restraining order on July
14, 2016, enjoining Notis from disclosing, using, copying, conveying, transferring, or transmitting Whole Hemp’s trade secrets,
including Whole Hemp’s plants. On June 13, 2016, the court ordered that all claims be submitted to arbitration, except
for the disposition of the temporary restraining order.
On
August 12, 2016, the court ordered that all of Whole Hemp’s plants in Notis’ possession be destroyed, which occurred
by August 24, 2016, at which time the temporary restraining order was dissolved and the parties will soon file a motion to dismiss
the district court action.
In
light of the Whole Hemp plants all being destroyed per the court order, the Company has immediately expensed all Capitalized agricultural
costs as of June 30, 2016, as all costs as of that date related to Whole Hemp plants.
Notis
commenced arbitration in Denver, CO on August 2, 2016, seeking injunctive relief and alleging breaches of the contracts between
the parties. Whole Hemp filed is Answer and counterclaims on September 6, 2016, asserting similar allegations that were asserted
to the court.
On
September 30, 2016, the arbitrator held an initial status conference and agreed to allow EWSD and Notis to file a motion to dismiss
some or all of Whole Hemp’s claims by no later than October 28, 2016. The parties were also ordered to make initial disclosures
of relevant documents and persons with knowledge of relevant information by October 21, 2016.
For
further information in respect of the Whole Hemp matter, see more detailed discussion below under Part II – Other Information,
Item 1. Legal proceedings and Item 5. Other Information,
West
Hollywood Lease
The
lease for the former office at 8439 West Sunset Blvd. in West Hollywood, CA has been partially subleased. The Company plans to
sublease the remainder of the office in West Hollywood, CA and continues to incur rent expense while the space is being marketed.
The landlord for the prior lease filed a suit in Los Angeles Superior Court in April 2015 against the Company for damages they
allege have been incurred from unpaid rent and otherwise. In January 2016, the landlord filed a first amended complaint adding
the independent guarantors under the lease as co-defendants and specifying damages claim of approximately $300,000. On September
8, 2016, the court approved the landlord’s application for writ of attachment in the State of California in the amount of $374,402
against Prescription Vending Machines, Inc. (“PVM”). A trial date has been set in May 2017. The Company is presently
unable to determine whether the likelihood of an unfavorable outcome of the dispute is probable or remote, nor can it reasonably
estimate a range of potential loss, should the outcome be unfavorable. On July 18, 2017, plaintiff filed a Request for Dismissal
with Prejudice of the litigation in respect of PVM.
Los
Angeles Lease
The
Company’s former landlord, Bank Leumi, filed an action against the Company in Los Angeles Superior Court for breach of lease
on August 31, 2016, seeking $29,977 plus fees and interest, in addition to rent payment for September 2016. The Company filed
a response to the complaint on September 21, 2016, and a case management conference is scheduled for December 9, 2016. In November
2016, the parties entered into a Settlement Agreement and General Release, pursuant to which the Company agreed to an eight-payment
plan in favor of the Bank, commencing December 2016 and terminating July 2017. All of the payments, which aggregated $46,522
for rent, fees, and costs, have been made.
Creaxion
On
August 23, 2017, Creaxion Corporation filed a Complaint in the Superior Court of Fulton County, Georgia, styled
Creaxion Corporation,
Plaintiff, v. Notis Global, Inc., Defendant
, Civil Action No. 2017CV294453. Plaintiff plead counts for (1) Breach of Contract
in the amount of $89,000, (2) Prejudgment interest, and (3) Attorney’s fees. The Company was served on September 26, 2017,
and did not respond to the Complaint. On November 30, 2017, the Court granted plaintiff’s request for a Default Judgment
in the amount of $89,000. Further, the Court scheduled a hearing for December 14, 2017, in respect of expenses, attorney’s
fees, and interest at a rate of 6.25%.
Sheppard,
Mullin
On
October 27, 2017, Sheppard, Mullin filed a Complaint in the Superior Court of the State of California for the County of Los Angeles,
styled
Sheppard, Mullin, Richter & Hampton LLP, a California limited liability partnership, plaintiff v. Notis Global,
Inc., a Nevada corporation, formerly known as Medbox, Inc.; and Does 1-10, inclusive, Defendants
, Case No. BC681382. Plaintiff
plead causes of action for (1) Breach of Contract; (2) Account Stated; and (3) and Unjust Enrichment, seeking approximately $240,000.
The Company accepted service on November 10, 2017, and, as of the date of this Report, has not responded to the Complaint.
NOTE
12 - SUBSEQUENT EVENTS
Entry into Senior Secured Convertible
Note Purchase Agreements
On April 27, 2017 for gross proceeds
of $100,000 the Company issued a senior secured convertible promissory note bearing interest at the rate of 10% per annum with
a maturity date of April 27, 2018. The loan and accrued interest are to be paid on the maturity date. If the note is repaid before
the maturity date the Company is required to make a payment to the holder of an amount in cash equal to the sum of the then-outstanding
principal amount of the note and interest multiplied by 130%. The promissory note contains conversion clauses that allow the lender
the option to convert the loan amount plus all accrued and unpaid interest due under the note into common stock at a conversion
rate of $0.0001 per share. In addition, the Company also issued 100,000,000 warrants to the lender to purchase additional shares
of common stock at an exercise price of $0.0001 per share. These warrants are fully vested and have a term of 4 years. The warrant
exercise price is subject to anti-dilution protection in the event that the Company issues additional equity securities at a price
less than the exercise price.
On May 8, 2017 for gross proceeds of $100,000
the Company issued a senior secured convertible promissory note bearing interest at the rate of 10% per annum with a maturity date
of May 8, 2018. The loan and accrued interest are to be paid on the maturity date. If the note is repaid before the maturity date
the Company is required to make a payment to the holder of an amount in cash equal to the sum of the then-outstanding principal
amount of the note and interest multiplied by 130%.The promissory note contains conversion clauses that allow the lender the option
to convert the loan amount plus all accrued and unpaid interest due under the note into common stock at a conversion rate of $0.0001
per share. In addition, the Company also issued 100,000,000 warrants to the lender to purchase additional shares of common stock
at an exercise price of $0.0001 per share. These warrants are fully vested and have a term of 4 years. The warrant exercise price
is subject to anti-dilution protection in the event that the Company issues additional equity securities at a price less than the
exercise price.
Common
stock issuances
Between
October 25, 2016 and November 15, 2016, we issued an aggregate of 2,482,175,595 shares of our common stock to six otherwise unrelated
persons in connection with the conversion of certain previously issued debt securities to such persons. We believe that such persons
are independent of each other and do not constitute a group as defined in Section 13(d) of the Exchange Act. We did not receive
any proceeds from such conversions. We had previously offered and sold the convertible debt securities in reliance on the exemptions
from registration pursuant to Section 4(a)(2) of the Securities Act and Rule 506 of Regulation D promulgated thereunder and offered
and sold the above-referenced shares in accordance with the provisions of Section 3(a)(9) of the Securities Act.
On
January 20, 2017, we issued 2,000,000 shares of our common stock to in connection with the settlement of the Crystal v. Medbox,
Inc. litigation. We did not receive any proceeds from such issuance. We issued such shares in reliance on the exemptions from
registration pursuant to Section 4(a)(2) of the Securities Act.
On August 24, 2017, we issued
38,700,000 shares of our common stock to one otherwise unrelated person in connection with the conversion of certain previously
issued debt securities to such person. We did not receive any proceeds from such conversion. We had previously offered and sold
the convertible debt securities in reliance on the exemptions from registration pursuant to Section 4(a)(2) of the Securities
Act and Rule 506 of Regulation D promulgated thereunder and offered and sold the above-referenced shares in accordance with the
provisions of Section 3(a)(9) of the Securities Act.
OTC
Markets
On
September 9, 2016, the Company received notice from the OTC Markets that it would move the Company’s trading market from
the OTCQB® to OTC Pink® market, if the Company did not file its Quarterly Report on Form 10-Q for the period ended June
30, 2016 by September 30, 2016. On or about October 1, 2016, the Company moved to the OTC Pink market. This might also impact
the Company’s ability to obtain funding.
Entry
into Note Purchase Agreement and Global Debenture Amendment
On
October 10, 2016, the Company entered into a Note Purchase Agreement (the “Purchase Agreement”) with an accredited
investor (the “Investor”), pursuant to which the Company agreed to sell, and the Investor agreed to purchase, a secured
convertible promissory note (the “Note”) in the aggregate principal amount of $53,000.
The
Investor deducted a commitment fee in the amount of $3,000 at the closing. The Note bears interest at the rate of 5% per annum
and matures on April 30, 2017. The Company may not prepay any part of the outstanding balance of the Note at any time prior to
maturity without the written consent of the Investor. At any time or from time to time, the Investor may convert the Note, in
whole or in part, into shares of the Company’s common stock at a conversion price that is the lower of (a) $0.75, or (b) 51% of
the lowest volume weighted average price for the 30 consecutive trading days prior to the conversion date.
In
connection with entry into the Note Purchase Agreement, the parties also entered into a Global Debenture Amendment (the “Debenture
Amendment”), pursuant to which the Investor shall be entitled to the same “look-back” period on establishing
the conversion price of a Note as any other Investor is entitled to pursuant to notes or debentures held by such Investor. Based
on the terms of the Company’s other convertible notes and debentures, other investors shall be entitled to the same rights established
in the Debenture Amendment. Therefore, each of the company’s investors holding convertible debt shall be entitled to the same
“look-back” period when establishing the conversion price for their respective notes or debentures.
PCH
Investment Group, Inc. – San Diego Project Investment
Effective
as of March 21, 2017, through a series of related transactions, we indirectly acquired an aggregate of 459,999 of the then-issued
and outstanding shares of capital stock (the “PCH Purchased Shares”) of PCH Investment Group, Inc., a California corporation
(“PCH”) for a purchase price of $300,000.00 in cash and the issuance of shares of our common stock. The PCH Purchased
Shares represented 51% of the outstanding capital stock of PCH. In connection with our then acquisition of the PCH Purchased Shares,
we (or our affiliates) were also granted an indirect option to acquire the remaining 49% (the “PCH Optioned Shares”)
of the capital stock of PCH. The option was to expire on February 10, 2019 (the “PCH Optioned Shares Expiry Date”).
Located
in San Diego, California, PCH is a management services business that focuses on the management of cannabis production and manufacturing
businesses. On November 1, 2016, PCH entered into a Management Services Agreement (the “PCH Management Agreement”)
with California Cannabis Group (“CalCan”) and Devilish Delights, Inc. (“DDI”), both of which are California
nonprofit corporations in the cannabis production and manufacturing business (“their business”). CalCan is licensed
by the City of San Diego, California, to cultivate cannabis and manufacture cannabis products, as well as to sell, at wholesale,
the cultivated and manufactured products at wholesale to legally operated medical marijuana dispensaries. The PCH Management Agreement
provided that PCH was responsible for the day-to-day operations and business activities of their business. In that context, PCH
is responsible for the payment of all operating expenses of their business (including the rent and related expenditures for CalCan
and DDI) from the revenue generated by their business, or on an out-of-pocket basis if the revenue should be insufficient. In
exchange for PCH’s services and payment obligations, PCH is entitled to 75% of the gross profits of their business. The
PCH Management Agreement did not provide for any gross profit milestone during its first 12 months; thereafter, it provided for
an annual $8 million gross profit milestone, with any amount in excess thereof to be carried forward to the next annual period.
In the event that, during any annual period, the gross profit thereunder was less than $8 million (including any carry-forward
amounts), then, on a one-time basis, PCH would have been permitted to carry-forward such deficit to the following annual period.
If, in that following annual period, the gross profit were to exceed $6 million, then PCH was entitled to an additional “one-time
basis” carry-forward of a subsequent deficit. The term of the PCH Management Agreement was for five years, subject to two
extensions, each for an additional five-year period, in all cases subject to earlier termination for an uncured material breach
by PCH of its obligations thereunder. Clint Pyatt, our then-current
Chief Operating Officer
and Senior Vice President, Government Affairs, was then a member of the Board of Directors of CalCan and DDI.
Pursuant
to a Securities Purchase Agreement, that was made and entered into as of March 16, 2017 (five days before the closing of the transaction),
our wholly-owned subsidiary, Pueblo Agriculture Supply and Equipment, LLC, a Delaware limited liability company (“PASE”),
acquired the PCH Purchased Shares from the three PCH shareholders: (i) Mystic, LLC, a California limited liability company that
Jeff Goh, our then-Chief Executive Officer, formed and controlled for his investments in cannabis projects, (ii) Clint Pyatt, and
(iii) Steve Kaller, the general manager of PCH
(
collectively, the “PCH Shareholders”).
As
a condition to the Lender entering into the Note Purchase Agreement and the PCH-Related Note (both as noted below) and providing
any additional funding to us in connection with our acquisition of the PCH Purchased Shares, our Board of Directors ratified the
forms of employment agreements for Mr. Goh, as our then-Chief Executive Officer, and for Mr. Pyatt, as our then-prospective President.
Once the agreements became effective, and following the second anniversary thereof, the terms were to have become “at-will.”
In addition to payment of a base salary, the agreements provided for certain cash, option, and equity bonuses, in each case to
become subject both to each individual and to us meeting certain performance goals to be acknowledged by them and to be approved
by a disinterested majority of our Board of Directors.
Due
to the nature of the PCH transaction, and the related parties involved with PCH, we formed a special committee of our Board of
Directors to consider all of the aspects of the above-described transaction, as well as the related financing proposed to be provided
by the Lender. The special committee consisted of three of our four directors: Ambassador Ned L. Siegel, Mitch Lowe, and Manual
Flores. In the context of the special committee’s charge, it engaged an otherwise independent investment banking firm (the
“Banker”) to analyze the potential acquisition of the PCH Purchased Shares through the Securities Purchase Agreement
(noted above) and the Stock Purchase Option Agreement (noted below), the related financing agreements (all as noted below), other
related business and financial arrangements, and the above-referenced employment agreements. After the Banker completed its full
review of those agreements and its own competitive analysis, it provided its opinion that the consideration to be paid in connection
with the acquisition of the PCH Purchased Shares and the terms of the PCH-Related Note were fair to us from a financial point
of view. Following the Banker’s presentation of its analysis and opinion, and the special committee’s own analysis,
the special committee unanimously recommended to our full Board of Directors that all of such transactions should be approved
and that we should consummate the acquisition of the PCH Purchased Shares, accept the option to acquire the PCH Optioned Shares,
enter into the PCH-Related Note, the documents ancillary thereto, and the Employment Agreements.
In
connection with our acquisition of the PCH Purchased Shares and our option to acquire the PCH Optioned Shares, PASE, EWSD I, LLC,
a Delaware limited liability company of which we own 98% of the equity (“EWSD”; the other two percent is owned by
two individuals who provide consulting services to us), PCH, and we entered into a Convertible Note Purchase Agreement (the “Note
Purchase Agreement”) with a third-party lender (the “PCH Lender”). Concurrently, PASE and we (with EWSD and
PCH as co-obligors) entered into a related 10% Senior Secured Convertible Promissory Note (the “PCH-Related Note”)
in favor of the PCH Lender. The initial principal sum under the PCH-Related Note is $1,000,000.00 and it bears interest at the
rate of 10% per annum. Principal and interest are subject to certain conversion rights in favor of the Lender. So long as any
principal is outstanding or any interest remains accrued, but unpaid, at any time and from time to time, at the option of the
PCH Lender, any or all of such amounts may be converted into shares of our common stock. Notwithstanding such conversion right,
and except in the circumstance described in the next sentence, the PCH Lender may not exercise its conversion rights if, in so
doing, it would then own more than 4.99% of our issued and outstanding shares of common stock. However, upon not less than 61-days’
notice, the PCH Lender may increase its limitation percentage to a maximum of 9.99%. The PCH Lender’s conversion price is
fixed at $0.0001 per share. Principal and accrued interest may be pre-paid from time to time or at any time, subject to 10 days’
written notice to the PCH Lender. Any prepayment of principal or interest shall be increased to be at the rate of 130% of the
amount so to be prepaid and, during the 10-day notice period, the PCH Lender may exercise its conversion rights in respect of
any or all of the amounts otherwise to be prepaid.
In
a series of other loan transactions prior to the closing of the acquisition of the PCH Purchased Shares, a different third party
lender (the “Ongoing Lender”) had lent to us, in five separate tranches, an aggregate amount of approximately $414,000
(the “Pre-acquisition Loans”), that, in turn, we lent to PCH to use for its working capital obligations. Upon the
closing of the acquisition of the PCH Purchased Shares and pursuant to the terms of the PCH-Related Note, the PCH Lender lent
to us (i) approximately $86,000, that, in turn, we lent to PCH to use for its additional working capital obligations, (ii) $300,000
for the acquisition of the PCH Purchased Shares, and (iii) $90,000 for various transaction-related fees and expenses.
Immediately subsequent to the closing of the acquisition of the PCH Purchased Shares, the PCH Lender lent to us (x) approximately
$170,000 for our operational obligations and (y) approximately $114,000 for us partially to repay an equivalent amount of the
Pre-acquisition Loans.
In
connection with the Pre-acquisition Loans and the PCH-Related Note, the makers and co-obligors thereof entered into an Amended
and Restated Security and Pledge Agreement in favor of the Lender, pursuant to which such parties, jointly and severally, granted
to the Lender a security interest in all, or substantially all, of their respective property. Further, PCH entered into a Guarantee
in favor of the PCH Lender in respect of the other parties’ obligations under the PCH-Related Note. PCH’s obligation
to the PCH Lender under these agreements is limited to a maximum of $500,000.
As
of the closing of the acquisition of the PCH Purchased Shares, we paid $300,000 to the PCH Shareholders. We were also obligated
to issue to the PCH Shareholders 1,500,000,000 shares (the “Purchase Price Shares”) of our common stock. That number
of issuable shares is subject to certain provisions detailed in the PCH-Related Note, which are summarized herein.
Notwithstanding
the number of issuable shares referenced above, the number of issued Purchase Price Shares is to be equal to 15% of the then-issued
and outstanding shares of our common stock at the time that we exercise our option to acquire the PCH Optioned Shares under the
Stock Purchase Option Agreement (the “PCH Option Agreement”; the parties to which are PASE, PCH, the PCH Shareholders).
Further, in the event that we issue additional equity securities prior to the date on which we issue the Purchase Price Shares
at a price per share that is less than the value referenced above, the PCH Shareholders shall be entitled to “full ratchet”
anti-dilution protection in the calculation of the number of Purchase Price Shares to be issued (with the exception of a recapitalization
by the Lender to reduce our overall dilution).
If
we did not exercise the option to acquire the PCH Optioned Shares prior to PCH Optioned Shares Expiry Date, the PCH Shareholders
had the right to reacquire the PCH Purchased Shares from us for the same cash consideration ($300,000.00) that we paid to them
for those shares. Further, if we are in default of our material obligations under the Securities Purchase Agreement, or if PASE
is the subject of any bankruptcy proceedings, then the PCH Shareholders have the same reacquisition rights noted in the preceding
sentence.
Pursuant
the PCH Option Agreement, PASE was granted the option to purchase all 49%, but not less than all 49%, of the PCH Optioned Shares.
The exercise price for the PCH Optioned Shares is an amount equivalent to five times PCH’s “EBITDA” for the
12-calendar month period, on a look-back basis, that concludes on the date of exercise of the Option, less $10.00 (which was the
purchase price of the option). The calculation of the 12-month EBITDA is to be determined by PASE’s (or our) then-currently
engaged independent auditors. If we exercise the option prior to the first anniversary of the closing of the acquisition of the
PCH Purchased Shares, then the exercise price for the PCH Optioned Shares shall be based on the EBITDA for the entire 12-calendar
month period that commenced with the effective date of the PCH Option Agreement.
PCH
Investment Group, Inc. – San Diego Project Termination
On
March 27, 2017, we filed a Current Report on Form 8-K to announce the above-described series of events, pursuant to which we indirectly
acquired 51% of the then-issued and outstanding shares of capital stock of PCH. Subsequently, it became clear to us that the acquisition
transaction and the then-prospective, anticipated benefits were not going to manifest themselves in a timely manner and in the
magnitude that we had originally anticipated.
Accordingly,
through a Settlement Agreement and Mutual General Release, with an effective date of August 16, 2017, we “unwound”
the acquisition and entered into a series of mutual releases with, among others, PCH, Mr. Pyatt, and Mr. Goh, but solely in connection
with his status as an equity holder of PCH. See, also,
Change of Officers and Directors
in connection with the severance
by each of Messrs. Pyatt and Goh of their respective employment and directorship relationships with us.
Pueblo
Farm
Grant
of Second Deed of Trust and Assignment of Rents
On
September 30, 2016, EWSD I, LLC (“EWSD I”), a wholly-owned subsidiary of ours granted a junior lender (the “Junior
Lender”) a Second Deed of Trust, Security Agreement and Financing Statement (the “Second Trust Deed”) and an
Assignment of Rents and Leases (the “Assignment of Rents”). The Second Trust Deed and the Assignment of Rents encumber
certain real property comprised of 320-acres of agricultural land in Pueblo, Colorado (the “Farm”) owned by EWSD I,
and the rents payable by tenants under any current and future leases of and from the Farm. The Second Trust Deed and the Assignment
of Rents secure the payment of all obligations of EWSD I pursuant to any debentures issued to the Junior Lender in accordance
with the Securities Purchase Agreement dated June 30, 2016 by and among EWSD I, Junior Lender, and us (the “June Securities
Purchase Agreement”).
The
security granted to the Junior Lender pursuant to the Second Trust Deed and the Assignment of Rents is subordinate to the rights
of Southwest Farms, Inc. (the “Senior Lender”) as set forth in the Deed of Trust, Security Agreement and Financing
Statement dated as of August 7, 2015 granted by EWSD I in favor of Senior Lender and the Assignment of Rents and Leases by and
between EWSD I and Senior Lender dated as of August 7, 2015. Such subordination is documented in a Subordination Agreement dated
as of August 23, 2016 by and among Senior Lender, Junior Lender, us, EWSD I, and Pueblo Agriculture Supply and Equipment, LLC,
another wholly-owned subsidiary of ours, as amended by a First Amendment to Subordination Agreement dated as of September 19,
2016 (collectively, the “Subordination Agreement”) pursuant to which Senior Lender consented to the Second Trust Deed
and the Assignment of Rents. The Subordination Agreement also provides that the Junior Lender may not increase the principal amount
of indebtedness pursuant to the June Securities Purchase Agreement beyond $1,500,000.
Pueblo
Farm – Management Services Agreement
On
May 31, 2017, we, and two of our subsidiaries, EWSD I, LLC (“EWSD”) and Pueblo Agriculture Supply and Equipment LLC,
and Trava LLC, a Florida limited liability company that has lent various sums to us (“Trava”; referenced above as
the “PCH Lender”), entered into a Management Services Agreement (the “MS Agreement”) in respect of our
hemp grow-and-extraction operations located in Pueblo, Colorado (the “Pueblo Farm”). The MS Agreement has a 36-month
term with two consecutive 12-month unilateral options exercisable in the sole discretion of Trava. Pursuant to the provisions
of the MS Agreement, Trava shall collect all revenue generated by the Pueblo Farm operations. Further, Trava is to satisfy all
of our Pueblo Farm-related past due expenses and, subject to certain limitations, to pay all current and future operational expenses
of the Pueblo Farm operations. Finally, commencing October 2017, Trava is obligated to make the monthly mortgage payments on the
Pueblo Farm, although we remain responsible for any and all “balloon payments” due under the mortgage. On a cumulative
calendar monthly cash-on-cash basis, Trava is obligated to tender to us or, at our option, to either or both of our subsidiaries,
an amount equivalent to 51% of the net cash for each such calendar month. Such monthly payments are on the 10
th
calendar
day following the end of a calendar month for which such tender is required. At the end of the five-year term (assuming the exercise
by Trava of each of the two above-referenced options), Trava has the unilateral right to purchase the Pueblo Farm operation at
a four times multiple of its EBITDA (calculated at the mean average thereof for each of the two option years).
Commencing
in September 2017 in connection with Trava monthly lending to us of funds sufficient for the Pueblo Farm’s monthly operational
expenses of the Pueblo Farm operations, we amended the MA Agreement to provide that, from time to time, Trava may exercise its
rights to convert some or all of the notes that evidence its lending of funds into shares of our common stock at a fixed conversion
price of $.0001 pre-share. If Trava converts, in whole or in part, any one or more of such notes, then (unless (i) thereafter,
we are unable to accommodate any future such conversions because of a lack of authorized, but unissued or unreserved, shares or
(ii) the public market price for a share of our common stock become “no bid”), Trava shall continue to exercise its
conversion rights in respect of all of such notes (to the 4.9% limitations set forth therein) and shall diligently sell the shares
of common stock into which any or all of such notes may be converted (collectively, the “Underlying Shares”) in open
market or other transactions (subject to any limitations imposed by the Federal securities laws and set forth in any “leak-out”
type of arrangements in respect of the “underlying shares” to which Trava is a party).
Trava
acknowledged that any proceeds derived by it from such sales of the underlying shares shall, on a dollar-for-dollar basis, reduce
our financial obligations under the notes. Once Trava has received sufficient proceeds from such sales to reduce our aggregate
obligations thereunder to nil (which reductions shall include any and all funds that Trava may have otherwise received in connection
with the respective rights and obligations of the parties to the MSA), then the MSA shall be deemed to have been cancelled without
any further economic obligations between Trava and us and Trava’s purchase right shall, accordingly, be extinguished.
Change
of Officers and Directors
On
May 16, 2017, we held a Special Meeting of our Board of Directors. At that Special Meeting, Messrs. Manuel Flores and Mitchel
Lowe, each a director of ours, notified us that they would resign from our Board of Directors effective immediately. Mr. Flores
and Mr. Lowe each made the decision to resign solely for personal reasons and time considerations and did not involve any disagreement
with us, our management, or our Board of Directors.
At
the Special Meeting, Clinton Pyatt, then our Chief Operating Officer and Senior Vice President of Government Affairs accepted
a position as a member of our Board of Directors and as our President. Clint’s Employment Agreement, which was approved
by our Board of Directors on March 20, 2017, provided that he would join our Board of Directors and become our President upon
his acceptance of such roles. Accordingly, he commenced his service as a director and our President at during the May 2017 Special
Meeting.
With
the resignations of Messrs. Flores and Lowe from the Board and the acceptance by Mr. Pyatt as a director, our Board had four vacancies.
Accordingly, at the Special Meeting, our Board of Directors approved the nomination of the following nominees, to serve as directors,
as noted:
Andrew
Kantarzhi, 33, is a Sales and Marketing veteran, with over a decade in assisting multi-national corporations with developing new
business and growing sales and revenue. Andrew previously acted as Director of Sales and Marketing at the International Management
Group for one of its flagship properties in Central Asia. In 2010, Mr. Kantarzhi acted as Eurasian Natural Resource Company’s
(LSE: ENRC; KASE: GB_ENRC) Sales Manager for ENRC’s Non-Core Materials Division, heading its Astana Sales Office. In 2011,
he was promoted to Director of Sales and Marketing of ENRC’s Ferrosilicon Division in Moscow, Russia, where the division
set record unit price sales and increased market share throughout the entire Russian Federation. Commencing in 2013, Mr. Kantarzhi
has managed accounts for Traxys North America’s Base Metals Division at its Manhattan, NY headquarters. Traxys is a commodities
trading firm and a member of the Carlyle Group. Since 2016, he has acted as Chief Commercial Officer for OC Testing, LLC, a New
York-based company that invests in and develops Cannabis-related research and testing facilities. We believed that Andrew’s
experience in sales and marketing, including experience in the cannabis industry, will provide a benefit to us, our stockholders,
and our Board by his providing us with significant guidance as we enter the next phase of our sales and marketing development.
Mr. Kantarzhi commenced his service as a director at the close of the May 2017 Special Meeting.
Charles
K. Miller, 56, was the Chief Financial Officer of Tekmark Global Solutions from 1997 until June of 2017. He was elected to the
Board of Directors of InterCloud Systems, Inc. (OTCQB: ICLD), in November 2012. InterCloud is a New Jersey-based global single-source
provider of value-added services for both corporate enterprises and service providers. Mr. Miller received his B.S. in accounting
and his M.B.A. from Rider College and is a Certified Public Accountant in New Jersey. We believed that Chuck’s more than
30 years of financial experience will provide a financial stability benefit to us, our stockholders, and our Board of Directors.
Mr. Miller commenced his service as a director at the close of the May 2017 Special Meeting.
Thomas
A. Gallo, 55, founded the Strategic Advisory Group (“SAG”) at Corinthian Partners L.L.C., a boutique investment bank
headquartered in New York City in 2014. Working within the investment banking department, SAG provided capital formation advice,
as well as raised capital for SAG’s client companies. In May, 2017, SAG and he joined the investment bank and brokerage
firm, Spartan Capital Securities, LLC, located in the Wall Street area of New York City. In June 2015, SAG and he joined Newbridge
Securities Corporation, an independent broker dealer and investment bank, where he currently serves as Senior Managing Director.
Mr. Gallo, a FINRA-licensed professional, focuses on providing strategic, capital markets, and financial advice to micro-cap public
and private companies. From July 2016 to April 2017, Tom served as a Director of Viatar CTC Solutions Inc., a Lowell, Massachusetts-based
medical technology company. From 2010 to 2014, he worked with a select group of high net-worth investors as their Investment Advisor,
as well as commencing to work with public companies as a Strategic Advisor and Investment Banker at GSS Capital. Mr. Gallo earned
a B.S. in Business Management & Marketing from Fordham University College of Business Administration in 1983. We believed
that Tom’s 25 years of Wall Street-based experience will provide a capital markets benefit to us, our stockholders, and
our Board of Directors. Mr. Gallo commenced his service as a director on May 19, 2017, upon his receipt of approval from Spartan
to serve as a director.
At
a Special Meeting of our Board of Directors held on June 1, 2017, our Board of Directors approved the nomination of the Judith
Hammerschmidt to fill a vacancy on our Board.
Judith
Hammerschmidt, 62, has spent the last 35 years as an international attorney. She began her career as a Special Assistant to the
Attorney General of the United States, focusing on international matters of interest to the US government, including negotiating
treaties and agreements with foreign governments. She then joined Dickstein, Shapiro & Morin, LLP, a Washington, DC firm,
where she represented companies around the world as they expanded internationally in high regulated environments. Her clients
included Guess? Inc., Pfizer Inc., Merck & Co., Inc., the Receiver for BCCI Bank of the United Arab Emirates, Recycled Paper
Products, Inc., and Herbalife International Inc. She provided structuring, growth and regulatory advice for these and other companies.
She joined Herbalife International as Vice President and General Counsel of Europe in 1994, becoming Executive Vice President
and International Chief Counsel in 1996. In 2002, she was part of the management group that sold Herbalife. Since that time, she
has served as outside counsel to a series of entrepreneurial companies looking to expand internationally, primarily in the food
and drug/nutritional supplements space. In addition, Ms. Hammerschmidt was a Principal in JBT, LLC, a privately held company that
owned “mindful dining” restaurants in the Washington, DC area. Those properties were sold in 2010. She continues to
act as outside counsel for small companies while serving as a director.
At
a Special Meeting of our Board of Directors held on June 14, 2017, our Board of Directors approved the following individuals to
serve on various committees, all as noted below:
Compensation
Committee
Thomas
A. Gallo, Chair
Judith
Hammerschmidt
Andrew
Kantarzhi
Ned
L. Siegel
Audit
Committee
Charles
K. Miller, Chair
Thomas
A. Gallo
Ned
L. Siegel
Nominating
& Governance Committee
Judith
Hammerschmidt, Chair
Andrew
Kantarzhi
Ned
L. Siegel
In
anticipation of the possibility of certain changes in the composition of our board and our executive suite, our Board of Directors,
at a Special Meeting held on July 28, 2017, named Ned Siegel, our long-standing, non-executive Chairman of the Board, as our Executive
Chairman for the four-month period that expires on November 30, 2017. As of the date of this Report, we expect to extend Mr. Siegel’s
term as our Executive Chairman.
On
August 11, 2017, Jeff Goh, who served as our Chief Executive Officer and one of our directors, tendered his resignation. Mr. Goh
is a former director and executive officer of PCH and, as of the date of his resignation, remained an owner of one-third of the
outstanding capital stock of PCH. Prior to the tendering of his resignation, Mr. Goh and one of the members of our Board’s
special committee had engaged in certain conversations in respect of Mr. Goh’s future with us or the methods by which he
might exit from his positions with us. As a result of those conversations ultimately not coming to a mutually satisfactory conclusion,
Mr. Goh tendered his resignation from all positions with us. We believe that Mr. Goh’s resignations as an executive officer
and a director were caused, in whole or in part, by his belief that he was no longer permitted to fulfill his position as our
chief executive officer and his concern that he was not being compensated in a manner consistent with his understandings of our
obligations to him. As noted in the resignation letter that he provided us, Mr. Goh has filed a wage claim with the Department
of Industrial Relations, Division of Labor Standards Enforcement.
Thereafter,
effective August 16, 2017, Clint Pyatt, who served as our president and one of our directors, resigned from those positions in
connection with our agreement of that date (the “Agreement”) with, among others, him, our then-51%-owned subsidiary,
PCH Investment Group, Inc. (“PCH”), of which he was an executive officer, director, and a principal. For information
concerning the Agreement, please see
PCH Investment Group, Inc. – San Diego Project Termination
, above. In connection
with the Agreement and his resignation, there were no disagreements between Mr. Pyatt and us.
Summaries
The
foregoing descriptions of agreements are merely summaries thereof and, if any of such agreements are deemed to be material agreements,
they shall be filed by the Company as exhibits to this Report, or incorporated by reference to previously filed Reports.