NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2016
NOTE 1 - NATURE OF BUSINESS AND BASIS OF PRESENTATION
NuGene International, Inc. (also refer
to as “we”, “us”, “our”, “the “Company”, “NuGene” or “NGI”)
was incorporated in the State of Nevada on October 31, 2013. NuGene, Inc. (our wholly owned subsidiary) was incorporated in the
state of California in December 2006. On January 20, 2015, we formed NuGene BioPharma, Inc. (“BioPharma”) as a wholly
owned California incorporated subsidiary of NGI. On November 6, 2015, we formed The Aesthetic Group, Inc. (“TAG”) as
a wholly owned California incorporated subsidiary of NGI. Both BioPharma and TAG have had no significant independent operations
since inception.
Basis of Presentation
The accompanying consolidated financial statements
of our Company have been prepared in accordance with accounting principles generally accepted in the United States. The consolidated
financial statements reflect the accounts of NuGene International, Inc. and its wholly owned subsidiaries BioPharma and TAG. All
significant inter-company balances and transactions have been eliminated in consolidation.
We have incurred net losses through the date of these financial statements and have yet to establish profitable
operations. Our consolidated financial statements have been presented on the basis that our business is a going concern, which
contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. We are subject to
the risks and uncertainties associated with a business with high short-term debt, limited commercial product revenues, including
limitations on our operating capital resources and uncertain demand for our products. We have incurred recurring operating losses
and negative operating cash flows since inception and through December 31, 2016, and we expect to continue to incur operating losses
and negative operating cash flows at least through the near future. Members of our Company’s management have been required
to advance our Company funding in order to partially meet our most critical cash requirements including payroll along with those
associated with certain critical goods and services. In the process of managing these situations, our management may have made
representations implying their personal guarantee of certain of our Company’s obligations.
For
further discussion of the advances made by management to meet the Company’s most critical cash needs, see the titled “Certain
Relationships and Related
Transactions”.
As a result of the
aforementioned factors, management has concluded that there is substantial doubt about our ability to continue as a going concern.
Our independent registered public accounting firm, in its report on our 2016 consolidated financial statements, raised substantial
doubt about our ability to continue as a going concern.
Our
consolidated financial statements as of and for the year ended December 31, 2016 do not contain any adjustments for this uncertainty.
In response to our Company’s cash needs, we raised funding as described in our footnotes that follow. Any additional amounts
raised will be used for our future investing and operating cash flow needs. However, there can be no assurance that we will be
successful in raising additional amounts of financing.
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING
POLICIES
Use of Estimates
Conformity with accounting principles generally
accepted in the United States of America (“GAAP”) requires the use of estimates and judgments that affect the reported
amounts in the financial statements and accompanying notes. These estimates form the basis for judgments we make about the carrying
values of our assets and liabilities that are not readily apparent from other sources. We base our estimates and judgments on historical
information and on various other assumptions that we believe are reasonable under the circumstances. GAAP requires us to make estimates
and judgments in several areas, including but not limited to, those related to revenue recognition, collectibility of accounts
receivable, contingent liabilities, fair value of financial instruments, fair value of acquired intangible assets and goodwill,
useful lives of intangible assets and property and equipment, excess and obsolete inventory, deferred tax asset valuation and income
taxes. These estimates are based on management’s knowledge about current events and expectations about actions we may undertake
in the future. Actual results could differ materially from those estimates.
Risks and Uncertainties
Our Company operates in an industry that is
subject to rapid change. Our Company's operations are subject to significant risk and uncertainties including financial, operational,
technological, regulatory and other risks, including the potential of business failure.
Reclassifications
For comparability, certain prior period amounts
have been reclassified, where appropriate, to conform to the current year’s financial statement presentation. These reclassifications
have no impact on net loss.
Cash Equivalents
Cash equivalents include investments with initial
maturities of three months or less. Our Company maintains its cash balances at credit-worthy financial institutions that are insured
by the Federal Deposit Insurance Corporation up to $250,000.
Inventories
Our Company’s
skin and hair care inventories consist of raw materials and finished goods and are valued at the lower of cost (first-in, first-out)
or market. Our Company evaluates its inventory for excess quantities and obsolescence on a regular basis. To determine if the cost
of our Company's inventory should be written down, current and anticipated demand, customer preferences and the age of the merchandise
are considered. For the year ended December 31, 2016
the Company recorded charges of approximately $437,000 to operations
as a result of excess and obsolete inventory related to the rebranding and repackaging of products. For the year ended December
31, 2015, the Company did not recognize any charges to operations associated with excess and obsolete inventory.
Valuation of long-lived Assets
The Company evaluates its long-lived assets
for impairment at least annually, or more frequently when a triggering event is deemed to have occurred. This assessment is subjective
in nature and requires significant management judgment to forecast future operating results, projected cash flows and current period
market capitalization levels. If the Company’s estimates and assumptions change in the future, it could result in a material
write-down of long-lived assets. The Company recognizes an impairment charge as the difference between the net book value of such
assets and the fair value of the assets on the measurement date.
Property and Equipment
Property and equipment consist of office furniture,
computer equipment, laboratory equipment, purchased software, website development and improvements made to our leased offices and
are stated at cost less accumulated depreciation. Depreciation is calculated using the straight-line method over the three or five
year useful lives of the assets or the remaining term of the lease. When property and equipment are retired or otherwise disposed
of, the related cost and accumulated depreciation are removed from the respective accounts, and any gain or loss is included in
operations. Expenditures for maintenance and repairs are expensed as incurred.
Revenue Recognition
In accordance with Accounting Standards Codification
(“ASC”) 605 -
Revenue Recognition
, the Company recognizes revenue from product sales when the product has been
ordered by the customer, the selling price is fixed or determinable, the product is shipped to the customer, title has transferred
and collectibility is reasonably assured.
Concentration of Revenues
During the year ended December 31, 2016, we
derived 12.3% and 12.2% of our revenues from two wholesale distributors (neither of these customers have balances in accounts receivable
at December 31, 2016). During the year ended December 31, 2015, we derived 31.1% and 15.7% of our revenues from two wholesale distributors
(ending balances in accounts receivable totaling $173,790 and $327,893, respectively). Our distributors purchase products from
us on a purchase order basis on standard terms. The distributors are under no obligation to continue to purchase our products.
The loss of any of our major distributors, a material reduction in their purchases or the cancellation of product orders or unexpected
returns of unsold products could significantly decrease our revenues and impede our future growth prospects. We do not have long-term
purchase commitments with our distributors.
Cost of Revenues
Cost of revenues include all of the costs to
manufacture our Company’s products. For products manufactured in our Company’s own facilities, such costs include raw
materials and supplies, direct labor and factory overhead. For products manufactured for our Company by third-party contractors,
such cost represents the amounts invoiced by the contractors.
Research and Development
Internal research and development costs are
expensed as incurred. Third-party research and development costs are expensed when the contracted work has been performed. Research
and development consists of consulting fees, direct labor and raw materials associated with the development of new products to
be commercialized by our Company.
Allowance for Doubtful Accounts
Our Company maintains allowances for
doubtful accounts for estimated losses resulting from the inability of our customers to make required payments. Account
balances are charged off against the allowance after all means of collection have been exhausted and the potential for
recovery is considered remote. Our allowance for doubtful accounts was $532,661 and $177,140 as of December 31, 2016 and
2015, respectively. Bad debt expense totaled $361,336 and $223,631, for the years ended December 31, 2016 and 2015,
respectively.
Convertible Financial Instruments
The Company bifurcates conversion options and
warrants from their host instruments and accounts for them as free standing derivative financial instruments if certain criteria
are met. The criteria include circumstances in which (a) the economic characteristics and risks of the embedded derivative instrument
are not clearly and closely related to the economic characteristics and risks of the host contract, (b) the hybrid instrument that
embodies both the embedded derivative instrument and the host contract is not re-measured at fair value under otherwise applicable
generally accepted accounting principles with changes in fair value reported in earnings as they occur and (c) a separate instrument
with the same terms as the embedded derivative instrument would be considered a derivative instrument. An exception to this rule
is when the host instrument is deemed to be conventional, as that term is described under applicable GAAP.
When the Company has determined that the embedded
conversion options and warrants should not be bifurcated from their host instruments, discounts are recorded for the intrinsic
value of conversion options embedded in the instruments based upon the differences between the fair value of the underlying common
stock at the commitment date of the transaction and the effective conversion price embedded in the instrument.
Debt Discounts
-
Debt discounts
under these arrangements are amortized to interest expense using the interest method over the earlier of the term of the related
debt or their earliest date of redemption.
Loss on Issuance
- The conversion features
of the notes and certain warrants were bifurcated from the host instrument as its conversion terms were not indexed to the Company’s
own stock. In addition, the warrants associated with the debt instruments were also treated as a free standing derivative liability.
The total fair value of the embedded conversion feature and the warrants exceeded the net proceeds received and resulted in a
loss on issuance of $2.1 million during the year ended December 31, 2016.
Common Stock Purchase Warrants and Derivative
Financial Instruments
- Common stock purchase warrants and other derivative financial instruments are classified as equity
if the contracts (1) require physical settlement or net-share settlement or (2) give the Company a choice of net-cash settlement
or settlement in its own shares (physical settlement or net-share settlement). Contracts which (1) require net-cash settlement
(including a requirement to net cash settle the contract if an event occurs and if that event is outside the control of the Company),
(2) give the counterparty a choice of net-cash settlement or settlement in shares (physical settlement or net-share settlement),
or (3) that contain reset provisions that do not qualify for the scope exception are classified as liabilities. The Company assesses
classification of its common stock purchase warrants and other derivatives at each reporting date to determine whether a change
in classification between equity and liabilities is required.
Beneficial conversion feature -
The
issuance of the convertible debt generated a beneficial conversion feature (“BCF”), which arises when a debt or equity
security is issued with an embedded conversion option that is beneficial to the investor or in the money at inception because the
conversion option has an effective strike price that is less than the market price of the underlying stock at the commitment date.
The Company recognized the BCF by allocating the intrinsic value of the conversion option, which is the number of shares of common
stock available upon conversion multiplied by the difference between the effective conversion price per share and the fair value
of common stock per share on the commitment date, resulting in a discount on the convertible debt (recorded as a component of additional
paid-in capital).
Share Based Payments
The Company recognizes compensation expense
for all equity-based payments in accordance with ASC 718 -
Share-based payments
. Under ASC 718’s fair value recognition
provisions, the Company recognizes equity-based compensation net of an estimated forfeiture rate and recognizes compensation cost
only for those shares expected to vest over the requisite service period of the award.
Share-based payments to employees, including
grants of employee stock options, are recognized as compensation expense in the accompanying consolidated statements of operations
based on the fair values of the related payments. Such expense is recognized over the period during which an employee is required
to provide services in exchange for the award, known as the requisite service period (usually the vesting period).
The Company accounts for share-based payments
granted to non-employees in accordance with ASC 505 -
Equity Based Payments to Non-Employees
. The Company determines the
fair value of the stock based payment as either the fair value of the consideration received or the fair value of the equity instruments
issued, whichever is more reliably measurable. If the fair value of the equity instruments issued is used, it is measured using
the stock price and other measurement assumptions as of the earlier of either (1) the date at which a commitment for performance
by the counterparty to earn the equity instruments is reached, or (2) the date at which the counterparty’s performance is
complete.
Net Loss per Share of Common Stock
The Company computes net loss per share in
accordance with ASC 260 -
Earnings Per Shar
e. ASC 260 requires presentation of both basic and diluted net loss per share
on the face of the statements of operations. Basic net loss per share is calculated by dividing the loss attributable to common
shareholders of the Company by the weighted average number of common shares outstanding during the period. Diluted net loss per
share is determined by adjusting the loss attributable to common shareholders and the weighted average number of common shares
outstanding for the effects of all potential dilutive common shares, such as stock issuable pursuant to the exercise of stock warrants
or the conversion of preferred stock into common stock.
Common stock equivalents totaling, 26,077,697 and 4,767,720 as of December 31, 2016 and 2015, respectively,
were not included in the computation of diluted earnings per share on the consolidated statements of operations because the Company
reported a net loss during the years ended December 31, 2016 and 2015 and therefore the effect would be anti-dilutive.
Fair Value of Financial Instruments
We measure assets and liabilities at fair value
based on an expected exit price as defined by the authoritative guidance on fair value measurements. Fair value represents the
estimated amount that would be received upon the sale of an asset or paid to transfer a liability in an orderly transaction between
market participants. As such, fair value may be based on assumptions that market participants would use in pricing an asset or
liability. The authoritative guidance on fair value measurements establishes a consistent framework for measuring fair value on
either a recurring or nonrecurring basis whereby inputs used in valuation techniques are assigned a hierarchical level. The following
are the hierarchical levels of inputs to measure fair value:
- Level 1:
|
Quoted prices in active markets for identical instruments;
|
- Level 2:
|
Other significant observable inputs (including quoted prices in active markets for similar instruments);
|
- Level 3:
|
Significant unobservable inputs (including assumptions in determining the fair value of certain investments).
|
The carrying values for cash and cash equivalents,
accounts receivable, other current assets, accounts payable and accrued liabilities, and deferred revenue approximate their fair
value due to their short maturities. Based on the borrowing rates currently available to the Company for loans with similar terms,
the carrying value of the notes payable approximate fair value.
Website Development
Costs and expenses incurred during the
planning and operating stages of our Company’s website development are expensed as incurred. The Company accounts for the
development of its website by expensing all costs associated with the planning of the website as incurred and capitalizing the
costs to develop the website. Once the website is available for use, the related costs will be amortized over their estimated useful
life on a straight-line basis (generally estimated to be 3 years). These costs are included in property and equipment in the consolidated
balance sheets.
Common Stock Purchase Warrants and Derivative
Financial Instruments
Common stock purchase warrants and other derivative
financial instruments are classified as equity if the contracts (1) require physical settlement or net-share settlement or (2)
give the Company a choice of net-cash settlement or settlement in its own shares (physical settlement or net-share settlement).
Contracts which (1) require net-cash settlement (including a requirement to net cash settle the contract if an event occurs and
if that event is outside the control of the Company), (2) give the counterparty a choice of net-cash settlement or settlement in
shares (physical settlement or net-share settlement), or (3) that contain reset provisions that do not qualify for the scope exception
are classified as equity or liabilities. The Company assesses classification of its common stock purchase warrants and other derivatives
at each reporting date to determine whether a change in classification between equity and liabilities is required.
Beneficial conversion feature –
The
issuance of the convertible debt generated a beneficial conversion feature (“BCF”), which arises when a debt or equity
security is issued with an embedded conversion option that is beneficial to the investor or in the money at inception because the
conversion option has an effective strike price that is less than the market price of the underlying stock at the commitment date.
The Company recognized the BCF by allocating the intrinsic value of the conversion option, which is the number of shares of common
stock available upon conversion multiplied by the difference between the effective conversion price per share and the fair value
of common stock per share on the commitment date, to additional paid-in capital, resulting in a discount on the convertible debt
(recorded as a component of additional paid in capital).
Royalty Expense
We recognize royalty expenses in accordance
with the terms of our license agreement with a celebrity product endorser. Royalties are expensed in the statements of operation
in the period that the related revenues are recognized, in cost of goods sold.
Income Taxes
Income taxes are accounted for in accordance
with ASC Topic 740 -
Income Taxes
. Under the asset and liability method, deferred tax assets and liabilities are recognized
for the future consequences of differences between the financial statement carrying amounts of existing assets and liabilities
and their respective tax bases (temporary differences). Deferred tax assets and liabilities are measured using tax rates expected
to apply to taxable income in the years in which those temporary differences are recovered or settled. Valuation allowances for
deferred tax assets are established when it is more likely than not that some portion or all of the deferred tax assets will not
be realized.
Management evaluates its tax positions on
an annual basis and has determined that as of December 31, 2016 and 2015, no additional accrual for income taxes is necessary.
The federal and state income tax returns of the Company are subject to examination by the IRS and state taxing authorities, generally
for three years after they were filed.
Recent Accounting Standards Updates
In
August 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2016-15,
Statement
of Cash Flows - Classification of Certain Cash Receipts and Cash Payments,
which addresses eight specific cash flow issues
with the objective of reducing the existing diversity in practice in how certain cash receipts and cash payments are presented
and classified in the statement of cash flows. The standard is effective for fiscal years beginning after December 15, 2017, including
interim periods within those fiscal years. Early adoption is permitted, including adoption in an interim period. The Company is
currently in the process of evaluating the impact of this new pronouncement on its consolidated statements of cash flows.
In April 2016, the FASB issued ASU No.
2016-10,
Revenue from Contracts with Customer
(“ASU No. 2016-10”)
. The
new guidance is an update to ASC No. 606 and provides clarity on identifying performance obligations and licensing implementation.
For public companies, ASU No. 2016-10 is effective for annual periods, including interim periods within those annual periods, beginning
after December 15, 2016. The Company does not expect ASU No. 2016-10 to have a material effect on the consolidated financial statements
and related disclosures.
In March 2016, the FASB issued ASU No.
2016-09, “
Compensation - Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting
”.
The amendment is to simplify 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. The amendments in
ASU No. 2016-09 are effective for interim and annual reporting periods beginning after December 15, 2016. The Company is currently
assessing the impact of ASU No. 2016-09 on the consolidated financial statements and related disclosures.
In March 2016, the FASB issued ASU No.
2016-08, “
Revenue from Contracts with Customers
(Topic 606):
Principal versus Agent Considerations”.
The purpose of ASU No. 2016-08 is to clarify the implementation of guidance on principal versus agent considerations. The amendments
in ASU No. 2016-08 are effective for interim and annual reporting periods beginning after December 15, 2017. The Company is currently
assessing the impact of ASU No. 2016-08 on the consolidated financial statements and related disclosures.
In February 2016, the FASB issued ASU No. 2016-02 -
Leases (Topic 842): Simplifying the Measurement of Inventory
(“Topic 842”). Topic 842 requires lessees to recognize
a right-of-use asset and lease liability for virtually all of their leases. The liability will be equal to the present value of
lease payments. The asset will be based on the liability, subject to adjustment, such as for initial direct costs. For income statement
purposes, the FASB retained a dual model, requiring leases to be classified as either operating or finance. Operating leases will
result in straight-line expense while finance leases will result in a front-loaded expense pattern (similar to current capital
leases). Classification will be based on criteria that are largely similar to those applied in current lease accounting, but without
explicit bright lines. Topic 842 is effective for the Company on January 1, 2019 and includes interim periods within that year.
Topic 842 will be applied using a modified retrospective transition, providing for certain practical expedients. Early application
is permitted and the Company is currently evaluating the potential impact that adoption may have on its consolidated financial
statements.
In July 2015, the FASB issued ASU No. 2015-11 -
Inventory (Topic 330): Simplifying the Measurement of Inventory
(“Topic 330”). Topic 330 requires measuring
inventory at the lower of cost and net realizable value based on estimated selling prices in the ordinary course of business,
less reasonably predictable costs of completion, disposal and transportation (changed from the previous guidance of lower of cost
or market). This update also clarified various other inventory measurement and disclosure requirements. The update does not apply
to inventory measured using the LIFO or retail inventory methods. The guidance is effective for annual reporting periods beginning
after December 15, 2016, including interim periods within that reporting period, and should be applied prospectively. Early application
is permitted and the Company is currently evaluating the potential impact that adoption may have on its consolidated financial
statements.
In May 2014, the FASB issued ASU No. 2014-09
-
Revenue from Contracts with Customers
(“ASU 2014-09). ASU 2014-09 outlines a single comprehensive model for entities
to use in accounting for revenue arising from contracts with customers and supersedes most current revenue recognition guidance,
including industry-specific guidance. ASU 2014-09 is based on the principle that an entity should recognize revenue to depict the
transfer of goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled
in exchange for those goods or services. The ASU also requires additional disclosure about the nature, amount, timing and
uncertainty of revenue and cash flows arising from customer contracts, including significant judgments and changes in judgments
and assets recognized from costs incurred to fulfill a contract. Entities have the option of using either a full retrospective
or a modified retrospective approach for the adoption of the new standard. This standard is effective for fiscal years beginning
after December 15, 2017, including interim periods within that reporting period. The Company is currently evaluating the new
guidance to determine the impact it will have on its consolidated financial statements.
Other accounting standards that have been issued
or proposed by FASB that do not require adoption until a future date are not expected to have a material impact on the consolidated
financial statements upon adoption. The Company does not discuss recent pronouncements that are not anticipated to have an impact
on or are unrelated to its financial condition, results of operations, cash flows or disclosures.
NOTE 3 - INVENTORIES
Inventories consist of the following:
|
|
December 31, 2016
|
|
|
December 31, 2015
|
|
Raw materials
|
|
$
|
7,296
|
|
|
$
|
72,287
|
|
Finished goods
|
|
|
43,743
|
|
|
|
105,205
|
|
Total Inventories
|
|
$
|
51,039
|
|
|
$
|
177,492
|
|
NOTE 4 - LICENSE AGREEMENTS
In November 2014, we entered into a License
Agreement with kathy ireland Worldwide
®
("kiWW
®
")
under which we licensed the right to utilize the trademarks and rights to the name, likeness and visual representations of Kathy
Ireland (“KI”) in connection with our cosmeceutical line of products. The initial term of the license is for eight
years and it may be renewed at the option of our Company for up to an additional four years. In accordance with the License Agreement,
we will pay 5% of the net sales for all licensed products sold and collected under the licensed marks or a minimum guaranteed royalty
of $100,000 in year one, which includes the period from approximately November 4, 2014 through December 31, 2015 (“Contract
Year 1”) of the License Agreement. The minimum guaranteed royalty increases $50,000 each year in years two through eight
of the License Agreement. We recognized $163,893 and $100,000 in royalty fees during the year ended December 31, 2016 and 2015,
respectively.
Additionally, we are obligated to pay an annual
Brand Participation Fee to kiWW
®
which provides for general advertising, good will and promotion of the KI brand.
NuGene prepaid kiWW $350,000 effective upon execution of the License as a Brand Participation fee for Contract Year 1. The Brand
Participation Fee for Contract Years 2 through 8 is $50,000 annually (Year 2 having been completely recognized in the three months
ended March 31, 2016) with an additional 1% of the total gross sales of Licensed Products of the prior year beginning in Contract
Year 4. The Company is currently in arrears with respect to the payment of the Year 2 fee that was due in November 2015. We
recognized $50,000 and $50,000 in brand participation fees during the year ended December 31, 2016 and 2015, respectively.
On March 17
,
2015, we entered into an
Intellectual Property Asset Purchase Agreement (“IP Agreement”) with an individual (“IP Seller”) to acquire
all of the rights, title and interest in certain intellectual property connected with a product named
SkinGuardian
(“SGIP”).
Upon the acquisition of SGIP, the Company issued 150,000 shares of restricted common stock (net, as amended) to the IP Seller valued
at $150,000. The consideration paid for SGIP was expensed during the year ended December 31, 2015.
NOTE 5 - PROPERTY AND EQUIPMENT
Property and equipment, net consist of the
following:
|
|
December 31, 2016
|
|
|
December 31, 2015
|
|
Software / website development
|
|
$
|
8,219
|
|
|
$
|
8,219
|
|
Equipment
|
|
|
141,125
|
|
|
|
136,585
|
|
Leasehold improvements
|
|
|
104,166
|
|
|
|
104,166
|
|
Property and equipment, gross
|
|
|
253,510
|
|
|
|
248,970
|
|
Accumulated depreciation
|
|
|
(95,221
|
)
|
|
|
(40,620
|
)
|
Property and equipment, net
|
|
$
|
158,289
|
|
|
$
|
208,350
|
|
Depreciation expense for the years ended December
31, 2016 and 2015 was $54,601 and $39,365, respectively.
NOTE 6 - PROMISSORY NOTES PAYABLE AND ADVANCES
Borrowings under notes payable and advances
as of December 31, 2016 and 2015 are summarized as follows:
|
|
|
|
|
Amounts converted
|
|
|
Carrying Value as
of
|
|
|
Carrying Value as
of
|
|
|
Accrued Interest
|
|
|
Accrued Interest
|
|
|
|
|
|
|
Company
|
|
|
to Common Stock as
of
|
|
|
December 31,
|
|
|
December 31,
|
|
|
as of December
31,
|
|
|
as of December
31,
|
|
|
Principal Value
|
|
|
|
Proceeds
|
|
|
December
31, 2016
|
|
|
2016
|
|
|
2015
|
|
|
2016
|
|
|
2015
|
|
|
as
of Maturity
|
|
15% Note
|
|
$
|
500,000
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
500,000
|
|
|
$
|
-
|
|
|
$
|
31,479
|
|
|
$
|
-
|
|
10% Note
|
|
|
50,000
|
|
|
|
-
|
|
|
|
50,000
|
|
|
|
50,000
|
|
|
|
5,726
|
|
|
|
1,383
|
|
|
|
50,000
|
|
10% Note (2015)
|
|
|
87,500
|
|
|
|
-
|
|
|
|
110,000
|
|
|
|
62,949
|
|
|
|
11,633
|
|
|
|
548
|
|
|
|
110,000
|
|
10% Note (2015 Advances)
|
|
|
322,500
|
|
|
|
-
|
|
|
|
361,111
|
|
|
|
229,555
|
|
|
|
37,852
|
|
|
|
1,642
|
|
|
|
361,111
|
|
10% Note (2016 Advances)
|
|
|
1,065,000
|
|
|
|
-
|
|
|
|
799,024
|
|
|
|
-
|
|
|
|
43,492
|
|
|
|
-
|
|
|
|
1,080,556
|
|
8% Convertible Note
|
|
|
245,000
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
4% Convertible Note
|
|
|
-
|
|
|
|
62,428
|
|
|
|
270,350
|
|
|
|
-
|
|
|
|
360
|
|
|
|
-
|
|
|
|
270,350
|
|
15% Note (2016 Advances)
|
|
|
35,000
|
|
|
|
-
|
|
|
|
35,000
|
|
|
|
-
|
|
|
|
2,373
|
|
|
|
-
|
|
|
|
35,000
|
|
9% Convertible Note
|
|
|
240,000
|
|
|
|
-
|
|
|
|
52,034
|
|
|
|
-
|
|
|
|
4,683
|
|
|
|
-
|
|
|
|
267,500
|
|
10% Convertible Note
|
|
|
70,000
|
|
|
|
-
|
|
|
|
6,837
|
|
|
|
-
|
|
|
|
341
|
|
|
|
-
|
|
|
|
77,779
|
|
5% Convertible Note
- conversion of Related Party
|
|
|
-
|
|
|
|
-
|
|
|
|
382,061
|
|
|
|
-
|
|
|
|
5,668
|
|
|
|
-
|
|
|
|
382,061
|
|
5% Convertible Note
|
|
|
375,000
|
|
|
|
-
|
|
|
|
160,000
|
|
|
|
-
|
|
|
|
3,879
|
|
|
|
-
|
|
|
|
480,000
|
|
15% CAH Note
|
|
|
-
|
|
|
|
-
|
|
|
|
575,000
|
|
|
|
-
|
|
|
|
65,693
|
|
|
|
-
|
|
|
|
575,000
|
|
|
|
$
|
2,990,000
|
|
|
$
|
62,428
|
|
|
$
|
2,801,417
|
|
|
$
|
842,504
|
|
|
$
|
181,700
|
|
|
$
|
35,052
|
|
|
$
|
3,689,357
|
|
2016 activity
On April 4, 2016, we issued a note payable
to Canyon Assets Holdings, Inc. (“Lender”) dated March 28, 2016 in the principal amount of $575,000. The note was issued
to the Lender in consideration for the Lender’s having satisfied on the Company’s behalf an outstanding note payable
(the “CAH Note”) of the Company (the “JTS Note”). The JTS Note issued September 25, 2015 was repaid in
full ($500,000 face value and accrued interest of $75,000) by the Lender with the payment of $575,000 in cash. The terms of the
CAH Note call for an interest rate of 15%, due one year from the date of the CAH Note. However, all accrued and unpaid interest
and all other amounts payable under the CAH Note are due to the Lender within ten (10) business days after the closing by the Company
of an equity or convertible debt financing in one or more series of transactions, with aggregate gross proceeds of at least $1
million.
On April 4, 2016, we issued a $275,000 face
value note payable and 50,000 shares of our common stock to Gemini Master Fund, LTD (“Gemini”) pursuant to a Security
Purchase Agreement dated March 30, 2016 (the date the funds were received by our Company). Under the terms of the related note
payable (the “Gemini Note”), the Company received $245,000, net of costs and original issue discount. Other significant
terms of the Gemini Note include:
|
·
|
A maturity date of December 31, 2016 in the absence of
events triggering mandatory early repayment (as summarized below);
|
|
·
|
Interest accrues at the rate of 8% on the $275,000 face
value (18% in the event of an event of default as defined in the Gemini Note);
|
|
·
|
The Gemini Note is convertible in part (subject to a $10,000
minimum) at the option of Gemini into shares of the Company’s common stock at the rate of $0.70 per share (subject to adjustment
summarized below);
|
|
·
|
The Company has the option to prepay the Gemini Note;
|
|
·
|
All prepayments of the Gemini Note, whether effected at
the option of the Company or subject to mandatory early repayment (as summarized herein), require the Company to repay Gemini
112% of the outstanding principal and all outstanding accrued interest through the date of prepayment;
|
|
·
|
All principal and interest outstanding under the Gemini
Note are required to be immediately repaid should the Company complete a financing or series of financings totaling $1.5 million
or more;
|
|
·
|
The conversion price of the Gemini Note is adjusted for
the following: 1) loss of Company DTC eligibility - conversion price adjusts to $0.25 per share; 2) stock dividends and splits
- as described in the Gemini Note; 3) a rights offering below the market price (as defined) - as described in the Gemini Note;
4) fundamental transactions (as defined) - as described in the Gemini Note; 5) subsequent equity sales below $0.70 per share -
as more particularly detailed and described in the Gemini Note; and
|
|
·
|
The Gemini Note is convertible into 392,857 shares of common
stock
|
The embedded conversion feature of the Gemini
Note was bifurcated and valued at $106,278.
Management used a Monte Carlo valuation
model to estimate the fair value of the embedded conversion option at issuance of the convertible note, with the following weighted
average key inputs:
|
|
At issuance
|
|
Stock price
|
|
$
|
0.68
|
|
Term (years)
|
|
|
0.76
|
|
Volatility
|
|
|
98.9
|
%
|
Risk-free rate of interest
|
|
|
0.5
|
%
|
Dividend yield
|
|
|
0.0
|
%
|
The embedded conversion feature is separately
measured at fair value, with changes in fair value recognized in current operations. The embedded conversion has been
reduced by $58,962 during the year ended December 31, 2016 (see Note 7).
In connection with the issuance of the
Gemini Note, we recorded additional debt discounts related to the following:
|
·
|
Issuance of 50,000 shares
of our common stock resulting in the relative fair value of $27,000;
|
|
·
|
Recording of a beneficial
conversion feature of $43,785; and
|
|
·
|
Original issuance discount
of $25,000.
|
The debt discounts are amortized to interest
expense using the effective interest method over the term of the notes. During the year ended December 31, 2016, the Company recognized
interest expense of approximately $202,000 resulting from the amortization of the entire debt discount noted above resulting in
a Gemini Note balance of $275,000.
On October 28, 2016, the Gemini Note was purchased
in full, including accrued interest of approximately $13,000, by another lender in exchange for a convertible note (“the
4% Convertible Note”) issued by the Company. The 4% Convertible Note accrues interest at 4% per annum, is entitled to the
same conversion features as the Gemini Note and matures on June 30, 2017. The lender charged the Company $45,000 in fees, which
were added to the balance, and converted approximately $62,000 of the 4% Convertible Note balance into 331,413 shares of the Company’s
common stock, resulting in a balance of $270,350 as of December 31, 2016.
During January through June 2016, three individuals
(the “Lenders”) advanced a total of $140,000 to the Company. The borrowings were not accompanied by documentation of
the nature of the borrowings. However, there were general discussions as to the repayment terms and the interest expected of 10%
per annum to be paid to the Lenders in connection with the borrowings. Accordingly, we have accounted for the borrowings based
on estimates of their still undocumented final terms.
In July 19, 2016, we issued a sixty day 15%
promissory note payable to a purchaser for cash proceeds totaling $35,000. In the event that we secure any future financing with
aggregate gross proceeds of at least $500,000 while the promissory note is outstanding, the promissory note and all accrued interest
therefrom will be immediately due and payable within ten business days of the closing of such financing.
From July through September 30, 2016, certain
investors advanced a total of $925,000 (the “Advances”) to the Company with a right to convert at no greater than $0.40
per share. In connection with the Advances,
the Company also issued warrants to purchase
770,833 shares of our common stock at an exercise price of $0.60 per share with a 5 year term. The relative fair value of the warrants
compared to the Advances was $295,540, which was recorded as a component of stockholders’ deficit with the offset recorded
as a discount on the Advances. The fair value of the warrants was determined using the Black-Scholes Model (see Note 8). The Company
then computed the effective conversion price of the Advances on the issuance date, noting that the Advances gave rise to a BCF
of $629,460. The sum of the relative fair value of the warrants and the BCF was recorded as a debt discount to be amortized over
the term of the advances.
The debt discounts are amortized to interest
expense using the effective interest method over the term of the Advances. During the year ended December 31, 2016, the
Company recognized interest expense of $643,469, from the amortization of the debt discount, resulting in the Advances balance
of $643,469.
The
Advances contain an embedded conversion feature that the Company has determined is a derivative requiring bifurcation in accordance
with the provisions of ASC 815. The embedded conversion feature of the Notes was valued at inception using the Monte Carlo simulation
at $1,212,384 and was recorded as a loss on the consolidated statements of operations. As of December 31, 2016, the derivative
was remeasured to $491,218 (see Note 7) and the difference was recorded as a change in fair value of derivative liabilities on
the consolidated statements of operations.
Management used a Monte Carlo valuation
model to estimate the fair value of the embedded conversion option at issuance of the Advances, with the following weighted average
key inputs:
|
|
At issuance
|
|
Stock price
|
|
$
|
0.74
|
|
Term (years)
|
|
|
0.75
|
|
Volatility
|
|
|
116
|
%
|
Risk-free rate of interest
|
|
|
0.5
|
%
|
Dividend yield
|
|
|
0.0
|
%
|
On October 21, 2016, we issued a $267,500 face
value convertible note that accrues interest at 9% per annum and matures on October 21, 2017 (“the 9% Convertible Note”).
The Company received proceeds of $240,000, net of costs and original issuance discount. Upon holding the note for six months, the
conversion terms allow the holder to convert outstanding principal into the Company’s common stock at the lower of (i) $0.40
per share or (ii) 65% of the lowest closing bid price of the common stock for the fifteen prior trading days, including upon which
the conversion notice is received by the Company. The 9% Convertible Note allows for prepayment within 180 days from the date of
issuance. If the note is outstanding for 90 days or less, the prepayment rate is 125% of principal plus accrued interest; and if
the note is outstanding for more than 90 days but less than 180 days, the prepayment rate is 150% of principal plus accrued interest.
In connection with the 9% Convertible Note,
the Company also issued warrants to purchase
222,916 shares of our common stock at an exercise price $0.60 per share with a 4 year term. The relative fair value of the warrants
compared to the 9% Convertible Note was $56,737, which was recorded as a component of stockholders’ deficit with the offset
recorded as a discount to the 9% Convertible Note. The fair value of the warrants was determined using the Black-Scholes Model
(see Note 8). The Company then computed the effective conversion price of the 9% Convertible Note on the issuance date, noting
that the 9% Convertible Note gave rise to a BCF of $151,112.
The
9% Convertible Note contains an embedded conversion feature that the Company has determined is a derivative requiring bifurcation
in accordance with the provisions of ASC 815. The embedded conversion feature of the 9% Convertible Note was valued at inception
using the Monte Carlo simulation at $296,786 with $32,150 being recorded as a discount to the 9% Convertible Note and $264,633,
the remainder, being recorded as a loss on the consolidated statements of operations.
Management used a Monte Carlo valuation
model to estimate the fair value of the embedded conversion option at issuance of the 9% Convertible Notes, with the following
weighted average key inputs:
|
|
At issuance
|
|
Stock price
|
|
$
|
0.50
|
|
Term (years)
|
|
|
1.03
|
|
Volatility
|
|
|
116
|
%
|
Risk-free rate of interest
|
|
|
0.7
|
%
|
Dividend yield
|
|
|
0.0
|
%
|
The
sum of the relative fair value of the warrants, BCF, original issuance discount, issuance costs and applicable portion of the embedded
conversion option that was recorded as a debt discount is to be amortized over the term of the 9% Convertible Note.
The
debt discounts are amortized to interest expense using the effective interest method over the term of the 9% Note. During
the twelve months ended December 31, 2016, the Company recognized interest expense of $52,034, from the amortization of the debt
discount, resulting in the 9% Convertible Note balance of $52,034.
As
of December 31, 2016, the derivative was remeasured to $215,873 (see Note 7) and the difference was recorded as a change in fair
value of derivative liabilities on the statement of operations.
On October 28, 2016, we issued a $480,000
face value convertible note that accrues interest at 5% per annum and matures on April 28, 2017 (“the 5% Convertible Note”).
The Company received proceeds of $375,000, net of costs and original issuance discount. The conversion terms allow the holder to
convert outstanding principal into the Company’s common stock if an event of default occurs, or if the Company does not repay
the note in full at the original maturity date, at 60% of the lowest closing bid price of the common stock for the thirty prior
trading days immediately preceding the trading date. Prepayment rates are 115% if the note is repaid within the first sixty days
from the date of issuance and 125% thereafter.
The Company computed the effective conversion
price of the 5% Convertible Note on the issuance date, noting that the 5% Convertible Note gave rise to a BCF of $375,000.
The
sum of the BCF, original issuance discount and issuance costs that was recorded as a debt discount is to be amortized over the
term of the 5% Convertible Note.
The debt discounts are amortized to interest expense using the effective interest
method over the term of the 5% Convertible Note. During the year ended December 31, 2016, the Company recognized interest expense
of $160,000, from the amortization of the debt discount, resulting in the 5% Convertible Note balance of $160,000.
In connection with the 5% Convertible Note,
the Company also issued warrants with a 7 year term to purchase 1,428,572 shares of our common
stock at an exercise price per share equal to the lower of (a) $0.47; or (b) 75% of the closing bid price of the common stock on
the effective date of the Company’s first public offering following the issuance date. The Company determined that the warrants
are derivatives requiring bifurcation in accordance with the provisions of ASC 815. The warrants were valued at inception using
the Monte Carlo simulation at $579,451 and recorded as a loss on the consolidated statements of operations.
Management used
a Monte Carlo valuation model to estimate the fair value of the warrant derivative at issuance of the 5% Convertible Note,
with the following weighted average key inputs:
|
|
At issuance
|
|
Stock price
|
|
$
|
0.45
|
|
Term (years)
|
|
|
7.00
|
|
Volatility
|
|
|
112
|
%
|
Risk-free rate of interest
|
|
|
1.6
|
%
|
Dividend yield
|
|
|
0.0
|
%
|
As
of December 31, 2016, the warrant derivatives were remeasured to $443,816 (see Note 7) and the difference was recorded as a change
in fair value of derivative liabilities on the statement of operations.
The
5% Convertible Note also contains an embedded conversion feature that the Company has determined is a derivative requiring bifurcation
in accordance with the provisions of ASC 815. The embedded conversion feature of the 5% Convertible Note was valued at inception
using the Monte Carlo simulation at $36,130 and recorded as a loss on the consolidated statements of operations.
Management
used a Monte Carlo valuation model to estimate the fair value of the embedded conversion option at issuance of the 5% Convertible
Note, with the following weighted average key inputs:
|
|
At issuance
|
|
Stock price
|
|
$
|
0.45
|
|
Term (years)
|
|
|
0.50
|
|
Volatility
|
|
|
118
|
%
|
Risk-free rate of interest
|
|
|
0.5
|
%
|
Dividend yield
|
|
|
0.0
|
%
|
As
of December 31, 2016, the derivative was remeasured to $34,517 (see Note 7) and the difference was recorded as a change in fair
value of derivative liabilities on the statement of operations.
On November 7, 2016, the amounts owed to
related parties totaling $382,061 were sold to two unrelated investors. The Company issued a note to each investor in the amount
of $191,030. The notes have an interest rate of 5% per annum and mature on the earlier of: (i) May 7, 2016; (ii) the date the Company
raises a total of $2 million, subsequent to the issuance of these notes. The notes have a conversion feature under which the note
holder can convert at any time at a conversion price of $0.40 per share.
On December 15, 2016, we issued a $77,779
face value convertible note that accrues interest at 10% per annum and matures on June 15, 2017 (“the 10% Convertible Note”).
The Company received proceeds of $70,000, net of original issuance discount. The conversion terms allow the holder to convert outstanding
principal into the Company’s common stock at 65% of the price of the common stock when the Company a capital raise transaction
of at least $15,000,000 in debt, and or equity subsequent to the issuance date. The 10% Convertible Note allows for prepayment
any time after 90 days from the date of issuance at a prepayment rate of 110% of principal and accrued interest outstanding. In
connection with the 10% Convertible Note,
the Company also issued warrants to purchase 77,778
shares of our common stock at an exercise price $0.50 per share with a 4 year term. The relative fair value of the warrants compared
to the 10% Convertible Note was $22,616, which was recorded as a component of stockholders’ deficit with the offset recorded
as a discount to the 10% Convertible Note. The fair value of the warrants was determined using the Black-Scholes Model (see Note
8). The Company then computed the effective conversion price of the 10% Convertible Note on the issuance date, noting that the
10% Convertible Note gave rise to a BCF of $47,384.
The
sum of the relative fair value of the warrants, BCF and original issuance discount was recorded as a debt discount is to be amortized
over the term of the 10% Convertible Note.
The debt discounts are amortized to interest expense using the effective
interest method over the term of the 10% Convertible Note. During the year ended December 31, 2016, the Company recognized interest
expense of $6,838, from the amortization of the debt discount, resulting in the 10% Convertible Note balance of $6,838.
The
10% Convertible Note contains an embedded conversion feature that the Company has determined is a derivative requiring bifurcation
in accordance with the provisions of ASC 815. The embedded conversion feature of the 10% Convertible Note was valued at inception
using the Monte Carlo simulation at $43,883 and recorded as a loss on the consolidated statements of operations.
Management
used a Monte Carlo valuation model to estimate the fair value of the embedded conversion option at issuance of the 10% Convertible
Notes, with the following weighted average key inputs:
|
|
At issuance
|
|
Stock price
|
|
$
|
0.41
|
|
Term (years)
|
|
|
0.41
|
|
Volatility
|
|
|
118
|
%
|
Risk-free rate of interest
|
|
|
0.6
|
%
|
Dividend yield
|
|
|
0.0
|
%
|
As
of December 31, 2016, the derivative was remeasured to $43,739 (see Note 7) and the difference was recorded as a change in fair
value of derivative liabilities on the statement of operations.
2015 activity
On September 25, 2015, we entered into a Securities
Purchase Agreement and issued a 15% Promissory Note with the principal face value of $500,000 (the “15% Note”) to an
accredited investor. Under the terms of the 15% Note, all principal and related accrued interest outstanding are due and payable
to the noteholder upon the earlier of: (i) September 25, 2016; or (ii) within ten business days after the consummation of an equity
or convertible debt financing with aggregate gross proceeds of at least $1,000,000.
Borrowings made
pursuant to the 15% Note bear interest at the annual rate of 15% (or $75,000), irrespective of whether paid at or prior to September
25, 2016. If any amount payable pursuant to the note payable is not paid when due (without regard to any applicable grace
periods as set forth in the Note), whether at stated maturity, by acceleration or otherwise, such overdue amount shall bear interest
at the rate of 15% from the date of such non-payment until such amount is paid in full. We have recognized $31,479 in interest
expense through December 31, 2015 based on an estimated repayment date of May 15, 2016.
During November 2015, we issued a one year
10% promissory notes payable (the “10% Note”) to a purchaser for cash proceeds totaling $50,000. In the event that
we secure any future financing with aggregate gross proceeds of at least $1 million while the 10% Note is outstanding, the 10%
Note and all accrued interest therefrom will be immediately due and payable within ten business days of the closing of such financing.
The holder may also convert any unpaid principal under the 10% Note into any funding instrument entered into by our Company for
a period of 180 days after the date of the 10% Note. The full interest of 10% of the borrowings under the 10% Note ($5,000) is
due irrespective of whether paid at maturity or when required to be prepaid. The 10% Note remains outstanding and we have recognized
$5,726 and $1,383 in interest expense through December 31, 2016 and December 31, 2015, respectively.
On November 30, 2015 and on three subsequent
dates during December 2015, four individuals (the “Lenders”) provided an advance to the Company with a face value of
$361,111 for cash proceeds totaling $322,500. The borrowings (“2015 Advances”) were not accompanied by documentation
of the nature of the 2015 Advances. However, there were general discussions as to the repayment terms, the interest expected to
be paid to the Lenders and additional equity of the Company to be issued to the Lenders in connection with the 2015 Advances. Accordingly,
we have accounted for the Advances based on estimates of their final terms.
On December 11, 2015, we entered into a Securities
Purchase Agreement and issued a 10% Convertible Promissory Note with the principal face value of $110,000 (the “10% 2015
Note”) to an accredited investor for cash proceeds of $87,500, net of issuance costs. Under the terms of the 10% 2015 Note,
all principal and related accrued interest outstanding are due and payable to the noteholder upon the earlier of: (i) December
10, 2016; or (ii) in the event that the Company completes a financing or a series of financings, with the same or different investors,
that in the aggregate result in gross proceeds to the Company of at least $3 million, then the Company is required to pre-pay and
redeem the entire remaining outstanding principal amount plus Interest of this Note in cash, provided that (A) the Company shall
pay the Holder one hundred twenty percent (120%) of the principal plus interest outstanding in repayment and (B) such amount must
be paid in cash on the next Business Day after receipt of the gross proceeds.
While any amounts are outstanding under the
10% 2015 Note, such amounts outstanding are convertible into share of the Company’s Common Stock at the lesser of: 1) $0.90
per share and 2) 75% of the price per share of the Company’s Common Stock sold in a future financing with gross proceeds
of at least $1 million, subject to adjustments as stated in the Note agreement.
In connection with the 10% 2015 Note, the Company
also issued a five-year warrant to purchase up to 61,111 shares of its common stock to the Note holder. The exercise price of the
warrant is $1.50 per share, subject to adjustments provided in the warrant agreement (but in no event at an exercise price below
$0.50 per share). The consideration upon exercise may also be paid on a cashless basis as detailed in the Note.
The Company accounted for warrants to be issued
in connection the 2015 Advances under similar terms as the warrant granted for the 10% 2015 Note.
In connection with the warrants expected to
be issued in connection with the 2015 Advances and the 10% 2015 Note, we have estimated a relative fair value of $138,333 using
the Black-Scholes option pricing model based on the following weighted average assumptions:
Total 2015 Advances and 10% 2015 Note face value
|
|
$
|
471,111
|
|
Warrants to be issued
|
|
|
256,172
|
|
Term
|
|
|
5 years
|
|
Strike price
|
|
$
|
1.50
|
|
Fair market value
|
|
$
|
0.95
|
|
Expected volatility
|
|
|
128
|
%
|
Risk-free interest rate
|
|
|
1.56
|
%
|
The sum
of the relative fair value of the warrants and the original issuance discount of $51,111 was recorded as a debt discount to be
amortized over the term of the advances.
The debt discounts are amortized to interest expense using the effective interest
method over the term of the 10% 2015 Note and the 2015 Advances. During the twelve months ended December 31, 2016, and December
31, 2015, the Company recognized interest expense of $166,107 and $20,837, respectively, from the amortization of the debt discount,
resulting in the 10% 2015 Note and 2015 Advances balance of $471,111.
NOTE 7 - FAIR VALUE MEASUREMENTS
The Company’s financial assets and liabilities
that are measured at fair value on a recurring basis as of December 31, 2016 by level within the fair value hierarchy, are as follows:
|
|
Quoted prices in active
markets
|
|
|
Significant other
observable inputs
|
|
|
Significant unobservable
inputs
|
|
|
|
(Level 1)
|
|
|
(Level 2)
|
|
|
(Level 3)
|
|
Embedded conversion options
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
832,663
|
|
Warrant derivatives
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
443,816
|
|
There were no transfers between Level 1, 2
or 3 during the years ended December 31, 2016 and 2015.
As of December 31, 2016, the embedded conversion
options (as discussed in Note 6) and warrant derivatives have aggregate fair values of $832,663 and $443,816, respectively. The
table below presents changes in fair value for the embedded conversion options and warrant derivatives, which is a Level 3 fair
value measurement:
Rollforward of Level 3 Fair Value Measurement for the Year Ended
December 31, 2016
|
|
Balance as of
December 31,
|
|
|
|
|
|
Change in Fair
Market
|
|
|
Balance as of
December 31,
|
|
|
|
2015
|
|
|
Issuance
|
|
|
Value
|
|
|
2016
|
|
Embedded conversion options
|
|
$
|
-
|
|
|
$
|
1,695,460
|
|
|
$
|
(862,797
|
)
|
|
$
|
832,663
|
|
Warrant derivatives
|
|
$
|
-
|
|
|
$
|
579,451
|
|
|
$
|
(135,635
|
)
|
|
$
|
443,816
|
|
The Company’s derivative liabilities are measured at fair
value using the Monte Carlo simulation valuation methodology. A summary of the weighted average (in aggregate) significant unobservable
inputs (Level 3 inputs) used in measuring the Company’s embedded conversion options that are categorized within Level 3
of the fair value hierarchy as of December 31, 2016 is as follows:
|
|
As of December 31, 2016
|
|
Stock price
|
|
$
|
0.36
|
|
Term (years)
|
|
|
2.72
|
|
Volatility
|
|
|
116
|
%
|
Risk-free rate of interest
|
|
|
1.18
|
%
|
Dividend yield
|
|
|
0.0
|
%
|
A summary of the weighted average significant unobservable inputs
(Level 3 inputs) used in measuring the Company’s warrant derivatives that are categorized within Level 3 of the fair value
hierarchy as of December 31, 2016 is as follows:
|
|
As of December 31, 2016
|
|
Stock price
|
|
$
|
0.36
|
|
Term (years)
|
|
|
6.84
|
|
Volatility
|
|
|
112
|
%
|
Risk-free rate of interest
|
|
|
2.23
|
%
|
Dividend yield
|
|
|
0.0
|
%
|
NOTE 8 - STOCKHOLDERS’ EQUITY
Preferred Stock
Our Company’s articles of incorporation
authorize 25,000,000 shares of preferred stock with a par value of $0.0001. We designated 2,000,000 shares of preferred stock as
Series A convertible preferred stock. The Series A convertible preferred stock is convertible into common stock at a ratio of one
to one. Additionally, as long as there are a minimum of 900,000 shares of Series A convertible preferred stock outstanding, the
holders of the Series A convertible preferred stock have the right to elect a majority of our Company’s Board of Directors.
Finally, in all manners brought to a vote of the shareholders, the holders of the Series A convertible preferred stock have three
votes to every one vote of common stock. As of December 31, 2016 and 2015, there were 1,917,720 shares of Series A convertible
preferred stock outstanding which were issued to the founders of NuGene, Ali and Saeed Kharazmi. Ali and Saeed Kharazmi each own
50% of the outstanding Series A convertible preferred stock and are our Company’s Chairman of the Board and Director, respectively.
Common Stock
Our Company has Advisory Agreements with members of its Advisory Board. The terms of the individual Advisory
Agreements vary and provide for up to 50,000 initial sign-on shares vesting for a maximum of an 18-month period, and up to 50,000
shares of common stock per annum issued on the anniversary of the effective date of the agreement. Expenses for the issuance of
common stock for services related to these share issuances was recognized over the service period in which the shares are earned
or over the respective vesting period, as applicable, and was calculated by multiplying the number of shares earned for the respective
reporting period by the share price on the date earned, during the respective quarter, as quoted on the OTC Marketplace. Selling,
general and administrative expenses (“SGA”) recognized in connection with the Advisory Agreements totaled $82,806 and
$572,216 for the years ended December 31, 2016 and 2015, respectively.
2016 activity
On April 4, 2016, we issued a $275,000
face value note payable and 50,000 shares of our common stock to Gemini Master Fund, LTD (“Gemini”) pursuant to a Security
Purchase Agreement dated March 30, 2016 (the date the funds were received by our Company).
In June 2016, Theodore Schwarz executed
an Offer Letter whereby Mr. Schwarz agreed to become a member of our Company’s Board of Directors (the “Board”).
Under the Offer Letter the Company has agreed to pay Mr. Schwarz $2,500 for each Board of Directors meeting attended. Additionally,
Mr. Schwarz may be granted 500,000 shares of the Company’s common stock in the future that may vest at the rate of 166,666
shares per year, over a three-year period provided Mr. Schwarz continues to serve on the Board. The stock has not been issued as
of December 31, 2016. The grant date fair value of the common stock was $330,000. The Company recognized stock based compensation
of $55,000 for the year ended December 31, 2016.
In connection with the purchase of the
Gemini note on October 28, 2016 (see Note 6), the new lender converted $62,428 of the outstanding note balance and $1,966 of interest
expense into 331,413 shares of our common stock over the course of November and December 2016.
2015 activity
On March 31, 2015, we entered into a stock
purchase agreement with a shareholder of our Company (the “Buyer”) resulting in the issuance of 50,000 shares of common
stock to the Buyer for proceeds of $50,000. Under the agreement, we extended to the Buyer an option to purchase an additional 60,000
shares of common stock at $1 per share within 45 days of the Closing. On May 8, 2015, the Buyer exercised his option to purchase
the remaining shares under the stock purchase agreement and accordingly, we issued the Buyer an additional 60,000 shares of our
common stock for cash proceeds of $60,000. On April 20, 2015, our Company entered into a stock purchase agreement with an unaffiliated
accredited investor for the sale of 27,273 shares of common stock at $1.10 per share, resulting in total cash proceeds of $30,000.
On June 2, 2015, our Company entered into a stock purchase agreement with an unaffiliated accredited investor for the sale of 100,000
shares of common stock at $2.00 per share, resulting in total cash proceeds of $200,000.
During 2015, offered positions on our Company’s
Board of Directors to two individuals, although one of the offers was later rescinded. In addition to annual cash stipends of $30,000,
the candidates were granted a total of 200,000 shares of our Company’s common stock vesting 25% on the third, sixth, ninth
and twelfth month following the inception of the proposed Board service. SGA totaling $164,416 was recognized in connection with
these shares over the service periods in which the shares were earned and was calculated based on the average closing price per
share of our common stock, during the respective quarter, as quoted on the OTC Marketplace.
In February 2015, we entered into a six-month
consulting agreement with an investor relations firm. In addition to a $27,000 retainer, the consulting agreement (as amended)
called for the vesting of 110,000 shares of our common stock over the six-month term, issuable upon the conclusion of the agreement.
On August 17, 2015, we issued the 110,000 shares of common stock owed to the investor relations firm. We recognized $167,092 of
SGA in connection with the consulting agreement during the year ended December 31, 2015.
In March 2015, we purchased technology
from an individual in exchange for 150,000 (as amended) shares of our common stock. The common stock was valued at the closing
price per share of our common stock, on the date of issuance resulting in the recognition of $150,000 in SGA for the year ended
December 31, 2015. During 2015, we issued 200,000 fully vested shares of our common stock to three consultants as compensation
for services rendered. The common stock was valued at the closing price per share of our common stock, on the date of issuance,
as quoted on the OTC Marketplace resulting in the recognition of $452,100 in stock based compensation for the year ended December
31, 2015.
Restricted Stock Awards
2016 activity
On March 17, 2016, we entered into a
consulting agreement for services over one year. In connection with the agreement, we granted the consultant 200,000 shares
of our fully vested common stock as consideration for the consultant’s services. The stock was issued on April 25,
2016. The grant date value of the restricted stock award was $128,000 and was recognized in full as stock based compensation
for the year ended December 31, 2016.
On September 22, 2016, the Company entered
into new compensation agreements and arrangements with two of its directors. As part of the agreements, our Chairman was granted
2,000,000 shares of our fully vested common stock. The stock has not been issued as of December 31, 2016. The grant date fair value
of stock award was $1,420,000 and was immediately recognized as stock based compensation.
2015 activity
In November 2015, the Company entered into
a consulting agreement with a third party for consulting services over six months. The Company agreed to pay the consultant 90,000
in shares of the Company’s restricted stock, which were issued over six months. The Company issued 30,000 shares of restricted
stock in February 2016, and the remaining 60,000 shares were issued in June 2016, resulting in approximately $38,000 of stock based
compensation expense for the year ended December 31, 2016.
Restricted Stock Units
In connection with the agreements the Company
entered into with two of its directors, each director was granted restricted stock units for 2,000,000 shares of the Company’s
common stock (“
RSUs
”). The RSUs vest at the rate of 33.33% each year anniversary of the issuance date (September
22, 2016). There is also 100% vesting upon a change in control of the Company.
The grant date fair value of the RSUs was $2,840,000.
The Company recognized stock based compensation of $259,360 for the year ended December 31, 2016.
Common Stock Options
On August 14, 2015,
we granted two employees an option to each purchase up to 1,000,000 shares of our common stock. The options have a strike price
of $1.50 per share, have a term of five years from the date of grant, vest evenly over 24 months and have a cashless exercise feature.
The fair value of these options was estimated using the Black-Scholes option-pricing model based on the following assumptions:
expected dividend yield 0%, expected volatility 130%, risk-free interest rate 1.61% and expected life of 5 years.
On May
2, 2016, we reduced the exercise price from $1.50 per share to $0.54 per share for these options. All other terms of the previous
option agreements remained unchanged. We remeasured the options on the modification date using the Black-Scholes Model
based
on the following assumptions: expected dividend yield 0%, expected volatility 113%, risk-free interest rate 0.96% and expected
life of 3 years
. The incremental fair value of vested options was approximately $71,000 and was recognized immediately.
The sum of the incremental compensation cost and the remaining unrecognized compensation cost for the unvested option shares was approximately
$1.7 million on the modification date and will be amortized ratably over the remaining vesting period. We
recognized $1,317,321 and $483,719 of Personnel expense as stock based compensation in connection with the vesting of the options
during the years ended December 31, 2016 and 2015, respectively.
On July 18, 2016,
we granted our Chief Executive Office a stock option to acquire 2,352,619 shares of our common stock with a 10 year term, which
represented approximately 5% of our fully-diluted issued and outstanding shares on the date of grant. The exercise price of the
option was $0.61 per share, which was the closing price for the Company stock at the date of issuance, and will vest ratably monthly
over 3 years, with 100% vesting upon a change in control of the Company. In accordance with the employment agreement, the Chief
Executive Officer will be issued stock options to acquire 5% of our fully-diluted issued and outstanding shares through our next
significant financing transaction or series of significant financing transactions. The grant date fair value of the option was
calculated by using the Black-Scholes Model based on the following assumptions: expected dividend yield 0%, expected volatility
97%, risk-free interest rate 1.27% and expected life of 6 years. The grant date fair value of this option was $1,126,899 and will
be amortized ratably over the vesting period.
We recognized $156,514 of Personnel expense as stock based compensation in
connection with the vesting of the options during the year ended December 31, 2016
.
A summary of the stock options activity for
the years ended December 31, 2016 and 2015 is as follows:
|
|
Number of Shares
|
|
|
Weighted Average
Exercise Price
|
|
|
Weighted Average
Contractual
Life
|
|
Outstanding as of December 31, 2014
|
|
|
-
|
|
|
$
|
-
|
|
|
|
-
|
|
Granted
|
|
|
2,000,000
|
|
|
|
0.54
|
|
|
|
5
|
|
Outstanding as of December 31, 2015
|
|
|
2,000,000
|
|
|
$
|
0.54
|
|
|
|
4.62
|
|
Granted
|
|
|
2,352,619
|
|
|
|
0.61
|
|
|
|
10
|
|
Outstanding as of December 31, 2016
|
|
|
4,352,619
|
|
|
|
0.58
|
|
|
|
6.82
|
|
Options vested
|
|
|
1,660,086
|
|
|
$
|
0.55
|
|
|
|
4.78
|
|
Stock based compensation associated with stock
options was $1,473,835 and $483,719 for the years ended December 31, 2016 and 2015, respectively. Unamortized stock based
compensation expense amounted to $1,770,273 as of December 31, 2016, and will be amortized over approximately 3 years.
Common Stock Warrants
Our Company has issued warrants to purchase
shares of our common stock to accredited investors and consultants as compensation for services rendered, as well as, in conjunction
with the purchase of our common stock. A summary of the Company’s warrants activity and related information as of December
31, 2016 is provided below.
In connection with the agreements the Company entered into with two of its directors, we issued a fully vested
warrant with a ten year term to each director to purchase shares of common stock equal to the greater of 1,000,000 shares or 2.5%
of the issued and outstanding common shares of the Company during the first 24 months immediately following the issuance. On the
date of issuance, each director was issued a warrant to purchase 1,008,367 shares of common stock at an exercise price of $0.71
per share, which was the closing price for the Company stock at the date of issuance. On December 30, 2016, the warrants to purchase
shares of common stock were increased by 8,285 shares of common stock for each director at an exercise price of $0.36 per share,
which was the closing price for the stock at the date of issuance. The aggregate grant date fair value of these warrants was calculated
by using the Black-Scholes Model based on the following assumptions: expected dividend yield 0%, expected volatility 102%, risk-free
interest rate 1.63% and expected life of 10 years. The grant date fair value of these warrants was $1,291,292 and the entire fair
value was recorded as Personnel expense as of December 31, 2016.
In connection with the Advances (see Note
6), the Company issued warrants to purchase 770,883 shares of our common stock at an exercise price $0.60 per share with a 5 year
term. The relative fair value of the warrants compared to the Advances was $295,541, which was recorded as a component of stockholders’
deficit with the offset recorded as a discount on the Advances. The fair value of the warrants was determined using the Black-Scholes
Model based on the following weighted average assumptions: common stock price on date of grant $0.74, expected dividend yield 0%,
expected volatility 98%, risk-free interest rate 1.1% and expected life of 5 years.
In connection with the 5% Convertible Note,
the Company issued warrants with a 7 year term to purchase 1,428,572 shares of our common
stock at an exercise price per share equal to the lower of (a) $0.47; or (b) 75% of the closing bid price of the common stock on
the effective date of the Company’s first public offering following the issuance date. The Company determined that the warrants
are a derivative requiring bifurcation in accordance with the provisions of ASC 815. The warrants were valued at inception using
the Monte Carlo simulation (see Note 6) at $579,450 and recorded as a loss on the consolidated statements of operations.
In connection with the 9% Convertible Note
(see Note 6),
the Company issued warrants to purchase 222,916 shares of our common stock
at an exercise price $0.60 per share with a 4 year term. The relative fair value of the warrants compared to the 9% Convertible
Note was $56,737, which was recorded as a component of stockholders’ deficit with the offset recorded as a discount to the
9% Convertible Note. The fair value of the warrants was determined using the Black-Scholes Model
based on the following
assumptions: common stock price on date of grant $0.50, expected dividend yield 0%, expected volatility 97%, risk-free interest
rate 1.12% and expected life of 4 years.
In connection with the 10% Convertible
Note (see Note 6),
the Company issued warrants to purchase 77,778 shares of our common stock
at an exercise price $0.50 per share with a 4 year term. The relative fair value of the warrants compared to the 10% Convertible
Note was $22,616, which was recorded as a component of stockholders’ deficit with the offset recorded as a discount to the
10% Convertible Note. The fair value of the warrants was determined using the Black-Scholes Model
based on the following
assumptions: common stock price on date of grant $0.41, expected dividend yield 0%, expected volatility 97%, risk-free interest
rate 1.86% and expected life of 4 years.
On August 14, 2015, we granted a five-year
fully vested warrant to purchase up to 150,000 shares of our common stock to each of two consultants as compensation for financial
services rendered. The warrants have a strike price of $2.00 per share and have a cashless exercise feature. The fair value of
the warrants was estimated to be $377,327 using the Black-Scholes option-pricing model based on the following assumptions: expected
dividend yield 0%, expected volatility 130%, risk-free interest rate 1.61%, and expected life of 5 years and is included in SGA
as stock based compensation in the accompanying statement of operations.
On August 14, 2015, we granted a three-year
fully vested warrant to purchase up to 50,000 shares of our common stock to a former consultant of our Company in satisfaction
of amounts previously owed to him. The warrant has a strike price of $1.50 per share and has a cashless exercise feature. The fair
value of the warrants was estimated to be $55,821 using the Black-Scholes option-pricing model based on the following assumptions:
expected dividend yield 0%, expected volatility 130%, risk-free interest rate 1.08%, and expected life of 3 years and is included
in SGA as stock based compensation in the accompanying statement of operations.
On December 11, 2015, we entered into a service
agreement (the “SA”) with KBHJJ, LLC (“KBHJJ”). KBHJJ will provide media awareness services to the Company
over the five-year life of the SA. In consideration for these services, our Company agreed to compensate KBHJJ as follows:
|
·
|
The grant of a two-year warrant to purchase up to 1,350,000
shares at an exercise price of $0.001 per share of the Company’s Common Stock vested as follows: 450,000 shares upon execution
of the agreement; 450,000 shares upon the six-month anniversary of the SA; and 450,000 shares upon the one-year anniversary of
the SA, contingent upon the completion of certain conditions.
|
|
·
|
Payment of $50,000 upon execution of the SA.
|
|
·
|
Payment of $50,000 due January 4, 2016.
|
|
·
|
Up to 500,000 shares of the Company’s Common Stock
that can be earned over the first 18 months of the SA, contingent on hitting benchmarks defined in the SA.
|
We recognized $567,000 of SGA as stock based
compensation in connection with the SA in the accompanying statements of operations in the year ended December 31, 2015.
In connection with the 10% 2015 Note, the Company
issued a five-year warrant to purchase up to 61,111 shares of its common stock to the Note holder. The exercise price of the warrant
is $1.50 per share, subject to adjustments provided in the warrant agreement (but in no event at an exercise price below $0.50
per share). The Company accounted for warrants to be issued in connection the 2015 Advances under similar terms as the warrant
granted for the 10% 2015 Note.
In connection with the warrants expected to
be issued in connection with the 2015 Advances and the 10% 2015 Note, we have estimated a relative fair value of $138,333 using
the Black-Scholes option pricing model based on the following weighted average assumptions:
Total 2015 Advances and 10% 2015 Note face value
|
|
$
|
471,111
|
|
Warrants to be issued
|
|
|
256,172
|
|
Term
|
|
|
5 years
|
|
Strike price
|
|
$
|
1.50
|
|
Fair market value
|
|
$
|
0.95
|
|
Expected volatility
|
|
|
128
|
%
|
Risk-free interest rate
|
|
|
1.56
|
%
|
We have a warrant outstanding held by an investor
to purchase up to 500,000 shares of our common stock at a price of $2.50 per share through December 26, 2020, exercisable beginning
on December 26, 2015.
Stock Warrants Outstanding as of December 31, 2016
|
|
Exercise
|
|
|
Warrants
|
|
|
Remaining
|
|
|
Warrants
|
|
Price
|
|
|
Granted
|
|
|
Life (Years)
|
|
|
Exercisable
|
|
$
|
0.001
|
|
|
|
1,350,000
|
|
|
|
0.94
|
|
|
|
900,000
|
|
$
|
0.36
|
|
|
|
16,570
|
|
|
|
10.0
|
|
|
|
16,570
|
|
$
|
0.47
|
|
|
|
1,428,572
|
|
|
|
6.82
|
|
|
|
1,428,572
|
|
$
|
0.50
|
|
|
|
77,778
|
|
|
|
3.96
|
|
|
|
77,778
|
|
$
|
0.60
|
|
|
|
993,799
|
|
|
|
4.46
|
|
|
|
993,799
|
|
$
|
0.71
|
|
|
|
2,016,734
|
|
|
|
9.73
|
|
|
|
2,016,734
|
|
$
|
1.50
|
|
|
|
306,172
|
|
|
|
3.56
|
|
|
|
306,172
|
|
$
|
2.00
|
|
|
|
300,000
|
|
|
|
3.62
|
|
|
|
300,000
|
|
$
|
2.50
|
|
|
|
500,000
|
|
|
|
3.99
|
|
|
|
500,000
|
|
$
|
0.72
|
|
|
|
6,989,625
|
|
|
|
5.68
|
|
|
|
6,539,625
|
|
NOTE 9 - RELATED PARTY TRANSACTIONS
On July 18, 2016, the Board of Directors of
the Company (the “Board”) appointed Steven R. Carlson to serve as CEO of the Company. His appointment was effective
on July 25, 2016. In connection with the hiring of Mr. Carlson, Ali Kharazmi resigned his position as our CEO. Mr. Kharazmi’s
resignation coincided with Mr. Carlson’s start date. Mr. Kharazmi will continue to render significant services
to the Company and will continue to serve as the Company’s Chairman of the Board.
The following individuals and entities
have been identified as related parties based on their affiliation with the Chairman of the Board and Acting Chief Financial Officer:
Ali Kharazmi
|
|
Chairman of the Board and greater than 10% shareholder
|
Mohammad Saeed Kharazmi
|
|
Acting Chief Financial Officer, Board Member and greater than 10% shareholder
|
Genetics Institute of Anti-Aging
|
|
Company with common ownership and management
|
Applied M.A.K. Enterprises, Inc. (“MAK”)
|
|
Company with common ownership and management
|
Advanced Surgical Partners, LLC (“ASP”)
|
|
Company with common ownership and management
|
Center for Weight Management & Plastic Surgery (“CWM”)
|
|
Company with common ownership and management
|
Center for Regenerative Science, LLC
|
|
Company with common ownership and management
|
The following amounts were owed to related
parties, affiliated with the Chairman of the Board and Acting Chief Financial Officer as of December 31, 2015:
ASP
|
|
$
|
70,890
|
|
CWM
|
|
|
34,000
|
|
Ali Kharazmi
|
|
|
25,641
|
|
Applied MAK
|
|
|
-
|
|
Mohammad Saeed Kharazmi
|
|
|
2,405
|
|
Less amounts advanced to ASP and repaid in January 2016
|
|
|
(95,000
|
)
|
Accounts payable - related parties
|
|
$
|
37,936
|
|
The amount owed to ASP relates to legal and
administrative services provided by ASP employees to our Company. Our Company temporarily advanced $95,000 to ASP prior to December
31, 2015 and was repaid in full prior to January 5, 2016. The amounts owed to Saeed Kharazmi at December 31, 2015 related to expense
reimbursements incurred in the ordinary course of business. The amount owed to CWM relates to medical procedures provided to NuGene
consultants as compensation for advertising and marketing services provided to NuGene. The amount owed to Ali Kharazmi and all
amounts outstanding represent advances that bore no interest and were due on demand or expense reimbursements incurred in the ordinary
course of business. Prior to the sale of the related party advances in November 2016, the amounts owed were as follows:
ASP
|
|
$
|
226,188
|
|
CWM
|
|
|
34,000
|
|
Ali Kharazmi
|
|
|
91,175
|
|
Applied MAK
|
|
|
-
|
|
Mohammad Saeed Kharazmi
|
|
|
30,698
|
|
Less amounts advanced to ASP and repaid in January 2016
|
|
|
-
|
|
Accounts payable - related parties
|
|
$
|
382,061
|
|
On November 7, 2016, the amounts owed to related
parties totaling $382,061 were sold to two unrelated investors. The Company issued a note to each investor in the amount of $191,030
(see Note 6). The notes have an interest rate of 5% per annum and mature on the earlier of: (i) May 7, 2017; (ii) the date the
Company raises a total of $2 million, subsequent to the issuance of these notes. The notes have a conversion feature under which
the note holder can convert at any time at a conversion price of $0.40 per share.
As of December 31, 2016, the Company has no
outstanding related party liabilities.
NOTE 10 - COMMITMENTS AND CONTINGENCIES
Commitments
We occupy our sole corporate facilities
at 17912 Cowan, Suite A, Irvine, California, 92614 from ASP, an affiliate of our Company, for approximately $17,109 per month (including
common area maintenance), consistent with the amount that is charged to ASP by the property owner. On February 5, 2015, ASP entered
into a new five-year lease for the property with the owner beginning July 1, 2015 and subsequently amended to begin June 1, 2015.
The lease was subsequently amended to increase the square footage under lease beginning in January 2016. The lease includes annual
increases in the monthly lease payments of approximately 3% each year.
As of December 31, 2016, aggregate future
minimum payments under the lease, including common area maintenance costs, are as follows:
2017
|
|
$
|
198,935
|
|
2018
|
|
|
204,585
|
|
2019
|
|
|
210,234
|
|
2020
|
|
|
106,530
|
|
Total
|
|
$
|
720,284
|
|
During the years ended December 31, 2016 and
2015, we incurred rent expense totaling $202,751 and $167,454, respectively.
On February 3, 2017, the Company finalized
and executed a Confirmation and Continuation Agreement (the “Agreement”) with kathy ireland WORLDWIDE, INC. (“kiWW“)
(See Note 12). In order to settle all disputes under the License Agreement previously entered by the Company and kiWW, the Company
agreed to, among other things, (i) issue to kiWW warrants in the form of a Common Stock Purchase Warrant (the “Warrant”)
to acquire 3,000,000 shares of the Company’s common stock (the Warrant expires five years from the date of issuance and is
exercisable for $0.01 per share, with a cash-less exercise option); and, (ii) issue to kiWW 500,000 restricted shares of the Company’s
common stock, which will be subject to the same lock-up agreement placed on executives of the Company pursuant to the Company’s
proposed secondary offering. In exchange, kiWW agreed that (i) the Company has performed, paid, and otherwise satisfied all of
its obligations under the License Agreement for calendar year 2016; (ii) as of the end of 2016, the Company was not in breach of
the License Agreement in any respect; and, (iii) the License Agreement is in full force and effect.
Legal Proceedings
On July 10, 2015, Stemage Skin Care, LLC (the “Plaintiff”)
filed a complaint in the U.S. District Court for the Central District of California entitled “Stemage Skin Care LLC, a North
Carolina limited liability company vs. NuGene International, Inc. et al.” (Civil Action No.8:15-cv-01078-AG-JCG). The complaint
also names as defendants NuGene, Inc., Ali Kharazmi, Saeed Kharazmi, Kathy Ireland Worldwide, Stephen Roseberry, Steve Rosenblum
and Erik Sterling. The complaint contains allegations of damage asserted to be grounded on: (i) copyright infringement; (ii) interference
with contract; (iii) intentional interference with prospective economic advantage; (iv) negligent interference with prospective
economic advantage; and (v) conspiracy. The complaint allegedly arises out of an August 20, 2012 agreement among the Plaintiff
and kathy ireland inc. (“KI”) pursuant to which KI made Kathy Ireland available to perform “Ambassador Services”
as defined within that agreement. That agreement effectively terminated in October 2014 and is the subject of a separate arbitration
with KI and Kathy Ireland before the American Arbitration Association. On or around August 4, 2016 the Company settled the litigation.
All parties to this litigation executed a settlement agreement resolving and waiving all claims, with a full dismissal, with prejudice,
of the action. Pursuant to the settlement, in December 2016 the Company paid the total sum of $50,000 to the Plaintiff.
On July 31, 2015 Star Health & Beauty,
LLC (“SH&B”) filed a complaint in the U.S. District Court for the Northern District of Georgia entitled “Star
Health & Beauty, LLC vs. NuGene, Inc. and NuGene International, Inc. Defendants” (Case No. 1:15-cv-02634-CAP). The complaint
alleges that our use of the NuGene name and trademark infringes on SH&B’s NUGEN name. SH&B seeks cancelation of our
NuGene trademark, as well as unspecified monetary damages. In February, 2017 the parties agreed upon terms to settle the matter,
subject to execution of a definitive written settlement agreement to include the following terms: (i) $60,000 to be paid by the
Company to SH&B, in installments of $5,000 upon execution of a Settlement Agreement, $25,000 90-days thereafter, and $30,000
60-days thereafter; (ii) issuance of 125,000 shares of the Company’s common stock to SH&B upon execution of a Settlement
Agreement; (iii) each side continues to use their names as the wish; (iv) full mutual releases of known and unknown claims; (v)
each bears its respective cost of litigation; and, (vi) dismissal with prejudice of the action. The written Settlement Agreement
is being finalized and should be executed within the next 30 days.
In May 2016, we were informed that the California
Labor Commissioner scheduled a hearing in connection with two individuals that claimed our Company did not fulfill its obligations
to pay a final paycheck. The two individuals are seeking back pay and penalties totaling approximately $31,000. A trial/hearing
was scheduled for March 14, 2017 to decide each matter. In February 2017 we settled both matters. In exchange for a complete release
from the first claimant, we will pay the first claimant a total of $9,000 in accordance with the following schedule: $4,500 on
or before March 10, 2017; four additional payments of $1,000 each on the 15
th
day of April, May, June, and July 2017;
and, a final payment of $500 on or before the 15
th
day of August. In exchange for a complete release from the second
claimant, we will pay the second claimant a total of $4,000 on or before March 10, 2017.
On May 6, 2016, we were presented with a demand for payment of compensation
for a former executive employee (the “Former Executive”) pursuant to his employment contract with our Company. The
amount of the compensation claimed by the Former Executive totaled $49,998. The Company’s management is evaluating the merits
of this matter. We believe that no amounts are due to the Former Executive and we have not accrued a liability as of December 31,
2016.
In December 2016, we were informed by the four holders of
our promissory notes totaling $480,000 (the “Holders”) that they would not honor their obligation to provide an
additional $600,000 in similar financing. The Holders allege that certain breaches of the notes by the Company relieve them
of their obligation. The Company firmly believes there is no merit whatsoever to the claims of the Holders. Rather than
pursue litigation against the Holders, the Company has elected to pursue other sources of financing. However, should the Holders seek any acceleration or damages of any kind under the Notes, NuGene is
committed to aggressively protect its rights, including though not limited to seeking damages from the Holders.
On February 24, 2017, we were informed
that the Company will need to respond to a lawsuit filed by Habib American Bank (“Habib”) in the Superior Court of
California, County of Orange. The action names Advanced Surgical Partners, LLC (“ASP”) as a defendant, as well as
a number of additional named parties including though not limited to NuGene, Inc.; our Chairman of the Board, Mohammad Ali Kharazmi
(“Ali”); and, our Acting Chief Financial Officer and Board Member, Mohammad Saeed Kharazmi (“Saeed”).
The action is based on a purported default under a commercial loan from Habib to ASP on or around January 2008 (the “Loan”).
According to the complaint, ASP currently owes Habib approximately $2.7 million under the Loan and that ASP has defaulted on the
Loan. The Loan was arranged by Ali on behalf of ASP. Ali and Saeed are owners of, and control, ASP; they are also guarantors on
the Loan. Additional family members of Ali and Saeed are alleged to be additional guarantors on the Loan, as are additional business
entities owned by, or affiliated with, Ali and Saeed. The Loan is secured, in part, by the pledge of real estate owned by family
members of Ali and Saeed (the “Pledged Real Estate”). A Deed of Trust was recorded by Habib against the Pledged Real
Estate, and there appears to be more than sufficient equity in the Pledged Real Estate to pay off the Loan. NuGene is also alleged
to be an additional guarantor on the Loan. A thorough search of NuGene records and files has failed to yield any documents or
indication that NuGene was in fact a guarantor on the Loan. The Company has no documentation of the Loan or its purported guaranty,
and there was no business relationship between ASP and NuGene which would suggest that a guaranty would have been provided. There
was no prior knowledge by the Company of the existence of the Loan or the purported guaranty. Ali has steadfastly rejected the
existence of the guaranty and has affirmatively assured the Company that he never authorized NuGene to guaranty the Loan, and
that he never signed any documents on behalf of NuGene regarding the Loan. At this time, the Company intends to aggressively defend
its rights and reject any status as a guarantor of the Loan. We believe that the Company’s risk and liability exposure under
the Loan is minimal based upon (i) good faith and evidentiary defenses; and, (ii) the fact that there is more than adequate value/equity
in the Pledged Real Estate to pay off the loan.
On April 4, 2017, Habib agreed to dismiss the Company from the litigation brought by Habib. A formal Settlement
Agreement and Release has been executed by and between the Company and Habib (see Note 12).
Other than that described above, we are not currently a party to
any other material legal proceedings. We are not aware of any pending or threatened litigation against us that in our view would
have a material adverse effect on our business, financial condition, liquidity, or operating results. However, legal claims are
inherently uncertain, and we cannot assure you that we will not be adversely affected in the future by legal proceedings.
NOTE 11 – INCOME
TAXES
The components of the Company’s loss before the provision
for income taxes for the years ended December 31, 2016 and 2016 consisted of the following:
|
|
2016
|
|
|
2015
|
|
United
States of America
|
|
$
|
(11,816,521
|
)
|
|
$
|
(5,219,066
|
)
|
Total
|
|
$
|
(11,816,521
|
)
|
|
$
|
(5,219,066
|
)
|
A reconciliation of the statutory U.S. federal income tax rate
to the Company’s effective tax rate for the years ended December 31, 2016 and 2015 is as follows:
|
|
2016
|
|
|
2015
|
|
Tax, computed at the federal statutory rate
|
|
|
34.00
|
%
|
|
|
34.00
|
%
|
State taxes, net of federal tax benefit
|
|
|
6.94
|
%
|
|
|
8.83
|
%
|
Nondeductible interest on convertible debt
|
|
|
(3.95
|
)%
|
|
|
0.00
|
%
|
Loss on derivative liability
|
|
|
(6.15
|
)%
|
|
|
0.00
|
%
|
Change in derivative liability value
|
|
|
2.87
|
%
|
|
|
0.00
|
%
|
Other permanent differences
|
|
|
(0.08
|
)%
|
|
|
(0.04
|
)%
|
Change in valuation allowance
|
|
|
(33.63
|
)%
|
|
|
(42.79
|
)%
|
|
|
|
|
|
|
|
|
|
Provision for income taxes
|
|
|
0.00
|
%
|
|
|
0.00
|
%
|
Significant components of deferred income tax assets and liabilities
for the years ended December 31, 2016 and 2015 is as follows:
|
|
2016
|
|
|
2015
|
|
Stock based compensation
|
|
$
|
2,456,636
|
|
|
$
|
654,360
|
|
Net operating losses
|
|
|
3,529,664
|
|
|
|
1,595,546
|
|
Accruals and reserves
|
|
|
317,900
|
|
|
|
80,823
|
|
Gross deferred tax assets
|
|
|
6,304,200
|
|
|
|
2,330,728
|
|
Less: Valuation allowance
|
|
|
(6,293,979
|
)
|
|
|
(2,320,506
|
)
|
Total deferred tax assets
|
|
|
10,221
|
|
|
|
10,221
|
|
|
|
|
|
|
|
|
|
|
Property and equipment
|
|
|
(10,221
|
)
|
|
|
(10,221
|
)
|
Total deferred tax liabilities
|
|
|
(10,221
|
)
|
|
|
(10,221
|
)
|
|
|
|
|
|
|
|
|
|
Net deferred tax assets
|
|
$
|
0
|
|
|
$
|
0
|
|
Deferred income tax assets and liabilities are recorded for
differences between the financial statement and tax basis of the assets and liabilities that will result in taxable or deductible
amounts in the future based on enacted laws and rates applicable to the periods in which the differences are expected to affect
taxable income. Valuation allowances are established when necessary to reduce deferred tax assets to the amount expected to be
realized.
The Company has evaluated the available positive and negative
evidence supporting the realization of its gross deferred tax assets, including the Company’s cumulative losses, and the
amount and timing of future taxable income, and has determined it is more likely than not that the federal and state deferred tax
assets will not be realized. Accordingly, the Company recorded a full valuation allowance against its federal and state deferred
tax assets as of December 31, 2016.
The change in the valuation allowance for the years ended December
31, 2016 and 2015 is as follows
|
|
2016
|
|
|
2015
|
|
Valuation allowance, beginning of year
|
|
$
|
2,320,506
|
|
|
$
|
87,469
|
|
Increase in valuation allowance
|
|
|
3,973,473
|
|
|
|
2,233,037
|
|
Valuation allowance, end of year
|
|
|
6,293,979
|
|
|
|
2,320,506
|
|
As of December 31, 2016, the Company had U.S federal and
California income tax net operating loss carryforwards of approximately $8.2 million and $8.2 million, respectively. The
federal and California net operating loss carryforwards will begin to expire in 2034 and 2034, respectively unless previously
utilized.
Pursuant to Internal Revenue Code Section 382, use of the Company's
federal and California net operating loss carryforwards may be limited if a cumulative change in ownership of more than 50% has
occurred within a three-year period. The Company is in the process of determining whether or not an ownership change has occurred
and any amount of net operating losses that may not be realized. Due to its valuation allowance position, the Company does not
believe the ultimate determination will have a material impact on the consolidated financial statements.
The Company adopted the provisions in ASC 740-10 which clarifies
the accounting for uncertain tax positions. The guidance requires that the Company recognize the impact of a tax position in the
financial statements if the position is more likely than not to be sustained upon examination by the tax authorities with full
knowledge of all relevant information, based solely on the technical merits of the position. If it is not more likely than not
that a position will be sustained, then the effect of the position must be measured. The Company must determine the probable outcomes
of each position, the likelihood of each outcome, and the amount of the outcome with a cumulative likelihood of more than 50%.
As of December 31, 2016, no reserve for unrecognized tax benefits was recorded.
The Company does not anticipate any material change in the
total amount of unrecognized tax benefits will occur within the next twelve months. The Company’s practice is to recognize
interest and/or penalties related to income tax matters in income tax expense. The Company had no accrual for interest or penalties
on the Company’s balance sheets as of December 31, 2016, and has not recognized interest and/or penalties in the consolidated
statements of operations for the years ended December 31, 2016 and 2015.
The Company is subject to taxation in the
United States and California. The Company's federal and California tax returns are open for examination for tax years 2013 and
forwards.
NOTE 12 - SUBSEQUENT EVENTS
On January 9, 2017, the Company issued an
investor a promissory note in the total principal amount of $277,778 with a 10% annual interest rate, which will be due on the
earlier of (i) January 9, 2018; or, (ii) the closing of the Secondary Offering. The Company received $250,000 of gross proceeds
from the Note. The investor has the right to convert the note into shares of the Company’s common stock during the 15-days
immediately following the closing of the Secondary Offering at a conversion price equal to 65% of the share price in the Secondary
Offering. The Company also granted to the investor warrants to purchase 277,778 shares of common stock at $0.50 per share. The
investor will also be issued 150,000 shares of our common stock.
On January 20, 2017, the Company issued an
investor a promissory note in the total principal amount of $114,000 with an 8% annual interest rate, which will be due 9-months
after the issuance of the note. The Company received $100,000 of gross proceeds from the Note. The investor has the right to convert
the note into shares of the Company’s common stock following 180-days after the issuance of the note at a conversion price
equal to 60% of the three (3) lowest closing bid prices for our common stock during the prior 15 trading day period.
On February 3, 2017, the Company finalized
and executed a Confirmation and Continuation Agreement (the “Agreement”) with kathy ireland WORLDWIDE, INC. (“kiWW“).In
order to settle all disputes under the License Agreement previously entered by the Company and kiWW, the Company agreed to, among
other things, (i) issue to kiWW warrants in the form of a Common Stock Purchase Warrant (the “Warrant”) to acquire
3,000,000 shares of the Company’s common stock (the Warrant expires five years from the date of issuance and is exercisable
for $0.01 per share, with a cash-less exercise option); and, (ii) issue to kiWW 500,000 restricted shares of the Company’s
common stock, which will be subject to the same lock-up agreement placed on executives of the Company pursuant to the Company’s
proposed secondary offering. In exchange, kiWW agreed that (i) the Company has performed, paid, and otherwise satisfied all of
its obligations under the License Agreement for calendar year 2016; (ii) as of the end of 2016, the Company was not in breach of
the License Agreement in any respect; and, (iii) the License Agreement is in full force and effect.
On February 8, 2017, the Company issued an
investor a promissory note in the total principal amount of $277,778 with a 10% annual interest rate, which will be due 9-months
after the issuance of the note. The Company received $250,000 of gross proceeds from the Note. The investor has the right to convert
the note into shares of the Company’s common stock commencing at the earlier of (i) the closing of the Secondary Offering;
or, (ii) 120-days after the issuance of the note, at a conversion price equal to (y) upon closing of the Secondary Offering until
120-days from issuance of the note, 65% of the pricing in the Secondary Offering; (z) 121 days after issuance of the note, 60%
of the lowest trade price of our common stock during the 15 trading days immediately preceding conversion, but in no event less
than $0.01 (however, in the event that the price falls below $0.01 then 50% of the lowest trade price of during 15 trading days
immediately preceding the conversion). The Company also granted to the investor warrants to purchase 277,778 shares of common stock
at $0.50 per share. Investor will also be issued 150,000 shares of our common stock.
On February 8, 2017, the Company issued an investor a promissory
note in the total principal amount of $240,411 with a 2% annual interest rate, which will be due at the earlier of (i) August 8,
2017; or, (ii) the closing of the Secondary Offering. The Company received $190,411 of gross proceeds from the Note. As a condition
to the note, all of the gross proceeds received by the Company were immediately used to pay-in-full the promissory note issued
by the Company on March 30, 2016 in the original principal amount of $275,000, thereafter amended and restated as the 4% convertible
note Due June 30, 2017. The investor has the right to convert the note into shares of the Company’s common stock commencing
at a conversion price equal to 65% of the pricing of the shares in the Secondary Offering.
On February 17, 2017, the Company issued an
investor a promissory note in the total principal amount of $277,778 with a 10% annual interest rate, which will be due at the
earlier of (i) the closing of the Secondary Offering; or, (ii) 9-months after the issuance of the note. The Company received $250,000
of gross proceeds from the Note. The investor has the right to convert the note into shares of the Company’s common stock
commencing at the earlier of (i) the closing of the Secondary Offering; or, (ii) 120-days after the issuance of the note, at a
conversion price equal to (y) upon closing of the Secondary Offering until 120-days from issuance of the note, 65% of the pricing
in the Secondary Offering; (z) 121 days after issuance of the note, 60% of the lowest trade price of our common stock during the
15 trading days immediately preceding conversion, but in no event less than $0.01 (however, in the event that the price falls
below $0.01 then 50% of the lowest trade price of during 15 trading days immediately preceding the conversion). The Company also
granted to the investor warrants to purchase 277,778 shares of common stock at $0.50 per share. Investor will also be issued 150,000
shares of our common stock.
On February 27, 2017, the Company issued an
investor a promissory note in the total principal amount of $58,000 with an 8% annual interest rate, which will be due 9-months
after the issuance of the note. The Company received $50,000 of gross proceeds from the Note. The investor has the right to convert
the note into shares of the Company’s common stock following 180-days after the issuance of the note at a conversion price
equal to 60% of the three (3) lowest closing bid prices for our common stock during the prior 15 trading day period.
On March 23, 2017, the Company issued an investor a promissory note
in the total principal amount of $110,000 with a 10% annual interest rate, which will be due 6-months after the issuance of the
note. The Company received $100,000 of gross proceeds from the Note. The investor has the right to convert the note into shares
of the Company’s common stock commencing at the earlier of (i) the closing of the Secondary Offering; or, (ii) 90-days after
the issuance of the note, at a conversion price equal to 60% of the lowest closing bid or traded price, whichever is lower, of
the Company’s Common Stock during the fifteen (15) trading days immediately preceding Issuance or Conversion Date, whichever
is lower. The Company also granted to the investor warrants to purchase 110,000 shares of common stock at $0.50 per share. Investor
will also be issued 60,000 shares of our common stock. The Company also issued 275,000 shares of common stock to the investor as
“Returnable Shares”. The Returnable Shares will be returned to the Company and canceled in the event (i) the note is
prepaid in full within the initial 180-days after issuance, or (ii) if investor elects to convert the Note within the initial 180-days
after issuance.
Effective March 20, 2017, the Company entered
into a consulting agreement with I|M1, LLC (“I|M1”) for I|M1 to provide assistance and advice regarding the promotion,
marketing, and branding of men’s products to be sold by the Company. The Company agreed to issue to I|M1 2,500,000 shares
of the Company’s restricted stock, which were to be immediately issued and earned. The Company also agreed to pay I|M1 $50,000
at the earlier of (i) June 30, 2017; or, (ii) a debt or equity offering closed by the Company for an amount at least $10,000,000.
On March 23, 2017, the
Company issued to Labrys Fund, LP (“Labrys”) a promissory note in the total principal amount of $110,000 with a 10%
annual interest rate, which will be due 6-months after the issuance of the note. The Company received $100,000 of gross proceeds
from the Note. Labrys has the right to convert the note into shares of the Company’s common stock commencing at the earlier
of (i) the closing of the Secondary Offering; or, (ii) 90-days after the issuance of the note, at a conversion price equal to 60%
of the lowest closing bid or traded price, whichever is lower, of the Company’s Common Stock during the fifteen (15) trading
days immediately preceding Issuance or Conversion Date, whichever is lower. The Company also granted to Labrys warrants to purchase
110,000 shares of common stock at $0.50 per share. Labrys will also be issued 60,000 shares of our common stock. The Company also
issued 275,000 shares of common stock to Labrys as “Returnable Shares”. The Returnable Shares will be returned to the
Company and canceled in the event (i) the note is prepaid in full within the initial 180-days after issuance, or (ii) if Labrys
elects to convert the Note within the initial 180-days after issuance.
On March 31, 2017, the Company and kiWW agreed to amend the Confirmation
and Continuation Agreement discussed above. Pursuant to an Amendment to Confirmation and Continuation Agreement, kiWW agreed that
of the 2,916,666 shares of common stock kiWW was to receive under the exercise of its warrants, 2,277,778 shares were instead to
be allocated and issued to I|M1 as payment under the consulting agreement between the Company and I|M1.
The Company entered into a License Agreement (the “License”),
with I|M1, LLC (“I|M1”) effective March 31, 2017. Under the License the Company we licensed the right to utilize the
trademarks and rights to the name, likeness, visual representations, and related intellectual property of I|M1 in connection with
our cosmeceutical line of men’s products containing adult human adipose stem cell derived or containing biologically active
or biologically derived ingredients. While NuGene is obligated to utilize commercially reasonable efforts to promote and grow the
I|M1 brand, the License contains no minimum sales requirements. NuGene will begin shipping licensed products under the License
on a date to be determined by NuGene in its sole and absolute discretion. There are no annual fees, brand participation fees,
or minimum fees due under the License. NuGene will pay to I|M1 a royalty fee in the amount of 5% of gross sales of products under
the License. The term of the License is 5-years.
On April 4, 2017, Habib agreed to dismiss the Company from the litigation brought by Habib. A formal Settlement
Agreement and Release has been executed by and between the Company and Habib.