Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

Form 10-Q

 

 

(Mark One)

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2015

OR

 

¨ TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

COMMISSION FILE NUMBER: 000-54928

 

 

MEDBOX, INC.

(Exact name of registrant as specified in its charter)

 

 

 

Nevada   45-3992444

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

600 Wilshire Blvd. Suite 1500, Los Angeles, CA   90017
(Address of principal executive offices)   (zip code)

(800) 762-1452

(Registrant’s telephone number, including area code)

N/A

(Former name, former address and former fiscal year, if changed since last report)

 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer   ¨    Accelerated filer   ¨
Non-accelerated filer   ¨  (Do not check if smaller reporting company)    Smaller reporting company   x

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x

As of November 6, 2015, the registrant had 114,410,410 shares of common stock, par value $0.001 per share, outstanding.

 

 

 


Table of Contents

MEDBOX, INC.

TABLE OF CONTENTS

 

    PART I – FINANCIAL INFORMATION

     1   

ITEM 1.

  

Financial Statements

     1   
  

Condensed Consolidated Balance Sheets as of September 30, 2015 (Unaudited) and December 31, 2014

     1   
  

Condensed Consolidated Statements of Comprehensive Loss for the Three and Nine Months Ended September  30, 2015 and 2014 (Unaudited)

     2   
  

Condensed Consolidated Statement of Stockholders’ Deficit for the Nine Months Ended September  30, 2015 (Unaudited)

     3   
  

Condensed Consolidated Statements of Cash Flows for the Nine Months Ended September  30, 2015 and 2014 (Unaudited)

     4   
  

Notes to Condensed Consolidated Financial Statements (Unaudited)

     5   

ITEM 2.

  

Management’s Discussion and Analysis of Financial Condition and Results of Operations

     33   

ITEM 3.

  

Quantitative and Qualitative Disclosures About Market Risk

     46   

ITEM 4.

  

Controls and Procedures

     46   

    PART II – OTHER INFORMATION

     48   

ITEM 1.

  

Legal Proceedings

     48   

ITEM 1A.

  

Risk Factors

     49   

ITEM 2.

  

Unregistered Sales of Equity Securities and Use of Proceeds

     50   

ITEM 3.

  

Defaults Upon Senior Securities

     50   

ITEM 4.

  

Mine Safety Disclosures

     50   

ITEM 5.

  

Other Information

     50   

ITEM 6.

  

Exhibits

     51   

  SIGNATURES

     52   


Table of Contents

PART I – FINANCIAL INFORMATION

Item 1. Financial Statements.

MEDBOX, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

 

     September 30, 2015     December 31, 2014  
     (unaudited)    
Assets     

Current assets

    

Cash and cash equivalents

   $ 346,761      $ 101,182   

Marketable securities

     94,817        94,776   

Accounts receivable

     —          8,774   

Inventory

     187,844        961,236   

Deposits in escrow

     15,000        400,476   

Prepaid insurance

     240,428        31,491   

Prepaid expenses and other current assets

     172,039        34,729   
  

 

 

   

 

 

 

Total current assets

     1,056,889        1,632,664   

Property and equipment, net of accumulated depreciation of $59,210 and $50,192, respectively

     573,470        158,318   

Land

     4,945,000        —     

Assets held for resale

     —          399,594   

Construction in progress

     68,959        —     

Intangible assets, net of accumulated amortization of $123,567 and $83,500 respectively

     669,086        709,153   

Note receivable, net of allowance of $350,000

     —          —     

Goodwill

     1,260,037        1,260,037   

Deferred Costs

     299,018        —     

Deposits and other assets

     140,212        104,726   
  

 

 

   

 

 

 

Total assets

   $ 9,012,671      $ 4,264,492   
  

 

 

   

 

 

 
Liabilities and Stockholders’ Equity     

Current liabilities

    

Accounts payables

   $ 3,609,486      $ 1,713,627   

Accrued interest payable

     324,330        372,937   

Accrued expenses

     122,663        610,497   

Accrued expenses directors

     185,498     

Accrued settlement and severance expenses

     912,065        —     

Deferred revenue, current

     219,487        204,091   

Notes payable

     431,415        261,434   

Related party notes payable

     —          678,877   

Convertible notes payable, net of discount of $266,497 and $1,225,573, respectively

     4,993,891        2,524,427   

Derivative Liability

     4,885,286        3,691,853   

Customer deposits

     1,057,340        1,525,808   
  

 

 

   

 

 

 

Total current liabilities

     16,741,461        11,583,551   

Notes Payable, less current portion

     4,326,484     

Deferred revenue, less current portion

     378,041        568,515   

Deferred tax liability

     160,000        160,000   
  

 

 

   

 

 

 

Total liabilities

     21,605,986        12,312,066   
  

 

 

   

 

 

 

Commitments and contingencies (Note 9)

    

Stockholders’ Deficit

    

Preferred stock, $0.001 par value: 10,000,000 authorized; 1,000,000 and 3,000,000 issued and outstanding as of September 30, 2015 and December 31, 2014, respectively

     1,000        3,000   

Common stock, $0.001 par value: 100,000,000 authorized, 99,250,518 and 30,496,909 issued and outstanding as of September 30, 2015 and December 31, 2014, respectively

     99,250        30,497   

Additional paid-in capital

     35,823,112        15,315,110   

Treasury stock

     (1,209,600     (1,209,600

Accumulated deficit

     (47,198,689     (22,078,193

Accumulated other comprehensive loss

     (108,388     (108,388
  

 

 

   

 

 

 

Total stockholders’ deficit

     (12,593,315     (8,047,574
  

 

 

   

 

 

 

Total liabilities and stockholders’ deficit

   $ 9,012,671      $ 4,264,492   
  

 

 

   

 

 

 

See notes to condensed consolidated financial statements.

 

1


Table of Contents

MEDBOX, INC.

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS

(Unaudited)

 

     For the 3 months ended     For the 9 months ended  
     September 30     September 30  
     2015     2014     2015     2014  

Revenue

   $ 288,961      $ 147,884      $ 390,156      $ 534,082   

Revenue, related party

     25,192        25,192        74,754        50,110   

Less: allowances and refunds

     —          —          —          (60,000
  

 

 

   

 

 

   

 

 

   

 

 

 

Net revenue

     314,153        173,076        464,910        524,192   

Cost of revenues

     656,383        1,813,562        1,837,711        3,492,105   
  

 

 

   

 

 

   

 

 

   

 

 

 

Gross loss

     (342,230     (1,640,486     (1,372,801     (2,967,913

Operating expenses

        

Selling and marketing

     103,765        319,204        442,261        749,212   

Research and development

     —          61,623        —          136,656   

General and administrative

     3,506,029        1,984,303        12,627,644        3,183,382   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total operating expenses

     3,609,794        2,365,130        13,069,905        4,069,250   
  

 

 

   

 

 

   

 

 

   

 

 

 

Loss from operations

     (3,952,024     (4,005,616     (14,442,706     (7,037,163
  

 

 

   

 

 

   

 

 

   

 

 

 

Other income (expense)

        

Interest income (expense), net

     (195,426     (123,007     (289,226     (71,343

Financing Costs

     (522,379     —          (2,822,011     —     

Change in fair value of derivative liabilities

     (2,544,014     548,315        509,057        548,315   

Amortization of debt discount

     (2,071,898     (216,224     (8,121,537     (216,224

Other income (expense)

     (6,208     —          45,927        (26,511
  

 

 

   

 

 

   

 

 

   

 

 

 

Total other income (expense)

     (5,339,925     209,084        (10,677,790     234,237   

Loss before provision for income taxes

     (9,291,949     (3,796,532     (25,120,496     (6,802,926

Provision for income taxes

     —          —          —          —     
  

 

 

   

 

 

   

 

 

   

 

 

 

Net loss

   $ (9,291,949   $ (3,796,532   $ (25,120,496   $ (6,802,926
  

 

 

   

 

 

   

 

 

   

 

 

 

Loss per share attributable to common stockholders

        

Basic

   $ (0.13   $ (0.13   $ (0.54   $ (0.22
  

 

 

   

 

 

   

 

 

   

 

 

 

Diluted

   $ (0.13   $ (0.13   $ (0.54   $ (0.22
  

 

 

   

 

 

   

 

 

   

 

 

 

Weighted average shares outstanding

        

Basic

     73,524,951        30,371,299        46,945,806        30,472,447   
  

 

 

   

 

 

   

 

 

   

 

 

 

Diluted

     73,524,951        30,371,299        46,945,806        30,472,447   
  

 

 

   

 

 

   

 

 

   

 

 

 

Other Comprehensive loss

        

Net loss

     (9,291,949     (3,796,532     (25,120,496     (6,802,926

Unrealized loss from marketable securities

     —          (158,507     —          (158,507
  

 

 

   

 

 

   

 

 

   

 

 

 

Comprehensive loss

   $ (9,291,949   $ (3,955,039   $ (25,120,496   $ (6,961,433
  

 

 

   

 

 

   

 

 

   

 

 

 

See notes to consolidated financial statements.

 

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MEDBOX, INC.

CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS’ DEFICIT

 

                                        Additional     Common           Accumulated Other     Total  
    Preferred Stock     Common Stock     Treasury Stock     Paid-In     Stock     Accumulated     Comprehensive     Stockholders’  
    Shares     Amount     Shares     Amount     Shares     Amount     Capital     Subscribed     Deficit     Loss     Deficit  

Balances at December 31, 2014

    3,000,000      $ 3,000        30,496,909      $ 30,497        (60,000   $ (1,209,600   $ 15,315,110      $ —        $ (22,078,193   $ (108,388   $ (8,047,574
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Stock-based compensation

        147,145      $ 147            5,331,235              5,331,382   

Exercise of warrants

        206,480        206            278,745              278,951   

Issuance of shares to settle accounts payable

        1,633,047        1,633            363,095              364,728   

Conversions of convertible notes payable

        67,475,105        67,475            10,090,187              10,157,662   

Issuance of warrants in connection with convertible notes payable

                4,304,522              4,304,522   

Exercise of warrants in connection with convertible notes payable

        2,291,832        2,292            135,218              137,510   

Share cancelation

    (2,000,000     (2,000     (3,000,000     (3,000         5,000              —     

Unrealized loss from marketable securities

                      —          —     

Net loss

                    (25,120,496       (25,120,496
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balances at September 30, 2015

    1,000,000      $ 1,000        99,250,518      $ 99,250        (60,000   $ (1,209,600   $ 35,823,112      $ —        $ (47,198,689   $ (108,388   $ (12,593,315
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

See notes to condensed consolidated financial statements.

 

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MEDBOX, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

 

     For the 9 months ended September 30,  
     2015     2014  

Cash flows from operating activities

    

Net loss

   $ (25,120,496   $ (6,802,926

Adjustments to reconcile net loss to net cash:

    

Depreciation and amortization

     90,315        59,364   

Provisions and allowances

     —          60,000   

Gain on sale of investments and property and equipment

     —          (9,600

Charges from escrow deposits

     280,400        —     

Inventory valuation reserve

     497,439        —     

Market value of securities received for services

     —          (190,132

Change in fair value of derivative liability

     (509,057     (548,315

Amortization of debt discount

     8,121,537        216,224   

Financing costs

     2,822,011     

Stock based compensation

     5,331,382        1,031,640   

Changes in operating assets and liabilities

    

Accounts receivable

     8,774        213,424   

Inventories

     275,953        110,788   

Deposits in escrow

     55,076        —     

Prepaid insurance

     (208,937     —     

Prepaid expenses and other assets

     (172,796     (896,954

Deferred costs

     (299,018     —     

Accounts payables

     2,521,976        907,684   

Accrued interest payable

     214,886        —     

Accrued expenses

     (487,834     —     

Accrued expenses directors

     185,498        —     

Accrued settlement and severance expenses

     912,065        —     

Customer deposits

     (468,468     807,347   

Deferred revenue

     (175,078     390,311   
  

 

 

   

 

 

 

Net cash used in operating activities

     (6,124,372     (4,651,145

Cash flows from investing activities

    

Issuance of note receivable

     —          (115,000

Purchase of property and equipment

     (14,795     (32,982

Purchase of real estate

     (500,000     (399,594

Purchase of intangible assets

     —          (166,183

Construction in Progress

     (68,959     —     
  

 

 

   

 

 

 

Net cash used in investing activities

     (583,754     (713,759

Cash flows from financing activities

    

Payments on notes payable

     (3,535     (75,000

Related party notes payable

     (624,888     379,880   

Proceeds from issuance of notes payable

     —          299,605   

Proceeds from issuance of common stock

     —          2,442,859   

Proceeds from issuance of convertible notes payable, net fees of approximately $352,000

     7,432,128        3,500,000   

Proceeds from issuance of convertible notes payable from related parties

     150,000        —     
  

 

 

   

 

 

 

Net cash provided by financing activities

     6,953,705        6,547,344   

Net decrease in cash

     245,579        1,182,440   

Cash and cash equivalents, beginning of period

     101,182        168,003   
  

 

 

   

 

 

 

Cash and cash equivalents, end of period

   $ 346,761      $ 1,350,443   
  

 

 

   

 

 

 

Supplemental disclosures of cash flow information:

    

Cash paid for interest

   $ 1,151      $ 37,078   
  

 

 

   

 

 

 

Cash paid for income tax

   $ —        $ —     
  

 

 

   

 

 

 

Non- cash investing and financing activities:

    

Common stock issued upon debt conversion

   $ 6,261,474      $ —     
  

 

 

   

 

 

 

Common stock issued for accounts payable

   $ 364,728      $ —     
  

 

 

   

 

 

 

Purchase of land with notes payable

   $ 5,000,000      $ —     
  

 

 

   

 

 

 

See notes to condensed consolidated financial statements.

 

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MEDBOX, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1 – BUSINESS ORGANIZATION, NATURE OF OPERATIONS

Medbox, Inc, which is incorporated in the state of Nevada (the “Company”), provides specialized consulting services to the marijuana industry and sells associated patented products, and medical vaporization devices. The Company works with clients who seek to enter the medical and cultivation marijuana markets in those states where approved. Medbox offers turnkey solutions that assist with licensing and compliance, site selection, design and permitting, safety and security, along with full build-out and operational oversight. The Company’s consulting solutions and technology create structure and process for clients and their respective businesses in this rapidly emerging sector. In addition, through its wholly owned subsidiary, Vaporfection International, Inc. (“VII”), the Company sells a line of vaporizer and accessory products online and through distribution partners. The Company is headquartered in Los Angeles, California.

The Company holds the license to operate a dispensary in Portland, Oregon, and a master lease on the property in which the dispensary is located. The Company entered into an Operating Agreement with an unrelated party (the “Operator”) in which the Operator will manage and operate the Dispensary. Per the terms of the Agreement, the Dispensary is “under the exclusive supervision and control of Operator, which shall be responsible for the proper and efficient operation of the Dispensary”. The term of the Agreement includes an initial term, which is five years, and a renewal term for an additional five years. The renewal term is at the discretion of the Operator.

The procurement fee for the dispensary was $400,000 (initially classified in Deferred Revenue), of which $50,000 was paid upon execution and delivery of the Agreement, and the remaining $350,000 is to be paid monthly in the amount of gross receipts less payroll and costs of inventories. If the procurement fees are not paid within six months, the payment terms become a minimum monthly payment of $5,000. As of the date of this report, there have been no amounts available under the above calculation to make payments towards the procurement fees.

The remaining $350,000 is evidenced by a Note Receivable to the Company. As of June 30, 2015 the Company determined it was not assured of the timing of the collectability of the Note Receivable and therefore has set up an allowance in the amount of $350,000 for the Note Receivable, and has reduced the Deferred Revenue to $50,000.

After the Procurement Fee is paid in full, it is the parties’ plan that ownership of the Dispensary (through a new merged corporation) will be apportioned 51% to Operator and 49% to Medbox. The Agreement also includes an annual Licensor Fee of 5% of the annual Gross Revenues, which will begin after the Procurement Fees have been paid in full.

The Company has determined that they do not hold the controlling financial interest in the Dispensary and are not the primary beneficiary, and therefore will not consolidate the Dispensary in their financial statements.

NOTE 2 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Principles of Consolidation

The consolidated financial statements include the accounts of Medbox, Inc. and its wholly owned subsidiaries:

 

    Prescription Vending Machines, Inc., a California corporation, d/b/a Medicine Dispensing Systems in the State of California (“MDS”), which distributes our Medbox™ product and provides related consulting services described further below.

 

    Vaporfection International, Inc., a Florida corporation through which we distribute our medical vaporizing products and accessories.

 

    Medbox Property Investments, Inc., a California corporation specializing in real property acquisitions and leases for dispensaries and cultivation centers.

 

    MJ Property Investments, Inc., a Washington corporation specializing in real property acquisitions and leases for dispensaries and cultivation centers in the state of Washington.

 

    Medbox Management Services, Inc., a California corporation specializing in providing management oversight and compliance services to state-licensed dispensaries for cultivation, dispensing, and marijuana infused products (MIPS).

 

    EWSD I, LLC, an Arizona corporation that owns property in Colorado.

All intercompany transactions, amounts and balances have been eliminated.

 

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MEDBOX, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 2 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, CONTINUED

 

Use of Estimates

The preparation of condensed consolidated financial statements in conformity with accounting principles generally accepted in the United States of America (“U.S. GAAP”) requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent liabilities at the date of the condensed consolidated financial statements as well as the reported expenses during the reporting periods. The Company’s significant estimates and assumptions include the valuation of the Company’s common stock used in the valuation of goodwill, accounts receivable and note receivable collectability, inventory, advances on investments, the valuation of restricted stock and warrants received from customers, the amortization and recoverability of capitalized patent costs and useful lives of long-lived assets, the derivative liability, and income tax expense. Some of these judgments can be subjective and complex, and, consequently, actual results may differ from these estimates. Although the Company believes that its estimates and assumptions are reasonable, they are based upon information available at the time the estimates and assumptions were made. Actual results could differ from these estimates.

Basis of Presentation

The accompanying unaudited interim financial statements and related notes have been prepared in accordance with U.S. GAAP for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X of the Securities and Exchange Commission for Interim Reporting. Accordingly, they do not include all of the information and footnotes required by U.S. GAAP for complete financial statements. The unaudited interim financial statements furnished reflect all adjustments (consisting of normal recurring accruals) which are, in the opinion of management, considered necessary for a fair presentation of the results for the interim periods presented. The results for the three and nine months ended September 30, 2015 are not necessarily indicative of results to be expected for a full year, any other interim periods or any future year or period.

The accompanying unaudited interim financial statements and the information included under the heading “Management’s Discussion and Analysis or Plan of Operation” should be read in conjunction with our company’s audited financial statements and related notes included in our company’s Form 10-K for the fiscal year ended December 31, 2014, filed with the SEC on March 26, 2015.

The condensed consolidated balance sheet data as of December 31, 2014 was derived from audited consolidated financial statements.

The Company has performed a review of all subsequent events through the date the unaudited interim financial statements were issued, and has determined that no additional disclosures are necessary.

Concentrations of Credit Risk

The Company maintains cash balances at several financial institutions in California, Illinois, and Florida. Accounts at each institution are insured by the Federal Deposit Insurance Corporation up to $250,000. At September 30, 2015 and December 31, 2014, the Company’s uninsured balances totaled $22,504 and $0, respectively. The Company has not experienced any losses in such accounts and periodically evaluates the credit worthiness of the financial institutions and has determined the credit exposure to be negligible.

Advertising and Marketing Costs

Advertising and marketing costs are expensed as incurred. The Company incurred advertising and marketing costs of approximately $0 and $319,000 for the three months ended September 30, 2015 and 2014, respectively and approximately $0 and $749,000 for the nine months ended September 30, 2015 and 2014, respectively.

 

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MEDBOX, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 2 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, CONTINUED

 

Fair Value of Financial Instruments

Pursuant to ASC No. 825, Financial Instruments, the Company is required to estimate the fair value of all financial instruments included on its balance sheets. The carrying value of cash, accounts receivable, other receivables, inventory, accounts payable and accrued expenses and notes payable, related party notes payable, customer deposits, provision for customer refunds and short term loans payable approximate their fair value due to the short period to maturity of these instruments. The Company’s marketable securities and customer deposits require fair value measurement on a recurring basis as the Company has received warrants for service provided to unrelated third party. The securities received as a payment for services provided will be exposed to gains or losses following their initial evaluation as of the date the revenue was earned.

Warrants and other financial assets received as a payment for the services provided are recorded as “Marketable securities” under the current assets if they are expected to be realized within 12 months. The Company uses the Black-Scholes model to measure the value of the warrants. At each reporting date the Company will reevaluate the value of marketable securities and record any changes in value to other comprehensive income (loss) under “Unrealized gain or losses from marketable securities”.

Embedded derivative – The Company’s convertible notes payable include embedded features that require bifurcation and are accounted for as a separate embedded derivative (see Note 5). The Company has estimated the fair market value of the embedded derivative of the Notes based on a weighted probability model. The key valuation assumptions used consist of the price of the Company’s stock, a risk free interest rate based on the average yield of a one year Treasury note and expected volatility of the Company’s common stock all as of the measurement dates, and various estimated reset exercise prices allocated by probability. The Company considers these inputs Level 3 assumptions.

A three-tier fair value hierarchy is used to prioritize the inputs in measuring fair value as follows:

 

Level 1    Quoted prices in active markets for identical assets or liabilities.
Level 2    Quoted prices for similar assets or liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active, or other inputs that are observable, either directly or indirectly.
Level 3    Significant unobservable inputs that cannot be corroborated by market data.

The assets or liability’s fair value measurement within the fair value hierarchy is based upon the lowest level of any input that is significant to the fair value measurement. The following table provides a summary of the liabilities that are measured at fair value on a recurring basis.

 

     Total      Quoted Prices
in Active
Markets for
Identical
Assets or
Liabilities
(Level 1)
     Quoted Prices
for Similar
Assets or
Liabilities in
Active
Markets
(Level 2)
     Significant
Unobservable
Inputs
(Level 3)
 

September 30, 2015

        

Marketable securities

   $ 94,817       $ 21,650       $ —        $ 73,167   

Derivative liability

     4,885,286         —          —          4,885,286   

Total

   $ 4,980,103       $ 21,650       $ —        $ 4,958,453   

 

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MEDBOX, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 2 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, CONTINUED

 

The following table sets forth a summary of the changes in the fair value of the Company’s Level 3 financial liabilities that are measured at fair value on a recurring basis:

 

     For the nine months
ended
September 30, 2015
 
     Total  

Balance at January 1, 2015

   $ 3,691,853   

Additions

     5,531,201   

Reclassified to equity upon conversion

     (3,828,711 )

Change in fair value of conversion feature

     (509,057 )

Ending balance

   $ 4,885,286   

Revenue Recognition

We enter into transactions with clients who require our expertise and are interested in being granted the right to have us engage exclusively with them in certain territories (which we describe as territory rights) to obtain the necessary licenses to operate a dispensary or cultivation center for the location, and to consult in daily operations of the dispensary or cultivation center.

Terms for each deal are varied and the sales arrangements typically include the delivery of our dispensing technology and dispensary location build-out and/or consultation on the location, licensing, build out and operation of a cultivation center. Medbox machines retail for approximately $50,000 for each machine set (including the POS system), and normally our contracts include the sale of the dispensary units within the scope of options to be provided that might also include location build out costs. Currently, our standard contracts have a five year term, call for an upfront, non-refundable consulting fee, and contain options including acquiring a Medbox dispensary machine and having the Company perform the buildouts for the location, at set prices. The Company has determined these optional purchases each constitute a separate purchasing decision, and therefore are considered a separate arrangement for revenue recognition purposes. Revenue on each of these options are evaluated for recognition when and if the customer decides to enter into the arrangement.

Based on these contracts, and other auxiliary agreements, our current revenue model consists of the following income streams:

Consulting fee revenues and build-outs

Consulting fee revenues is a consistent component of our current and anticipated future revenues and is negotiated at the time we enter into a contract. Consulting revenue consists of providing ongoing consulting services over the life of the contract, to the established business in the areas of regulatory compliance, security, operations and other matters to operate the dispensary. The majority of the consulting fees arise from the upfront, non-refundable consulting fee in our standard contract, and is recognized using the straight line method over the life of the contract. Consulting fee revenue is only recognized when the following four criteria are met: 1) persuasive evidence of an arrangement exists, 2) delivery has occurred or services have been rendered, 3) sales price is fixed and determinable and 4) collectability is reasonably assured.

Revenue for the build-outs of the dispensary or cultivation center, if the customer chooses to have it performed by the Company, is recognized after issuance of a certificate of occupancy for the newly completed facility. This consists of a complete interior build-out of the retail store front including necessary construction (not to include installation of plumbing, electrical, HVAC systems and masonry), furniture fixtures and security system.

Due to the uncertainties inherent in the emerging industry, the Company deferred recognition of revenue for sale of completed dispensaries with licenses until the issuance of a certificate of occupancy by the municipality. The certificate of occupancy is the final approval to open a dispensary in the customer’s community, at which time all criteria for revenue recognition, including delivery and acceptance, has been met. Additionally, at the time of the issuance of the certificate of occupancy, under the contract terms, all payments owed by the customer have been received by the Company. Similarly, recognition of revenue for sale of completed cultivation center is deferred until all licensing and permitting is completed and approved.

Unbilled costs and associated fees related to the build-outs are recorded in inventory and are subject to valuation testing at each quarter end for net realizable value (lower of cost or market) and collectability.

 

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MEDBOX, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 2 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, CONTINUED

 

Other revenue includes sales of territory, location, and management rights

The Company at times enters into specific contracts to assign exclusive location and management rights, for a dispensary, that the Company has been granted through a license approved by local authorities. These rights are transferred under a management rights agreement to an operator for retail, dispensary, or cultivation centers. The Company also has one agreement with a related party in which they granted the related party the exclusive rights to a certain territory.

Other revenue is only recognized when the following four criteria are met: 1) persuasive evidence of an arrangement exists, 2) delivery has occurred or services have been rendered, 3) sales price is fixed and determinable and 4) collectability is reasonably assured. In the sale of the territory rights to the related party, the revenue is being recognized over the term of the agreement.

 

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MEDBOX, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 2 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, CONTINUED

 

Revenues on VII product sales. Our VII subsidiary sells table top vaporizer machines and accessories. Vaporizer sales are recognized as the product is shipped unless otherwise agreed with the customer.

Revenue from referral fees. The Company had an agreement, which expired in November 2014, for referral services to explore matching its clients with a real estate financing partner to facilitate property purchases and subsequent leasebacks to clients. Referral fee revenue was recognized over the life of the agreement.

Cost of Revenue

Cost of revenue consists primarily of expenses associated with the delivery and distribution of our products and services. These include expenses related to the manufacture of our dispensary units, construction expense related to the customer dispensary, site selection and establishment of licensing requirements, and consulting expense for the continued management of the dispensary unit build out, server and security equipment, rent expense, energy and bandwidth costs, and support and maintenance costs prior to when the client moves in. We only begin capitalizing costs when we have obtained a license and a site for operation of a customer dispensary or cultivation center. The previously capitalized costs are charged to cost of revenue in the same period that the associated revenue is earned. In the case where it is determined that previously inventoried costs are in excess of the projected net realizable value of the sale of the licenses then the excess cost above net realizable value is written off to cost of revenues. In addition, cost of revenue related to our vaporizer line of products consists of direct procurement cost of the products along with costs associated with order fulfilment, shipping, inventory storage and inventory management costs.

Inventory

Inventory is stated at the lower of cost or market value. Cost is determined on a cost basis that approximates the first-in, first-out (FIFO) method.

 

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MEDBOX, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 2 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, CONTINUED

 

Work in process and related capitalized costs includes costs to build out a dispensary in Portland Oregon that opened in the second quarter of 2015. Costs include tenant improvements to the facility, furniture, fixtures and Medbox dispensary units to be used by the licensed operator. The costs related to the Portland dispensary have been classified in deferred costs until the related revenue is recognized.

Basic and Fully Diluted Net Income/Loss Per Share

Basic net income/loss per share is computed by dividing net loss available to common stockholders by the weighted average number of shares of common stock outstanding during the period. Diluted net income per share includes the effects of any outstanding options, warrants and other potentially dilutive securities. The Company did not consider any potential common shares in the computation of diluted loss per share for the three and nine months ending September 30, 2015 and 2014, due to the net loss, as they would have an anti-dilutive effect on EPS.

As of September 30, 2014, the Company had 3,000,000 shares of Series A preferred stock outstanding with par value of $0.001 that could have been converted into 15,000,000 shares of the Company’s common stock. On August 24, 2015, 2 million shares of Series A preferred stock was cancelled, leaving 1 million shares outstanding at September 30, 2015 . Additionally the Company has approximately 14,084,000 warrants to purchase common stock outstanding as of September 30, 2015. The Company also has approximately $4,994,000 in convertible debentures outstanding at September 30, 2015, whose underlying shares were not included that are convertible at the holders’ option at a conversion price of the lower of $0.75 or 51% of the VWAP over the last 40 days prior to conversion (subject to reset upon a future dilutive financing).

Income Taxes

The Company accounts for income taxes under the asset and liability method in accordance with ASC No. 740. The Company recognizes deferred tax liabilities and assets for the expected future tax consequences of events that have been included in the financial statements or tax returns. Under this method, deferred tax liabilities and assets are determined based on the difference between the financial statement and tax bases of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse. The components of the deferred tax assets and liabilities are classified as current and non-current based on their characteristics. A valuation allowance is provided for certain deferred tax assets if it is more likely than not that the Company will not realize tax assets through future operations.

In addition, the Company’s management performs an evaluation of all uncertain income tax positions taken or expected to be taken in the course of preparing the Company’s income tax returns to determine whether the income tax positions meet a “more likely than not” standard of being sustained under examination by the applicable taxing authorizes. This evaluation is required to be performed for all open tax years, as defined by the various statutes of limitations, for federal and state purposes. An IRS audit is still open on the year ended December 31, 2011, in which the Company received a notice of deficiency for the amount of approximately $60,000. The Company is in discussions with the IRS to set up a payment plan for the amount owed.

Commitments and Contingencies

Certain conditions may exist as of the date the financial statements are issued, which may result in a loss to the Company but which will only be resolved when one or more future events occur or fail to occur. The Company’s management and its legal counsel assess such contingent liabilities, and such assessment inherently involves an exercise of judgment. In assessing loss contingencies related to legal proceedings that are pending against the Company or unasserted claims that may result in such proceedings, the Company’s legal counsel evaluates the perceived merits of any legal proceedings or unasserted claims as well as the perceived merits of the amount of relief sought or expected to be sought therein.

If the assessment of a contingency indicates that it is probable that a material loss has been incurred and the amount of the liability can be estimated, then the estimated liability would be accrued in the Company’s financial statements. If the assessment indicates that a potentially material loss contingency is not probable, but is reasonably possible, or is probable but cannot be estimated, then the nature of the contingent liability, together with an estimate of the range of possible loss if determinable and material, would be disclosed.

Loss contingencies considered remote are generally not disclosed unless they involve guarantees, in which case the nature of the guarantee would be disclosed.

 

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MEDBOX, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 2 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, CONTINUED

 

Going Concern

The accompanying unaudited interim financial statements have been prepared in conformity with generally accepted accounting principles, which contemplate continuation of the Company as a going concern. The Company has an accumulated deficit of approximately $47,199,000 as of September 30, 2015. During the nine months ended September 30, 2015, the Company had a net loss of approximately $25,120,000, negative cash flow from operations of approximately $6,124,000 and negative working capital of approximately $15,685,000. The Company will need to raise capital in order to fund its operations.

These factors, among others, raise substantial doubt about the Company’s ability to continue as a going concern. The ability to continue as a going concern is dependent on the Company’s ability to raise additional capital and implement a business plan. The financial statements do not include any adjustments that might be necessary if the Company is unable to continue as a going concern.

On August 14, 2015 and August 20, 2015, the Company entered into two Securities Purchase Agreements with two separate investors, in the aggregate principal amount of up to approximately $5,480,000 (collectively the “August 2015 Debentures”), of which approximately $2,729,000 was funded during the third quarter of 2015, with up to a remaining $2,751,000 still to be funded.

Management is actively seeking additional financing and expects to complete additional financing arrangements in the next few months. The Company expects that these plans will provide it the necessary liquidity to continue operations for the next 12 months.

To address its financing requirements, the Company will continue to execute on its business model by attempting to raise additional capital through the sales of debt or equity securities or other means. It is uncertain the Company can obtain financing to fund operating deficits until profitability is achieved. This need may be adversely impacted by: uncertain market conditions, approval of sites and licenses by regulatory bodies and adverse operating results. The outcome of these matters cannot be predicted at this time.

Recent Accounting Pronouncements

In August 2014, the FASB issued Accounting Standards Update No. 2014-15, Presentation of Financial Statements – Going Concern (Subtopic 205-40), Disclosure of Uncertainties about an Entities Ability to Continue as a Going Concern (ASU 2014-15). The guidance in ASU 2014-15 sets forth management’s responsibility to evaluate whether there is substantial doubt about an entity’s ability to continue as a going concern as well as required disclosures. ASU 2014-15 indicates that, when preparing financial statements for interim and annual financial statements, management should evaluate whether conditions or events, in the aggregate, raise substantial doubt about the entity’s ability to continue as a going concern for one year from the date the financial statements are issued or are available to be issued. This evaluation should include consideration of conditions and events that are either known or are reasonably knowable at the date the financial statements are issued or are available to be issued, as well as whether it is probable that management’s plans to address the substantial doubt will be implemented and, if so, whether it is probable that the plans will alleviate the substantial doubt. ASU 2014-15 is effective for annual periods ending after December 15, 2016, and interim periods and annual periods thereafter. Early application is permitted. The Company has elected to early adopt this guidance in the current interim period.

In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2014-09, “Revenue from Contracts with Customers,” which requires an entity to recognize the amount of revenue to which it expects to be entitled for the transfer of promised goods or services to customers. ASU 2014-09 will replace most existing revenue recognition guidance in U.S. GAAP when it becomes effective. The new standard is effective for annual reporting periods for public business entities beginning after December 15, 2017, including interim periods within that reporting period. The new standard permits the use of either the retrospective or cumulative effect transition method. The Company is currently evaluating the effect that ASU 2014-09 will have on its financial statements and related disclosures. The Company has not yet selected a transition method nor determined the effect of the standard on its ongoing financial reporting.

NOTE 3 – ASSET ACQUISITION

On July 24, 2015, the Company entered into an Agreement of Purchase and Sale of Membership Interest (the “Acquisition Agreement”) with East West Secured Development, LLC (the “Seller”) to purchase 100% of the membership interest of EWSD I, LLC (“EWSD”) which has entered into an agreement with Southwest Farms, Inc. (“Southwest”) to purchase certain real property comprised of 320-acres of agricultural land in Pueblo, Colorado (the “Acquired Property” or “the Farm”).

 

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MEDBOX, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 3 – ASSET ACQUISITION, CONTINUED

 

The purchase price to acquire EWSD consisted of (i) $500,000 paid by the Company as a deposit into the escrow for the Acquired Property, and (ii) the Company’s future payments to Seller of a royalty of 3% of the adjusted gross revenue, if any, from operation of the Acquired Property (including sale of any portion of or interest in the Acquired Property less any applicable expenses) for the three-year period beginning on January 1, 2016. Such royalty payments shall be payable 50% in cash and 50% in Company common stock (the “Royalty Payment”). The Company determined that the royalty payments could not be estimated at the time of acquisition, and therefore the contingent payments have not been recognized as part of the acquisition price. The contingent consideration will be remeasured to fair value each subsequent period until the contingency is resolved, in this case, for the three year period beginning on January 1, 2016, with any changes in fair value recognized in earnings. Per the terms of the agreement, the closing is deemed to have occurred when the Special Warranty Deed is recorded (which occurred on August 7, 2015), all terms of the purchase agreement for the Farm have been complied with, including the Farm closing, which also took place on August 7, 2015. Therefore the acquisition date has been determined to be August 7, 2015. There were no assets or liabilities of EWSD on the acquisition date.

In connection with EWSD’s purchase of the Acquired Property, EWSD entered into a secured promissory note (the “Note”) with Southwest in the principal amount of $3,670,000. Interest on the outstanding principal balance of the Note shall accrue at the rate of five percent per annum. The Note shall be payable by EWSD in thirty-five payments of principal and interest, which shall be calculated based upon an amortization period of thirty years, commencing on September 1, 2015 and continuing thereafter on the first day of each calendar month through and including July 1, 2018; and one final balloon payment of all unpaid principal and accrued but unpaid interest on August 1, 2018. The Note is secured by a deed of trust, security agreement, assignment of rents and financing statement encumbering the Acquired Property.

In connection with the closing (the “Closing”) on the Farm, EWSD also entered into an unsecured promissory note (the “Unsecured Note”) with the Seller, in respect of earnest money payments previously made by Seller to Southwest, in the principal amount of $830,000. Interest on the outstanding principal balance of the Unsecured Note shall accrue at the rate of six percent per annum. The Unsecured Note shall be payable by EWSD in thirty-five payments of principal and interest, which shall be calculated based upon a hypothetical amortization period of thirty years, commencing on September 1, 2015 and continuing thereafter on the first day of each calendar month through and including July 1, 2018; and one final balloon payment of all unpaid principal and accrued but unpaid interest on August 1, 2018. The balance owing on the two notes is $4,485,763 as of September 30, 2015.

Principal payments due on the notes are as follows:

 

     Secured
Promissory
Note
     Unsecured
Promissory
Note
     Total  

2015

   $ 8,851         301,658         310,509   

2016

     54,691         27,299         81,990   

2017

     58,007         30,635         88,642   

2018

     3,536,670         467,952         4,004,622   

Current maturities related to these notes as presented on the accompanying Balance Sheet, amount to $378,278.

The Closing occurred on August 7, 2015, as a result of which the Company, through its new, wholly-owned subsidiary, EWSD, became the owner of the Acquired Property.

The Company has determined that the Acquired Property is an acquisition of assets and does not constitute a business. Prior to its acquisition by the Company, the Acquired Property was leased to a farmer who cultivated corn on 150 of its 320 acres. The Company intends to engage an independent contractor to manage the operations and hire its own new staff to initially cultivate hemp on the Acquired Property. No employees of the former farm will work in the new operation. The new operation will have an entirely new customer base, sales force and marketing plan as well as new production techniques and a new trade name. Management has determined that the purchase of the Acquired Property and planned operations do not constitute continuation of the prior business and therefore it does not meet the criteria for a business acquisition. The Acquired Property was determined to have a fair value of $5,000,000, based on the $500,000 cash payment and the amounts due under the Secured and Unsecured notes for its purchase from third parties.

The purchase price is comprised of:

 

Cash deposit

   $ 500,000   

Note Payable to Southwest

     3,670,000   

Note Payable to EWSD (Seller)

     830,000   
  

 

 

 
   $ 5,000,000   
  

 

 

 

 

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MEDBOX, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 3 – ASSET ACQUISITION, CONTINUED

 

The assets acquired included various buildings that were on the land. The Company did not acquire the Farm to obtain or use these buildings, and are replacing two of the buildings with new buildings that will better suit the Company’s planned operations, and renovating the greenhouses to also better serve the Company’s planned operations. The buildings which remain are a mechanics shop and a processing building, which the Company will utilize as is. The fair value of these two buildings has been determined to be $55,000. Therefore the purchase price has been allocated $4,945,000 to Land and $55,000 to Buildings and structures (included in Property and equipment on the accompanying Balance Sheet).

 

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MEDBOX, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 4 – INVENTORIES

Inventories are stated at the lower of cost or market value. Cost is determined on a standard cost basis that approximates the first-in, first-out (FIFO) method.

The consolidated inventories at September 30, 2015 and December 31, 2014 consist of the following:

 

     September 30, 2015      December 31, 2014  

Work in process and related capitalized costs

   $ —        $ 308,867   

Deposits on dispensing machines

     —           325,973   

Vaporizers and accessories

     187,844         154,930   

Dispensing machines

     —           171,466   

Total inventory, net

   $ 187,844       $ 961,236   

On May 4, 2015, AVT, Inc., the manufacturing partner of the Company, announced that they had commenced a voluntary filing for restructuring and court protection under Chapter 11 of the United States Bankruptcy Code. Dispensing machines and Deposits on dispensing machines noted in schedule above are with AVT. Additionally, during the second quarter of 2015, the Company completed a strategic review of the Medbox machines and concluded that they would take a reduced role in future marketing efforts. As a result of the strategic review, the Company evaluated the inventory and the related deposits in connection with reduced demand and concluded a write down of both assets was required. The bankruptcy of the manufacturing partner further complicates the process to convert the inventory and advances to cash and therefore is an additional factor in the decision to write down the inventory and record a valuation reserve against the deposits. During the three months ended September 30, 2015, the Company ended negotiations with the supplier and bankruptcy counsel advised that collection of deposits and availability of inventory from the supplier was unlikely. Accordingly, the remaining deposit and inventory valued at $142,500 were written off.

Work in process and related capitalized costs includes costs to build out a dispensary in Portland, Oregon that opened in the second quarter of 2015 (Note 1). The costs related to the Portland dispensary have been classified in deferred costs until the related revenue is recognized.

 

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MEDBOX, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 5 – CONVERTIBLE NOTES PAYABLE AND DERIVATIVE LIABILITY

On July 21, 2014, as amended on September 19, 2014 and October 20, 2014, the Company entered into a Securities Purchase Agreement whereby the Company agreed to issue convertible debentures (“July 2014 Debentures”) in the aggregate principal amount of $3,500,000, in five tranches. The initial closing in the aggregate principal amount of $1,000,000 occurred on July 21, 2014. The second closing in the amount of $1,000,000 occurred on August 26, 2014; the third of $500,000 on September 26, 2014. The fourth and fifth, each in the amount of $500,000, were to occur within 2 and 5 business days, respectively, of the effective date of the registration statement filed by the Company for the resale of the shares of common stock issuable upon conversion of the July 2014 Debentures. The Registration statement was withdrawn and terminated in December 2014, and a new registration statement was filed on April 9, 2015. The July 2014 Debentures bear interest at the rate of 10% per year. The debt is due July 21, 2015, with the original agreement calling for amortization payments, including accrued principal and accrued interest, beginning on the eleventh day of the fourth month after issuance and will continue on the eleventh day of each following eight successive months thereafter.

Also on September 19, 2014, as amended on October 20, 2014, the Company entered into a securities purchase agreement pursuant to which it agreed to issue convertible debentures (“September 2014 Debentures”) in the aggregate principal amount of $2,500,000, in two tranches. The initial closing in the principal amount of $1,000,000 occurred on September 19, 2014. The second closing, of $1,500,000, is to occur within 2 days of the effective date of the registration statement filed by the Company for the resale of the shares of common stock issuable upon conversion of the September 2014 Debentures. The September 2014 Debentures bear interest at the rate of 5% per year. The debt is due September 19, 2015, and the original agreement called for amortization payments, including accrued principal and accrued interest, due in nine monthly installments, commencing the fourth month after issuance.

Both the original July 2014 Purchase Agreement Debentures and September 2014 Debentures prior to subsequent amendment, share the following significant terms:

All amounts are convertible at any time, in whole or in part, at the option of the holders into shares of the Company’s common stock at a conversion price. The Notes were initially convertible into shares of the Company’s common stock at the initial Fixed Conversion Price of $11.75 per share. The Fixed Conversion Price is subject to adjustment for stock splits, combinations or similar events. If the Company makes any subsequent equity sales (subject to certain exceptions), under which an effective price per share is lower than the Fixed Conversion Price, then the conversion price will be reduced to equal such price.

The Company may make the amortization payments on the debt in cash, prompting a 30% premium or, subject to certain conditions, in shares of common stock valued at 70% of the lowest volume weighted average price of the common stock for the 20 prior trading days.

In connection with each of the purchase agreements, the Company entered into a registration rights agreement with the respective investors, pursuant to which the Company agreed to file a registration statement for the resale of the shares of common stock issuable upon conversion of, or payable as principal and interest on, the respective debentures, within 45 days of the initial closing date under each agreement, and to have such registration statements declared effective within 120 days of the initial closing dates of each purchase agreement. Through subsequent modifications of the July 2014 Debentures and September 2014 Debentures, the required date to file the registration statement and the effective date of the registration statement have been changed to April 15, 2015 and July 15, 2015, respectively. The registration statement was filed on April 9, 2015, and became effective on June 11, 2015.

The conversion feature of the July 2014 Debenture and the September 2014 debenture meets the definition of a derivative and due to the reset provision to occur upon subsequent sales of securities at a price lower than the fixed conversion price, requires bifurcation and is accounted for as a derivative liability. The derivative was initially recognized at its estimated fair value of approximately $1,885,000 and created a discount on the Notes that will be amortized over the life of the Notes using the effective interest rate method. The fair value of the embedded derivative is measured and recognized at fair value each subsequent reporting period and the changes in fair value are recognized in the Statement of Operations as Change in fair value of derivative liability. For the nine months ended September 30, 2015 the Company recognized a gain on the change in fair value of derivative liabilities of approximately $509,000 (including the change in fair value related to the new convertible debentures issued in the first, second and third quarters of 2015 discussed below). See Note 2 Fair value measure for additional information on the fair value and gains or losses on the embedded derivative.

On January 30, 2015, the Company and the Investors entered into an Amendment, Modification and Supplement to the Purchase Agreement (the “Purchase Agreement Amendment” or the “Modification”) pursuant to which the Investors agreed to purchase an additional $1,800,000 in seven Modified Closings: (1) $200,000 was funded at the Closing of the Purchase Agreement Amendment; (2) $100,000 to be funded within thirty (30) days of the Closing; (3) $100,000 to be funded within two days following the filing of a registration statement with the SEC to register the shares underlying the Debentures (the “Registration Statement”) and of the Company having filed with the SEC a restatement of the Company’s consolidated financial statements as described in the Company’s Current Report on Form 8-K filed with the SEC on December 22, 2014; (4) $100,000 to be funded within two days of receipt of the first comment letter from the SEC with regard to the Registration Statement; (5) $500,000 to be funded within two days of the date that the

 

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MEDBOX, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 5 – CONVERTIBLE NOTES PAYABLE AND DERIVATIVE LIABILITY, CONTINUED

 

Registration Statement is declared effective by the SEC; (6) $500,000 to be funded within five days of the date that the Registration Statement is declared effective by the SEC; and (7) $100,000 to be funded within each of 90, 120, 150, and 180 days from the Closing of the Purchase Agreement Amendment. The Modification also eliminated the amortization payments discussed above, and provided for accrued and unpaid interest to be payable upon conversion or maturity rather than on specified payment dates. The Company is also required to open a new dispensary in Portland, Oregon during the first calendar quarter of 2015(which was later modified to April 30, 2015). The Company must also file the Registration Statement by March 8, 2015 (later amended), and it must be declared effective by June 15, 2015 in order to avoid default and acceleration under the Amended and Restated Debenture. As noted above, the Registration Statement was filed on April 9, 2015, and became effective June 11, 2015.

On March 13, 2015 the Company and the Investors entered into a further amendment (“March 2015 Amendment”) to the July 21, 2014, 10% Convertible debentures, as amended January 30, 2015, whereby the reset of the fixed conversion rate to $1.83 caused by recent dilutive issuances was reiterated for all previously issued notes. In addition, the March 2015 Amendment modified the opening date of the Portland, Oregon dispensary to be April 30, 2015. Neither of these modified terms had an impact on the accounting treatment of the Debentures.

The July 2014 financing was further modified on March 23, 2015. The closing dates of the financing were again modified, investments by two members of the Board of Director’s (“Board”) was required, and the deadline for filing of the registration statement was changed to no later than April 15, 2015, and its effective date to no later than July 15, 2015. Neither of these modified terms had an impact on the accounting treatment of the Debentures.

On April 9, 2015, the Company and their investors entered into an Amendment, Modification and Supplement to the July 2014 convertible debenture, which amends the closings as set forth in the March 23, 2015 Modification, to increase the amounts due in the third tranche, due two days after the filing of the Registration Statement, to $450,000.

On January 28, 2015, the Company and the Investors entered into an Amendment, Modification and Supplement to the September 2014 Debenture, pursuant to which the remaining $1,500,000 will be funded in four Modified Closings as set forth in the agreement, and contains other modifications with the same terms as was contained in the January 30, 2015 Modification.

The Company considered if the above modifications should be accounted for as an extinguishment or modification of the existing debt. The Company first evaluated if the modification of terms could be considered a troubled debt restructuring, but the modification did not meet the criteria as the Investors did not grant a concession to the Company for economic or legal reasons related to any financial difficulties of the Company. The majority of the modifications related to deadlines being extended for certain required events. The only financial modification was to revise the payment schedule on the Debentures to eliminate the amortization payments and instead require all to be due at maturity. The Company concluded this is not regarded as a concession as it is not the forgiveness of any interest payments, nor reduction of principal, nor change to the maturity date. Therefore, the modification of the terms was evaluated to determine if the changes in the Debentures’ future cash flows were in excess of 10% and considered substantial, which would require the Debentures to be accounted for as extinguished and replaced with new debt. As the modification resulted in a less than 10% estimated change in future cash flows, the Company concluded that the modification of the terms of the July 2014 and September 2014 Debentures was to be accounted for as a modification of the existing Debentures.

As part of the January 30, 2015 Modification, the Parties entered into a Modified Debenture Agreement for the $200,000 that was funded at the Closing and agreed to use the same form of Modified Debenture for each of the other foregoing Modified Closings (collectively, the “Modified Debentures”). The fixed conversion price of the Modified Debenture was the lower of $5.00 or 51% of the lowest volume weighted average price for the 20 consecutive trading days prior to the applicable conversion date. This new fixed conversion price was a dilutive issuance to the outstanding July 2014 and September 2014 Debentures, thereby triggering a reset of the older fixed conversion price. As a result of the reset to the conversion price, at January 30, 2015, the derivative liability was remeasured to a fair value of approximately $2,690,000, using a weighted probability model as estimated by management. A decrease in fair value of the derivative liability of approximately $1,072,000 was recognized as a gain on the Statement of Consolidated Comprehensive Loss in the nine months ended September 30, 2015.

The additional Modified Debentures under the July 2014 Debentures closed on February 27, 2015 in the amount of $100,000, March 13, 2015 in the amount of $50,000, March 16, 2015 in the amount of $25,000, March 20, 2015 in the amount of $75,000 and on March 26, 2015 in the amount of $150,000. All these Modified Debentures have a fixed conversion price of the lower of $1.83 or 51% of the VWAP for the last 20 days prior to the conversion. This new fixed conversion price was a dilutive issuance to the outstanding July 2014 and September 2014 Debentures, thereby triggering a reset of the previous $5 fixed conversion price. This reset resulted in the derivative liability being revalued at February 27, 2015, using a weighted probability model for a fair value of $2,720,000, for a decrease in fair value of approximately $334,000, recognized as a gain on the Statement of Consolidated Comprehensive Loss.

 

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MEDBOX, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 5 – CONVERTIBLE NOTES PAYABLE AND DERIVATIVE LIABILITY, CONTINUED

 

The additional Modified Debentures under the September 2014 Debentures closed on January 29, 2015 in the amount of $100,000 and February 24, 2015 in the amount of $100,000. These Modified Debentures have a fixed conversion price of the lower of $5.00 or 51% of the VWAP for the last 20 days prior to the conversion. This new fixed conversion price was a dilutive issuance to the outstanding July 2014 and September 2014 Debentures, thereby triggering a reset of the previous $5.00 fixed conversion price. The resulting reset and remeasurement of the fair value of the derivative liability is included in the amounts of the change to fair value discussed above.

The additional fundings of the July 2014 Modified Debentures under the closing schedule detailed above resulted in $2,811,500 being received during the second quarter. The first $300,000 had a fixed conversion price of the lower of $1.83 or 51% of the VWAP for the last 40 days prior to the conversion. The April 17, 2015 closing contained a fixed conversion price of the lower of $0.88 or 51% of the VWAP for the last 40 days prior to the conversion. This new fixed conversion price was a dilutive issuance to the outstanding July 2014 and September 2014 Debentures, thereby triggering a reset of the previous $1.83 fixed conversion price. This reset resulted in the derivative liability being revalued at April 17, 2015, using a weighted probability model for a fair value of $3,287,000, for a increase in fair value of approximately $1,764,000, recognized as a loss on the Statement of Consolidated Comprehensive Loss during the second quarter of 2015.

There was additional funding of $1,300,000 of the September 2014 Modified Debentures under the closing schedule detailed above. These Modified Debentures all have a fixed conversion price of the lower of $0.88 or 51% of the VWAP for the last 40 days prior to the conversion.

The Directors’ convertible debentures required under the March 23, 2015 Modification, issued in the first quarter of 2015, total $150,000, and have a three year term and an interest rate of 8% per annum. They were originally convertible at a fixed conversion price of the lower of $1.83 or 51% of the VWAP for the last 20 days prior to conversion. As with the Modified Debentures, the debentures included a reset provision, which resulted in the conversion feature being bifurcated and accounted for as a derivative liability, with an initial fair value of $132,175. The director’s convertible debentures also reset on February 27, 2015 and April 17, 2015, with the changes to fair value included in the amounts disclosed above.

The Modified Debentures also included a warrant instrument granting the Investor the right to purchase shares of common stock of the Company equal to the principal amount of the applicable Modified Debenture divided by a price equal to 120% of the last reported closing price of the Common stock on the applicable closing date of the Modified Debenture, with a three year term.

The warrants issued in the nine months ended September 30, 2015 in connection with all the Modified Debentures detailed above, and the August 2015 Securities Purchase Agreement (“August 2015 Debentures”) discussed below, are summarized below:

 

Date issued

   Number of
warrants
     Exercise
price
     Fair Value  

July 2014 Modified Debentures

        

January 30, 2015

     40,552       $ 4.93       $ 159,601   

February 26, 2015

     45,537         2.20         79,904   

March 13, 2015

     21,151         2.36         39,965   

March 16, 2015

     10,575         2.36         19,981   

March 20, 2015

     41,946         1.79         59,942   

March 27, 2015

     75,758         1.98         119,888   

April 2, 2015

     60,386         1.66         74,025   

April 2, 2015

     30,193         1.66         37,012   

April 10,2015

     107,914         1.39         112,460   

April 17,2015

     41,667         1.20         37,680   

April 24,2015

     127,119         1.18         112,635   

April 24, 2015

     21,186         1.18         18,772   

May 1, 2015

     156,250         .96         113,133   

May 7, 2015

     134,615         .78         79,234   

May 8, 2015

     42,000         .75         23,768   

 

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MEDBOX, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 5 – CONVERTIBLE NOTES PAYABLE AND DERIVATIVE LIABILITY, CONTINUED

 

Date issued

   Number of
warrants
     Exercise
price
     Fair Value  

May 15, 2015

     200,000         .75         113,365   

May 22, 2015

     250,000         .60         113,366   

May 29, 2015

     258,621         .58         112,537   

June 5, 2015

     288,462         .52         120,738   

June 12, 2015

     930,233         .43         303,246   

June 19, 2015

     3,448,276         .29         751,159   

September 2014 Modified Debentures

        

January 28, 2015

     18,038         5.54         80,156   

February 13, 2015

     57,870         1.73         96,689   

April 2, 2015

     181,159         1.66         222,109   

April 24, 2015

     90,579         1.10         80,548   

May 15, 2015

     200,000         .75         113,365   

June 12, 2015

     1,744,186         .43         570,248   

August 2015 Debentures

        

August 24, 2015

     6,666,667         .06         321,757   

September 18, 2015

     588,235         .17         82,804   

Directors

        

January 5, 2015

     129,305         .40         39,901   

January 30, 2015

     129,250         .40         39,916   

February 2, 2015

     237,778         .22         16,619   
  

 

 

       

 

 

 

Total

   $ 16,375,508          $ 4,266,522   
  

 

 

       

 

 

 

The Company determined that the warrants were properly classified in equity as there is no cash settlement provision and the warrants have a fixed exercise price and therefore result in an obligation to deliver a known number of shares.

Effective September 18, 2015, the holder of the September 2014 Debentures and the Company agreed to amend its September 2014 Warrants, to reduce the exercise price of the warrants to purchase an aggregate of 2,291,832 shares of the Company’s common stock to six cents per share. The holder agreed to exercise in full those warrants in cash within three trading days of the filing with the SEC of a Form 8-K, which occurred on September 18, 2015. During the three months ended September 30, 2015, approximately 2,292,000 warrants were exercised.

Effective September 18, 2015, the holder of the July 2014 Debentures and the Company agreed to amend its July 2014 Warrants, to reduce the exercise price of the warrants to purchase an aggregate of 6,332,441 shares of Common Stock to six cents per share. The holder agreed to exercise in full those warrants in cash within three trading days of the filing with the SEC of a Form 8-K, which occurred on September 18, 2015. As of September 30, 2015 the warrants have not yet been exercised, and will be upon the finalization of the increase in authorized shares (Note 8).

As a result of the conversion feature being bifurcated and recognized as a derivative liability, the Company evaluated the warrants and determined that they have a sufficient number of authorized and unissued shares as of September 30, 2015, after consideration of the subsequent increased authorized shares, (See Note 10), to settle all existing commitments.

The Company adopted a sequencing policy that reclassifies contracts, with the exception of stock options, from equity to assets or liabilities for those with the earliest inception date first. Future issuance of securities will be evaluated as to reclassification as a liability under our sequencing policy of earliest inception date first until either all of the convertible debentures are converted or settled.

During the nine months ended September 30, 2015, $4,420,000 principal of the July 2014 Debentures and $1,710,000 principal and approximately $49,000 accrued interest of the September 2014 Debentures, and $150,000 principal of the Directors debentures, in addition to approximately $49,000 accrued interest were converted into approximately 67,475,000 of the Company’s common shares at an average price of $0.09, based on 51% of the calculated VWAP. Upon conversion, the derivative fair value for the amounts converted were remeasured through the date of conversion, with the conversion date fair value reclassified to equity, amounting to $4,519,000 in the nine months ended September 30,2015. As a result of the conversions, the resulting decrease of fair value of approximately $1,730,000 of the related debt discount was recognized on the Statement of Consolidated Comprehensive Loss.

 

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MEDBOX, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 5 – CONVERTIBLE NOTES PAYABLE AND DERIVATIVE LIABILITY, CONTINUED

 

August 2015 Debentures

On August 14, 2015, the Company entered into a Securities Purchase Agreement whereby the Company agreed to issue convertible debentures in the aggregate principal amount of up $3,979,877. The initial closing in the aggregate principal amount of $650,000 occurred on August 14, 2015. An additional 5 payments were made in the total amount of $1,078,880 through September 30, 2015. The seventh tranche in the amount of $250,000 will occur 8 days after the filing of a registration statement filed by the Company for the resale of the shares of common stock issuable upon conversion of the August 2015 Debentures, the eighth tranche in the amount of $1,250,000 will occur within 3 business days of the effective date of the registration statement and the ninth tranche, in the amount of $750,000 will occur within 7 business days of the effective date of the registration statement. The August 2015 Debentures bear interest at the rate of 10% per year.

On August 20, 2015, the Company also entered into a Securities Purchase Agreement with another investor, in the aggregate principal amount of up to $1,500,000 (collectively the “August 2015 Debentures”), which was amended on September 19, 2015, to increase the principal by an additional $200,000. Through September 30, 2015, two tranches totaling $500,000 have been funded. A third tranche in the amount of $500,000 (after amendment) is to occur within two days after the filing of a registration statement, with the fourth tranche in the amount of $700,000 to occur within 2 days of the effective date of the registration statement.

The August 2015 Debentures contain the following significant terms:

The debentures all mature in one year from the date of each individual closing.

All amounts are convertible at any time, in whole or in part, at the option of the holders into shares of the Company’s common stock at a fixed conversion price. The conversion price is the lower of (a) $0.75, or (b) a 49% discount to the lowest daily VWAP (as reported by Bloomberg) of the Common Stock during the 30 trading days prior to the conversion date. The Fixed Conversion Price is subject to adjustment for stock splits, combinations or similar events. If the Company makes any subsequent equity sales (subject to certain exceptions), under which an effective price per share is lower than the Fixed Conversion Price, then the conversion price will be reset to equal such price. The Company may prepay the Debentures in cash, prompting a 30% premium or, subject to certain conditions, in shares of common stock valued at 51% of the lowest volume weighted average price of the common stock for the 30 prior trading days. The premium will be recognized at such time as the Company may choose to prepay the Debentures.

In connection with each of the purchase agreements, the Company entered into a registration rights agreement with the respective investors, pursuant to which the Company agreed to file a registration statement for the resale of the shares of common stock issuable upon conversion of, or payable as principal and interest on, the respective debentures, within 45 days of the initial closing date under each agreement, and to have such registration statements declared effective within 120 days of the initial closing dates of each purchase agreement. The pre-effective registration statement was filed with the SEC on October 16, 2015.

The conversion feature of the August 2015 Debenture meets the definition of a derivative and due to the reset provision to occur upon subsequent sales of securities at a price lower than the fixed conversion price, requires bifurcation and is accounted for as a derivative liability. The derivative was initially recognized at its estimated fair value of approximately $2,345,000 and created a discount on the Notes that will be amortized over the life of the Notes using the effective interest rate method. The fair value of the embedded derivative is measured and recognized at fair value each subsequent reporting period and the changes in fair value are recognized in the Statement of Operations as Change in fair value of derivative liability (discussed above). See Note 2 Fair value measure for additional information on the fair value and gains or losses on the embedded derivative.

The debenture entered into with the second investor on August 20, 2015 included a warrant instrument granting the Investor the right to purchase shares of common stock of the Company equal to the principal amount of the applicable Debenture divided by a price equal to 120% of the last reported closing price of the Common stock on the applicable closing date of the Debenture, with a three year term. During the three months ending September 30, 2015, there were 7,254,902 warrants issued, with a fair value of $404,561, calculated with the Black Sholes Merton model. There were no conversions of the August 2015 Debentures during the three months ended September 30, 2015.

 

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MEDBOX, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 5 – CONVERTIBLE NOTES PAYABLE AND DERIVATIVE LIABILITY, CONTINUED

 

Entry into Security Agreement

In connection with entry into the August 20 Purchase Agreement and August 14 Purchase Agreement, the investors party to such agreements and the Company entered into a Security Agreement, dated August 21, 2015, securing the amounts underlying the August 14 Debentures and the August 20 Debentures. The Security Agreement grants a security interest in all assets and personal property of the Company, subject to certain excluded real property assets. The security interests under the Security Agreement shall terminate following the date the registration statement is declared effective.

July 2015 Debenture

On July 10, 2015, another accredited investor (the “July 2015 Investor”) purchased a separate Convertible Debenture (the “July 2015 Debenture”) in the aggregate principal amount of $500,000, that closed in five weekly tranches between July 10 and August 15, 2015. The July 2015 Debenture is in substantially the same form as the August 14 Debentures, and does not include issuance of warrants . As such, the conversion feature was also determined to require bifurcation, and derivative accounting. All amounts related to the July 2015 derivative liability are included in amounts disclosed above for the August 2015 debentures.

On October 14, 2015, the August 14 Investor assigned the right to purchase August 14 Debentures in the principal amount of $100,000 to the July 2015 Investor and the July 2015 Investor purchased such August 15 Debentures on the same day.

 

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MEDBOX, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 6 – SHARE BASED AWARDS, RESTRICTED STOCK AND RESTRICTED STOCK UNITS (“RSUs”)

On July 23, 2014, in connection with the election of a new Chairman, President and CEO, the Company entered into a two year employment contract with the new CEO. Under the employment contract, the CEO received an award of RSU’s, to be issued within 90 days of the effective date of the Employment Agreement, under the Equity Incentive Plan adopted by the Company, in the amount of the greater (by value) of 50,000 shares of common stock or $500,000 of common stock based on the volume weighted average price for the 30 day period prior to the date of the grant. The Company also agreed to make an equal stock award to the CEO on each anniversary date of the employment agreement. The fair value of the awards, as determined on grant date, was $711,500 which wss being amortized over the CEO’s one year service period. On June 30, 2015, Guy Marsala, President, Chief Executive Officer, and director of the Company, tendered his resignation as President and Chief Executive Officer of the Company and as a director on the Company’s board, effective immediately (Note 9). The remaining value of Mr. Marsala’s grants was recorded as expense in the second quarter of 2015. In connection with Mr. Marsala’s separation agreement approximately 2,580,000 options with a 10 year term were granted at an exercise price of $0.13. The fair value of $335,117 was calculated using the Black Sholes Merton model, and was immediately expensed.

On August 21, 2014, the Compensation Committee of the Board granted Restricted Stock and RSU’s to two Board members who were elected to the Board on April 9, 2014. Under the award, the Directors received 346,875 shares of restricted stock and 121,875 RSU’s under which the holders have the right to receive 121,875 shares of common stock. The grant date fair value of the restricted stock was $3,607,500 and the grant date fair value of the RSU’s was $1,267,500. The restricted Stock and RSU’s vested over the remaining first year of the new Board members’ term ending on March 31, 2015. The fair value of the grant was amortized over the period from the date of grant, August 21, 2014 to the end of the first year of the Board members’ term, March 31, 2015. Under the Board members’ contracts, additional grants will be made for the second year of the contract.

During October 2014, the Compensation Committee of the Board granted 19,452 RSU’s to a new Board member who was elected to the Board on October 22, 2014. The Board member’s contract calls for grants of 100,000 RSU’s for each succeeding year of service beginning on April 1, 2015, which vest quarterly. On September 24, 2015, the same Board member resigned from her positions as a member of the board of directors of the Company, chairperson of the Company’s audit committee and a member of its special committee, effective immediately. Stock compensation expense for this director in the second and third quarter was $353,000 and $197,000, respectively, which completes recognition of stock compensation expense for her service. The remaining 50,000 unvested RSU’s were forfeited upon her resignation.

On February 10, 2015, the Compensation Committee of the Board granted 100,174 RSU’s to certain officers and employees of the Company as for retention and bonuses. The grant date fair value of the RSU’s was approximately $114,000. The RSU’s vest every six months through December 31, 2016. The fair value of the grant is being amortized over the period from the date of grant, February 10, 2015 through the vesting dates in six month increments.

On January 15, 2015, the Board granted 75,000 RSUs to a consultant, which vest in 25,000 installments quarterly through July 15, 2015, beginning with 25,000 which vested immediately on the grant date. The grant date fair value of the RSU’s was approximately $450,000.

On May 11, 2015, the Board granted 38,600 RSUs to various officers and employees, which vested immediately on the grant date. The grant date fair value of the RSU’s was approximately $20,000, which was immediately expensed.

On May 11, 2015, the new CEO (Note 9) was awarded 196,078 RSUs in connection with his retention agreement. The grant date fair value of the RSU’s was approximately $100,000. The RSUs vest quarterly through May 11, 2016.

On August 26, 2015, the Board granted 79,917 RSUs to various officers and employees, which vested immediately on the grant date. The grant date fair value of the RSU’s was approximately $12,000, which was immediately expensed.

On August 31, 2015, the Board granted 156,250 RSUs to the CFO of the Company, which vested immediately on the grant date. The grant date fair value of the RSU’s was approximately $25,000, which was immediately expensed.

 

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MEDBOX, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 6 – SHARE BASED AWARDS, RESTRICTED STOCK AND RESTRICTED STOCK UNITS (“RSUs”), CONTINUED

 

A summary of the activity related to restricted stock and RSUs for the nine months ended September 30, 2015 is presented below:

 

Restricted stock

   Total shares      Grant date fair
value
 

Restricted stock non-vested at January 1, 2015

     168,750       $ 10.40   

Restricted stock granted

     150,000        —    

Restricted stock vested

     (206,250      10.40   

Restricted stock forfeited

     —          —    
  

 

 

    

 

 

 

Restricted stock non-vested at September 30, 2015

     112,500      $ 10.40  
  

 

 

    

 

 

 

Restricted stock units (RSU’s)

   Total shares      Grant date fair
value
 

RSU’s non-vested at January 1, 2015

     199,584       $ 10.70   

RSU’s granted

     698,522       $ 0.51 - $6.07   

RSU’s vested

     (590,502 )    $ 0.51 - $6.07   

RSU’s forfeited

     (50,000 )   
  

 

 

    

 

 

 

RSU’s non-vested September 30, 2015

     257,604       $ 0.51 - $10.70   
  

 

 

    

 

 

 

 

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MEDBOX, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 6 – SHARE BASED AWARDS, RESTRICTED STOCK AND RESTRICTED STOCK UNITS (“RSUs”), CONTINUED

 

A summary of the expense related to restricted stock, RSUs and stock option awards for the three and nine months ended September 30, 2015 is presented below:

 

Summary of the expense related to Restricted

Stock and RSUs

   For the three
months ended
September 30,
2015
     For the nine
months ended
September 30,
2015
 

Restricted Stock

   $ 390,000       $ 2,420,782   

RSU’s

     574,840         2,501,150   

Stock options

     —           335,117   

Common stock

     74,333         74,333   
  

 

 

    

 

 

 

Total

   $ 1,039,173       $ 5,331,382   
  

 

 

    

 

 

 

On August 11, 2015, the Compensation Committee, with the Board’s approval, granted the Chairman of the Board a bonus of $371,666. The bonus is to be paid 20% in common stock of Medbox at $.0621 per share (the share price of the Company’s common stock on the date of grant) for a total grant of 1,196,988 shares, issued under the Medbox, Inc. 2014 Equity Incentive Plan. The remainder is to be paid in cash, including $50,000 which was paid in June and July, with the balance in monthly payments of $30,918 from August 2015 to March 2016.

NOTE 7 – RELATED PARTY TRANSACTIONS

During the year ended December 31, 2014, the Company issued four notes payable to PVM International Inc. (“PVMI”), a related party which is 100% owned by a co-founder of the Company, in the amounts of $250,000, $100,000, $500,000, and $375,000. These notes were subsequently partially repaid leaving $284,488 outstanding as of June 30, 2014. On October 17, 2014 the Company entered into an assignment agreement with PVMI through which PVMI assigned all rights and titles for any opened escrow on real estate purchase agreements in San Diego in exchange for a related party notes payable from the Company. As of the signing date the agreement was valued at $190,400 which represented the value of escrow deposits paid by PVMI for eight different real estate agreements. All of the notes and amounts owed under the assignment agreement were repaid in full during the third quarter of 2015.

On March 28, 2014, the Company entered into an agreement with a related party for territory rights in Colorado for $500,000. The agreement has a term of five years and in accordance with the Company’s revenue recognition policy, the revenue will be recognized over the five year term. Approximately $350,000 remains in deferred revenue as of September 30, 2015.

During the third quarter of 2014, the Company created the following affiliated entities in connection with license applications: A. Hanna Growers, Inc., Herbal Choice of Illinois, Inc., Nature’s Treatment of Illinois, Inc., Green Blossom of Illinois, Inc., Midwestern Compassionate Care of Illinois, Inc., Midwestern Wellness Group of Illinois, Inc., Green Blossom, Inc., Nature’s Treatment, Inc. and Herbal Choice, Inc.

 

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MEDBOX, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 8 – STOCKHOLDER’S EQUITY

Common Stock

Authorized share increase

On June 30, 2015, the Board of Directors of the Company and the holders of a majority of the Company’s voting securities approved by written consent an amendment to the Company’s Articles of Incorporation to increase the authorized number of shares of the Company’s common stock from 100,000,000 shares to 400,000,000 shares, par value of $0.001 per share. The Company’s Board of Directors approved the increase of authorized capital so that it will have sufficient shares of common stock available for issuance upon the conversion or exercise of currently outstanding convertible debt securities and warrants and for future capital raises. The Company filed a Schedule 14C Information Statement regarding the matter submitted to a vote of their security holders with the Securities and Exchange Commission. The increase of authorized capital approved by the stockholders became effective on October 27, 2015.

Change of Control

Effective August 24, 2015, Vincent Chase, Incorporated, which is owned by the former CEO of the Company, cancelled without consideration all of its 2 million shares of Preferred Stock and 3 million shares of Common Stock. As a result of this action, neither VM nor any of its affiliates holds a majority of the voting power of the Company, which to the Company’s knowledge is no longer held by a single person or entity or group thereof.

For common shares which were issued upon conversion of the convertible debentures during the nine months ended September 30, 2015 see Note 5.

During the nine months ended September 30, 2015 the Company issued 1,633,047 shares of its common stock, valued at approximately $365,000 as based on the market price of the common stock on the date of settlement, as a payment of certain accounts payables.

In addition, in January, 2015, the Company issued 206,480 of their common stock upon exercise of the warrants held by various previous owners of VII.

NOTE 9 – COMMITMENTS AND CONTINGENCIES

The Company leases property for its day to day operations and facilities for possible retail dispensary locations and cultivation locations as part of the process of applying for retail dispensary and cultivation licenses.

Office Leases

On August 1, 2011, the Company entered into a lease agreement for office space located in West Hollywood, California through June 30, 2017 at a monthly rate of $14,397. Starting July 1, 2014, the monthly rent increased by 3% to $14,828 per month. The Company moved to new offices in Los Angeles, CA in April 2015. The sublease on the new office has a term of 18 months and with monthly rent of $7,486. The Company plans to sublease the office in West Hollywood, CA.

Total rent expense under operating leases for the three months ended September 30, 2015 and 2014 was approximately $90,000 and $53,000, respectively. Rent expense for the nine months ended September 30, 2015 and 2014 was approximately $211,000 and $157,000, respectively.

Retail/Cultivation facility leases

The Company’s business model of acquiring retail dispensary and cultivation licenses often requires us to acquire real estate either through lease arrangements or through purchase agreements in order to secure a possible license. On May 8, 2014, the Company entered into a lease agreement for the Portland dispensary for five years with a monthly payment of $7,400 in order to apply for a license and build-out of a location for a client.

On July 22, 2014 one of the Company’s subsidiaries Medbox Property Investments, Inc., entered into a new lease for a facility which was to be used in the application process for both a dispensary and cultivation facility. The Company paid an initial security deposit of $30,000 and the lease was payable monthly at a rate of $20,000 per month. The lease had a five year term, but was contingent upon

 

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license approval which allowed for early termination of the lease after January 1, 2015 if the license was not granted. Due to the fact that the Company was unsuccessful in obtaining the license related to the mentioned facility the lease agreement was terminated in November 2014 and the Company forfeited the security deposit.

The following table is a summary of our material contractual lease commitments as of September 30, 2015:

 

Year Ending

   Office Rent      Retail/Cultivation
Facility Lease
 

2015

   $ 66,942       $ 22,200   

2016

     245,310         88,800   

2017

     88,968         88,800   

2018

     —          88,800   

2019

     —          29,600   

Total

   $ 401,220       $ 318,200   

 

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Real Estate Commitments

Through December 31, 2014 the Company paid $930,000 either by deposit into twelve escrow accounts or direct payments to sellers, to secure the purchase and/or extend the closing dates on real estate to be used for future retail/cultivation facilities with an aggregate purchase price of $26,830,000. The real estate purchase agreements had closing dates varying between December 1, 2014 and February 10, 2015.

During 2014, the Company entered into numerous real estate contracts to secure locations during the licensing process. The contracts allow the Company to demonstrate to licensing authorities that the locations are available for use as a dispensary or cultivation location. The contracts are generally structured with an escrow deposit, a deferred closing until a license is granted and periodic withdrawals from the deposit to compensate the seller for holding the property off the market in escrow during the pendency of the license application. The periodic transfers out of escrow to the seller are in some cases creditable towards the purchase price but in most cases represent charges in lieu of rent. The charges in lieu of rent and other non-refundable charges paid to property sellers have been recorded as expense of $195,712 for the nine months ended September 30, 2014 in the statement of operations. During the third quarter of 2014, one of the Company’s subsidiaries, MJ Property Investments, Inc., allowed the escrows to expire on two real estate purchase agreements with an aggregate purchase price of $2,500,000. As a result the Company forfeited $100,000 in earnest money due to unfavorable terms demanded by the sellers to extend the escrow and closing date.

During the second quarter of 2014 one of the Company’s subsidiaries entered into a real estate purchase agreement in Washington state. The purchase transaction was closed during the third quarter of 2014 for a total purchase price of $399,594 partially financed by a promissory note for $249,000. The note was due January 30, 2015 and bore interest at twelve percent (12%). The Company did not repay the note on its maturity date, and is therefore is incurring the default interest rate of eighteen percent (18%). The property was classified as Assets held for resale as of December 31, 2014 because the Company’s plan was to sell the property to a third party to hold as a lessor to the operator of the dispensary. (See Note 10, Subsequent Events) On September 30, 2015, the Company, through its subsidiary, entered into an amendment to the Note Payable, whereby the maturity date was extended to April 1, 2017, with the interest at twelve percent (12%).

During the nine months ended September 30, 2015 the Company recovered approximately $105,000 and forfeited approximately $280,000 out of escrow deposits outstanding as of December 31, 2014. As of September 30, 2015 the Company has only one open real estate agreement for a property in San Diego with a purchase price of $875,000 and related outstanding deposit of $15,000

Officers

On June 30, 2015, Guy Marsala, President, Chief Executive Officer, and director of the Company since July 23, 2014, tendered his resignation as President and Chief Executive Officer of the Company and as a director on the Company’s board, effective immediately. Mr. Marsala confirmed that such resignation is not because of a disagreement with the Company on any matter relating to its operations, policies or practices.

In connection with his resignation, the Company and Mr. Marsala entered into a Separation Agreement dated June 30, 2015. Pursuant to the terms of the Separation Agreement, Mr. Marsala is entitled to receive $500,000 in severance pay, payable in equal monthly installments of $30,000, and a grant of options to purchase up to $335,275 of shares of common stock at an exercise price based on the closing price of the Company’s common stock on June 30, 2015, in lieu of any rights under his employment agreement, which was terminated.

 

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NOTE 9 – COMMITMENTS AND CONTINGENCIES, CONTINUED

 

Chief Operating Officer/Chief Executive Officer

On April 22, 2015, the Board of Company appointed Jeffrey Goh as Chief Operating Officer, effective immediately. In connection with his appointment as Chief Operating Officer, Mr. Goh and the Company have agreed that Mr. Goh’s annual base salary will be $300,000, subject to annual increases of between 5% and 7% based upon performance goals and the Company’s financial results. Mr. Goh will be eligible to receive a cash bonus of up to a maximum of $150,000 per year (“Cash Bonus”), plus a bonus grant of restricted stock units convertible into Company common stock up to a maximum of $150,000 per year (“Equity Bonus”). Each of the Cash Bonus and Equity Bonus shall be determined based upon the achievement of performance goals to be mutually agreed upon amongst Mr. Goh and the Board of Directors for the given year. Mr. Goh shall also be entitled to receive an award of 100,000 restricted stock units convertible into Company common stock on each anniversary of the original date of his employment with the Company. In the event that Mr. Goh terminates his employment with or without cause or the Company terminates Mr. Goh’s employment without cause, Mr. Goh shall be entitled to receive a severance payment equivalent to 6, 12, or 18 months of base salary, based upon whether the length of Mr. Goh’s employment with the Company at the time of termination is less than 12 months, greater than 12 months but less than 24 months, or greater than 24 months, respectively.

Effective June 30, 2015, Jeffrey Goh, was promoted to President and interim Chief Executive Officer of the Company.

Voting Agreement

On August 21, 2015, Medbox, P. Vincent Mehdizadeh (“VM”), PVM International, Inc., (“PVM”), and Vincent Chase, Incorporated, (“VC”) (VM, PVM and VC, collectively, the “VM Group”) and each member of the Board of Directors of the Company, namely, Ned Siegel, Mitch Lowe and Jennifer Love, entered into a certain Second Amendment to Voting Agreement, dated August 21, 2015 (the “Second Amendment”) amending in certain respects that certain Voting Agreement dated January 21, 2015 among such parties as previously amended by that certain First Amendment to Voting Agreement (the “First Amendment”) dated August 11, 2015 (collectively, the “Voting Agreement”).

Pursuant to the First Amendment, the VM Group previously agreed (i) to extend the Expiration Date of the Voting Agreement from January 20, 2016 to July 20, 2016, provided the Company made certain pre-payments on the remaining $478,877 balance due to PVM on an outstanding promissory note (Note 7), and (ii) to forebear from exercising its rights to appoint a director to the Board of Directors of the Company (under Section 4 of that certain Settlement Agreement dated January 21, 2015 among the Company and the VM Group, the “Settlement Agreement”), until the Expiration Date of the Voting Agreement as extended by the First Amendment.

Pursuant to the Second Amendment, the VM Group and the Company:

(a) further extended the Expiration Date of the Voting Agreement to July 20, 2018,

(b) provided that the Company would make certain accelerated pre-payments on the $328,877 balance under the Note consisting of: (i) three equal payments of principal in the amount of $82,220, together with accrued and unpaid interest, payable on each of August 24, 2015, August 31, 2015 and September 8, 2015, and (ii) one final payment on September 14, 2015 equal to the remaining principal and accrued and unpaid interest due under the Note (the payments have all been paid as of September 30, 2014);

(c) provided that the VM Group would forebear from exercising its right to appoint a director to the Board of Directors of the Company (under Section 4 of that certain Settlement Agreement), until the Expiration Date of the Voting Agreement as extended by the Second Amendment; and

(d) the VM Group executed, that certain Consent of Stockholders of Medbox, Inc. (the “Consent”) approving the following amendments of the Articles of Incorporation (the “Articles”) of the Company:

(i) elimination of the provisions of Section IV of the Articles giving the holders of the Series A Convertible Preferred Stock of the Company (the “Preferred”) disproportionately greater voting rights than the holders of Common Stock and instead providing for the Preferred to have one vote per common share on an as- converted basis voting as a single class with the common shares upon any matter submitted to the stockholders for a vote, and

(ii) to eliminate the provisions of Section V of the Articles providing the holders of a majority of the outstanding shares of Preferred the right to approve any corporate action except for: (1) actions which would adversely alter or change the rights, preferences, privileges or restrictions of the Preferred or increase the authorized number thereof, (2) any changes to the terms of the Preferred; (3) creation of any new class of shares having preferences over or being on a parity with the Preferred as to dividends or

 

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assets, unless the purpose of creation of such class is, and the proceeds to be derived from the sale and issuance thereof are to be used for, the retirement of all Preferred then outstanding; or, (4) any payment of dividends or other distributions or any redemption or repurchase of options or warrants to purchase stock of the Company, except for repurchases of options or stock issued under an equity incentive plan approved by the Board.

Litigation

On May 22, 2013, Medbox initiated litigation in the United States District Court in the District of Arizona against three shareholders of MedVend Holdings LLC (“Medvend”) in connection with a contemplated transaction that Medbox entered into for the purchase of an approximate 50% ownership stake in Medvend for $4.1 million. The lawsuit alleges fraud and related claims arising out of the contemplated transaction during the quarter ended June 30, 2013. The litigation is pending and Medbox has sought cancellation due to a fraudulent sale of the stock because the selling shareholders lacked the power or authority to sell their ownership stake in MedVend, and their actions were a breach of representations made by them in the agreement. On November 19, 2013 the litigation was transferred to United States District Court for the Eastern District of Michigan. MedVend recently joined the suit pursuant to a consolidation order executed by a new judge assigned to the matter. In the litigation, the selling shareholder defendants seek alternatively to have the transaction performed, or to have it unwound and be awarded damages and allege breach of the agreement by Medbox and that $600,000 was wrongfully retained by the Company. Medbox has denied liability with respect to any and all such counterclaims. A new litigation schedule was recently issued setting trial for September 2015. On June 5, 2014, the Company entered into a purchase and sale agreement (the “Medvend PSA”) with PVM International, Inc. (“PVMI”) concerning this matter. Pursuant to the Medvend PSA, the Company sold to PVMI the Company’s rights and claims attributable to or controlled by the Company against those three certain stockholders of Medvend, known as Kaplan, Tartaglia and Kovan (the “Medvend Rights and Claims”), in exchange for the return by PVMI to the Company of 30,000 shares of the Company’s common stock. PVMI is owned by Vincent Mehdizadeh, the Company’s largest stockholder. The Company will have the right, under the Medvend PSA, to purchase from PVMI, at any time, the Medvend Rights and Claims, for the consideration provided by PVMI, plus the sum of any of PVMI’s reasonable expenditures incurred in pursuit of the Medvend Rights and Claims. The court has not yet ruled on the substitution of PVMI as plaintiff in this matter. If necessary, the Company plans to vigorously defend against this matter. The case is in the discovery stage, and, at this time, the Company cannot determine whether the likelihood of an unfavorable outcome of the dispute is probable or remote, nor can they reasonably estimate a range of potential loss, should the outcome be unfavorable.

On February 20, 2015, Michael A. Glinter, derivatively and on behalf of nominal defendants Medbox, Inc. the Board and certain executive officers (Pejman Medizadeh, Matthew Feinstein, Bruce Bedrick, Thomas Iwanskai, Guy Marsala, J. Mitchell Lowe, Ned Siegel, Jennifer Love, and C. Douglas Mitchell) filed a suit in the Superior Court of the State of California for the County of Los Angeles. The suit alleges breach of fiduciary duties and abuse of control by the defendants. Relief is sought awarding damages resulting from breach of fiduciary duty and to direct the Company and the defendants to take all necessary actions to reform and improve its corporate governance and internal procedures to comply with applicable law. This action has been stayed pending the outcome of the actions filed in the United States District Court for the District of Nevada (Calabrese and Gray). Due to the early stages of this suit the Company is unable to determine whether the likelihood of an unfavorable outcome of the dispute is probable or remote, nor can it reasonably estimate a range of potential loss, should the outcome be unfavorable.

On January 21, 2015, Josh Crystal on behalf of himself and of all others similarly situated filed a class action lawsuit in the U.S. District Court for Central District of California against Medbox, Inc., and certain past and present members of the Board (Pejman Medizadeh, Bruce Bedrick, Thomas Iwanskai, Guy Marsala, and C. Douglas Mitchell). The suit alleges that the Company issued materially false and misleading statements regarding its financial results for the fiscal year ended December 31, 2013 and each of the interim financial periods that year. The plaintiff seeks relief of compensatory damages and reasonable costs and expenses or all damages sustained as a result of the wrongdoing. On April 23, 2015, the Court issued an Order consolidating the three related cases in this matter: Crystal v. Medbox, Inc., Gutierrez v. Medbox, Inc., and Donnino v. Medbox, Inc., and appointing a lead plaintiff. On July 27, 2015 Plaintiffs filed a Consolidated Amended Complaint. The Company must file a responsive pleading on or before December 4, 2015. The Company intends to vigorously defend against these suits. Due to the early stages of the suits the Company is unable to determine whether the likelihood of an unfavorable outcome of the dispute is probable or remote, nor can it reasonably estimate a range of potential loss, should the outcome be unfavorable.

On January 18, 2015, Ervin Gutierrez filed a class action lawsuit in the U.S. District Court for the Central District of California. The suit alleges violations of federal securities laws through public announcements and filings that were materially false and misleading when made because they misrepresented and failed to disclose that the Company was recognizing revenue in a manner that violated US GAAP. The plaintiff seeks relief for compensatory damages and reasonable costs and expenses or all damages sustained as a result of the wrongdoing. On April 23, 2015, the Court issued an Order consolidating the three related cases in this matter: Crystal v. Medbox, Inc., Gutierrez v. Medbox, Inc., and Donnino v. Medbox, Inc., and appointing a lead plaintiff. On July 27, 2015 Plaintiffs filed a Consolidated Amended Complaint. The Company must file a responsive pleading on or before December 4, 2015. The Company intends to vigorously defend against this suit. Due to the early stages of the suit the Company is unable to determine whether the likelihood of an unfavorable outcome of the dispute is probable or remote, nor can it reasonably estimate a range of potential loss, should the outcome be unfavorable.

On January 29, 2015, Matthew Donnino filed a class action lawsuit in the U.S. District Court for Central District of California. The suit alleges that the Company issued materially false and misleading statements regarding its financial results for the fiscal year ended December 31, 2013 and each of the interim financial periods that year. The plaintiff seeks relief for compensatory damages and reasonable costs and expenses or all damages sustained as a result of the wrongdoing. On April 23, 2015, the Court issued an Order consolidating the three related cases in this matter: Crystal v. Medbox, Inc., Gutierrez v. Medbox, Inc., and Donnino v. Medbox, Inc., and appointing a lead plaintiff. On July 27, 2015 Plaintiffs filed a Consolidated Amended Complaint. The Company must file a

 

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responsive pleading on or before December 4, 2015. The Company intends to vigorously defend against this suit. Due to the early stages of the suit the Company is unable to determine whether the likelihood of an unfavorable outcome of the dispute is probable or remote, nor can it reasonably estimate a range of potential loss, should the outcome be unfavorable.

On February 12, 2015, Jennifer Scheffer, derivatively on behalf of Medbox, Guy Marsala, Ned Siegel, Mitchell Lowe and C. Douglas Mitchell filed a lawsuit in the Eighth Judicial District Court of Nevada seeking damages for breaches of fiduciary duty regarding the issuance and dissemination of false and misleading statements and regarding allegedly improper and unfair related party transactions, unjust enrichment and waste of corporate assets. On April 17, 2015, Ned Siegel and Mitchell Lowe filed a Motion to Dismiss. On April 20, 2015, the Company filed a Joinder in the Motion to Dismiss. On July 27, 2015, the Court held a hearing on and granted the Motion to Dismiss without prejudice. Due to the early stages of the suit the Company is unable to determine whether the likelihood of an unfavorable outcome of the dispute is probable or remote, nor can it reasonably estimate a range of potential loss, should the outcome be unfavorable.

On March 10, 2015 Robert J. Calabrese, derivatively and on behalf of nominal defendant Medbox, Inc., filed a suit in the United States District Court for the District of Nevada against certain Company officers and/or directors (Ned L. Siegel, Guy Marsala, J. Mitchell Lowe, Pejman Vincent Mehdizadeh, Bruce Bedrick, and Jennifer S. Love). The suit alleges breach of fiduciary duties and gross mismanagement by issuing materially false and misleading statements regarding the Company’s financial results for the fiscal year ended December 31, 2013 and each of the interim financial periods. Specifically the suit alleges that defendants caused the Company to overstate the Company’s revenues by recognizing revenue on customer contracts before it had been earned. The plaintiff seeks relief for compensatory damages and reasonable costs and expenses for all damages sustained as a result of the alleged wrongdoing. Due to the early stages of the suit the Company is unable to determine whether the likelihood of an unfavorable outcome of the dispute is probable or remote, nor can it reasonably estimate a range of potential loss, should the outcome be unfavorable.

On March 27, 2015 Tyler Gray, derivatively and on behalf of nominal defendant Medbox, Inc., filed a suit in the United States District Court for the District of Nevada against the Company’s Board of Directors and certain executive officers (Pejman Vincent Mehdizadeh, Matthew Feinstein, Bruce Bedrick, Thomas Iwanski, Guy Marsala, J. Mitchell Lowe, Ned Siegel, Jennifer S. Love, and C. Douglas Mitchell). The suit alleges breach of fiduciary duties and abuse of control. The plaintiff seeks relief for compensatory damages and reasonable costs and expenses for all damages sustained as a result of the alleged wrongdoing. Additionally the plaintiff seeks declaratory judgments that plaintiff may maintain the action on behalf of the Company, that the plaintiff is an adequate representative of the Company, and that the defendants have breached and/or aided and abetted the breach of their fiduciary duties to the Company. Lastly the plaintiff seeks that the Company be directed to take all necessary actions to reform and improve its corporate governance and internal procedures to comply with applicable law. Due to the early stages of this suit the Company is unable to determine whether the likelihood of an unfavorable outcome of the dispute is probable or remote, nor can it reasonably estimate a range of potential loss, should the outcome be unfavorable.

On May 20, 2015 Patricia des Groseilliers, derivatively and on behalf of nominal defendant Medbox, Inc., filed a suit in the United States District Court for the District of Nevada against the Company’s Board of Directors and certain executive officers (Pejman Vincent Mehdizadeh, Ned Siegel, Guy Marsala, J. Mitchell Lowe, Bruce Bedrick, Jennifer S. Love, Matthew Feinstein, C. Douglas Mitchell, and Thomas Iwanski). The suit alleges breach of fiduciary duties and unjust enrichment. The plaintiff seeks relief for compensatory damages and reasonable costs and expenses for all damages sustained as a result of the alleged wrongdoing. Additionally the plaintiff seeks declaratory judgments that plaintiff may maintain the action on behalf of the Company, that the plaintiff is an adequate representative of the Company, and that the defendants have breached and/or aided and abetted the breach of their fiduciary duties to the Company. Lastly the plaintiff seeks that the Company be directed to take all necessary actions to reform and improve its corporate governance and internal procedures to comply with applicable law. Due to the early stages of this suit the Company is unable to determine whether the likelihood of an unfavorable outcome of the dispute is probable or remote, nor can it reasonably estimate a range of potential loss, should the outcome be unfavorable.

On June 3, 2015 Mike Jones, derivatively and on behalf of nominal defendant Medbox, Inc., filed a suit in the U.S. District Court for Central District of California against the Company’s Board of Directors and certain executive officers (Guy Marsala, J. Mitchell Lowe, Ned Siegel, Jennifer S. Love, C. Douglas Mitchell, Pejman Vincent Mehdizadeh, Matthew Feinstein, Bruce Bedrick, and Thomas Iwanski). The suit alleges breach of fiduciary duties, abuse of control, and breach of duty of honest services. The plaintiff seeks relief for compensatory damages and reasonable costs and expenses for all damages sustained as a result of the alleged wrongdoing. Additionally the plaintiff seeks declaratory judgments that plaintiff may maintain the action on behalf of the Company, that the plaintiff is an adequate representative of the Company, and that the defendants have breached and/or aided and abetted the breach of their fiduciary duties to the Company. Lastly the plaintiff seeks that the Company be directed to take all necessary actions to reform and improve its corporate governance and internal procedures to comply with applicable law. On July 20, 2015, the Court issued an Order consolidating this litigation with those previously consolidated in the Central District (Crystal, Gutierrez, and Donnino). Due to the early stages of this suit the Company is unable to determine whether the likelihood of an unfavorable outcome of the dispute is probable or remote, nor can it reasonably estimate a range of potential loss, should the outcome be unfavorable.

On July 20, 2015 Kimberly Freeman, derivatively and on behalf of nominal defendant Medbox, Inc., filed a suit in the Eighth Judicial District Court of Nevada against the Company’s Board of Directors and certain executive officers (Pejman Vincent Mehdizadeh, Guy Marsala, Ned Siegel, J. Mitchell Lowe, Jennifer S. Love, C. Douglas Mitchell, and Bruce Bedrick). The suit alleges breach of fiduciary duties and unjust enrichment. The plaintiff seeks relief for compensatory damages and reasonable costs and expenses

 

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for all damages sustained as a result of the alleged wrongdoing. Additionally the plaintiff seeks declaratory judgments that plaintiff may maintain the action on behalf of the Company, that the plaintiff is an adequate representative of the Company, and that the defendants have breached and/or aided and abetted the breach of their fiduciary duties to the Company. Lastly the plaintiff seeks that the Company be directed to take all necessary actions to reform and improve its corporate governance and internal procedures to comply with applicable law. Due to the early stages of this suit the Company is unable to determine whether the likelihood of an unfavorable outcome of the dispute is probable or remote, nor can it reasonably estimate a range of potential loss, should the outcome be unfavorable.

On December 26, 2014, Medicine Dispensing Systems, a wholly-owned subsidiary of Medbox, filed a suit against Kind Meds, Inc. to collect fees of approximately $550,000 arising under a contract to establish a dispensary. Kind Meds, Inc. filed a cross complaint against Medicine Dispensing Systems for breach of contract and breach of implied covenant of good faith and fair dealing, claiming damages of not less than $500,000. We believe that the cross complaint is without merit. We will continue to pursue this Kind Meds for the amounts owed under the contract and will vigorously defend ourselves against the cross complaint. At this time the Company in unable to determine whether the likelihood of an unfavorable outcome of the dispute is probable or remote, nor can it reasonably estimate a range of potential loss, should the outcome be unfavorable.

The Company commenced arbitration proceedings against a former employee on June 13, 2013 related to employment claims asserted by the employee. Thereafter, the employee filed a suit in Los Angeles County Superior Court. The suit was stayed pending the outcome of the arbitration and thereafter dismissed without prejudice. The Company obtained a favorable arbitration award. The Company then filed an Application to Confirm the Arbitration Award in Arizona Superior Court, Maricopa County. After being unable to serve the employee, the Company performed service by publication and filed proofs of publication for service on the employee on February 27, 2015 and March 2, 2015. If the arbitration award is not enforced, the employee’s claim can be re-filed in California.

In October 2014, the Board of Directors of the Company appointed a special board committee (the “Special Committee”) to investigate a federal grand jury subpoena pertaining to the Company’s financial reporting which was served upon the Company’s accountants as well as certain alleged wrongdoing raised by a former employee of the Company. The Company was subsequently served with two SEC subpoenas in early November 2014. The Company is fully cooperating with the grand jury and the SEC. In connection with its investigation of these matters, the Special Committee in conjunction with the Audit Committee initiated an internal review by management and by an outside professional advisor of certain prior period financial reporting of the Company. The outside professional advisor reviewed the Company’s revenue recognition methodology for certain contracts for the third and fourth quarters of 2013. As a result of certain errors discovered in connection with the review by management and its professional advisor, the Audit Committee, upon management’s recommendation, concluded on December 24, 2014 that the consolidated financial statements for the year ended December 31, 2013 and for the third and fourth quarters therein, as well as for the quarters ended June 30, 2014, June 30, 2014 and September 30, 2014, should no longer be relied upon and would be restated to correct the errors. On March 6, 2015 the audit committee determined that the consolidated financial statements for the year ended December 31, 2012, together with all three, six and nine month financial information contained therein, and the quarterly information for the first two quarters of the 2013 fiscal year should also be restated. On March 11, 2015, the Company filed its restated Form 10 Registration Statement with the SEC with restated financial information for the years ended December 31, 2012 and December 31, 2013, and on March 16, 2015, the Company filed amended and restated quarterly reports on Form 10-Q, with restated financial information for the periods ended March 31, June 30 and September 30, 2014, respectively.

 

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NOTE 10 – SUBSEQUENT EVENTS

Share purchase and transfer

On March 5, 2015, Mr. Mehdizadeh announced that an agreement has been executed with Lizada Capital LLC, an investor in the field of legal cannabis products, that would result in the transfer of the majority of Mr. Mehdizadeh’s shares of the Company to that firm. As of September 30, 2015, the prospective buyer has cancelled this agreement.

October 2015 Debentures

On October 14, 2015, the Company issued seven debentures in the aggregate of $2,000,000 to a service provider (the “October 2015 Investor”) as consideration for services previously rendered to the Company on the same terms as the August 14 Debentures and August 14 Purchase Agreement (the “October 2015 Debentures” and “October 2015 Purchase Agreement”, respectively) except that the October 2015 Purchase Agreement does not provide for registration rights to the October 2015 Investor with regard to the shares underlying the October 2015 Debentures. The service provider has agreed with the Company not to convert the October 2015 Debentures for any amount in excess of fees payable for services previously rendered to the Company at the time of conversion. To the extent that the sale of shares underlying the October 2015 Debentures do not satisfy outstanding amounts payable to the service provider, such amounts will remain payable to the service provider by the Company.

Lease

On October 14, 2015, one of the Company’s subsidiaries entered into a lease regarding a property in Washington state (Note 9). The lease has a five year term, with monthly lease payments of $2,500. The property had been classified as Asset held for resale during previous periods, but as management’s plans regarding the property have changed, as evidenced by the subsequent period lease, it was reclassified as Property and equipment as of September 30, 2015.

Settlements

As disclosed in Note 9, class actions and derivative lawsuits were filed against and purportedly on behalf of the Company captioned (1) Josh Crystal v. Medbox, Inc., et al., in the U.S. District Court for Central District of California; (2) Matthew Donnino v. Medbox, Inc., et al., in the U.S. District Court for Central District of California; (3) Ervin Gutierrez v. Medbox, Inc., et al., in the U.S. District Court for Central District of California; (4) Mike Jones v. Guy Marsala, et al., in the U.S. District Court for Central District of California; (5) Jennifer Scheffer v. P. Vincent Mehdizadeh, et al., in the Eighth Judicial District Court of Nevada; (6) Kimberly Y. Freeman v. Pejman Vincent Mehdizadeh, et al., in the Eighth Judicial District Court of Nevada; (7) Tyler Gray v. Pejman Vincent Mehdizadeh, et al., in the U.S. District Court for the District of Nevada; (8) Robert J. Calabrese v. Ned L. Siegel, et al., in the U.S. District Court for the District of Nevada; (9) Patricia des Groseilliers v. Pejman Vincent Mehdizadeh, et al., in the U.S. District Court for the District of Nevada; (10) Michael A. Glinter v. Pejman Vincent Mehdizadeh, et al., in the Superior Court of the State of California for the County of Los Angeles. The complaints named as defendants the Company, prior and current members of the board of directors of the Company, and prior and current officers of the Company. The complaints alleged that the Company issued materially false and misleading statements regarding its financial results for the fiscal years ended December 31, 2012 and December 31, 2013 and each of the interim financial periods during those years and for each of the first three interim financial periods for the fiscal year ended 2014. The derivative lawsuits alleged breach of fiduciary duties, unjust enrichment, waste of corporate assets, abuse of control, and breach of duty of honest services.

On October 16, 2015, solely to avoid the costs, risks, and uncertainties inherent in litigation, the parties to the class actions and derivative lawsuits entered into settlements, that collectively effect a global settlement of all claims asserted in the class actions and the derivative actions. The global settlement provides, among other things, for the release and dismissal of all asserted claims. The global settlement is contingent on final court approval, respectively, of the settlements of the class actions and derivative actions. As a result of amounts already reflected in the Company’s financial statements, and the coverage by the Company’s insurance carrier, the final terms of the settlements are not expected to have a material adverse effect on the Company’s financial position or results of operations.

Board of Directors appointment

On October 15, 2015, Jeff Goh, 51, President and Interim Chief Executive Officer of the Company was elected to the board of directors of the Company.

The Farm Operating Agreement

On November 4, 2015, the Company signed an operating agreement with an independent contractor to perform cultivating services at the Farm. The independent operator will receive 10% of the profits of the Farm, after deduction of direct expenses. The term of the agreement is five years from the date of the agreement, with the parties permitted to extend the term through mutual agreement by successive two year terms.

New Litigation

On October 27, 2015, Richard Merritts, derivatively and on behalf of nominal defendant Medbox, Inc., filed a suit in the Superior Court of the State of California for the County of Los Angeles against the Board and certain executive officers (Guy Marsala, J. Mitchell Lowe, Ned Siegel, Jennifer S. Love, C. Douglas Mitchell, Pejman Vincent Mehdizadeh, Matthew Feinstein, Bruce Bedrick, Jeff Goh, and Thomas Iwanski). The suit alleges breach of fiduciary duties by the defendants. Relief is sought awarding damages resulting from breach of fiduciary duty and to direct the Company and the defendants to take all necessary actions to reform and improve its corporate governance and internal procedures to comply with applicable law. Merritts’ lawsuit has not been served.

 

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

Forward-Looking Statements

Information in this Quarterly Report on Form 10-Q may contain forward-looking statements. This information may involve known and unknown risks, uncertainties and other factors that may cause our actual results, performance or achievements to be materially different than the future results, performance or achievements expressed or implied by any forward-looking statements. Forward-looking statements, which involve assumptions and describe our future plans, strategies and expectations, are generally identifiable by use of the words “may,” “should,” “expect,” “anticipate,” “estimate,” “believe,” “intend” or “project” or the negative of these words or other variations on these words or comparable terminology.

Examples of forward-looking statements include, but are not limited to, statements regarding our proposed services, market opportunities and acceptance, expectations for revenues, cash flows and financial performance, and intentions for the future. Actual events or results may differ materially from those discussed in forward-looking statements as a result of various factors, including, without limitation, the risks outlined under “Risk Factors” in the Company’s Form 10K for the year ended December 31, 2014, filed with the Securities and Exchange Commission (the “SEC”) on March 26, 2015, the Company’s amended Form S-1A filed on May 22, 2015 and the Company’s Form S-1 filed on October 22, 2015. In light of these risks and uncertainties, there can be no assurance that the forward-looking statements contained in this Quarterly Report on Form 10-Q will in fact be accurate. Further, we do not undertake any obligation to publicly update any forward-looking statements, except as may be required under applicable securities laws. As a result, you should not place undue reliance on these forward-looking statements

Overview

Our business includes contracting with clients for our services and the sale of cannabis-related products such as our lines of tabletop and portable medical vaporizers. Our clients currently operate or plan to establish dispensaries for the sale of marijuana for medical use or retail operations for the sale of marijuana for recreational use or cultivation centers for the cultivation of marijuana, in those states where approved.

We began our business model with entering into one-time consulting agreements to help our clients obtain a license to sell or cultivate marijuana and to assist them with the build out of a location for their business, including the sale to the client of a Medbox dispensing system, pursuant to a consulting agreement that we refer to as our “Turn-Key Business Establishment Agreement”. Historically, we have generated revenue from various sources on a “one-time basis” for services that we provide to clients in helping them create, license, build out and open dispensaries and cultivation centers. We are now transitioning to a recurring revenue model as described below.

Under our new business model, we seek to obtain licenses to operate dispensaries, cultivation centers and manufacturing facilities with the licenses held by Medbox or an affiliated company. We contract with unaffiliated third-party operators to manage the day-to-day operations of cultivation centers, dispensaries and manufacturing facilities we develop and assign them the rights to manage and operate the dispensary in exchange for a percentage of operating income or a fixed fee based on applicable state law. We also provide ongoing consulting services, for which we receive recurring revenues. We also sell portable and tabletop vaporizers and accessories under the Vaporfection brand name. In the third quarter of 2015, we began to sell a portable line of vaporizers called miVape in the market place.

In 2014, we arranged for the submission of 36 license applications in five states on behalf of clients. We have obtained 5 licenses or registrations in the States of Oregon, Illinois, Washington and California for or on behalf of clients or for potential clients. We intend to retain the management rights for these locations and will seek to assign the rights to third parties for a fee. Most of the current dispensary and cultivation sites are expected to begin conducting business in 2015 and 2016. We are also currently in discussions with third-party license holders that operate dispensaries and cultivation centers to provide them consulting, training, compliance and regulatory support.

We are party to a master lease Portland, OR that we lease to an operator of a dispensary. We also own 320 acres in the greater Pueblo, CO area and have engaged an independent farmer to cultivate hemp on the site. We are in escrow (with a planned closing for on or about December 1, 2015) for a dispensary site in San Diego to be operated by an independent operator.

We are planning to build a consistent, predictable and valuable revenue model based upon our knowledge and expertise in the regulation of the cannabis industry and by helping our clients function efficiently in a developing industry. State and local laws regarding the operations of dispensaries, retail centers and cultivation centers for marijuana vary. In states where revenue sharing with cannabis companies is permissible, our business structure will revolve around charging fees based upon a percentage of operating income, as defined in the business contract, generated from our clients’ businesses. In states where revenue sharing is not permissible, agreements that we enter into with our clients will provide for fee-for-service arrangements on a “cost-plus” basis.

 

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About Our New Business Model

In March 2014, Medbox formed an affiliated company, Allied Patient Care, Inc., to apply for a license to operate a medical marijuana dispensary in the Portland, OR area. Allied Patient Care, Inc., is a non-profit entity incorporated under Oregon law and controlled by an independent contractor who has signed an independent contractor agreement with Medbox. Medbox paid for the costs to obtain the license and those expenses were recognized as inventory in our December 31, 2013 and December 31, 2012 consolidated financial statements reflected in our Form 10 both before and after restatements that were filed with the SEC in our Amendment No. 3 to Form 10 on March 11, 2015. The costs remained in inventory after the restatement because Medbox had, by the time of the restatement, obtained the license and secured a location for the dispensary.

In order to assure the City of Portland that the dispensary would be operated in a suitable area, on May 7, 2014 Medbox leased an approximately 9,730 square foot facility in the City of Portland. The lease provides for a term of 5 years, through May 7, 2019, and Medbox pays $7,400 per month as rent for the master lease for the facility. In July, 2014, Allied Patient Care was granted a license from the Oregon Health Authority to operate a medical marijuana dispensary in Portland, OR at the site leased by Medbox. Medbox then completed tenant improvements to build out the dispensary in the leased space. The tenant improvements were recorded as deferred costs on the consolidated balance sheet of Medbox and will be amortized proportionately to the recognition of revenue.

In April 2015, Medbox signed an Operator Agreement (the “Agreement”) with an independent operator to manage and operate the dispensary in Portland. The term of the Agreement is for five years with an option to extend the term for an additional five years at the discretion of the operator.

The operator’s responsibilities under the Agreement include: the hiring and supervision of all the employees of the dispensary operation, establishing prices for products sold at the dispensary, purchasing of all inventory, establishing and revising policies and procedures, receiving, holding and disbursing funds, maintaining bank accounts and making payments on accounts payable and fees, and collections of accounts receivable, and arranging for sales and marketing. Medbox is making the leased facility available to the operator pursuant to a sublease with a 5-year term beginning May 1, 2015, under which the operator will pay rent of $8,000 per month to Medbox. Medbox is sub-licensing its license for the operations of the dispensary to the independent operator in exchange for a procurement fee of $400,000 and the payment of a percentage of the operating profits of the dispensary during the term of the Agreement. Upon execution and delivery of the Agreement, the independent operator paid $50,000 of the procurement fee with the remaining $350,000 to be paid monthly in the amount of gross receipts less payroll and costs of inventories. The $350,000 was evidenced by a note between the operator and the Company. If the procurement fees are not paid within six months, the payment terms become a minimum monthly payment of $5,000. An annual licensor fee of five percent (5%) of the annual gross profit of the dispensary is to commence after the procurement fee is paid in full. These license fee payments are to be made within twenty days of the close of each monthly accounting period, with a true-up at year end.

Upon the closing of the Agreement, the Company recognized the $400,000 procurement fee as Deferred Revenue, because not all services required under the Agreement had been rendered by the Company. As of June 30, 2015, the Company determined it was not assured of the timing of the collectability of the note and set up an allowance in the amount of $350,000 for the note, and has reduced the Deferred Revenue by the same amount, to a remaining balance of Deferred Revenue of $50,000.

 

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Based on the responsibilities of the independent operator as set forth in the Agreement, and detailed above, the Company has determined that it does not hold a controlling financial interest in the dispensary and is not the primary beneficiary, and, therefore, the Company is not consolidating the Dispensary in its financial statements.

Revenue Recognition

The Company will recognize revenue pursuant to the foregoing transaction when it is realized or realizable and earned. The Agreement evidences that an arrangement exists, and that the price is fixed or determinable. Services are rendered each month as the operator leases the dispensary and operates as sub-licensee under the license from the Oregon Health Authority. Each period, the Company will evaluate whether collectability is reasonably assured. The Company will recognize the deferred revenue as the amounts due on the note are received, at which time collectability is reasonably assured. The Company will recognize revenue after the procurement fee is paid in full, when it receives the accounting report from the independent operator at the end of each monthly period, provided collection is reasonably assured. Medbox has not yet recognized any revenue under the Agreement because the sales volume from the continuing operations has not yet reached a level to allow the operator to make payments against the procurement fee. Medbox did receive and recognize rental income from the sublease of $8,000 per month for the months April to July 2015 and, correspondingly, recorded rent expense of $7,400 per month under the master lease.

Medbox is currently in negotiations to terminate the Agreement, and it is expected that the Agreement will end in the fourth quarter of 2015. Medbox plans to immediately engage a new independent operator to operate the day-to-day operations of the Portland dispensary. It is anticipated that the Company will enter into a new agreement which will call for the independent operator to pay a fixed percentage of revenue to Medbox for the sub-licensing of the license as well as monthly rent under a new sublease. It is also anticipated that Medbox will recognize revenue each month based on its percentage of revenue due from the new operator under the new agreement, provided that the collection of the fee is reasonably assured, along with sublease rental income to be earned monthly.

Farm Transaction

In July 2015, Medbox closed on the acquisition of a 320 acre farm near Pueblo, CO (the “Farm”). Medbox plans to use this property to:

 

    Cultivate and process hemp

 

    Store water for municipal uses

 

    Excavate and sell aggregate

The Farm may be used to cultivate and process cannabis in the future depending on how laws and regulations evolve in Pueblo and other municipalities in the State of Colorado.

For the cultivation of hemp, Medbox plans to clear the land, install greenhouses and other farming structures and equipment and to provide irrigation, with the cost of the improvements recorded on the consolidated balance sheet of Medbox and depreciated over their useful lives. Medbox has already obtained a license from the Colorado Department of Agriculture to cultivate hemp on the Farm.

 

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On November 4, 2015, Medbox engaged an independent operator to plant the hemp seeds, cultivate and irrigate the crop, harvest the crop and process the end product. The term of the engagement is for five years, with the opportunity to renew for successive, two year terms, if agreed by the parties. The independent operator will receive 10% of the profits of the Farm, after deduction of direct expenses. The first crops are expected to be harvested and processed in the first half of 2016. Multiple crop cycles are expected each year beginning in 2016.

Water storage and aggregate excavation are long-term possible uses for the Farm. Medbox has not begun active planning to exploit the water and aggregate resources on the Farm. It is anticipated that planning for water and aggregate development will begin in late 2016 or 2017, with related accounting policies developed concurrently with project planning.

Comparison of the three months ended September 30, 2015 and 2014

The Company reported a condensed consolidated net loss of approximately $9,292,000, for the three months ended September 30, 2015 and approximately $3,797,000 for the three months ended September 30, 2014. The increase in net loss of approximately $5,495,000 was primarily due to increases in the change in fair value of the derivative liabilities, the amortization of the debt discount and

 

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financing costs. The additional increase in general and administrative expenses was partially offset by a decrease in cost of revenues. The Company is in the process of modifying its business model to provide ongoing management and support services for clients so that contracts that we enter into will provide recurring revenue. During this transition period to our new business model, expenses to secure new contracts and licenses are incurred and revenue is deferred principally until new licenses are obtained and new dispensaries and cultivation centers begin operating.

Revenue

Total revenue for the three months ended September 30, 2015, consisted of amounts of deferred revenue which were recognized in the current period for consulting agreements and the sale of territory rights to a related party, as well as revenue from sales of vaporizers and accessories of the Company’s subsidiary Vaporfection International, Inc. (“VII”).

The revenue for the three months ended September 30, 2015 and 2014 increased by approximately $141,000 due to increased recognition of deferred revenue of $151,000 due to completion of obligations to clients along with introduction of our new portable vaporizers which led to an increase in sales of approximately $66,000. In the second quarter of 2015 the Company began receiving rental income under a sublease which increased the third quarter revenue with $16,000 for the quarter. There was no corresponding rental income in the second quarter of 2014. This was offset by approximately $92,000 in referral fees recognized in 2014; there was no corresponding referral revenue for 2015.

Cost of revenue

Cost of revenues decreased approximately $1,157,000 in the third quarter of 2015 as compared to the same period in 2014. The decrease was primarily due to the decrease in new market development costs. In addition, during the third quarter of 2014, the Company recorded an inventory write-down for slow moving inventory of vaporizers and incurred charges from escrow deposits, which did not recur in the third quarter of 2015. These decreases were partially offset by an additional charge in the third quarter of 2015 to write off deposits paid to the Company’s supplier, who filed for bankruptcy.

On May 4, 2015, AVT, Inc., a manufacturing partner of the Company announced that it had commenced a voluntary filing for restructuring and court protection under Chapter 11 of the United States Bankruptcy Code. Additionally, during the second quarter of 2015, the Company completed a strategic review of the Medbox machines and concluded that the machines would have a reduced role in future marketing and sales efforts. As a result of the strategic review, the Company evaluated the inventory and the related deposits in connection with reduced demand and strategic shift and concluded a write down of both assets was required. The bankruptcy of AVT, Inc. further complicated the process to convert the inventory and advances to cash and, therefore, was an additional factor in the decision to write down the inventory and record a valuation reserve against the deposits. Accordingly, during the second quarter of 2015, the Company evaluated the realizability of the dispensing machines and deposits, and wrote the inventory down by approximately $61,000 to an estimated net realizable value of $110,000 and recorded a valuation reserve against the deposits of approximately $100,000 resulting in net deposits of approximately $33,000. During the three months ended September 30, 2015, the Company ended negotiations with the supplier and bankruptcy counsel advised that collection of deposits and availability of inventory from the supplier was unlikely. Accordingly, the remaining deposit and inventory valued at $143,000 were written off.

During the third quarter of 2015, new market development costs decreased by approximately $710,000 as compared to the same period in 2014. New market development costs consist of costs incurred in new markets prior to securing a location and obtaining a license for new dispensary or cultivation facilities. During the three months ended September 30, 2015, the costs of developing the new markets in San Diego, Illinois, Washington and Nevada were approximately $361,000 compared to costs of approximately $1,070,000 for the third quarter of 2014. While the locations related to the new market development costs are the same for both periods, the costs incurred were higher in the third quarter of 2014 because of front-loaded costs in the development cycle which include initial application costs, research costs and legal and zoning work.

During the third quarter of 2014, the Company recorded an approximately $329,000 write down of slow moving, older models of vaporizer inventory; there was no corresponding write down during 2015.

During 2014, the Company entered into numerous real estate contracts to secure locations in connection with the licensing process. The contracts allow the Company to demonstrate to licensing authorities that the locations are available for use as a dispensary or cultivation location. The contracts are generally structured with an escrow deposit, a deferred closing until a license is granted and periodic withdrawals from the deposit to compensate the seller for holding the property off the market in escrow during the pendency of the license application. The periodic transfers out of escrow to the seller are in some cases credited towards the purchase price of the real estate but in most cases represent charges in lieu of rent. The charges in lieu of rent and other non-refundable charges paid to real estate sellers were recorded as expense in the statement of operations in the amount of approximately $296,000 for the three months ended September 30, 2014, compared to approximately $40,000 during the same period of 2015, a decrease of approximately $256,000.

Rental expense on the master lease for the Portland sublease income described above was $22,200.

Operating Expenses

Operating expenses consist of all other costs incurred during the period other than cost of revenue. The Company incurred approximately $3,610,000 in operating expenses for the three months ended September 30, 2015 compared to approximately $2,365,000 for the three months ended September 30, 2014. The increase of approximately $1,245,000 was primarily due to the increase in general and administrative expenses of $1,522,000.

 

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Sales and Marketing expenses

Sales and marketing expenses include employee costs, outside services for sales and marketing consultants, lobbying costs, travel and entertainment and sales lead generation. Sales and marketing costs decreased by approximately $215,000 in the third quarter of 2015 compared to the same period of 2014 primarily due to a non-recurring marketing expense in the third quarter of 2014 for the San Diego market of approximately $150,000 and a decrease in employee costs of approximately $43,000.

Research and development expenses

Research and development expenses for the third quarter of 2014 in the amount of approximately $62,000 consists of engineering work done on the software enhancements of the Medbox, additional research on vaporizers, and patent related expenses. There were no similar expenses during the same period of 2015.

General and administrative

General and administrative expenses include salary costs, including stock based compensation, professional costs, including the costs associated with being a public company and consultants, rent and other costs. The expenses incurred during the three month periods ended September 30, 2015 and 2014 are summarized and described below:

 

Change in,

   For the three
months ended
September, 30 2015
     For the three
months ended
September, 30 2014
     Increase
(Decrease)
 

Salary and related:

        

Employee costs and bonuses

   $ 208,883       $ 108,754       $ 100,129   

Payroll fees

     32,168         24,213         7,955   

Stock based compensation

     1,039,173         1,031,640         7,533   
  

 

 

    

 

 

    

 

 

 

Subtotal salary and related

     1,280,224         1,164,607         115,617   

Professional costs:

        

Costs of being public

     753,362         99,078         654,284   

Fund raising consultants

     8,500         50,833         (42,333

Legal costs

     892,106         112,766         779,340   

Professional accounting and audit services

     48,184         41,313         6,871   

Independent contractors costs

     155,427         97,119         58,308   

Management fee - Vincent Chase, Inc.

     —           75,000         (75,000
  

 

 

    

 

 

    

 

 

 

Subtotal professional costs

     1,857,579         476,109         1,381,470   

Rent expense

     70,181         59,057         11,124   

Other:

        

Insurance

     165,627         43,469         122,158   

Travels, meetings and conferences

     63,665         17,412         46,253   

Bad debt

     —           123,600         (123,600

Other (sum of smaller accounts)

     68,753         100,049         (31,296
  

 

 

    

 

 

    

 

 

 

Subtotal other

     298,045         284,530         13,515   
  

 

 

    

 

 

    

 

 

 

Total general and administrative

   $ 3,506,029       $ 1,984,303       $ 1,521,726   
  

 

 

    

 

 

    

 

 

 

Salary costs

During the third quarter of 2014, the Company introduced a new stock compensation plan to attract new talent to the Board of Directors and the management team which added approximately $1,000,000 in stock compensation expense for each of the quarters ended September 30, 2014 and 2015.

Employee costs and bonuses increased due to the addition of the full time CFO in October 2014 along with a Senior VP of Operations and Government relations and a Senior VP of Business Development in 2015 to lead the growth and development of the business.

Professional costs

Legal costs increased during the three months ended September 30, 2015 as compared to the same period in 2014, mainly as the Company dealt with more general corporate legal matters, including the costs to defend the legal actions and shareholders law suits brought against the Company, assist the Company with contracting and to provide general corporate counsel.

Costs of being public include legal fees for our Securities and Exchange Commission counsel, filing fees, independent directors fees and bonuses and investor relations costs. During the three months ended September 30, 2015, these amounts increased as compared to the same period of the previous year due to our registration statement on Form S-1 filed with the SEC on October 16, 2015, our form 14C Information Statement, informing our shareholders of an amendment to our charter to increase authorized stock filed on September 24, 2015, our August 2015 convertible note financing, modifications to convertible debenture loan agreements and related filings, director’s bonus, and additional SEC compliance.

 

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Rent

The Company moved to new offices in Los Angeles, CA in April 2015 to reduce occupancy costs. Rent expense increased over the third quarter of 2014 due to the fact that the previously occupied office space in West Hollywood was only partially subleased. The sublease on the new office has a term of 18 months and with monthly rent of approximately $7,500. The Company plans to sublease the office in West Hollywood, CA and continues to accrue rent expense while the space is being marketed.

Other costs

Other expense increased mostly due to new increased costs of approximately $122,000 for directors’ and officers’ liability coverage. In addition, the Company’s development of the newly acquired farm in Colorado and other markets led to an increase in travel of $46,000 for three months ended September 30, 2015 compared to the same period of 2014.

During the third quarter of 2014, the Company identified past due accounts receivable as doubtful for collection and recorded bad debt expense of $123,600. There were no similar events during the third quarter of 2015.

Other Income (Expense)

Other income (expense) includes the financing costs associated with the issuance of our July 2014 convertible debenture, September 2014 convertible debenture, and August 2015 convertible debentures, including the amortization of the debt discount and the change in fair value of the derivative liability. As disclosed in Note 5 of the accompanying financial statements, the reset provision for the subsequent sale of any dilutive issuance at a lower sale or exercise price than the then current conversion price results for accounting purposes as a liability being recognized for the fair value of the derivative. This derivative is remeasured each period end, with the change in fair value for the three months ending September 30, 2015 of approximately $2,544,000 of expense being recognized in Other income (expense). This derivative also results in a debt discount for the initial fair value recognized for the derivative. The debt discount also includes the fair value of the warrants issued in connection with the convertible debentures. This debt discount is amortized over the life of the convertible debenture, or until conversion if earlier, which amounted to approximately $2,072,000 of amortization expense for the three months ended September 30, 2015. Additionally, the current quarter closings of convertible debentures resulted in the calculated fair value of the conversion feature and the warrants being greater than the face amounts of the debt by approximately $522,000, with this excess amount being immediately expensed as Financing costs.

Interest expense for the stated interest on our convertible debentures incurred in the three months ended September 30, 2015 amounted to approximately $135,000. During the three months ended September 30, 2015 the Company incurred interest expense of approximately $35,000 related to notes for the purchase of the land in Colorado, which closed in the third quarter of 2015 and approximately $22,000 related to the promissory note issued in relation to the purchase of property in Washington State.

Comparison of the nine months ended September 30, 2015 and 2014

The Company reported a condensed consolidated net loss of approximately $25,120,000, for the nine months ended September 30, 2015 and approximately $6,803,000 for the nine months ended September 30, 2014. The increase in net loss of approximately $18,317,000 was primarily due to increases in general and administrative expenses, the amortization of the debt discount and financing costs, offset by a decrease in costs of revenue. The Company is in the process of modifying its business model to provide ongoing management and support services for clients so that contracts we enter into with clients would provide recurring revenue. During this transition period to our new business model, expenses to secure new contracts and licenses are incurred and revenue is deferred principally until new licenses are obtained and new dispensaries and cultivation centers begin operating.

Operating expenses increased for the nine months ended September 30, 2015 compared to the same period of 2014 mainly due to the introduction during the third quarter of 2014 of a new stock compensation plan to attract new talent to the Board of Directors and the management team which added to operating costs stock compensation expense of approximately $4,300,000 for the current period. Other causes of operating expense increases were increased legal expense to defend shareholder’s suits, assist the Company with contracting and to provide general corporate counsel of approximately $2,001,000 and public company expenses including the professional fees for restatements, Registration Statement and periodic filings with the SEC of approximately $1,488,000.

Revenue

Total revenue consisted of deferred revenue which was recognized in the current period for consulting agreements, sale of territory rights to a related party and revenue from sales of vaporizers and accessories of the Company’s subsidiary Vaporfection International, Inc. (“VII”).

The revenue for the nine months ended September 30, 2015 and 2014 decreased by approximately $59,000 due to non-recurring 2014 transactions including $175,000 for sale of management rights in one Arizona location and approximately $190,000 in referral fees. There were no similar transactions in 2015. During the nine months ended September 30, 2015, we recorded an increase of approximately $131,000 in consulting revenue due to recognition of deferred revenue from completion of obligations to clients along with an increase of approximately $58,000 in vaporizer and accessories sales due to introduction of our new portable vaporizers. Also, during the nine months ended September 30, 2015, the Company received rental income of $32,000 under a sublease; there was no corresponding rental income in the same period of 2014.

 

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Allowances and refunds

During the first nine months of 2014, the Company recorded an allowance for refunds of $60,000 for San Diego clients. There were no corresponding transactions during the same period of 2015.

Cost of revenue

Cost of revenues decreased approximately $1,654,000 for the nine months ended September 30, 2015 as compared to the same period of 2014. The decrease was primarily due to the decrease in new market development costs. In addition, during the third quarter of 2014, the Company recorded an inventory write-down for slow moving inventory of vaporizers, which did not recur in the third quarter of 2015. These decreases were partially offset by an additional charge in the third quarter of 2015 to write off deposits paid to the Company’s supplier who filed for bankruptcy.

On May 4, 2015, AVT, Inc., a manufacturing partner of the Company announced that it had commenced a voluntary filing for restructuring and court protection under Chapter 11 of the United States Bankruptcy Code. Additionally, during the second quarter of 2015, the Company completed a strategic review of the Medbox machines and concluded that the machines would have a reduced role in future marketing and sales efforts. As a result of the strategic review, the Company evaluated the inventory and the related deposits in connection with reduced demand and strategic shift and concluded a write down of both assets was required. The bankruptcy of AVT, Inc. further complicated the process to convert the inventory and advances to cash and, therefore was an additional factor in the decision to write down the inventory and record a valuation reserve against the deposits. Accordingly, during the second quarter of 2015 the Company evaluated the realizability of the dispensing machines and deposits, and wrote the inventory down by approximately $61,000 to an estimated net realizable value of $110,000 and recorded a valuation reserve against the deposits of approximately $293,000 resulting in net deposits of $33,000. During the three months ended September 30, 2015 the Company ended negotiations with the supplier and bankruptcy counsel advised that collection of deposits and availability of inventory from the supplier was unlikely. Accordingly, the remaining deposit and inventory valued at $143,000 were written off.

During the first nine months of 2015 new market development costs decreased by approximately $1,539,000 compared to the same period of 2014. Cost of inventory for the nine months ended September 30, 2014 includes the cost of one property sold with the balance consisting of costs to develop markets in San Diego, Illinois, Washington, Nevada. New market development costs consist of costs incurred in new markets prior to securing a location and obtaining a license for new dispensary or cultivation facilities in the state. While the locations related to the new market development costs are the same for both comparable periods, the costs incurred were higher in the first nine months of 2014 because of front-loaded costs in the development cycle which include initial application costs, research costs and legal and zoning work.

During the nine months ended September 30, 2014, the Company recorded approximately $329,000 for the write down of slow moving, older models of vaporizer inventory; there was no corresponding write down during 2015.

Rental expense on the Portland master lease for the sublease income described above was $37,000.

Operating Expenses

Operating expenses consist of all other costs incurred during the period other than cost of revenue. The Company incurred approximately $13,069,905 in operating expenses for the nine months ended September 30, 2015 compared to approximately $4,069,000 for the nine months ended September 30, 2014. The increase of approximately $9,001,000 was primarily due to the increase in general and administrative expenses of $9,444,000 slightly offset by a decrease in sales and marketing expenses of $307,000.

Sales and Marketing expenses

Sales and marketing expenses include employee costs, outside services for sales and marketing consultants, lobbying costs, travel and entertainment and sales lead generation. The Company incurred approximately $442,000 and $749,000 in sales and marketing expenses for the nine months ended September 30, 2015 and 2014, respectively. The decrease of approximately $307,000 was primarily due to a decrease of $222,000 in marketing expense which was principally due to a non-recurring marketing expense during the third quarter of 2014 for the San Diego market of approximately $150,000 and a decrease of approximately $107,000 in lobbying expense as the Company focused on developing specific opportunities as opposed to opening new markets and finding new sites.

Research and development expenses

Research and development expenses of approximately $137,000 incurred during the nine months ended September 30, 2014 consisted of engineering work done on the software enhancements of the Medbox, additional research on vaporizers, and patent related expenses. There were no similar expenses during the same period of 2015.

 

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General and administrative

General and administrative expenses include salary costs, including stock based compensation, professional costs, including the costs associated with being a public company and consultants, rent and other costs. The expenses incurred during the nine months ended September 30, 2015 and 2014 are summarized and described below:

 

Change in,

   For the nine months
ended September, 30
2015
     For the nine months
ended September, 30
2014
     Increase
(Decrease)
 

Salary and related:

        

Employee costs and bonuses

   $ 670,559         230,996       $ 439,563   

Payroll fees

     89,283         68,383         20,900   

Stock based compensation

     5,331,382         1,031,640         4,299,742   
  

 

 

    

 

 

    

 

 

 

Subtotal salary and related

     6,091,224         1,331,019         4,760,205   

Professional costs:

        

Costs of being public

     1,747,190         259,652         1,487,538   

Fund raising consultants

     64,601         63,333         1,268   

Legal costs

     2,269,456         268,334         2,001,122   

Settlements expenses related to executive separation

     514,597         —           514,597   

Lobbying costs

     —           22,700         (22,700

Professional accounting and audit services

     638,363         117,158         521,205   

Independent contractors costs

     215,702         241,098         (25,396

Management fee - Vincent Chase, Inc.

     —           150,000         (150,000
  

 

 

    

 

 

    

 

 

 

Subtotal professional costs

     5,449,909         1,122,275         4,327,634   

Rent expense

     180,729         172,679         8,050   

Other:

        

Insurance

     457,063         106,969         350,094   

Travels, meetings and conferences

     156,177         31,874         124,303   

Bad debt

     —           148,600         (148,600

Other (sum of smaller accounts)

     292,542         269,966         22,576   
  

 

 

    

 

 

    

 

 

 

Subtotal other

     905,782         557,409         348,373   
  

 

 

    

 

 

    

 

 

 

Total general and administrative

   $ 12,627,644       $ 3,183,382       $ 9,444,262   
  

 

 

    

 

 

    

 

 

 

Salary costs

During the third quarter of 2014, the Company introduced a new stock compensation plan to attract new talent to the Board of Directors and the management team which added approximately $4,299,000 in stock compensation expense in the first nine months of 2015 as compared to the same period of the previous year.

Employee costs and bonuses increased due to the addition of the full time CFO in October 2014 along with a Senior VP of Operations and Government relations and a Senior VP of Business Development in 2015 to lead the growth and development of the business.

Professional costs

Legal costs increased during the nine months ended September 30, 2015 over 2014, mainly as the Company dealt with more general corporate legal matters, including the costs to defend the legal actions and shareholders law suits brought against the Company, assist the Company with contracting and to provide general corporate counsel. During the second quarter of 2015 the Company’s recorded a liability to indemnify its former CEO Dr. Bruce Bedrick for legal expenses in the amount of approximately $430,000 principally in connection with shareholders law suits.

Costs of being public include legal fees for our Securities and Exchange Commission counsel, filing fees, independent directors’ fees and bonuses and investor relations costs. During the nine months ended September 30, 2015, these amounts increased as compared to the same period of the previous year caused by preparation of our restated financial statements in 2015 (as discussed in Note 19 to our financial statements for the year ended December 31, 2014 included in our Form 10K filed with the SEC on March 26, 2015), registration statement on Form S-1 filed with the SEC on April 9, 2015 which became effective on June 11, 2015, a second Form S-1, filed with the SEC on October 16, 2015, which has not yet become effective, a Form 14C shareholder information statement filed on September 24, 2015, modifications to convertible debenture loan agreements and related filings, director’s bonus, and additional SEC compliance. In addition of the aforementioned reasons, the Company incurred an increase of $521,000 in professional accounting and audit service. These costs in 2015 mainly include the independent registered accounting firm and independent consultants in relation to the restatements of the previous years ended December 31, 2013 and 2012, and the interim periods, as well as the audit for the year ended December 31, 2014 and registration statements on Form S-1 and amendments thereto and the form 14C.

Settlements expense of approximately $515,000 includes the severance payments and related costs payable to Guy Marsala, former CEO of the Company in addition to approximately $335,000 for stock options issued in connection with his separation agreement.

 

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Rent

The Company moved to new offices in Los Angeles, CA in April 2015 to reduce occupancy costs. Rent expense increased over the first nine months of 2014 due to the fact that the previously occupied office space in West Hollywood was only partially subleased. The sublease on the new office has a term of 18 months and with monthly rent of approximately $7,500. The Company plans to sublease the office in West Hollywood, CA and continues to accrue rent expense while the space is being marketed.

Other costs

Other expense increased mostly due to new increased costs of approximately $350,000 for directors’ and officers’ liability coverage. In addition, the Company’s participation in multiple professional tradeshows and investor conferences and development of the newly acquired farm in Colorado and other markets led to an increase in travel expenses of approximately $124,000 for the nine months ended September 30, 2015 compared to the same period of 2014.

During the third quarter of 2014, the Company identified past due accounts receivable as doubtful for collection and recorded bad debt expense of $148,600. There were no similar events during the third quarter of 2015.

Other Income (Expense)

Other income (expense) includes the financing costs associated with the issuance of our July 2014 convertible debenture, September 2014 convertible debenture, and August 2015 convertible debentures, including the amortization of the debt discount and the change in fair value of the derivative liability. As disclosed in Note 5 of the accompanying financial statements, the reset provision for the subsequent sale of any dilutive issuance at a lower sale or exercise price than the then current conversion price results for accounting purposes as a liability being recognized for the fair value of the derivative. This derivative is remeasured each period end, with the change in fair value for the nine months ended September 30, 2015 of approximately $509,000 of income being recognized in Other income (expense). This derivative also results in a debt discount for the initial fair value recognized for the derivative. The debt discount also includes the fair value of the warrants issued in connection with the convertible debentures. This debt discount is amortized as Other expense over the life of the convertible debenture, or until conversion if earlier, which amounted to approximately $8,122,000 of amortization expense for the nine months ended September 30, 2015. Additionally, the convertible debenture closings during the first nine months of 2015 resulted in the calculated fair value of the conversion feature and warrants being greater than the face amounts of the debt by approximately $2,822,000, with this excess amount being immediately expensed as Financing costs.

Interest expense for the stated interest on our convertible debentures incurred for the nine months ended September 30, 2015 amounted to approximately $302,000. In the January 30, 2015 amendment to the July 2014 and September 2014 debentures (see Note 5 in accompanying financial statements) the payment schedule was amended to no longer require amortization payments. In connection with the amortization payments, there was a 30% premium which was recognized as accrued interest until such time as the payments were scheduled to be paid. As the amendment removed the amortization payments, this 30% accrued interest will no longer be settled, and, therefore, approximately $100,000 in accrued interest has been reversed. In addition, the Company incurred approximately $43,000 of interest on the promissory note issued in relation to the purchase of property in Washington State and approximately $35,000 of interest related to notes for the purchase of the land in Colorado. All of the above resulted in interest expense (including immaterial other amounts of interest expense) of approximately $289,000 for the nine months ended September 30, 2015.

Also during the second quarter of 2015 the Company recorded $75,000 in other income due to recovery of previously written off accounts receivable.

 

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Liquidity and Capital Resources

As of September 30, 2015, the Company had cash on hand of approximately $347,000 compared to approximately $101,000 at December 31, 2014.

Cash Flow

During the nine months ended September 30, 2015 cash was primarily used to fund operations and pursue license application processes.

 

     For the nine months ended September 30,  

Cash flow

   2015      2014  

Net cash used in operating activities

   $ (6,124,372 )    $ (4,651,145 )

Net cash used in investing activities

     (583,754 )      (713,759 )

Net cash provided by financing activities

     6,953,705         6,547,344   
  

 

 

    

 

 

 

Net increase (decrease) in cash

   $ 245,579       $ 1,182,440   
  

 

 

    

 

 

 

Cash Flows – Operating Activities

During the nine months ended September 30, 2015, cash flows used in operating activities were approximately $6,124,000, consisting primarily of the net loss for the first nine months of 2015 of approximately $25,120,000, reduced for non-cash adjustments for amortization of the debt discount of approximately $8,122,000, stock based compensation of approximately $5,331,000, financing costs of approximately $2,822,000, inventory write off of approximately $497,000, charges from escrow deposits of $280,000 and depreciation and amortization of approximately $90,000. The net loss is increased for the non-cash adjustments of a gain from the change in fair value adjustment of derivative liability of approximately $509,000. Additional significant components of cash used in operating activities were a decrease in accrued expenses of approximately $488,000 related primarily to the payment of legal bills included in accrued expenses at December 31, 2014, increase in prepaid insurance expenses and other prepaid expenses of approximately $382,000 related primarily to the advance funding for the Company’s annual director and officers insurance policy and payment of retainers, decrease in customer deposits of approximately $468,000 due to refunds and completion on some agreements and increase in deferred costs of approximately $300,000 related to the costs associated with Operating Agreement with an unrelated party (the “Operator”) in which the Operator will manage and operate the Dispensary for which the Company holds the license in Portland, Oregon. These operating uses of cash were primarily offset by an increase of approximately $2,522,000 due to the timing and deferral of the payment of trade payables, an increase in accrued settlement and severance expenses of approximately $912,000 mainly related to Guy Marsala separation and Bruce Bedrick indemnification for legal expenses related to shareholder lawsuits, a decrease in inventory of approximately $276,000 primarily related to transfer of the accumulated cost for construction and development of the Portland, Oregon dispensary to deferred costs and accrued expenses for directors’ bonuses in the amount of approximately $260,000.

During the nine months ended September 30, 2014, cash flows used in operating activities were approximately $4,651,000, consisting primarily of the net loss for the first nine months of 2014 of approximately $6,803,000, reduced for non-cash adjustments of depreciation and amortization of approximately $59,000, the establishment of a non-cash bad debt provision of $60,000, amortization of a debt discount of approximately $216,000, and stock based compensation of approximately $1,032,000 and increased for the non-cash adjustments of gain from fair value adjustment of derivative liability of approximately $548,000, fair value of marketable securities received as payment for services of approximately $190,000. An additional component of cash used in operating activities was an increase in prepaid expenses and other assets of approximately $897,000 related primarily to net deposits paid into escrow accounts of approximately $634,000, deferred loan costs of $196,000 related to convertible notes payable and the balance of the advance funding of approximately $78,000 for the Company’s annual director and officers’ liability insurance policy. These operating uses of cash were offset by a decrease in inventory of approximately $111,000, and a net decrease of accounts receivable of approximately $213,000, increases in accounts payable and accrued expenses of approximately $908,000 due to the timing and deferral of the payment of trade payables and the overall increase in operating costs. In addition, customer deposits and deferred revenue provided net cash during the nine month periods of approximately $807,000 and $390,000, respectively, primarily due to the increase in customer deposits collected on contracts prior to work being completed and revenue recognized.

 

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Cash Flows – Investing Activities

During the nine months ended September 30, 2015, cash flows used in investing activities was approximately $583,000, consisting primarily of the $500,000 cash portion of the Farm acquisition, and approximately $84,000 for construction and equipment related to the Farm. During the nine months ended September 30, 2014, cash flows used in investing activities were approximately $714,000, consisting of the purchase of one property held for resale for $399,594, intangible assets additions for a domain name and patent costs of approximately $166,000, purchases of fixed assets of approximately $33,000 and increases in the balances of notes receivable of $115,000.

Cash Flows – Financing Activities

During the nine months ended September 30, 2015, cash flows provided by financing activities were approximately $6,954,000, consisting mainly of approximately $7,432,000 of proceeds (net of issuance costs of approximately $353,000) from the additional note issuances of the July 2014, September 2014, and August 2015 convertible notes payable of approximately $7,640,000, and $150,000 in the issuance of convertible debentures to two of our Directors. This was offset mainly by $625,000 in payments on notes payable to a related party. During the nine months ended September 30, 2014, cash flows provided by financing activities were approximately $6,547,000, consisting of approximately $2,443,000 of proceeds from issuance of common stock, $3,500,000 of proceeds from issuance of convertible notes payable net, proceeds from related party notes payable of approximately $380,000 and net proceeds from short term notes of approximately $300,000, offset by payments on a note payable of $75,000 which we acquired as a part of the VII purchase.

 

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Future Liquidity and Cash Flows

Management believes that the Company’s cash balances on hand, cash flows expected to be generated from operations, proceeds from current and future expected debt issuances and proceeds from future share capital issuances will be sufficient to fund the Company’s net cash requirements through September, 2016. However, in order to execute the Company’s long-term growth strategy, which may include selected acquisitions of businesses or facilities that may bolster the expansion of the Company’s management services business, and purchases of real estate which would be used as a basis for acquiring retail dispensary and cultivation facilities in regulated markets, the Company will need to raise additional funds through public or private equity offerings, debt financings, or other means.

On July 24, 2015, the Company entered into an Agreement of Purchase and Sale of Membership Interest with East West Secured Development, LLC to purchase 100% of the membership interest of EWSD I, LLC which has entered into an agreement with Southwest Farms, Inc. to purchase certain real property comprised of 320-acres of agricultural land in Pueblo, Colorado (the “the Farm”). We are in active negotiations to secure an independent operator to manage the Farm for hemp cultivation. We expect the first harvest of product from the Farm in early 2016 with continuing operations and harvests throughout 2016.

We have obtained 5 licenses or registrations in the States of Oregon, Illinois, Washington and California for or on behalf of clients or for potential clients. We intend to retain the management rights for these locations and will seek to assign the rights to third parties for a fee. Most of the current dispensary and cultivation sites are expected to begin conducting business in 2015 and 2016. We are also currently in discussions with third-party license holders that operate dispensaries and cultivation centers to provide them consulting, training, compliance and regulatory support.

During the first nine months of 2015, we received approximately $7,432,000 in net funding from our lenders.

On August 14, 2015, the Company entered into a Securities Purchase Agreement whereby the Company agreed to issue convertible debentures in the aggregate principal amount of approximately $4 million. Approximately $1.7 million of the commitment was funded before September 30, 2015. The remaining $2.3 million is expected to be funded in the fourth quarter of 2015 when we expect our Registration Statement on Form S-1 filed October 16, 2015 to become effective.

On August 20, 2015, the Company also entered into a Securities Purchase Agreement with another investor, in the aggregate principal amount of up to $1,500,000, which was amended on September 19, 2015, to increase the principal by an additional $200,000. Through September 30, 2015, two tranches totaling $500,000 have been funded. The remaining $1.2 million is expected to be funded in the fourth quarter of 2015 when we expect our second Registration Statement on Form S-1 filed in 2015 to become effective.

Management is actively seeking additional financing and expects to complete additional financing arrangements in the next few months. The Company expects that these plans will provide it the necessary liquidity to continue operations for the next 12 months.

The Company will continue to execute on its business model by attempting to raise additional capital through the sales of debt or equity securities or other means, however there is no guarantee that such financing will be available on terms acceptable to the Company, or at all. If the Company is unable to obtain adequate debt or equity financing, it may be forced to slow or reduce the scope of operations and expansion, and its business would be materially affected.

In addition, our VII subsidiary used cash for the production and promotion of its portable vaporizer product which we released in April 2015 at the Denver trade show. Our VII subsidiary is expected to be a net user of cash until the new product sales ramp up. VII is expected to swing to positive cash flow later in 2015.

On October 27, 2015 we filed an amendment to Articles of Incorporation in the State of Nevada to increase the authorized number of shares of the Company’s common stock from 100,000,000 shares to 400,000,000 shares, par value of $0.001 per share.

 

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Item 3. Quantitative and Qualitative Disclosures About Market Risk.

Not Applicable

Item 4. Controls and Procedures.

Evaluation of Disclosure Controls and Procedures

As of the end of the period covered by this report, our management, with the participation of our principal executive officer and principal financial officer, evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Based on their evaluation of our disclosure controls and procedures, our principal executive officer and principal financial officer, concluded that our disclosure controls and procedures were not effective as of September 30, 2015, to ensure that information required to be disclosed by the Company in the reports that we file or submit under the Exchange Act is (a) recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms and (b) accumulated and communicated to management, including our principal executive officer and principal financial officer, as appropriate to allow for timely decisions regarding required disclosure due to the need for more enhanced and formalized documentation regarding the financial statement closing and review process to ensure that the application of the Company’s accounting policies and the presentation of disclosures in the notes to the financial statements is adequate.

As reported in our Annual Report on Form 10-K for the year ended December 31, 2014, our management concluded that a material weaknesses existed. The Company is taking the following steps which it believes will remediate the material weakness.

 

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During the fourth quarter of 2014, the Company hired a new full time CFO. The Company anticipates that the CFO will assist the Company in the identification of required key controls, the necessary steps required for procedures to ensure the appropriate communication and review of inputs necessary for the financial statement closing process, as well as for the appropriate presentation of disclosures within the financial statements. With material, complex and non-routine transactions, management has, and will continue to, seek guidance from third-party experts and/or consultants to gain a thorough understanding of these transactions. The actions that we are taking are subject to ongoing senior management review and Audit Committee oversight. Management believes there have been improvements during the first nine months of 2015 and the continuing efforts will effectively remediate the material weakness which existed as of December 31, 2014 during 2015.

As we continue to evaluate and work to improve our internal control over financial reporting, management may execute additional measures to address potential control deficiencies or modify the remediation plan described above and will continue to review and make necessary changes to the overall design of our internal controls.

 

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PART II—OTHER INFORMATION

Item 1. Legal Proceedings.

Settlements

Class actions and derivative lawsuits were filed against and purportedly on behalf of the Company captioned (1) Josh Crystal v. Medbox, Inc., et al., in the U.S. District Court for Central District of California; (2) Matthew Donnino v. Medbox, Inc., et al., in the U.S. District Court for Central District of California; (3) Ervin Gutierrez v. Medbox, Inc., et al., in the U.S. District Court for Central District of California; (4) Mike Jones v. Guy Marsala, et al., in the U.S. District Court for Central District of California; (5) Jennifer Scheffer v. P. Vincent Mehdizadeh, et al., in the Eighth Judicial District Court of Nevada; (6) Kimberly Y. Freeman v. Pejman Vincent Mehdizadeh, et al., in the Eighth Judicial District Court of Nevada; (7) Tyler Gray v. Pejman Vincent Mehdizadeh, et al., in the U.S. District Court for the District of Nevada; (8) Robert J. Calabrese v. Ned L. Siegel, et al., in the U.S. District Court for the District of Nevada; (9) Patricia des Groseilliers v. Pejman Vincent Mehdizadeh, et al., in the U.S. District Court for the District of Nevada; (10) Michael A. Glinter v. Pejman Vincent Mehdizadeh, et al., in the Superior Court of the State of California for the County of Los Angeles. The complaints named as defendants the Company, prior and current members of the board of directors of the Company, and prior and current officers of the Company. The complaints alleged that the Company issued materially false and misleading statements regarding its financial results for the fiscal years ended December 31, 2012 and December 31, 2013 and each of the interim financial periods during those years and for each of the first three interim financial periods for the fiscal year ended 2014. The derivative lawsuits alleged breach of fiduciary duties, unjust enrichment, waste of corporate assets, abuse of control, and breach of duty of honest services.

On October 16, 2015, solely to avoid the costs, risks, and uncertainties inherent in litigation, the parties to the class actions and derivative lawsuits entered into settlements, that collectively effect a global settlement of all claims asserted in the class actions and the derivative actions. The global settlement provides, among other things, for the release and dismissal of all asserted claims. The global settlement is contingent on final court approval, respectively, of the settlements of the class actions and derivative actions. As a result of amounts already reflected in the Company’s financial statements, and the coverage by the Company’s insurance carrier, the final terms of the settlements are not expected to have a material adverse effect on the Company’s financial position or results of operations.

On October 27, 2015, Richard Merritts, derivatively and on behalf of nominal defendant Medbox, Inc., filed a suit in the Superior Court of the State of California for the County of Los Angeles against the Board and certain executive officers (Guy Marsala, J. Mitchell Lowe, Ned Siegel, Jennifer S. Love, C. Douglas Mitchell, Pejman Vincent Mehdizadeh, Matthew Feinstein, Bruce Bedrick, Jeff Goh, and Thomas Iwanski). The suit alleges breach of fiduciary duties by the defendants. Relief is sought awarding damages resulting from breach of fiduciary duty and to direct the Company and the defendants to take all necessary actions to reform and improve its corporate governance and internal procedures to comply with applicable law. Merritts’ lawsuit has not been served.

 

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Item 1A. Risk Factors.

In addition to the other information set forth in this report, you should carefully consider the factors discussed under “Risk Factors” as filed in the Company’s Form 10-K filed with the Securities and Exchange Commission on March 26, 2015 and the Company’s Quarterly Report on Form 10-Q filed with the Securities and Exchange Commission on May 15, 2015.

 

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Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.

October 2015 Debentures

On October 14, 2015, the Company issued seven debentures in the aggregate of $2,000,000 to a service provider (the “October 2015 Investor”) as consideration for services previously rendered to the Company on the same terms as the August 14 Debentures and August 14 Purchase Agreement (the “October 2015 Debentures” and “October 2015 Purchase Agreement”, respectively) except that the October 2015 Purchase Agreement does not provide for registration rights to the October 2015 Investor with regard to the shares underlying the October 2015 Debentures. The service provider has agreed with the Company not to convert the October 2015 Debentures for any amount in excess of fees payable for services previously rendered to the Company at the time of conversion. To the extent that the sale of shares underlying the October 2015 Debentures do not satisfy outstanding amounts payable to the service provider, such amounts will remain payable to the service provider by the Company.

Item 3. Defaults Upon Senior Securities.

None.

Item 4. Mine Safety Disclosures.

Not applicable.

Item 5. Other Information.

None.

 

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Item 6. Exhibits.

 

Exhibit No.

  

Description

  10.1    Agreement of Purchase and Sale of Membership Interest entered into July 23, 2015 between and East West Secured Development, LLC and the Company of 100% of the membership interest of EWSD I, LLC.*
  10.2    Secured Promissory Note of EWSD*
  10.3    Deed of Trust securing Promissory Note*
  10.4    Assignment of Rents and Leases encumbering the real property*
  10.5    Unsecured Promissory Note*
  10.6    First Amendment to Voting Agreement, dated August 11, 2015 among the Company, the VM Group and each member of the board of directors of the Company (previously filed as Exhibit 10.1 to the Company’s Current Report on Form 8-K filed with the Securities and Exchange Commission on August 19, 2015)
  10.7    Form of Securities Purchase Agreement, dated August 14, 2015 between the Company and the August 14, 2015 Investor (previously filed as Exhibit 10.2 to the Company’s Current Report on Form 8-K filed with the Securities and Exchange Commission on August 19, 2015)
  10.8    Registration Rights Agreement, dated August 14, 2015 between the Company and the August 14, 2015 Investor (previously filed as Exhibit 10.3 to the Company’s Current Report on Form 8-K filed with the Securities and Exchange Commission on August 19, 2015).
  10.9    Form of Debenture (previously filed as Exhibit 10.1 to the Company’s Current Report on Form 8-K filed with the Securities and Exchange Commission on August 19, 2015).
  10.10    Second Amendment to Voting Agreement, dated August 21, 2015 among the Company, the VM Group and each member of the board of directors of the Company (previously filed as Exhibit 10.1 to the Company’s first Current Report on Form 8-K filed with the Securities and Exchange Commission on August 26, 2015).
  10.11    Securities Purchase Agreement, dated August 20, 2015 between the Company and the August 20, 2015 Investor (previously filed as Exhibit 10.1 to the Company’s second Current Report on Form 8-K filed with the Securities and Exchange Commission on August 26, 2015).
  10.12    Registration Rights Agreement, dated August 20, 2015 between the Company and the August 20, 2015 Investor (previously filed as Exhibit 10.2 to the Company’s second Current Report on Form 8-K filed with the Securities and Exchange Commission on August 26, 2015).
  10.13    Form of Debenture under Securities Purchase Agreement (previously filed as Exhibit 10.3 to the Company’s second Current Report on Form 8-K filed with the Securities and Exchange Commission on August 26, 2015).
  10.14    Form of Warrant under Securities Purchase Agreement (previously filed as Exhibit 10.4 to the Company’s second Current Report on Form 8-K filed with the Securities and Exchange Commission on August 26, 2015)
  10.15    Form of Security Agreement, dated August 21, 2015 between the Company and certain investors (previously filed as Exhibit 10.5 to the Company’s second Current Report on Form 8-K filed with the Securities and Exchange Commission on August 26, 2015)
  10.16    First Amendment to Securities Purchase Agreement, dated September 4, 2015, among the Company and the August 14, 20145 Investor (previously filed as Exhibit 10.1 to the Company’s Current Report on Form 8-K filed with the Securities and Exchange Commission on September 11, 2015)
  10.17    Supplemental Agreement, dated September 18, 2015 between the Company and the September 2014 Investor (previously filed as Exhibit 10.1 to the Company’s Current Report on Form 8-K filed with the Securities and Exchange Commission on September 18, 2015).
  10.18    September 2014 Warrant Amendment, dated September 18, 2015 (previously filed as Exhibit 10.2 to the Company’s Current Report on Form 8-K filed with the Securities and Exchange Commission on September 18, 2015).
  10.19    Side Letter, dated September 22, 2015, to Securities Purchase Agreements, dated August 14, 2015 and July 21, 2014, as amended, and the 10% Convertible Debentures issued thereunder, among the Company and the August 14, 2015 Investor (previously filed as Exhibit 10.1 to the Company’s Current Report on Form 8-K filed with the Securities and Exchange Commission on September 28, 2015)
  10.20    Supplemental Agreement, dated September 28, 2015 between the Company and the July 2014 Investor (previously filed as Exhibit 10.1 to the Company’s Current Report on Form 8-K filed with the Securities and Exchange Commission on October 2, 2015).
  10.21    July 2014 Warrant Amendment, dated September 28, 2015 (previously filed as Exhibit 10.2 to the Company’s Current Report on Form 8-K filed with the Securities and Exchange Commission on October 2, 2015).
  10.22    Side Letter, dated September 29, 2015, to Securities Purchase Agreement, dated September 19, 2014, as amended, the 5% Convertible Debenture issued April 3, 2015 thereunder, and Securities Purchase Agreement, dated August 20, 2015, as amended, among the Company and the Investor (previously filed as Exhibit 10.1 to the Company’s Current Report on Form 8-K filed with the Securities and Exchange Commission on October 2, 2015).
  31.1    Certification of the Principal Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.*
  31.2    Certification of the Principal Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.*
  32.1    Certification of the Principal Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.*
  32.2    Certification of the Principal Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.*
101.INS    XBRL Instance Document.*
101.SCH    XBRL Taxonomy Extension Schema.*
101.CAL    XBRL Taxonomy Extension Calculation Linkbase.*
101.DEF    XBRL Taxonomy Extension Definition Linkbase.*
101.LAB    XBRL Taxonomy Extension Label Linkbase.*
101.PRE    XBRL Taxonomy Extension Presentation Linkbase.*

 

* Filed herewith.

 

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

    Medbox, Inc.
Date: November 12, 2015     By:  

/s/ Jeffrey Goh

      Jeffrey Goh
      Chief Executive Officer (principal executive officer)
Date: November 12, 2015     By:  

/s/ C. Douglas Mitchell

      C. Douglas Mitchell
      Chief Financial Officer (principal financial and accounting officer)

 

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