CONDENSED NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS
March 31, 2018
(Unaudited)
NOTE
1 -
NATURE OF OPERATIONS
Drone
USA, Inc. (“Drone”) is an Unmanned Aerial Vehicles (“UAV”) and related services and technology company
that intends to engage in the research, design, development, testing, manufacturing, distribution, exportation, and integration
of advanced low altitude UAV systems, services and products. Drone also provides product procurement, distribution, and logistics
services through its wholly-owned subsidiary, HowCo Distributing Co., (“HowCo”) (collectively, the “Company”)
to the United States Department of Defense and Defense Logistics Agency. The Company has operations based in West Haven, Connecticut
and Vancouver, Washington. The Company is registered with the U.S. State Department and has met the requirements of the Arms
Export Control Act and International Traffic in Arms Regulations (“ITAR”). The registration allows for the Company
to apply for export, and temporary import, of product, technical data, and services related to defense articles. The Company continues
to seek strategic acquisitions and partnerships with UAV firms that offer superior technologies in high-growth markets, as well
as acquisitions and partnerships with firms that have complementary technologies and infrastructure.
NOTE
2
-
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND GOING CONCERN
Basis
of Presentation and Principles of Consolidation
The
accompanying consolidated financial statements include the accounts of Drone USA, Inc. and its wholly-owned subsidiaries, Drone
USA, LLC (inactive), and HowCo. All significant intercompany accounts and transactions have been eliminated in consolidation.
The
accompanying unaudited condensed consolidated financial statements of the Company have been prepared in accordance with accounting
principles generally accepted in the United States of America (“GAAP”) and the rules and regulations of the Securities
and Exchange Commission for interim financial information. Accordingly certain information and footnote disclosures normally included
in financial statements in accordance with GAAP have been omitted.
In the opinion of management,
all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating
results for the six months ended March 31, 2018 are not necessarily indicative of the results that may be expected for the year
ending September 30, 2018. The unaudited condensed consolidated financial statements should be read in conjunction with the audited
consolidated financial statements as of and for the year ended September 30, 2017 and footnotes thereto included in the Company’s
Annual Report on Form 10-K filed with the SEC on December 29, 2017. The consolidated balance sheet as of September 30, 2017 contained
herein has been derived from the audited consolidated financial statements as of September 30, 2017, but does not include all
disclosures required by GAAP.
Going
Concern
The accompanying consolidated financial statements
have been prepared assuming the Company will continue as a going concern, which contemplates the recoverability of assets and the
satisfaction of liabilities in the normal course of business. For the six months ended March 31, 2018, the Company has incurred
a net loss of $3,021,808 and used cash in operations of $795,719. The working capital deficit, stockholders' deficit and accumulated
deficit was $13,020,086, $9,201,968, and $16,878,233, respectively, at March 31, 2018. Furthermore, on April 13, 2017 the Company
received a default notice on its payment obligations under the senior secured credit facility agreement (see Note 5), defaulted
on its Note Payable – Seller, and as of March 31, 2018 is subject to lawsuits and has received demands for payment of past
due amounts from several consultants and service providers. These matters raise substantial doubt about the Company’s ability
to continue as a going concern for a period of twelve months from the issuance date of this report. The ability of the Company
to continue as a going concern is dependent upon management’s ability to further implement its business plan and raise additional
capital as needed from the sales of stock or debt. The Company has been implementing cost-cutting measures and restructuring or
setting up payment plans with vendors and service providers and plans to raise equity through a private placement, and restructure
or repay its secured obligations. The accompanying unaudited condensed consolidated financial statements do not include any adjustments
that might be required should the Company be unable to continue as a going concern.
Use
of Estimates
The
preparation of consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions
that affect the reported amounts of assets and liabilities and disclosures of contingent liabilities at the date of the consolidated
financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ
from those estimates. Significant estimates include the allowance for bad debt on accounts receivable, reserves on inventory,
valuation of goodwill and intangible assets for impairment analysis, valuation of the earn-out liability, valuation of stock based
compensation, the valuation of derivative liabilities and the valuation allowance on deferred tax assets.
DRONE
USA, INC. AND SUBSIDIARIES
CONDENSED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March
31, 2018
(Unaudited)
Fair
Value Measurements
The
Company follows the FASB
Fair Value Measurements
standard, as they apply to its financial instruments. This standard defines
fair value, outlines a framework for measuring fair value, and details the required disclosures about fair value measurements.
Fair
value is defined as the price that would be received to sell an asset, or paid to transfer a liability, in an orderly transaction
between market participants at the measurement date. The standard establishes a hierarchy in determining the fair value of an
asset or liability. The fair value hierarchy has three levels of inputs, both observable and unobservable. Level 1 inputs include
quoted market prices for identical assets or liabilities in an active market that the Company has the ability to access at the
measurement date. Level 2 inputs are market data, other than Level 1, that are observable either directly or indirectly. Level
2 inputs include quoted market prices for similar assets or liabilities, quoted market prices in an inactive market, and other
observable information that can be corroborated by market data. Level 3 inputs are unobservable and corroborated by little or
no market data. The standard requires the utilization of the lowest possible level of input to determine fair value and carrying
amounts of current liabilities approximate fair value due to their short-term nature. The Company accounts for certain instruments
at fair value using level 3 valuation.
|
|
At March 31, 2018
|
|
|
At September 30, 2017
|
|
Description
|
|
Level 1
|
|
|
Level 2
|
|
|
Level 3
|
|
|
Level 1
|
|
|
Level 2
|
|
|
Level 3
|
|
Derivative liability
|
|
|
-
|
|
|
|
-
|
|
|
$
|
116,693
|
|
|
|
-
|
|
|
|
-
|
|
|
$
|
-
|
|
A
roll forward of the level 3 valuation financial instruments is as follows:
|
|
Derivative
Liabilities
|
|
Balance at September 30, 2017
|
|
$
|
-
|
|
Initial valuation of derivative liability recorded as derivative expense
|
|
|
70,028
|
|
Initial valuation of derivative liability recorded as debt discount
|
|
|
79,000
|
|
Change in fair value of derivative liability
|
|
|
(32,335
|
)
|
Balance at March 31, 2018
|
|
$
|
116,693
|
|
Inventory
Inventory
consists of finished goods, which are purchased directly from manufacturers. The Company utilizes a just in time type of inventory
system where products are ordered from the vendor only when the Company has received sales order from its customers. Inventory
is stated at the lower of cost and net realizable value on a first-in, first-out basis.
Revenue
Recognition
Sales
are recognized upon shipment of product to the customer. Provisions for returns and allowances are recorded in the period the
sales occur. Payments received from customers prior to shipment of the product to them, are recorded as customer deposit liabilities.
Convertible
Notes with Fixed Rate Conversion Options
The
Company may enter into convertible notes, some of which contain, predominantly, fixed rate conversion features, whereby the outstanding
principal and accrued interest may be converted by the holder, into common shares at a fixed discount to the market price of the
common stock at the time of conversion. This results in a fair value of the convertible note being equal to a fixed monetary amount.
The Company records the convertible note liability at its fixed monetary amount by measuring and recording a premium, as applicable,
on the Note date with a charge to interest expense in accordance with ASC 480 - "Distinguishing Liabilities from Equity".
Stock-based compensation
Stock-based compensation is accounted
for based on the requirements of ASC 718 –
“Compensation –Stock Compensation
”, which requires recognition
in the financial statements of the cost of employee and director services received in exchange for an award of equity instruments
over the period the employee or director is required to perform the services in exchange for the award (presumptively, the vesting
period). The ASC also requires measurement of the cost of employee and director services received in exchange for an award based
on the grant-date fair value of the award. The Company utilizes the Black-Sholes option pricing model and uses the simplified method
to determine expected term because of lack of sufficient exercise history. Additionally, effective January 1, 2017, the Company
adopted the Accounting Standards Update No. 2016-09 (“ASU 2016-09
”), Improvements to Employee Share-Based Payment
Accounting
. ASU 2016-09 permits the election of an accounting policy for forfeitures of share-based payment awards, either
to recognize forfeitures as they occur or estimate forfeitures over the vesting period of the award. The Company has elected to
recognize forfeitures as they occur and the cumulative impact of this change did not have any effect on the Company’s consolidated
financial statements and related disclosures.
Pursuant to ASC 505-50 –
“Equity-Based
Payments to Non-Employees”
, all share-based payments to non-employees, including grants of stock options, are recognized
in the consolidated financial statements as compensation expense over the service period of the consulting arrangement or
until performance conditions are expected to be met. Using a Black-Scholes valuation model, the Company periodically reassessed
the fair value of non-employee options until service conditions are met, which generally aligns with the vesting period of the
options, and the Company adjusted the expense recognized in the consolidated financial statements accordingly.
DRONE USA, INC. AND SUBSIDIARIES
CONDENSED NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS
March 31, 2018
(Unaudited)
Derivative
Liabilities
The
Company has certain financial instruments that contain embedded derivatives. The Company evaluates all its financial instruments
to determine if those contracts or any potential embedded components of those contracts qualify as derivatives to be separately
accounted for in accordance with ASC 810-10-05-4 and 815-40. This accounting treatment requires that the carrying amount
of any embedded derivatives be recorded at fair value at issuance and marked-to-market at each balance sheet date. In
the event that the fair value is recorded as a liability, as is the case with the Company, the change in the fair value during
the period is recorded as either income or expense. Upon conversion, exercise or repayment, the respective derivative liability
is marked to fair value at the conversion, repayment or exercise date and then the related fair value amount is reclassified to
income or expense as part of gain or loss on extinguishment.
Net
Loss Per Share
Basic
loss per share is calculated by dividing the loss attributable to stockholders by the weighted-average number of shares outstanding
for the period. Diluted loss per share reflects the potential dilution that could occur if securities or other contracts to issue
common stock were exercised or converted into common stock or resulted in the issuance of common stock that shared in the earnings
(loss) of the Company. Diluted loss per share is computed by dividing the loss available to stockholders by the weighted average
number of shares outstanding for the period and dilutive potential shares outstanding unless such dilutive potential shares would
result in anti-dilution. As of March 31, 2018 and 2017, potentially dilutive securities consisted of the following:
|
|
March 31, 2018
|
|
|
March 31, 2017
|
|
Stock options
|
|
|
44,351,200
|
|
|
|
33,025,000
|
|
Warrants
|
|
|
600,000
|
|
|
|
500,000
|
|
Related party convertible debt and accrued interest
|
|
|
9,398,132
|
|
|
|
3,688,000
|
|
Senior convertible debt
|
|
|
77,814,212
|
|
|
|
17,670,000
|
|
Convertible debt
|
|
|
31,285,292
|
|
|
|
-
|
|
Contingent liability – advisory fees
|
|
|
-
|
|
|
|
3,156,448
|
|
Total
|
|
|
163,448,836
|
|
|
|
58,039,448
|
|
Segment
Reporting
The
Company uses “the management approach” in determining reportable operating segments. The management approach considers
the internal organization and reporting used by the Company’s chief operating decision maker for making operating decisions
and assessing performance as the source for determining the Company’s reportable segments. The Company’s chief operating
decision maker is the chief executive officer of the Company, who reviews operating results to make decisions about allocating
resources and assessing performance for the entire Company. As of March 31, 2018, the Company did not report any segment information
since the Company only generates sales from its subsidiary, HowCo.
Recent
Accounting Pronouncements
In
May 2014, the FASB issued a new accounting standard that attempts to establish a uniform basis for recording revenue to virtually
all industries financial statements, under U.S. GAAP as amended in March 2016 and April 2016. The revenue standard’s core
principle is built on the contract between a vendor and a customer for the provision of goods and services. It attempts to depict
the exchange of rights and obligations between the parties in the pattern of revenue recognition based on the consideration to
which the vendor is entitled. In order to accomplish this objective, companies must evaluate the following five basic steps: (i)
identify the contract with the customer, (ii) identify the performance obligations in the contract, (iii) determine the transaction
price, (iv) allocate the transaction price to the performance obligations in the contract, and (v) recognize revenue when (or
as) the entity satisfies a performance obligation. There are three basic transition methods that are available - full retrospective,
retrospective with certain practical expedients, and a cumulative effect approach. Under the third alternative, an entity would
apply the new revenue standard only to contracts that are incomplete under legacy U.S. guidance at the date of initial application
and recognize the cumulative effect of the new standard as an adjustment to the opening balance of retained earnings. Prior years
would not be restated and additional disclosures would be required to enable users of the financial statements to understand the
impact of adopting the new standard in the current year compared to prior years that are presented under legacy U.S. guidance.
For public business entities, this standard is effective for annual periods beginning after December 15, 2017, and interim periods
within those annual periods. Early adoption is prohibited. The Company does not believe that the adoption of this new accounting
standard to have a material impact on its consolidated financial position and results of operations.
In
February 2016, the FASB issued a new accounting standard on leases. The new standard, among other changes, will require lessees
to recognize a right-of-use asset and a lease liability on the balance sheet for all leases. The lease liability will be measured
at the present value of the lease payments over the lease term. The right-of-use asset will be measured at the lease liability
amount, adjusted for lease prepayments, lease incentives received and the lessee’s initial direct costs (e.g. commissions).
The new standard is effective for annual reporting periods beginning after December 15, 2018, including interim reporting periods
within those annual reporting periods. The adoption will require a modified retrospective approach for leases that exist or are
entered into after the beginning of the earliest period presented. The Company is currently evaluating the impact of this new
accounting standard on its consolidated financial position and results of operations.
The
Company does not believe that any other recently issued but not yet effective accounting pronouncements, if adopted, would have
a material effect on the accompanying consolidated financial statements.
NOTE
3 -
INVENTORY
At
March 31, 2018 and September 30, 2017, inventory consists of finished goods which was valued at $333,994 and $681,057, respectively.
DRONE USA, INC. AND SUBSIDIARIES
CONDENSED NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS
March 31, 2018
(Unaudited)
NOTE
4 -
LINE OF CREDIT - BANK
The
Company has a revolving line of credit with a financial institution. This revolving line of credit is in the amount of $50,000,
and is personally guaranteed by the Company’s Chief Executive Officer (“CEO”). The line bears interest at a
fluctuating rate equal to the prime rate plus 4.25%, which at March 31, 2018 and September 30, 2017 was 9.00% and 8.50%, respectively.
As of March 31, 2018, the balance of the line of credit was $45,959 with $4,041 available.
NOTE
5
-
NOTE PAYABLE – SELLER
In
connection with the acquisition of HowCo in September 2016, the Company issued a note payable in the amount of $900,000 to the
sellers of HowCo. The note matured on September 9, 2017 and bears interest at 5.50% per annum. The note requires payment of unpaid
principal and interest upon maturity. The note is secured by all assets of HowCo Distribution Co. and subordinated to the Senior
Secured Credit Facility discussed below. The note is currently in default and the default interest rate is 8% per annum. At March
31, 2018 and September 30, 2017, accrued interest on this note amounted to $89,583 and $53,682, respectively.
NOTE
6 -
CONVERTIBLE NOTES PAYABLE – RELATED PARTIES
The
Company has an $840,000 convertible note payable (“Note 1”) to a related party entity controlled by the Company’s
CEO. Note 1 bears interest at an annual rate of 7% with an original maturity date of June 11, 2017 that was extended to June 11,
2018, at which time all unpaid principal and interest is due. The holder of Note 1 has the option to convert the outstanding principal
and accrued interest, in whole or in part, into shares of common stock at a conversion price equal to the volume weighted average
price per share of common stock for the 30-day period prior to conversion. As of March 31, 2018 and September 30, 2017, Note 1
has not been converted and the balance of the note was $688,444 and $688,444, and accrued interest was $101,806 and $77,776, respectively.
This note is considered a stock settled debt in accordance with ASC 480 and the fixed monetary amount is equal to the principal
amount based on the conversion formula.
The
Company has a convertible note payable (“Note 2”) with the Company’s CEO. Note 2 bears interest at an annual
rate of 7% with a maturity date of December 31, 2017, at which time all unpaid principal and interest was due. On December 15,
2017, the due date of Note 2 was extended to July 2, 2018. The holder of Note 2 has the option to convert the outstanding principal
and accrued interest, in whole or in part, into shares of common stock at a conversion price equal to the volume weighted average
price per share of common stock for the 30-day period prior to conversion. During the six months ended March 31, 2018, the Company
borrowed $500 and repaid $90,000 on this note. As of March 31, 2018 and September 30, 2017, Note 2 has not been converted and
the balance was $32,500 and $122,000, and accrued interest was $12,744 and $10,707, respectively. This note is considered a stock
settled debt in accordance with ASC 480 and the fixed monetary amount is equal to the principal amount based on the conversion
formula.
NOTE
7 –
CONVERTIBLE NOTES PAYABLE AND ADVISORY FEE LIABILITIES
Senior
Secured Credit Facility Note
Effective
September 13, 2016 (“Effective Date”), the Company entered into a senior secured credit facility note (the “Agreement”)
with an investment fund to provide capital for the acquisition of HowCo. The Company can borrow up to $6,500,000, subject to lender
approval, with an initial convertible promissory note at closing of $3,500,000 (the “Convertible Note”). The Convertible
Note bears interest at a rate of 18% per annum, required monthly payments of $52,500 which is interest only starting on October
13, 2016 through February 13, 2017, and monthly payments, including interest and principal, of $298,341 starting on March 13,
2017 through maturity on March 13, 2018. Events of default are defined in the Agreement and Convertible Note. In the event of
default the Convertible Note balance will bear interest at 25% per annum. In connection with this Agreement, the Company was obligated
to pay additional advisory fees of $850,000 payable in the form of cash or common stock in accordance with the terms of the Agreement.
The Company was also required to reserve 7,000,000 shares of common stock related to this transaction. The reserved shares will
be released upon the satisfaction of the loan.
DRONE USA, INC. AND SUBSIDIARIES
CONDENSED NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS
March 31, 2018
(Unaudited)
In the event the lender makes additional loans
under the Agreement, the Company agreed to pay additional advisory fees under similar terms as the $850,000 fee. As of March 31,
2018, the Company had issued 539,204 shares of common stock in satisfaction of the $850,000 advisory fee in accordance with the
terms of the agreement, such shares being issued in September 2016. The proceeds from the sale of the 539,204 shares were supposed
to be applied towards the $850,000 advisory fee due. Based upon the value of the shares, at the time the lender sells the shares,
the Company may be required to redeem unsold shares for the difference between the $850,000 and the lender’s sales proceeds.
Accordingly, the $850,000 was reflected as a current liability through December 31, 2017. In January 2018, in connection a settlement
agreement, the accrued advisory fee was reclassified to the principal balance of the replacement Convertible Note. Through the
date of the settlement agreement and through March 31, 2018, the lender had not reported any proceeds from the sale of these shares
(see below). Prior to the settlement agreement in January 2018, notwithstanding anything contained in the Agreement to the contrary,
in the event the Lender has not realized net proceeds from the sale of Advisory Fee Shares equal to at least the Advisory Fee by
the earlier to occur of: (A) the twelve (12) month anniversary of the Effective Date; (B) the occurrence of an Event of Default;
or (C) the Maturity Date, then at any time thereafter, the Lender shall have the right, upon written notice to the Borrower, to
require that the Borrower redeem all Advisory Fee Shares then in Lender’s possession for cash equal to the Advisory Fee,
less any cash proceeds received by the Lender from any previous sales of Advisory Fee Shares, if any. In the event such redemption
notice is given by the Lender, the Borrower shall redeem the then remaining Advisory Fee Shares in Lender’s possession for
an amount of Dollars equal to the Advisory Fee, less any cash proceeds received by the Lender from any previous sales of Advisory
Fee Shares, if any, payable by wire transfer to an account designated by Lender within five (5) Business Days from the date the
Lender delivers such redemption notice to the Borrower.
The
Convertible Note is only convertible upon default or mutual agreement by both parties at a conversion rate of 85% of the lowest
of the daily volume weighted average price of the Company’s common stock during the 5 business days immediately prior to
the conversion date. Once a default occurs the Convertible Note will be accounted for as stock settled debt at its fixed monetary
value and any shares issued upon conversion are also subject to a make whole provision similar to that described above for the
$850,000 advisory fee payable. On March 13, 2017 the Company defaulted on the monthly principal and interest payment of $298,341.
Due to this default, as of March 31, 2017, the Company has accounted for the embedded conversion option as stock settled debt
and recorded a debt premium of $617,647 with a charge to interest expense, and the interest rate increased to 25% (default rate).
The Company has been making interest-only payments of $52,500 each month, however, the Company has not made the full default interest
payment of $72,917 per month.
On
March 28, 2017, the Company entered into an agreement with the above senior secured credit facility lender to receive a range
of advisory services for a total of $1,200,000 with no definitive terms or length of service which was expensed in fiscal 2017
and had been recorded as an accrued liability – advisory fees through December 31, 2017. In connection with the settlement
agreement discussed below, in January 2018, the advisory services fee payable was reclassified to the principal balance of the
replacement Convertible Note.
On
January 3, 2018, the Company entered into a settlement agreement (the “Settlement Agreement”) and replacement note
agreements with the investment fund related to a senior secured credit facility note dated September 13, 2016. On the effective
date of the Settlement Agreement, all amounts owed to the investment fund aggregated $5,788,642 and consisted of a convertible
promissory note of $3,500,000, accrued interest payable of $238,642, and accrued advisory fees payable of $2,050,000. Additionally,
on the effective date, the amount due of $5,788,642 was split and apportioned into 2 separate and distinct replacement notes (“Replacement
Note A” and “Replacement Note B”). Replacement Note A shall have a principal amount of $1,000,000 and Replacement
Note B shall have a principal balance of $4,788,642, both of which shall be and remained secured by the original security agreements,
the pledge agreements, the guarantee agreement and other applicable loan documents and both shall bear interest at 18% per annum.
The default was not waived by this settlement agreement. The Company originally recorded a premium on stock settled debt of $617,647
on the $3,500,000, and subsequent to the settlement agreement recorded an additional premium on stock settled debt of $403,878
on the additional $2,288,642.
The Credit Agreement is hereby amended such
that the Maturity Date is extended to January 13, 2019 (the "Extended Maturity Date") for replacement Note B, while the
Note A maturity date remained at March 13, 2018 but was due as of March 2017 due to the principal and interest payment default
discussed above. Notwithstanding anything contained in this Agreement to the contrary, all Obligations owing by the Company and
all other Credit Parties under the Credit Agreement, First Replacement Note B, and all other Loan Documents shall be paid in full
by the Extended Maturity Date as follows: $52,500 per month from January 13, 2018 to December 13, 2018 and the remaining principal
and accrued interest on January 13, 2019.
DRONE USA, INC. AND SUBSIDIARIES
CONDENSED NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS
March 31, 2018
(Unaudited)
On January 30, 2018, the Replacement Note A
in the principal amount of $1,000,000 was purchased by Livingston Asset Management LLC (“Livingston”) from the original
lender. On November 15, 2017, the Company executed a Liability Purchase Term Sheet with Livingston Asset Management (“Livingston”)
under which Livingston agreed to purchase up to $10,000,000 that the Company owes to its creditors through direct purchase of the
debts from the Company’s creditors. (See below). Replacement Note A is due to Livingston and bears interest at 18% per annum.
At any time and from time to time while this Note is outstanding, but only upon: (i) the occurrence of an Event of Default under
any of the Loan Documents; or (ii) mutual agreement between the Company and the Holder, this Note may be, at the sole option of
the Holder, convertible into shares of the Company’s common stock, in accordance with the terms and conditions set forth
below. At any time while this Note is outstanding, but only upon: (i) the occurrence of an Event of Default under any of the Loan
Documents; or (ii) mutual agreement between the Company and the Holder, the Holder may convert all or any portion of the outstanding
principal, accrued and unpaid interest, and any other sums due and payable hereunder or under any other Loan Documents (such total
amount, the "Conversion Amount") into shares of common stock of the Company (the "Conversion Shares") at a
price equal to: (i) the Conversion Amount (the numerator);
divided by
(ii) 85% of the lowest of the daily volume weighted
average price of the Company’s common stock during the five business days immediately prior to the conversion date, which
price shall be indicated in the conversion notice (the denominator) (the "Conversion Price"). Upon liquidation by the
Holder of Conversion Shares issued pursuant to a Conversion Notice, provided that the Holder realizes a net amount from such liquidation
equal to less than the Conversion Amount specified in the relevant conversion notice (such net realized amount, the "Realized
Amount"), the Company shall issue to the Holder additional shares of the Company's common stock equal to: (i) the Conversion
Amount specified in the relevant conversion notice;
minus
(ii) the Realized Amount, as evidenced by a reconciliation statement
from the Holder (a "Sale Reconciliation") showing the Realized Amount from the sale of the Conversion Shares;
divided
by
(iii) the average volume weighted average price of the Company's common stock during the five business days immediately
prior to the date upon which the Holder delivers notice (the "Make-Whole Notice") to the Company that such additional
shares are requested by the Holder (such number of additional shares to be issued, the "Make-Whole Shares"). As of March
31, 2018, there has been one issuance under section 3(a)(10) of the Securities Act for 1,500,000 shares (see below), which have
been recorded at par value with an equal charge to additional paid-in capital and which value has been recorded as a liability
remaining in convertible note balance, until these shares have been sold and reported to the Company by the lender as part of the
Make-Whole provision at which time the proceeds value of such shares will be reclassified to additional paid-in capital.
Other
Convertible Debt
In
July 2017, the FASB issued Accounting Standards Update No. 2017-11 Earnings Per Share (Topic 260) Distinguishing Liabilities from
Equity (Topic 480) Derivatives and Hedging (Topic 815) (“ASU 2017-11”), which changes the classification analysis
of certain equity-linked financial instruments (or embedded features) with down round features. When determining whether certain
financial instruments should be classified as liabilities or equity instruments, a down round feature no longer precludes equity
classification when assessing whether the instrument is indexed to an entity’s own stock. ASU 2017-11 also clarifies existing
disclosure requirements for equity-classified instruments. As a result, a freestanding equity-linked financial instrument (or
embedded conversion option) no longer would be accounted for as a derivative liability at fair value as a result of the existence
of a down round feature. For freestanding equity classified financial instruments, ASU 2017-11 requires entities that present
earnings per share (EPS) in accordance with ASC Topic 260 to recognize the effect of the down round feature when it is triggered.
That effect is treated as a dividend and as a reduction of income available to common shareholders in basic EPS. For the Company,
ASU 2017-11 is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018. Early
adoption is permitted, including adoption in an interim period. The Company adopted this standard on October 1, 2017.
On
October 5, 2017, the Company entered into a Securities Purchase Agreement with Power Up Lending Group Ltd. (“Power Up”)
under which the Company received $78,500, net of $21,500 in fees and expenses to be recorded as a debt discount and amortized
to interest expense over the Note term, in return for issuing a convertible promissory note (the “Note”) in the principal
amount of $100,000. Power Up received a right of first refusal for the first nine months from the date of the Note to provide
any debt or equity financing less than $150,000. The Note bears interest at 10% per annum and has a maturity date of July 15,
2018. The Note may be prepaid at a premium ranging from 112% to 137% depending on the length of time following the date of the
Note. The Note is convertible after 180 days into shares of the Company’s common stock at a discount of 35% of the average
of the two lowest closing bid prices of Drone USA’s common stock 15 days prior to the date of conversion and the maximum
number of shares issued to Power Up may not exceed 4.99% of the issued and outstanding shares of the Company’s common stock.
The Note is subject to customary default provisions, including a cross default provision. The Company’s CEO entered into
a confession of judgment in the principal amount of the Note. The Company has accounted for the convertible promissory note as
stock settled debt under ASC 480 and recorded a debt premium of $53,846 with a charge to interest expense.
DRONE USA, INC. AND SUBSIDIARIES
CONDENSED NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS
March 31, 2018
(Unaudited)
On
November 9, 2017, the Company received a first tranche payment of $75,500 under the terms of a Securities Purchase Agreement dated
October 25, 2017, with Crown Bridge Partners, LLC (“Crown Bridge”) under which the Company issued to Crown Bridge
a convertible note in the principal amount of $105,000 and a five-year warrant to purchase 100,000 shares of the Company’s
common stock at an exercise price of $0.35 as a commitment fee which is equal to the product of one-third of the face value of
each tranche divided by $0.35. The warrants have full ratchet price protection and cashless exercise rights. The convertible note
(the “Note”) issued to Crown Bridge is in the principal amount of $105,000, has an original issue discount of $10,500
and issue costs of $19,000 both of which are recorded as debt discount along with the warrant relative fair value to be amortized
over the twelve month term of this tranche, bears interest of 10% (12% default rate) per annum, and has a maturity date of 12
months from the date of each tranche of payments under the Note with future tranches being at the discretion of Crown Bridge.
The conversion rate for any conversion of unpaid principal and interest under the Notes is at a 35% discount to the lowest market
price of the shares of the Company’s common stock within a 20 day trading period prior to the date of conversion to which
an additional 10% discount will be added if the conversion price of the Company’s common stock is less than $0.05 per share
and no shares of the Company’s common stock can be issued to the extent Crown Bridge would own more than 4.99% of the outstanding
shares of the Company’s common stock and the conversion shares contain piggy-back registration rights. The Note is subject
to customary default provisions including an event of default if the bid price of the Company’s common stock is less than
its par value of $.0001 per share. The Company is entitled to prepay the Note between 30 days after its issuance until 180 days
from its issuance at amounts that increase from 112% of the prepayment amount to 137% of the prepayment amount depending on the
length of time when prepayments are made. The Company has accounted for the convertible promissory note as stock settled debt
under ASC 480 and recorded a debt premium of $56,538 with a charge to interest expense.
On November
15, 2017, the Company executed a Liability Purchase Term Sheet with Livingston Asset Management (“Livingston”) under
which Livingston agreed to purchase up to $10,000,000 that the Company owes to its creditors through direct purchase of the debts
from the Company’s creditors in return for (i) a convertible note issued by the Company in the principal amount of $50,000
bearing interest of 10% per year to cover certain legal fees and other expenses of Livingston that matures in six months and is
convertible into shares of our common stock at a 30% reduction off the lowest closing bid price for 20 trading days prior to the
date of conversion, (ii) a convertible note subject to these same terms as the convertible note issued to Livingston payable to
Scottsdale Capital Advisors in the principal amount of $15,000 as a placement agent fee and (iii) the right of Livingston to retain
30% of any negotiated reduction off the face amount of the liability the Company owes to such creditors. The Company has accounted
for the convertible promissory notes as stock settled debt under ASC 480 and recorded a debt premium of $27,857 with a charge
to interest expense. On March 7, 2018 the Company entered into a placement agent and advisory agreement with Scottsdale Capital
Advisors in connection with the Livingston liability purchase term sheet executed on November 15, 2017. The placement agent services
amounted to $15,000 payable in the form of a convertible note which was assigned by Livingston (the “Scottsdale Note”).
The Scottsdale Note matures six months from the date of issuance and shall accrue interest at the rate of 10% per annum. The $15,000
note is convertible into shares of the Company’s common stock at a discount of 30% of the low closing bid price for the
twenty trading days prior to the conversion and is not subject to any registration rights.
Pursuant
to the Liability Purchase Term Sheet, following a court judgment for the liabilities purchased by Livingston, the Company will
issue free trading shares of its common stock under section 3(a)(10) of the Securities Act to Livingston in the amount of such
judgment in a series of tranches so that Livingston will not own more than 9.99% of our outstanding shares per tranche. In connection
with the Livingston Liability Purchase Term Sheet, on February 8, 2018, the Company and Livingston entered into a Settlement Agreement
and Stipulation whereby Livingston filed a complaint for payment of Replacement Note A in the principal amount of $1,000,000 (the
“Claim Amount”) pursuant to the section 3(a)(10) settlement (See above). In accordance with the terms of the Settlement
Agreement, the Court was advised of Company's intention to rely upon the exception to registration set forth in Section 3(a)(l0)
of the Act to support the issuance of its common shares and the Court held a fairness hearing regarding the issuance (the "Hearing")
on March 12, 2018. Following entry of an Order by the Court which occurred on March 12, 2018, in settlement of the claims, the
Company shall issue and deliver to Livingston shares of its common stock (the "Settlement Shares") in one or more tranches
as necessary, and subject to adjustment and ownership limitations as set forth in the Settlement Agreement, sufficient to generate
proceeds such that the aggregate Remittance Amount equals the Claim Amount. The parties reasonably estimate that the fair market
value of the Settlement Shares to be received by Livingston is equal to approximately $1,666,667 which is based on a discount
of 40%.
On November 28, 2017, the Company received
a payment of $84,000, net of issue costs of $23,500 which was recorded as a debt discount and is being amortized to interest expense
over the Note term, under the terms of a Securities Purchase Agreement dated November 20, 2017, with Labrys Fund, LP (“Labrys”)
under which Drone USA issued to Labrys (i) a convertible note (the “Note”) in the principal amount of $107,500 that
bears interest of 10% (24% default rate) per annum and (ii) 335,938 shares of the Company’s common stock as a commitment
fee which were to be returned to the Company in the event that it pays all unpaid principal and interest under the Note within
180 days of November 20, 2017. Pursuant to ASC 260, as of December 31, 2017, the 335,938 contingent shares issued under the Financial
Consulting Agreement are not considered outstanding and are not included in basic net loss per share or as potentially dilutive
shares in calculating the diluted EPS. The Note has a maturity date of August 28, 2018 and a conversion rate for any unpaid principal
and interest at a 35% discount to the market price which is defined as the average of the two lowest trading prices (defined as
the lower of the trading price or closing bid price) for the Company’s common stock during the fifteen (15) trading day period
ending on the latest complete trading day prior to the date of conversion. The conversion rate is further reduced if the Company
enters into any section 3(a)(9) or 3(a)(10) transactions under the Securities Act of 1933, as amended, if the terms of those transactions
offer greater discounts on conversion prices or a longer look back period for determining the conversion rate and under certain
other enumerated events, including if the conversion price is less than $.01 per share or if the Company loses the “bid”
price for its common stock ($0.0001 on the “ask” with zero market makers on the “bid” per Level 2 and/or
a market such as OTC Pink). In addition, if the Company issues any shares of its common stock at less than the conversion price
Labrys is entitled to full ratchet anti-dilution in such event. No shares of the Company’s common stock can be issued to
the extent Labrys would own more than 4.99% of the outstanding shares of the Company’s common stock unless Labrys agrees
to increase the ownership to 9.99%. The Company is required at all times to have authorized and reserved six times the number of
shares that is actually issuable upon full conversion of the Note (based on the conversion price of the Note in effect from time
to time). Initially, the Company must instruct its transfer agent to reserve 6,198,049 shares of its common stock. The Note is
subject to customary default provisions and also includes a cross-default provision as well as default being triggered if the Company
loses the “bid” price for its common stock ($0.0001 on the “ask” with zero market makers on the “bid”
per Level 2 and/or a market such as OTC Pink) and a $15,000 penalty if not paid by the maturity date. The Company is entitled to
prepay the Note between the issue date until 180 days from its issuance but not thereafter. In November 2017, the Company
accounted for the convertible promissory note as stock settled debt under ASC 480 and recorded a debt premium of $57,885 with a
charge to interest expense. On February 7, 2018 the Company amended the terms to the Note whereby Labrys waives all existing events
of default on the Note and in return will no longer be required, under any circumstances, to return the commitment shares back
to the Company’s treasury. The Company was under default for failing to maintain a market capitalization of at least $5,000,000
on any trading day. The 335,938 commitment shares were considered issued in February 2018 which was recorded as interest and financing
costs at the then market close price of $0.09 per share for a value of $30,234.
DRONE USA, INC. AND SUBSIDIARIES
CONDENSED NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS
March 31, 2018
(Unaudited)
On
December 7, 2017, the Company received a payment of $79,000, net of an original issue discount of $5,800 and issue costs of $20,200
fees which was recorded as a debt discount which is being amortized into interest expense over the Note term, under the terms
of a Securities Purchase Agreement dated November 21, 2017, with EMA Financial, LLC (“EMA Financial”) under which
the Company issued to EMA Financial a convertible note (the “Note”) in the principal amount of $105,000 that bears
interest of 10% (24% default rate) per annum. The Note has a maturity date of December 7, 2018 and has a conversion rate for any
unpaid principal and interest at a conversion price which is the lower of (i) the closing sales price of the Company’s common
stock on the trading day immediately preceding the date of funding and (ii) a 35% discount to (a) the lowest sales price of the
shares of the Company’s common stock within a 20 day trading period including and immediately preceding the conversion date
or (b) the lowest bid price on the conversion date, whichever is lower, and the conversion shares contain piggy-back registration
rights. The conversion rate is further reduced under certain events, including if the closing sales price is less than $0.095
in which case the conversion rate is a 50% discount under the terms set forth above. No shares of the Company’s common stock
can be issued to the extent EMA Financial would own more than 4.99% of the outstanding shares of the Company’s common stock.
The Company also is required at all times to have authorized and reserved eight times the number of shares that is actually issuable
upon full conversion or adjustment of the Note (based on the conversion price of the Note in effect from time to time) and initially
must instruct its transfer agent to reserve 6,802,000 shares of common stock in the name of EMA Financial for issuance upon conversion.
The Note is subject to customary default provisions and also includes a cross-default provision as well as default being triggered
if the Company loses the “bid” price for its common stock ($0.0001 on the “ask” with zero market makers
on the “bid” per Level 2 and/or a market such as OTC Pink). The Company is entitled to prepay the Note between the
issue date until 180 days from its issuance at a premium of 135% of the unpaid principal and interest if paid within 90 days after
the issue date and 150% thereafter. In connection with the issuance of this Note, the Company determined that the terms of the
Note contain a conversion formula that caused variations in the conversion price resulting in the treatment of the conversion
option as a bifurcated derivative to be accounted for at fair value. Accordingly, under the provisions of FASB ASC Topic No. 815-40,
“Derivatives and Hedging – Contracts in an Entity’s Own Stock”, the embedded conversion option contained
in the convertible instruments were accounted for as derivative liabilities at the date of issuance and shall be adjusted to fair
value through earnings at each reporting date. The fair value of the embedded conversion option derivatives were determined using
the Binomial valuation model. At the end of each period, the Company revalued the embedded conversion option and warrants derivative
liabilities. In connection with this Note, on the initial measurement date of December 7, 2017, the fair values of the embedded
conversion option derivative of $149,028 was recorded as derivative liabilities, $70,028 was charged to current period operations
as initial derivative expense, and $79,000 was recorded as a debt discount and is being amortized into interest expense over the
term of this Note. At the end of the period, the Company revalued the embedded conversion option derivative liability. In connection
with this revaluations, the Company recorded derivative expense of $19,680 and $37,693 for the three and six months ended March
31, 2018. During the six months ended March 31, 2018, the fair value of the derivative liability was estimated using the Binomial
valuation model with the following assumptions:
Dividend rate
|
|
|
0
|
|
Term (in years)
|
|
|
.69 year
|
|
Volatility
|
|
|
222.18
|
%
|
Risk-free interest rate
|
|
|
1.76% to 2.09
|
%
|
A
number of terms included in the Securities Purchase Agreement and Note issued subsequently (see paragraph below) were more favorable
than the terms granted to EMA Financial under its Securities Purchase Agreement and the EMA Note. Accordingly, on December 31,
2017, EMA Financial notified the Company that pursuant to the EMA Securities Purchase Agreement that the EMA Note was automatically
amended by increasing (i) the annual interest rate to 12% percent and (ii) the Original Issue Discount to $9,450.
DRONE USA, INC. AND SUBSIDIARIES
CONDENSED NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS
March 31, 2018
(Unaudited)
On
December 13, 2017, the Company received a payment of $60,000, net of original issue discount fees of $7,500 and $15,000 of issue
costs recorded as debt discounts and amortized to interest expense over the Note term under the terms of a Securities Purchase
Agreement dated December 8, 2017, with Morningview Financial, LLC (“Morningview Financial”) under which the Company
issued to Morningview Financial a convertible note (the “Note”) in the principal amount of $82,500 that bears interest
of 12% (18% default rate) per annum. The Note has a maturity date of 12 months and a conversion rate for any unpaid principal
and interest and a conversion price which is a 35% discount to the lowest sales price of the shares of the Company’s common
stock within a 20-day trading period including and immediately preceding the conversion date. The conversion rate is further reduced
under certain events, including if the closing sales price is less than $0.05 in which case the conversion rate is a 45% discount
under the terms set forth above. No shares of the Company’s common stock can be issued to the extent Morningview Financial
would own more than 4.99% of the outstanding shares of the Company’s common stock. The Company also is required at all times
to have authorized and reserved eight times the number of shares that is actually issuable upon full conversion or adjustment
of the Note (based on the conversion price of the Note in effect from time to time). The Note is subject to customary default
provisions and also includes a cross-default provision as well as default being triggered if the Company’s Trading Price
as that term is defined in the Note is less than $.0001 or if a money judgment, writ or similar process shall be entered or filed
against the Company or any of its subsidiaries for more than $50,000, and shall remain unvacated, unbonded or unstayed for a period
of 20 days unless otherwise consented to by the holder of the Note. Additionally, upon default and default notice by the lender,
the amount immediately due shall be increased to 150% or 200% of the outstanding principal and interest due depending upon the
default provisions, plus default interest. The Company is entitled to prepay the Note between the issue date until 180 days from
its issuance at a premium of 135% of the unpaid principal and interest. The Company has accounted for the convertible promissory
note as stock settled debt under ASC 480 and recorded a debt premium of $44,423 with a charge to interest expense.
On
January 3, 2018, the Company entered into a Securities Purchase Agreement with Power Up under which the Company received $42,000,
net of $11,000 in fees and expenses which were recorded as a debt discount and amortized to interest expense over the Note term,
in return for issuing a convertible promissory note (the “Note”) in the principal amount of $53,000. Power Up received
a right of first refusal for the first nine months from the date of the Note to provide any debt or equity financing less than
$150,000. The Note bears interest at 10% per annum and has a maturity date of October 15, 2018. The Note may be prepaid at a premium
ranging from 112% to 137% depending on the length of time following the date of the Note. The Note is convertible after 180 days
into shares of the Company’s common stock at a discount of 35% of the average of the two lowest closing bid prices of the
Company’s common stock 15 days prior to the date of conversion and the maximum number of shares issued to Power Up may not
exceed 4.99% of the issued and outstanding shares of Drone USA common stock. The Note is subject to customary default provisions,
including a cross default provision. The Company is required to have authorized for issuance six times the number of shares that
would be issuable upon full conversion of the Note (assuming that the 4.99% limitation is not in effect) and based on the applicable
conversion price of the Note in effect from time to time, initially to be 3,462,355 shares of common stock. The Company has accounted
for the convertible promissory note as stock settled debt under ASC 480 and recorded a debt premium of $28,538 with a charge to
interest expense.
On January 9, 2018, the Company received a
payment of $84,000, net of $23,500 in fees and expenses which was recorded as a debt discount and amortized to interest expense
over the Note term under the terms of a Securities Purchase Agreement dated November 20, 2017, with Labrys under which the Company
issued to Labrys (i) a convertible note (the “Note”) in the principal amount of $107,500 that bears interest of 10%
per annum and (ii) 421,238 shares of the Company’s common stock as a commitment fee which was to be returned to the Company
in the event that it pays all unpaid principal and interest under the Note within 180 days of December 26, 2017. Pursuant to ASC
260, as of January 9, 2018, the 421,238 contingent shares issued under the Financial Consulting Agreement are not considered outstanding
and are not included in basic net loss per share or as potentially dilutive shares in calculating the diluted EPS. The Note has
a maturity date of nine months or September 26, 2018, and a conversion rate for any unpaid principal and interest at a 35% discount
to the market price which is defined as the average of the two lowest trading prices (defined as the lower of the trading price
or closing bid price) for the Company’s common stock during the fifteen trading day period ending on the latest complete
trading day prior to the date of conversion. The conversion rate is further reduced if the Company enters into any section 3(a)(9)
or 3(a)(10) transactions under the Securities Act of 1933, as amended, if the terms of those transactions offer greater discounts
on conversion prices or a longer look back period for determining the conversion rate and under certain other enumerated events,
including if the conversion price is less than $.01 per share or if the Company loses the “bid” price for its common
stock ($0.0001 on the “ask” with zero market makers on the “bid” per Level 2 and/or a market such as OTC
Pink). In addition, if the Company issues any shares of its common stock at less than the conversion price, Labrys is entitled
to full ratchet anti-dilution in such event. No shares of Drone USA common stock can be issued to the extent Labrys would own more
than 4.99% of the outstanding shares of the Company’s common stock unless Labrys agrees to increase the ownership to 9.99%.
The Company is required at all times to have authorized and reserved six times the number of shares that is actually issuable upon
full conversion of the Note (based on the conversion price of the Note in effect from time to time). Initially, the Company must
instruct its transfer agent to reserve 8,535,980 shares of its common stock. The Note is subject to customary default provisions
and also includes a cross-default provision as well as default being triggered if the Company loses the “bid” price
for its common stock ($0.0001 on the “ask” with zero market makers on the “bid” per Level 2 and/or a market
such as OTC Pink). The Company is entitled to prepay the Note between the issue date until 180 days from its issuance but not thereafter.
The Company has accounted for the convertible promissory note as stock settled debt under ASC 480 and recorded a debt premium of
$57,885 with a charge to interest expense. On February 7, 2018 the Company amended the terms to the Note whereby Labrys waives
all existing events of default on the Note and in return will no longer be required, under any circumstances, to return the commitment
shares back to the Company’s treasury. The Company was under default for failing to maintain a market capitalization of at
least $5,000,000 on any trading day. The 421,238 commitment shares were considered issued in February 2018 at a price of $0.09
per share based on the then market close price for a total value of $37,911 which was recorded as interest and financing costs.
DRONE USA, INC. AND SUBSIDIARIES
CONDENSED NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS
March 31, 2018
(Unaudited)
On
January 31, 2018 the Company received a payment of $95,000, net of $2,750 for legal fees and $7,250 for due diligence to be recorded
as a debt discount and amortized to interest expense over the Note term under the terms of a Securities Purchase Agreement dated
January 31, 2018, with Auctus Fund, LLC (“Auctus”) under which the Company issued to Auctus a convertible note (the
“Note”) in the principal amount of $105,000 that bears interest of 10% per annum. The Note has a maturity date of
nine months or October 26, 2018, and a conversion rate for any unpaid principal and interest at a 35% discount to the market price
which is defined as the average of the two lowest trading prices (defined as the lower of the trading price or closing bid price)
for the Company’s common stock during the fifteen trading day period ending on the latest complete trading day prior to
the date of conversion. The conversion rate is further reduced if the Company enters into any section 3(a)(9) or 3(a)(10) transactions
under the Securities Act of 1933, as amended, if the terms of those transactions offer greater discounts on conversion prices
or a longer look back period for determining the conversion rate and under certain other enumerated events, including if the conversion
shares cannot be delivered by DWAC. In addition, if the Company issues any shares of its common stock at less than the conversion
price, Auctus is entitled to full ratchet anti-dilution in such event. No shares of the Company’s common stock can be issued
to the extent Auctus would own more than 4.99% of the outstanding shares of the Company’s common stock unless Auctus agrees
to increase the ownership to 9.99%. The Company is required at all times to have authorized and reserved ten times the number
of shares that is actually issuable upon full conversion of the Note (based on the conversion price of the Note in effect from
time to time). The Note is subject to customary default provisions and also includes a cross-default provision as well as default
being triggered if the Company loses the “bid” price for its common stock ($0.0001 on the “ask” with zero
market makers on the “bid” per Level 2 and/or a market such as OTC Pink). The Company is entitled to prepay the Note
between the issue date until 180 days from its issuance but not thereafter. The Company has accounted for the convertible promissory
note as stock settled debt under ASC 480 and recorded a debt premium of $56,538 with a charge to interest expense.
On
March 5, 2018, the Company entered into a Securities Purchase Agreement with Power Up under which the Company received $42,000,
net of $11,000 in fees and expenses to be recorded as a debt discount and amortized to interest expense over the Note term, in
return for issuing a convertible promissory note (the “Note”) in the principal amount of $53,000. Power Up received
a right of first refusal for the first nine months from the date of the Note to provide any debt or equity financing less than
$150,000. The Note bears interest at 10% per annum and has a maturity date of December 15, 2018. The Note may be prepaid at a
premium ranging from 112% to 137% depending on the length of time following the date of the Note. The Note is convertible after
180 days into shares of the Company’s common stock at a discount of 35% of the average of the two lowest closing bid prices
of the Company’s common stock 15 days prior to the date of conversion and the maximum number of shares issued to Power Up
may not exceed 4.99% of the issued and outstanding shares of Drone USA common stock. The Note is subject to customary default
provisions, including a cross default provision. The Company is required to have authorized for issuance six times the number
of shares that would be issuable upon full conversion of the Note (assuming that the 4.99% limitation is not in effect) and based
on the applicable conversion price of the Note in effect from time to time, initially to be 13,046,154 shares of common stock.
The Company has accounted for the convertible promissory note as stock settled debt under ASC 480 and recorded a debt premium
of $28,538 with a charge to interest expense.
The
senior secured credit facility note balance and convertible debt balances consisted of the following at March 31, 2018 and September
30, 2017:
|
|
March 31, 2018
|
|
|
September 30, 2017
|
|
Principal
|
|
$
|
6,672,142
|
|
|
$
|
3,500,000
|
|
Premiums
|
|
|
1,923,770
|
|
|
|
617,647
|
|
Unamortized discounts
|
|
|
(177,894
|
)
|
|
|
(338,075
|
)
|
|
|
|
8,418,018
|
|
|
|
3,779,572
|
|
Non-current
|
|
|
-
|
|
|
|
-
|
|
Current
|
|
$
|
8,418,018
|
|
|
$
|
3,779,572
|
|
For
the six months ended March 31, 2018 and 2017, amortization of debt discount amounted to $445,734 and $368,820, respectively.
DRONE USA, INC. AND SUBSIDIARIES
CONDENSED NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS
March 31, 2018
(Unaudited)
NOTE
8 –
NOTE AND LOAN PAYABLE
On
October 19, 2017, the Company entered into a loan agreement with a third party entity under which the Company received approximately
$232,500, net of fees and expenses of $17,500 recorded as debt discounts and amortized to interest expense over the Note term,
in return for issuing a promissory note (the “Note”) in the principal amount of $250,000. The Note bears interest
at 12% (18% default rate) per annum and has a maturity date of April 20, 2018. The Note may be prepaid in full or in part with
additional premium or penalty. The Note is secured by certain assets of the Company’s CEO, certain assets of HowCo and all
of the assets of Drone USA as a junior security interest to the first secured interest of the senior lender. Additionally, the
loan is guaranteed by the Company’s CEO. For the three and six months ended March 31, 2018, amortization of debt discount
amounted to $8,799 and $15,545 and the balance of the note was $248,045 net of remaining discount of $1,955. On April 20, 2018,
the note matured and all principal and unpaid interest was due immediately. The Company is currently working with the lender to
settle this note and in the meantime is responsible for all collection expenses, including reasonable attorneys’ fees incurred
with or without suit and on appeal. The Company will be accruing interest at the default interest rate of 18% until settlement.
On
February 2, 2018, the Company entered into a oral loan agreement with a vendor under which the Company reclassified $579,106 in
accounts payable in return for promising to pay the principal amount of $579,106. The loan bears interest at 18% per annum and
has a maturity date of October 31, 2018. The loan will be paid in full by the maturity date by making monthly payments of $70,000
from February 28, 2018 to September 30, 2018 and a final balance payment of approximately $63,000 by October 31, 2018. The loan
does not have a default interest rate nor prepayment penalties if the note is paid in full or in part. During the six months ended
March 31, 2018 the Company has made its first two payments of principal and interest and the balance of the note was $455,559.
NOTE
9 -
STOCKHOLDERS’ DEFICIT
Preferred
Stock
As
of March 31, 2018, the Company is authorized to issue 5,000,000 shares of $.0001 par value preferred stock, with designations,
voting, and other rights and preferences to be determined by the Board of Directors of which 4,999,750 remain available for designation
and issuance.
As
of March 31, 2018 and 2017, the Company has designated 250 shares of $0.0001 par value Series A preferred stock, of which 250
shares are issued and outstanding. These preferred shares have voting rights per share equal to the total number of issued and
outstanding shares of common stock divided by 0.99.
Common
Stock
Stock
Incentive Plan
The
Company established its 2016 Stock Incentive Plan (the “Plan”) that permits the granting of incentive stock options
and other common stock awards. The maximum number of shares available under the Plan is 100,000,000 shares. The Plan is open to
all employees, officers, directors, and non-employees of the Company. Option granted under the Plan will terminate and may no
longer be exercised (i) immediately upon termination of an employee or consultant for cause or (ii) one year after termination
of employment, but not later than the remaining term of the option. As of March 31, 2018, 55,648,800 awards remain available
for grant under the Plan.
Shares
Issued for Services
On
September 1, 2017, the Company entered into a consulting agreement with an individual. In connection with this agreement, the
Company agreed to issue 10,000 common shares per month until the agreement is terminated. During the six months ended March 31,
2018, an aggregate of 30,000 common shares were issuable pursuant to the agreement. Such shares were valued on the vesting dates
of October 1, 2017 and November 1, 2017 at $3,950, or $0.20 and $0.195 per share, respectively, based on the quoted trading price.
In connection with these shares, during the six months ended March 31, 2018, the Company recorded professional fees of $3,950.
This agreement was terminated in December 2017.
DRONE USA, INC. AND SUBSIDIARIES
CONDENSED NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS
March 31, 2018
(Unaudited)
Shares
Issued for debt issuance costs
On November 28, 2017, pursuant to a Securities
Purchase Agreement and Convertible Note Agreement with Labrys (see Note 7), the Company considered issued to Labrys 335,938 shares
of the Company’s common stock, as a commitment fee which was to be returned to the Company in the event that it pays all
unpaid principal and interest under the Note within 180 days of November 20, 2017. Prior to the February 7, 2018 amendment discussed
below, pursuant to ASC 260 the 335,938 shares were considered contingent shares and not considered outstanding and not accounted
for due to the contingency. On February 7, 2018 the Company amended the terms of the convertible note dated November 28, 2017 whereby
the holder waives all existing events of default to date and in return shall no longer be required to return, under any circumstances,
the commitment shares back to the Company’s treasury. On February 16, 2018 the Company issued the 335,938 shares at the then
market close price of $0.09 per share for a value of $30,234 which was expensed.
On February 16, 2018, pursuant to a Securities
Purchase Agreement and Convertible Note Agreement with Labrys (see Note 7), the Company issued to Labrys 421,238 shares of the
Company’s common stock, as a commitment fee which was to be returned to the Company in the event that it pays all unpaid
principal and interest under the Note within 180 days of December 26, 2017. Prior to the February 7, 2018 amendment discussed below,
pursuant to ASC 260 the 421,238 shares were considered contingent shares ad not considered outstanding and not accounted for due
to the contingency. On February 7, 2018 the Company amended the terms to the convertible note dated December 26, 2017 whereby the
holder waives all existing events of default to date and in return shall no longer be required to return, under any circumstances,
the commitment shares back to the Company’s treasury. On February 16, 2018 the Company issued the 421,238 shares at the then
market close price of $0.09 per share for a value of $37,911 which was expensed.
On
March 14, 2018, pursuant to Replacement Note A with Livingston (see Note 7), the Company issued to Livingston 1,500,000 shares
of the Company’s common stock under section 3(a)(10) of the Securities Act, which have been recorded at par value with an
equal charge to additional paid-in capital and which value has been recorded as a liability remaining in convertible note balance,
until these shares have been sold and reported to the Company.
Stock
Options
For
the six months ended March 31, 2018 and 2017, the Company recorded $145,322 and $894,016 of compensation and consulting expense
related to stock options, respectively. Total unrecognized compensation and consulting expense related to unvested stock options
at March 31, 2018 amounted to $1,352,943. The weighted average period over which share-based compensation expense related to these
options will be recognized is approximately 3 years.
For
the six months ended March 31, 2018, a summary of the Company’s stock options activity is as follows:
|
|
Number of
Options
|
|
|
Weighted-
Average
Exercise Price
|
|
|
Weighted-
Average
Remaining
Contractual
Term (Years)
|
|
|
Weighted-
Average
Grant-Date
Fair Value
|
|
|
Aggregate
Intrinsic
Value
|
|
Outstanding at September 30, 2017
|
|
|
44,351,200
|
|
|
$
|
0.21
|
|
|
|
9.27
|
|
|
$
|
-
|
|
|
$
|
0
|
|
Granted
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
Forfeited
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
Outstanding at March 31, 2018
|
|
|
44,351,200
|
|
|
$
|
0.21
|
|
|
|
8.68
|
|
|
$
|
-
|
|
|
$
|
0
|
|
Exercisable at March 31, 2018
|
|
|
27,294,600
|
|
|
$
|
0.20
|
|
|
|
8.51
|
|
|
$
|
-
|
|
|
$
|
0
|
|
All
options were issued at an options price equal to the market price on the date of the grant.
Warrants
On
November 9, 2017, the Company received a first tranche payment of $75,500 under the terms of a Securities Purchase Agreement dated
October 25, 2017, with Crown Bridge under which the Company issued to Crown Bridge a convertible note in the principal amount
of $105,000 and a five-year warrant to purchase 100,000 shares of the Company’s common stock at an exercise price of $0.35
as a commitment fee which is equal to the product of one-third of the face value of each tranche divided by $0.35. The warrants
have full ratchet price protection and cashless exercise rights (See Note 7).
DRONE USA, INC. AND SUBSIDIARIES
CONDENSED NOTES TO CON
SOLIDATED
FINANCIAL STATEMENTS
March
31, 2018
(Unaudited)
For
the six months ended March 31 2018, a summary of the Company’s warrant activity is as follows:
|
|
Number of
Warrants
|
|
|
Weighted-
Average
Exercise
Price
|
|
|
Weighted-
Average
Remaining
Contractual
Term (Years)
|
|
|
Weighted-
Average
Grant-Date
Fair Value
|
|
|
Aggregate
Intrinsic
Value
|
|
Outstanding at September 30, 2017
|
|
|
500,000
|
|
|
$
|
0.01
|
|
|
|
3.44
|
|
|
$
|
-
|
|
|
$
|
95,000
|
|
Granted
|
|
|
100,000
|
|
|
|
0.35
|
|
|
|
4.61
|
|
|
|
-
|
|
|
|
-
|
|
Outstanding at March 31, 2018
|
|
|
600,000
|
|
|
$
|
0.07
|
|
|
|
3.64
|
|
|
$
|
-
|
|
|
$
|
32,500
|
|
Exercisable at March 31, 2018
|
|
|
600,000
|
|
|
$
|
0.07
|
|
|
|
3.64
|
|
|
$
|
-
|
|
|
$
|
32,500
|
|
NOTE
10 -
RELATED PARTY TRANSACTIONS
Since
July 2017, the Company utilizes the office space and equipment of an entity in West Haven, Connecticut related to the Company’s
CEO at no cost.
The
Company has certain convertible notes payable to related parties (see Note 6).
NOTE
11 -
COMMITMENTS AND CONTINGENCIES
Contingencies
Legal
Matters
In
connection with the merger with Texas Wyoming Drilling, Inc., a vendor has a claim for unpaid bills of approximately $75,000 against
the Company. The Company and its legal counsel believe the Company is not liable for the claim pursuant to its indemnification
clause in the merger agreement.
During
the quarter ended June 30, 2017, the Company received demands for non-payment of five months of rent for its New York location.
In July 2017, the Company vacated the New York premises. Subsequent to June 30, 2017, a lawsuit was filed in the Supreme Court
of the State of New York for an alleged breach of a Service Agreement for approximately $63,000 in connection with the lease the
Company entered into for its former office space in New York. As of September 30, 2017, the Company accrued into accounts payable
approximately $63,000 pursuant to ASC 420-10-30 “Cost to Terminate an Operating Lease”. In October 2017, the Company
entered into a settlement agreement with the New York lease landlord and paid $30,000 in full settlement and recorded a settlement
gain of $33,361.
The
Company has filed a lawsuit against the former Chief Strategy Officer and member of the Board, who was terminated for cause on
July 7, 2017, for breach of contract, breach of the covenant of good faith and fair dealing, and violation of the California Business
& Professions Code. On July 31, 2017, the former Chief Strategy Officer and member of the Board subsequently filed a counterclaim
against the Company seeking, among other items, damages in excess of $900,000, prejudgment interest, and reimbursement of legal
fees. The Company believes it will prevail in this matter and therefore has not accrued any additional liabilities. Prior to the
termination and as of March 31, 2018 and September 30, 2017, there was accrued a 401(k) matching contribution of $9,230 and a
$100,000 sign on bonus.
On
August 9, 2017, a lawsuit was filed by an investor relations firm against the Company in the Supreme Court, Westchester County
(Index No. 61772/2017). The complaint alleged two causes of action, one for goods and services furnished and one for an account
stated, in the amount of $74,325. The plaintiff obtained a default judgment. The Company has filed an Order to Show Cause to vacate
the default judgment on the grounds that the service of the complaint was invalid. The court granted the Company’s Order
to Show Cause on December 19, 2017 and set the hearing on the Order to Show Cause for January 12, 2018. At December 31, 2017,
$68,544 was accrued in accounts payable. On February 14, 2018 the Company entered into a stipulation agreement with the investor
relations firm which settled the amount due at $20,000 if payment was made by February 21, 2018. The lump sum payment was made
on February 16, 2018 and a gain on extinguishment of debt of $48,544 was recorded.
On February 6, 2018 the Company sent a letter
to the previous owners of HowCo Distributing Co. (“HowCo”) in relation to the Stock Purchase Agreement entered into.
The Company believes that there were certain financial misrepresentations provided during the acquisition of Howco during 2016.
These misrepresentations likely impacted the transaction price paid as well as the working capital after closing. The Company estimates
that damages sum to approximately $800,000 in regards to working capital deficit as well as approximately $370,000 in regards to
the transaction prices. On March 13, 2018 the Company started a lawsuit against the previous owners by issuing a summons. On April
12, 2018, the Company received the Defendants’ answer and affirmative defenses in relation to the summons sent out to the
previous owners of HowCo Distributing Co. on March 13, 2018 on the financial misrepresentations provided during the acquisition
of HowCo. The answer states that damages at issue, if any, were caused by the fault of others. The owners seek for the Company
to dismiss its complaint with prejudice and award them for their attorneys’ fees, costs and disbursements.
DRONE USA, INC. AND SUBSIDIARIES
CONDENSED NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS
March 31, 2018
(Unaudited)
Commitments
Exclusive
Agreement
On
June 1, 2016, the Company entered into an exclusive agreement with a Brazilian entity in the drone technology market. The agreement
provides that the Company will acquire exclusive rights to this entity’s UAV technology and intellectual property that includes
research and development efforts completed by this entity. The Company will also secure exclusive export and representation rights
to this entity’s products along with the non-binding option to acquire full ownership of this entity for $1 million should
the companies agree at a later date it would be in the best interest of both businesses. As consideration for this agreement,
the Brazilian entity CEO was appointed to the position of Chief Technology Officer of the Company and granted an option for 2,000,000
shares of common stock.
Consulting
Agreements
In
June 2017, the Company entered into an agreement with an investment bank to provide placement agent services on an exclusive basis
as it relates to a private placement (“the placement”). The agreement calls for the investment bank to receive 9%
of the gross proceeds of the placement and 2.5% warrant coverage of the amount raised. The warrants shall entitle the investment
bank to purchase securities of the Company at a purchase price equal to 110% of the implied price per share of the placement or
100% of the public market closing price of the Company’s common stock on the date of the placement, whichever is lower.
The warrants shall have a term of five years after the closing of the placement. The agreement expired on September 30, 2017 but
the terms of the agreement was effective for certain capital raised during the six months ended March 31, 2018 (see Note 7).
Lease
Obligations
The
Company entered into an agreement with a manufacturer in Pismo Beach, California. The agreement provides for certain services
to be provided by the manufacturer as needed by the Company. The agreement has an initial term of three years with one year renewals.
In connection with this agreement, the Company has agreed to sublease space based in San Luis Obispo, California from the manufacturer
for the purposes of the development and manufacturing of unmanned aerial vehicles. The lease provides for base monthly rent of
approximately $15,000 for the initial term to be increased to $16,500 per month upon extension. The lease term begins February
1, 2017 and expires January 31, 2019 with the option to extend the term an additional 24 months. However, the Company never took
possession of the premises and in July 2017, the Company made a decision to not take possession of the premises. The Company is
in default of the rent payments and had received verbal demand of payments. As of March 31, 2018, the Company has not made any
of the required monthly rent payments in connection with this agreement. As of March 31, 2018 and September 30, 2017, the Company
had accrued into accounts payable the remaining amounts due under the term of the lease for a total accrual of $360,000 pursuant
to ASC 420-10-30.
In
May 2017, the Company extended HowCo’s office lease through May 30, 2020. The lease requires monthly payments including
base rent plus CAM with annual increases. Future minimum lease payments under non-cancelable operating leases at March 31, 2018
are as follows:
Years ending March 31,
|
|
Amount
|
|
2018
|
|
|
44,507
|
|
2019
|
|
|
60,499
|
|
2020
|
|
|
25,460
|
|
Total minimum non-cancelable operating lease payments
|
|
$
|
130,466
|
|
For
the six months ended March 31, 2018 and 2017, rent expense amounted to $28,330 and $27,774, respectively.
Purchase
commitments
The
Company entered into agreements to act as a distributor or dealer with third party drone suppliers. Some of these agreements require
the Company to maintain certain levels of inventory of the supplier’s products. Such levels of inventory are not quantifiable
as of the date of this report.
DRONE USA, INC. AND SUBSIDIARIES
CONDENSED NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS
March 31, 2018
(Unaudited)
Profit
Sharing Plan (for HowCo)
On
April 13, 2018, HowCo Distributing announced to its employees a company-wide profit sharing program. In fiscal year 2018, HowCo
Distributing, will redistribute the total of ten-percent of company net income. The employee profit is equal to their annual salary
divided by the Company’s total annual payroll and multiplied by 10% of net income for the fiscal year.
Other
On
January 29, 2018, the Company entered into a settlement agreement and mutual release with a vendor who had provided public relations
and other consulting services whereby the Company shall pay to this vendor an aggregate amount of $60,000 of which $30,000 was
paid on February 2, 2018. Additionally, the Company shall pay ten monthly payments of $3,000 per month beginning on February 29,
2018. Additionally, the vendor returned 400,000 common shares of the Company’s common stock which will be cancelled.
NOTE
12 -
CONCENTRATIONS
Concentration
of Credit Risk
The
Company maintains its cash in bank and financial institution deposits that at times may exceed federally insured limits. At March
31, 2018, cash in bank did not exceed the federally insured limits of $250,000. The Company has not experienced any losses in
such accounts through March 31, 2018.
Economic
Concentrations
With respect to customer concentration, three
customers accounted for approximately 55%, 16%, and 11% , of total sales for the six months ended March 31, 2018. Three customers
accounted for approximately 65%, 12% and 11% of total sales for the six months ended March 31, 2017.
With respect to accounts receivable concentration,
four customers accounted for approximately 94% of total accounts receivable at March 31, 2018 at 56%, 15%, 14% and 9%. Three customers
accounted for approximately 60%, 12% and 12% of total accounts receivable at March 31, 2017.
With respect to supplier concentration, there
were two suppliers accounted for approximately 41% and 12% of total purchases for the six months ended March 31, 2018. Two suppliers
accounted for approximately 48% and 13% of total purchases for the six months ended March 31, 2017.
With respect to accounts payable concentration, two suppliers accounted
for approximately 23% and 11% of total accounts payable at March 31, 2018. Two suppliers accounted for approximately 44% and 11%
of total accounts payable at March 31, 2017.
With respect to foreign sales, it totaled approximately
$32,000 for the six months ended March 31, 2018. Foreign sales totaled approximately $207,000 for the six months ended March 31,
2017.
NOTE
13 -
SUBSEQUENT EVENTS
Shares
Issued for Services
On April 1, 2018, the Company entered into
a one year oral management consulting agreement with an individual. In connection with this agreement, the Company issued 4,000,000
common shares to the consultant. Such shares were valued on the vesting dates of April 1, 2018 at $296,000, or $0.074 per share
based on the quoted trading price. In connection with these shares, the Company will record professional fees over the one-year
term.
Shares Issued for Conversion
During the period from April 30, 2018 through
May 8, 2018 the company received multiple notices of conversion from Power Up Lending Group Ltd., to convert a total of $49,000
of principal from the convertible note entered into on October 5, 2017 (see Note 7). The Company issued 1,995,869 common shares
for these conversions leaving a remaining principal balance due on this note of $51,000.
Legal
On
April 12, 2018, the Company received the Defendants’ answer and affirmative defenses in relation to the summons sent out
to the previous owners of HowCo Distributing Co. on March 13, 2018 on the financial misrepresentations provided during the acquisition
of HowCo. The answer states that damages at issue, if any, were caused by the fault of others. The owners seek for the Company
to dismiss its complaint with prejudice and award them for their attorneys’ fees, costs and disbursements.