UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

 

Form 10-Q

 

 

 

(Mark One)

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

 

FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2016

 

OR 

 

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

 

COMMISSION FILE NUMBER: 000-54928

 

 

 

NOTIS GLOBAL, 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.)

 

633 West 5th Street, 28th Floor, Los Angeles CA   90071
(Address of principal executive offices)   (zip code)

 

(800) 762-1452

(Registrant’s telephone number, including area code)

 

600 Wilshire Blvd. Suite 1500, Los Angeles, CA 90017

(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 October 18, 2016, the registrant had 7,196,422,273  shares of common stock, par value $0.001 per share, outstanding.

 

 

 

 

NOTIS GLOBAL, INC.

 

TABLE OF CONTENTS

 

PART I – FINANCIAL INFORMATION 1
     
ITEM 1. Financial Statements 1
     
  Condensed Consolidated Balance Sheets as of June 30, 2016 (Unaudited) and December 31, 2015 1
     
  Condensed Consolidated Statements of Comprehensive Income (Loss) for the Three and Six Months Ended June 30, 2016 and 2015 (Unaudited) 2
     
  Condensed Consolidated Statement of Stockholders’ Deficit for the Six Months Ended June 30, 2016 (Unaudited) 3
     
  Condensed Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2016 and 2015 (Unaudited) 4
     
  Notes to Condensed Consolidated Financial Statements (Unaudited) 5
     
ITEM 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations 41
     
ITEM 3. Quantitative and Qualitative Disclosures About Market Risk 51
     
ITEM 4. Controls and Procedures 52
     
PART II – OTHER INFORMATION 53
   
ITEM 1. Legal Proceedings 53
     
ITEM 1A. Risk Factors 58
     
ITEM 2. Unregistered Sales of Equity Securities and Use of Proceeds 59
     
ITEM 3. Defaults Upon Senior Securities 59
     
ITEM 4. Mine Safety Disclosures 59
     
ITEM 5. Other Information 59
     
ITEM 6. Exhibits 60
     
SIGNATURES 61

 

 

 

 

PART I – FINANCIAL INFORMATION

 

Item 1. Financial Statements.

 

NOTIS GLOBAL, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

 

   June 30, 2016   December 31, 2015 
  (unaudited)     
Assets        
Current assets          
Cash and cash equivalents  $21,733   $119,010 
Marketable securities   28,390    9,410 
Accounts receivable   21,968    29,999 
Notes receivable   35,000    60,000 
Inventory   32,300    150,823 
Deposits in escrow   10,000    - 
Prepaid insurance   115,849    73,755 
Prepaid expenses and other current assets   323,241    83,663 
Total current assets   588,481    526,660 
           
Property and equipment, net of accumulated depreciation of $31,977 and $16,986, respectively   455,588    470,578 
Land   4,945,000    4,945,000 
Construction in progress   1,153,264    624,173 
Deferred Costs   -    375,018 
Deposits and other assets, net of reserve of $112,500 and $115,000, respectively   7,486    50,212 
Total assets  $7,149,819   $6,991,641 
           
Liabilities and Stockholders' Deficit          
Current liabilities          
Accounts payables  $5,670,863   $3,100,804 
Accrued interest payable   824,919    430,702 
Accrued expenses, directors   237,854    241,410 
Accrued settlement and severance expenses   653,313    962,703 
Accrued legal contingencies   412,538    185,225 
Other accrued expenses   174,154    275,269 
Deferred revenue, current   160,822    214,343 
Notes payable, net of premium of $10,000 and $16,667, respectively and discounts of $323,924 and $0, respectively   1,294,051    256,897 
Related party notes payable, net of discount of $12,000 and $0, respectively   277,866    - 
Convertible notes payable, net of discount of $0 and $151,414 , respectively   7,334,454    6,667,523 
Convertible notes payable, directors   105,000    - 
Derivative Liability   2,159,066    19,246,594 
Warrant Liability   5,552    940,000 
Customer deposits   931,204    931,204 
Total current liabilities   20,241,656    33,452,674 
           
Notes Payable, less current portion   4,044,206    4,288,631 
Deferred revenue, less current portion   258,203    337,523 
Total liabilities   24,544,065    38,078,828 
Commitments and contingencies (Note 11)          
Stockholders' Deficit          
Preferred stock, $0.001 par value: 10,000,000 authorized; 0 issued and outstanding as of June 30, 2016 and December 31, 2015, respectively   -    - 
Common stock, $0.001 par value: 10,000,000,000 authorized, 3,008,785,640 and 240,971,727  issued and outstanding as of June 30, 2016 and December 31, 2015, respectively   3,008,786    240,972 
Additional paid-in capital   45,709,863    42,600,089 
Treasury stock   (1,209,600)   (1,209,600)
Accumulated deficit   (64,728,521)   (72,524,893)
Accumulated other comprehensive loss   (174,774)   (193,755)
Total stockholders' deficit   (17,394,246)   (31,087,187)
Total liabilities and stockholders' deficit  $7,149,819   $6,991,641 

 

See notes to condensed consolidated financial statements.

 

 1 

 

 

NOTIS GLOBAL, INC.

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME(LOSS)

(UNAUDITED)

 

   For the three months ended   For the six months ended 
   June 30,   June 30, 
   2016   2015   2016   2015 
                 
Revenue  $246,233   $59,447   $474,147   $101,195 
Revenue, related party   25,192    24,918    49,836    49,562 
Less: allowances and refunds   -    -    -    - 
Net revenue   271,425    84,365    523,983    150,757 
Cost of revenues   194,311    867,025    370,730    1,181,328 
Gross profit(loss)   77,114    (782,660)   153,253    (1,030,571)
                     
Operating expenses                    
Selling and marketing   41,321    159,156    223,067    338,497 
General and administrative   2,483,166    5,236,018    6,233,455    9,121,614 
Total operating expenses   2,524,487    5,395,174    6,456,522    9,460,111 
Loss from operations   (2,447,373)   (6,177,834)   (6,303,269)   (10,490,682)
                     
Other income (expense)                    
Interest expense, net   (271,825)   (90,010)   (522,050)   (93,800)
Financing Costs   (544,736)   (1,774,750)   (3,060,579)   (2,299,632)
Change in fair value of derivative liabilities   9,940,307    814,213    18,819,893    3,053,071 
Change in fair value of warrant liability   441,148    -    997,121    - 
Amortization of debt discount   (745,150)   (4,229,977)   (2,613,227)   (6,049,639)
Gain on sale of assets of subsidiary   -    -    5,498    - 
Gain on sale of interest in subsidiary   331,000    -    630,571    - 
Loss on sale of rights and assets   (178,032)        (178,032)     
Other income   23,231    63,450    20,446    52,095 
Total other income (expense)   8,995,943    (5,217,074)   14,099,641    (5,337,905)
                     
Income/(loss) before provision for taxes   6,548,570    (11,394,908)   7,796,372    (15,828,587)
                     
Provision for taxes   -    -    -    - 
                     
Net income/(loss)  $6,548,570   $(11,394,908)  $7,796,372   $(15,828,587)
                     
Income/(loss) per share attributable to common stockholders                    
Basic  $0.01   $(0.32)  $0.02   $(0.47)
Diluted  $0.00   $(0.32)  $0.00   $(0.47)
Weighted average shares outstanding                    
Basic   701,378,818    36,100,385    506,569,535    33,435,964 
Diluted   10,739,100,799    36,100,385    5,605,827,806    33,435,964 
                     
Other Comprehensive income/(loss)                    
Net income/(loss)   6,548,570    (11,394,908)   7,796,372    (15,828,587)
Unrealized gain from marketable securities   15,847    57,476    18,981    40 
Comprehensive income/(loss)  $6,564,417   $(11,337,432)  $7,815,353   $(15,828,547)

 

See notes to condensed consolidated financial statements.

 

 2 

 

 

NOTIS GLOBAL, INC.

CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS’ DEFICIT

(UNAUDITED)

 

                            Additional      Accumulated Other   Total 
   Preferred Stock   Common Stock   Treasury Stock   Paid-In   Accumulated   Comprehensive   Stockholders' 
   Shares   Amount   Shares   Amount   Shares   Amount   Capital   Deficit   Loss   Deficit 
Balances at January 1, 2016   0   $-    240,971,727   $240,972    (60,000)  $(1,209,600)  $42,600,089   $(72,524,893)  $(193,755)  $(31,087,187)
Sale of common stock             851,063    851              15,149              16,000 
Stock-based compensation             24,232,402    24,232              620,291              644,523 
Issuance of shares to consultants             93,792,308    93,792              2,223              96,015 
Conversions of convertible notes payable             2,648,938,140    2,648,939              2,469,308              5,118,247 
Issuance of warrants in connection with convertible notes payable                                 46,000              46,000 
Reclassification of warrant liability out of equity                                 (62,673)             (62,673)
Warrants issued in connection with notes payable                                 19,476              19,476 
Unrealized gain from marketable securities                                           18,981    18,981 
Net income                                      7,796,372         7,796,372 
Balances at June 30, 2016   -   $-    3,008,785,640   $3,008,786    (60,000)  $(1,209,600)  $45,709,863   $(64,728,521)  $(174,774)  $(17,394,246)

 

See notes to condensed consolidated financial statements.

 

 3 

 

 

NOTIS GLOBAL, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(UNAUDITED)

 

   Six months ended June 30, 
   2016   2015 
Cash flows from operating activities          
Net income/(loss)  $7,796,372   $(15,828,587)
Adjustments to reconcile net loss to net cash:          
Depreciation and amortization   14,991    64,691 
Provisions and allowances   70,000    - 
Loss on sale of rights and assets   178,032    - 
Gain on sale of interest in subsidiary   (630,571)   - 
Charges from escrow deposits   -    240,400 
Inventory valuation reserve   -    354,939 
Change in fair value of derivative liability   (18,819,893)   (3,053,071)
Change in fair value of warrant liability   (997,121)   - 
Amortization of debt discount   2,613,227    6,049,639 
Financing costs   3,060,579    2,299,632 
Stock based compensation   644,523    4,292,209 
Changes in operating assets and liabilities          
Accounts receivable   8,031    8,774 
Inventory   48,523    228,634 
Deposits in escrow   (10,000)   20,076 
Prepaid insurance   (42,094)   (338,875)
Prepaid expenses and other current assets   (196,852)   (185,916)
Deferred costs   105,172    - 
Accounts payables   3,445,251    1,659,988 
Accrued interest payable   394,217    165,657 
Other accrued expenses   (101,115)   (488,135)
Accrued expenses directors   (3,556)   - 
Accrued settlement and severance expenses   (309,390)   1,004,486 
Accrued legal contingencies   227,313    - 
Customer deposits   -    (311,000)
Deferred revenue   (132,841)   (51,304)
Deferred costs   -    (299,018)
Net cash used in operating activities   (2,637,202)   (4,166,781)
           
Cash flows from investing activities          
Issuance of  note receivable   (10,000)   - 
Proceeds from the sale of subsidiary   35,000    - 
Proceeds received for sale of interest held in subsidiary   630,571    - 
Proceeds received for sale of rights and assets   91,814    - 
Construction in Progress   (529,091)   - 
Net cash provided by investing activities   218,294    - 
           
Cash flows from financing activities          
Payments on notes payable   (223,347)   (12,434)
Proceeds from issuance of notes payable   569,000    - 
Proceeds from issuance of/(payments on) notes payable, related party   41,667    (150,000)
Payments on related party notes payable   (2,500)   - 
Exercise of employee stock options   16,000    - 
Proceeds from issuance of convertible notes payable, net of fees   1,815,811    4,642,300 
Proceeds from issuance of convertible notes payable from directors, net   105,000    150,000 
Net cash provided by financing activities   2,321,631    4,629,866 
           
Net decrease in cash and cash equivalents   (97,277)   463,085 
Cash and cash equivalents, beginning of period   119,010    101,182 
Cash and cash equivalents, end of period  $21,733   $564,267 
           
Supplemental disclosures of cash flow information:          
           
Cash paid for interest  $38,595   $1,151 
Cash paid for income tax  $-   $- 
           
Non- cash investing and financing activities:          
Common stock issued upon debt conversion  $5,118,247   $5,810,512 
Common stock issued to consultants  $96,015   $364,728 
Issuance of note payable for financing costs  $700,000   $- 
Issuance of convertible debentures for accounts payable  $500,000   $- 
Notes Payable issued for accounts payable  $250,700   $- 

 

See notes to condensed consolidated financial statements.

 

 4 

 

 

NOTIS GLOBAL, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 

NOTE 1 – BUSINESS ORGANIZATION, NATURE OF OPERATIONS

 

Business Description

 

Notis Global, Inc., (formerly Medbox, Inc.) which is incorporated in the state of Nevada (the “Company”), provides specialized services to the hemp and marijuana industry, distributes hemp product processed by contractual partners and through June 30, 2016, owned independently and through affiliates, real property and licenses that it leased and assigned or sublicensed to partner cultivators and operators in return for a percentage of revenues or profits from sales and operations (Note 5). Prior to 2016, through its consulting services, Company worked with clients who sought to enter the medical and cultivation marijuana markets in those states where approved. In 2015, the Company expanded into hemp cultivation with the acquisition of a 320 acre farm in Colorado by the Company’s wholly owned subsidiary, EWSD 1, LLC. The farm was operated by an independent farming partner until the relationship was terminated in May 2016 (Note 3). In addition, through its wholly owned subsidiary, Vaporfection International, Inc. (“VII”), the Company sold a line of vaporizer and accessory products online and through distribution partners. On March 28, 2016, the Company sold the assets of VII and exited the vaporizer and accessory business. The Company is headquartered in Los Angeles, California.

 

Effective January 28, 2016, the Company changed its legal corporate name from Medbox, Inc., to Notis Global, Inc. The name change was effected through a parent/subsidiary short-form merger pursuant to Section 92A.180 of the Nevada Revised Statutes. Notis Global, Inc., the Company’s wholly-owned Nevada subsidiary formed solely for the purpose of the name change, was merged with and into the Company, with Notis Global, Inc. as the surviving entity. The merger had the effect of amending the Company’s Certificate of Incorporation to reflect the new legal name of the Company. There were no other changes to the Company’s Certificate of Incorporation. The Company’s Board of Directors approved the merger.

 

Notis Global, Inc., operates the business directly and through the utilization of 5 primary operating subsidiaries, as follows:

 

EWSD I, LLC, a Delaware corporation that owns property in Colorado.

  

Pueblo Agriculture Supply and Equipment, LLC, a Delaware corporation that was established to own extraction equipment

 

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

 

Vaporfection International, Inc., a Florida corporation through which we distributed our medical vaporizing products and accessories. (all the assets of which were sold during the three months ended March 31, 2016, see Note 6)

 

Medbox Property Investments, Inc., a California corporation specializing in real property acquisitions and leases for dispensaries and cultivation centers.  This corporation currently owns no real property.

 

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

 

San Diego Sunrise, LLC, a California corporation to hold San Diego, California dispensary operations. (as of June 30, 2016, the Company has sold its interest in San Diego Sunrise, LLC, see Note 5)

  

On March 3, 2014, in order to obtain the license for one of the Company’s clients, the Company registered an affiliated nonprofit corporation Allied Patient Care, Inc., in the State of Oregon. Additionally, on April 21, 2014, the Company registered an affiliated nonprofit corporation Alternative Health Cooperative, Inc. in the State of California. As a result of our sale of the Sunset and Portland dispensaries and related rights and assets, the Company no longer owns the rights to these nonprofit corporations. (Note 5)

 

On April 15, 2016, at a special meeting of the shareholders of the Company, the shareholders of the Company holding a majority of the total shares of outstanding common stock of the Company voted to amend the Company’s Articles of Incorporation to increase the number of authorized shares of common stock of the Company from 400,000,000 to 10,000,000,000 (the “Certificate of Amendment”). The Certificate of Amendment was filed with the Nevada Secretary of State and was declared effective on April 18, 2016.

 

 5 

 

 

NOTE 2 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

 

Going Concern

 

The condensed consolidated financial statements were prepared on a going concern basis. The going concern basis assumes that the Company will continue in operation for the foreseeable future and will be able to realize its assets and discharge its liabilities in the normal course of business. During the six months ended June 30, 2016, the Company had net income of approximately $7.8 million, negative cash flow from operations of $2.6 million and negative working capital of $19.7 million. During the year ended December 31, 2015, the Company had a net loss of approximately $50.5 million, negative cash flow from operations of $9.6 million and negative working capital of $32.9 million. The Company will need to raise capital in order to fund its operations. The Company is also in the process of obtaining final approval on a settlement agreement in their Class action and Derivative lawsuits (Note 11) and recently received a Wells Notice from the SEC (Note 11) in connection with misstatements by prior management in the Company’s financial statements for 2012, 2013 and the first three quarters of 2014. On September 22, 2016, the Company received notice of an Event of Default and Acceleration from one of its lenders regarding a Promissory Note issued on March 14, 2016. The Company has negotiated a 30 day forbearance on acceleration of the note. The Company is unable to predict the outcome of these matters, however, a rejection of the settlement agreements or adverse action of the SEC or legal action taken by the Company’s lenders could have a material adverse effect on the financial condition, results of operations and/or cash flows of the Company and their ability to raise funds in the future. These factors, among others, raise substantial doubt about the Company’s ability to continue as a going concern. The ability to continue as a going concern is dependent on the Company’s ability to raise additional capital and implement its business plan. The condensed consolidated financial statements do not include any adjustments that might be necessary if the Company is unable to continue as a going concern.

 

Management’s plans include:

 

The Company has received approximately $1,266,000, net of approximately $40,000 in withholdings, in additional closings under the June 30, 2016 funding (Note 7), subsequent to June 30, 2016. Additionally, on September 30, 2016, the Company entered into a securities purchase agreement with a new investor pursuant to which two wholly-owned subsidiaries of the Company, EWSD I, LLC (“EWSD I”) and Pueblo Agriculture Supply and Equipment, LLC (“Pueblo”, and together with EWSD I, the “Subsidiaries”) agreed to jointly sell, and the Investor agreed to purchase, an aggregate of up to $3,350,000 in subscription amount of discounted promissory notes (that could raise approximately $2,000,000 in cash, of which the Company has already received approximately $650,000) (Note 12).

 

The Company also expects that the acquisition of EWSD I, LLC (“EWSD”) (Note 3), who owns a 320-acre farm in Pueblo, Colorado, will generate recurring revenues for the Company through farming hemp, extracting and selling CBD oil, and collecting fees from production related to extracting CBD oil for other farmers, while controlling the full production cycle to ensure consistent quality. Lastly, management is actively seeking additional financing over the next few months to fund operations.

 

The Company will continue to execute on its business model by attempting to raise additional capital through the sales of debt or equity securities or other means. However, there is no guarantee that such financing will be available on terms acceptable to the Company, or at all. It is uncertain whether the Company can obtain financing to fund operating deficits until profitability is achieved. This need may be adversely impacted by: unavailability of financing, uncertain market conditions, the success of the crop growing season, the demand for CBD oil, the ability of the Company to obtain financing for the equipment and labor needed to cultivate hemp and extract the CBD oil,, and adverse operating results. The outcome of these matters cannot be predicted at this time.

 

On May 24, 2016, the Company received a notice from the OTC Markets Group, Inc. (“OTC Markets”) that the Company’s bid price is below $.01 and does not meet the Standards for Continued Eligibility for OTCQB as per the OTCQB Standards. If the bid price has not closed at or above $.01 for ten consecutive trading days by November 20, 2016, the Company will be moved to the OTC Pink marketplace. Additionally, on September 9th, the Company received notice from the OTC that OTC Markets would move the Company’s listing from the OTCQB market to OTC Pink Sheets market, if the Company had not filed this Quarterly Report on Form 10-Q for the period ended June 30, 2016 by September 30, 2016. On or about October 1, 2016, the Company moved to the OTC Pink Sheets market. These actions might also impact the Company's ability to obtain funding.

 

Principles of Consolidation

 

The condensed consolidated financial statements include the accounts of Notis Global, Inc. and its wholly owned subsidiaries, as named in Note 1 above. All intercompany transactions have been eliminated in consolidation.

 

Use of Estimates

 

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

 

 6 

 

 

Reclassification

 

The Company has reclassified certain prior fiscal year amounts in the accompanying condensed consolidated financial statements to be consistent with the current fiscal year presentation.

 

Concentrations of Credit Risk

 

The Company maintains cash balances at several financial institutions in the Los Angeles, California area and Iowa. Accounts at each institution are insured by the Federal Deposit Insurance Corporation up to $250,000. The Company has not experienced any losses in such accounts and periodically evaluates the credit worthiness of the financial institutions and has determined the credit exposure to be negligible.

 

Advertising and Marketing Costs

 

Advertising and marketing costs are expensed as incurred. The Company incurred advertising and marketing costs of approximately $0 and $319,000 for the three months ended June 30, 2016 and 2015, respectively and approximately $0 and $749,000 for the six months ended June 30, 2016 and 2015, respectively.

 

Fair Value of Financial Instruments

 

Pursuant to ASC No. 825, Financial Instruments, the Company is required to estimate the fair value of all financial instruments included on its balance sheets. The carrying value of cash, accounts receivable, other receivables, inventory, accounts payable and accrued expenses, notes payable, related party notes payable, customer deposits, provision for customer refunds and short term loans payable approximate their fair value due to the short period to maturity of these instruments.

 

Embedded derivative - The Company’s convertible notes payable include embedded features that require bifurcation due to a reset provision and are accounted for as a separate embedded derivative (see Note 7).

 

As of December 31, 2015, and for new issuances of convertible debentures during the fourth quarter of fiscal 2015, the Company estimated the fair value of the conversion feature derivatives embedded in the convertible debentures based on a Monte Carlo Simulation model (“MCS”). The MCS model was used to simulate the stock price of the Company from the valuation date through to the maturity date of the related debenture and to better estimate the fair value of the derivative liability due to the complex nature of the convertible debentures and embedded instruments. Management believes that the use of the MCS model compared to the black Scholes model as previously used would provide a better estimate of the fair value of these instruments. Beginning in the fourth quarter of 2015, using the MCS model, the Company valued these embedded derivatives using a “with-and-without method,” where the value of the Convertible Debentures including the embedded derivatives, is defined as the “with”, and the value of the Convertible Debentures excluding the embedded derivatives, is defined as the “without.” This method estimates the value of the embedded derivatives by observing the difference between the value of the Convertible Debentures with the embedded derivatives and the value of the Convertible Debentures without the embedded derivatives. The Company believes the “with-and-without method” results in a measurement that is more representative of the fair value of the embedded derivatives.

 

For each simulation path, the Company used the Geometric Brownian Motion (“GBM”) model to determine future stock prices at the maturity date. The inputs utilized in the application of the GBM model included a starting stock price, an expected term of each debenture remaining from the valuation date to maturity, an estimated volatility, and a risk-free rate.

 

For the six months ended June 30, 2016, the Company estimated the fair value of the conversion feature derivatives embedded in the convertible debentures based on an internally calculated adjustment to the MCS valuation determined at December 31, 2015. This adjustment took into consideration the changes in the assumptions, such as market value and expected volatility of the Company’s common stock, and the discount rate used in the December 31, 2015 valuation as compared to June 30, 2016.    The valuation also took into consideration the term in the debentures which limits the amounts converted to not result in the investor owning more than 4.99% of the outstanding common stock of the Company, after giving effect to the converted shares. The Company believes this methodology results in a reasonable fair value of the embedded derivatives for the interim period.

 

For the six months ended June 30, 2015, the Company estimated the fair value of the conversion feature derivatives embedded in the convertible debentures based on weighted probabilities of assumptions used in the Black Scholes pricing model. The key valuation assumptions used consists, in part, of the price of the Company’s common stock, a risk free interest rate based on the average yield of a Treasury note and expected volatility of the Company’s common stock all as of the measurement dates, and the various estimated reset exercise prices weighted by probability.

 

 7 

 

 

Warrants

 

The Company reexamined the determination made as of December 31, 2015 that they did not have sufficient authorized shares available for all of their outstanding warrants to be classified in equity at June 30, 2016, and concluded there still were insufficient authorized shares (Note 7). Therefore, the Company recognized a Warrant liability as of June 30, 2016. The Company estimated the fair value of the warrant liability based on a Black Scholes valuation model. The key assumptions used consist of the price of the Company’s stock, a risk free interest rate based on the average yield of a two or three year Treasury note (based on remaining term of the related warrants), and expected volatility of the Company’s common stock over the remaining life of the warrants.

 

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

 

Level 1Quoted prices in active markets for identical assets or liabilities.

 

Level 2Quoted 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 3Significant unobservable inputs that cannot be corroborated by market data.

 

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

 

   Total   Quoted Prices
in Active
Markets for
Identical
Assets or
Liabilities
(Level 1)
   Quoted Prices
for Similar
Assets or
Liabilities in
Active
Markets
(Level 2)
   Significant
Unobservable
Inputs
(Level 3)
 
June 30, 2016                    
Marketable securities  $28,390   $10,825   $   $17,565 
Total assets  $28,390   $10,825   $   $17,565 
                     
Warrant liability   5,552              5,552 
Derivative liability   2,159,066            2,159,066 
                     
Total liabilities  $2,164,618   $   $   $2,164,618 

  

   Total  

Quoted Prices

in Active

Markets for

Identical

Assets or

Liabilities

(Level 1)

  

Quoted Prices

for Similar

Assets or

Liabilities in

Active

Markets

(Level 2)

  

Significant

Unobservable

Inputs

(Level 3)

 
December 31, 2015                    
Marketable securities  $9,410   $5,629       $3,781
Total assets  $9,410   $5,629   $   $3,781 
                     
Warrant liability   940,000              940,000 
Derivative liability   19,246,594            19,246,594 
                     
Total liabilities  $20,186,594   $   $   $20,186,594 

 

 8 

 

 

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 six

months ended

June 30, 2016

 
   Total 
Beginning balance  $20,186,594 
Initial recognition of conversion feature   4,932,162 
Change in fair value of conversion feature   (18,819,893)
Reclassified to equity upon conversion   (3,199,797)
Additions to warrant liability   62,673 
Change in fair value of warrant liability   (997,121)
      
Ending Balance  $2,164,618 

 

Revenue Recognition

 

Prior to 2015, the Company entered into transactions with clients who are interested in being granted the right to have the Company engage exclusively with them in certain territories (which are described as territory rights) to obtain the necessary licenses to operate a dispensary or cultivation center for the location, and to consult in daily operations of the dispensary or cultivation center.

 

Terms for each transaction are varied and, prior to 2015, sales arrangements typically included the delivery of our dispensing technology and dispensary location build-out and/or consultation on the location, licensing, build out and operation of a cultivation center. Prior to 2015, the Company’s standard contracts had a five year term, calling for an upfront, non-refundable consulting fee, and containing options including acquiring a Medbox dispensary machine and having the Company perform the build-outs for the location, at set prices. The up-front fees under these contracts are recognized over the five year term, and are included in deferred revenue. The Company has determined these optional purchases each constituted a separate purchasing decision, and therefore are considered a separate arrangement for revenue recognition purposes. Revenue on each of these options are evaluated for recognition when and if the customer decides to enter into the arrangement.

 

In 2015 and the first quarter of 2016, the Company concentrated on revenue generating transactions to develop and set up dispensaries, including obtaining the conditional use permits (“CUP”) that grant the dispensary the authorization to operate, as well as cultivation centers. The Company entered into joint ventures and operating agreements, whereby separate unrelated party controls the operations of the dispensary or cultivation center, and the Company receives an agreed upon percentage of the revenue or profits of the operating entity. The revenue in the second quarter of 2016 consisted mainly of the recognition of previously deferred revenue and the sale of CBD oil.

 

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

 

Consulting fee revenues and build-outs

 

Prior to 2015, consulting fee revenues were a consistent component of our revenues and were negotiated at the time the Company entered into a contract. Consulting revenue consisted of providing ongoing consulting services over the life of the contract, to the established business in the areas of regulatory compliance, security, operations and other matters to operate the dispensary. The majority of the consulting fees from prior to 2015 arose from the upfront, non-refundable consulting fee in the Company’s standard contract, and were recognized using the straight line method over the life of the contract. Consulting fee revenue is only recognized when the following four criteria are met: 1) persuasive evidence of an arrangement exists, 2) delivery has occurred or services have been rendered, 3) sales price is fixed and determinable and 4) collectability is reasonably assured. Consulting fee revenue continues to be recognized in our income statement over the life of the aforementioned contracts.

 

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

 

Revenues from Operating Agreements

 

Under the foregoing business model, the Company entered into operating agreements with independent parties, giving the operator the rights to control the operations of a dispensary or cultivation center during the term of the agreement. In exchange, the Company earns a fee based on a percentage of the revenue or profit of the dispensary or cultivation center. The Company has determined they are not the principal in the revenue sharing agreements and recognizes revenue under these agreements on a net basis as the fees are earned and it has been concluded that collectability is reasonably assured.

 

 9 

 

 

Revenues from Cannabidiol oil product

 

The Company recognizes revenue from the sale of Cannabidiol oil products ("CBD oil") upon shipment when title passes and when collectability is reasonably assured.

 

Cost of Revenue

 

Cost of revenue consists primarily of expenses associated with the delivery and distribution of our products and services. Under our prior business model, we only began capitalizing costs when we have obtained a license and a site for operation of a customer dispensary or cultivation center. The previously capitalized costs are charged to cost of revenue in the same period that the associated revenue is earned. In the case where it is determined that previously inventoried costs are in excess of the projected net realizable value of the sale of the licenses, then the excess cost above net realizable value is written off to cost of revenues. Cost of revenues also includes the rent expense on master leases held in the Company’s name, which are subleased to the Company’s operators. In addition, cost of revenue related to our vaporizer line of products consists of direct procurement cost of the products along with costs associated with order fulfillment, shipping, inventory storage and inventory management costs.

 

Inventory

 

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

 

Capitalized agricultural costs

 

Pre-harvest agricultural costs, including irrigation, fertilization, seeding, laboring, and other ongoing crop and land maintenance activities, are accumulated and capitalized as inventory and cease to be accumulated when the crops reach maturity and is ready to be harvested. All costs incurred subsequent to the crops reaching maturity will be expensed as incurred.  The Company has reflected the capitalized agriculture costs as a current asset as the growing cycle of the crops are estimated to be approximately six months.

 

Basic and Diluted Net Loss Per Share

 

Basic net income/loss per share is computed by dividing net income (loss) available to common stockholders by the weighted average number of shares of common stock outstanding during the period. The Company did not consider any potential common shares in the computation of diluted loss per share for the three and six months ending June 30, 2016 and 2015, due to the net loss, as they would have an anti-dilutive effect on EPS.

 

As of March 31, 2015, the Company had 3,000,000 shares of Series A preferred stock outstanding with par value of $0.001 that could have been converted into 15,000,000 shares of the Company’s common stock. On August 24, 2015, 2,000,000 shares of Series A preferred stock were cancelled, leaving 1,000,000 shares outstanding, which were converted into common shares on November 16, 2015. There were no shares of Series A preferred stock outstanding at June 30, 2016. Additionally, the Company had approximately 67,466,000 and 338,000 warrants to purchase common stock outstanding as of June 30, 2016 and 2015, respectively, which were not included in the computation of diluted loss per share, as based on their exercise prices they would all have an anti-dilutive effect on net loss per share. The Company also had outstanding at June 30, 2016 and 2015 approximately $7,309,000 and $4,656,000 in convertible debentures, respectively, that are convertible at the holders’ option at a conversion price of the lower of $0.75 or 51% to 60% of either the lowest trading price or the VWAP over the last 20 to 30 days prior to conversion (subject to reset upon a future dilutive financing), whose underlying shares were not included in a computation of diluted loss per share due to the net loss.

 

Accounts Receivable and Allowance for Bad Debts

 

The Company is subject to credit risk as it extends credit to our customers for work performed as specified in individual contracts. The Company extends credit to its customers, mostly on an unsecured basis after performing certain credit analyses. Prior to 2015, our typical terms required the customer to pay a portion of the contract price up front and the rest upon certain agreed milestones. The Company’s management periodically reviews the creditworthiness of its customers and provides for probable uncollectible amounts through a charge to operations and a credit to an allowance for doubtful accounts based on our assessment of the current status of individual accounts. Accounts still outstanding after the Company has used reasonable collection efforts are written off through a charge to the allowance for doubtful accounts. As of June 30, 2016, the Company’s management considered all accounts outstanding fully collectible.

 

 10 

 

 

Property and Equipment

 

Property and equipment are recorded at cost. Expenditures for major additions and improvements are capitalized and minor replacements, maintenance, and repairs are charged to expense as incurred. When property and equipment are retired or otherwise disposed of, the cost and accumulated depreciation are removed from the accounts and any resulting gain or loss is included in the results of operations for the respective period. Depreciation is provided over the estimated useful lives of the related assets using the straight-line method for financial statement purposes. The Company uses accelerated depreciation methods for tax purposes where appropriate. The estimated useful lives for significant property and equipment categories are as follows:

 

Vehicles  5 years
Furniture and Fixtures  3 - 5 years
Office equipment  3 years
Machinery  2 years
Buildings  10 - 39 years

 

Income Taxes

 

The Company accounts for income taxes under the asset and liability method. The Company recognizes deferred tax liabilities and assets for the expected future tax consequences of events that have been included in the consolidated financial statements or tax returns. Under this method, deferred tax liabilities and assets are determined based on the difference between the financial statement and tax bases of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse. The components of the deferred tax assets and liabilities are classified as current and non-current based on their characteristics. A valuation allowance is provided for certain deferred tax assets if it is more likely than not that the Company will not realize tax assets through future operations.

 

In addition, the Company’s management performs an evaluation of all uncertain income tax positions taken or expected to be taken in the course of preparing the Company’s income tax returns to determine whether the income tax positions meet a “more likely than not” standard of being sustained under examination by the applicable taxing authorities. This evaluation is required to be performed for all open tax years, as defined by the various statutes of limitations, for federal and state purposes.

 

Commitments and Contingencies

 

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

 

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

 

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

 

The Company accrues all legal costs expected to be incurred per event. For legal matters covered by insurance, the Company accrues all legal costs expected to be incurred per event up to the amount of the deductible.

 

Recent Accounting Pronouncements

 

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

 

 11 

 

 

On July 22, 2015, the Financial Accounting Standards Board (“FASB”) issued a new standard that requires entities to measure most inventory “at the lower of cost and net realizable value,” thereby simplifying the current guidance under which an entity must measure inventory at the lower of cost or market. The new standard will not apply to inventories that are measured by using either the last-in, first-out (LIFO) method or the retail inventory method. The new standard will be effective for fiscal years beginning after December 15, 2016, and interim periods in fiscal years beginning after December 15, 2016. The Company is in the process of evaluating the impact of adoption on its consolidated financial statements.

 

In April 2015, the FASB issued a new standard that requires an entity to determine whether a cloud computing arrangement contains a software license. If the arrangement contains a software license, the entity would account for the fees related to the software license element in a manner consistent with how the acquisition of other software licenses is accounted for. If the arrangement does not contain a software license, the customer would account for the arrangement as a service contract. The new standard will be effective for fiscal years beginning after December 15, 2015, and interim periods in fiscal years beginning after December 15, 2016. The Company is in the process of evaluating the impact of adoption on its consolidated financial statements.

 

In February 2016, the FASB issued “Leases (Topic 842)” (ASU 2016-02). This update amends leasing accounting requirements. The most significant change will result in the recognition of lease assets and lease liabilities by lessees for those leases classified as operating leases under current guidance. The new guidance will also require significant additional disclosures about the amount, timing and uncertainty of cash flows from leases. ASU 2016-02 is effective for fiscal years and interim periods beginning after December 15, 2018, which for the Company is December 31, 2018, the first day of its 2019 fiscal year. Upon adoption, entities are required to recognize and measure leases at the beginning of the earliest period presented using a modified retrospective approach. Early adoption is permitted, and a number of optional practical expedients may be elected to simplify the impact of adoption. The Company is currently evaluating the impact of adopting this guidance. The overall impact is that assets and liabilities arising from leases are expected to increase based on the present value of remaining estimated lease payments at the time of adoption.

 

In March 2016, the FASB issued ASU 2016-09, Improvements to Employee Share-Based Payment Accounting, which amends Accounting Standards Codification ("ASC") Topic 718, Compensation – Stock Compensation.  ASU 2016-09 simplifies several aspects of the accounting for share-based payment transactions, including the income tax consequences, classification of awards as either equity or liabilities, and classification on the statement of cash flows. ASU 2016-09 is effective for fiscal years beginning after December 15, 2016, and interim periods within those fiscal years and early adoption is permitted. The Company is in the process of evaluating the impact of adoption on its consolidated financial statements.

 

Management’s Evaluation of Subsequent Events

 

The Company evaluates events that have occurred after the balance sheet date of June 30, 2016, through the date which the condensed consolidated financial statements were issued. Based upon the review, other than described in Note 12 – Subsequent Events, the Company did not identify any recognized or non-recognized subsequent events that would have required adjustment or disclosure in the condensed consolidated financial statements.

 

NOTE 3 – ASSET ACQUISITION

 

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

 

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

 

In connection with EWSD’s purchase of the Acquired Property, EWSD entered into a secured promissory note (the “Note”) with Southwest in the principal amount of $3,670,000 (Note 8). Interest on the outstanding principal balance of the Note shall accrue at the rate of five percent per annum. The Note shall be payable by EWSD in thirty-five payments of principal and interest, which shall be calculated based upon an amortization period of thirty years, commencing on September 1, 2015 and continuing thereafter on the first day of each calendar month through and including July 1, 2018; and one final balloon payment of all unpaid principal and accrued but unpaid interest on August 1, 2018. The Note is secured by a deed of trust, security agreement, assignment of rents and financing statement encumbering the Acquired Property.

 

 12 

 

 

EWSD also entered into an unsecured promissory note (the “Unsecured Note”) in the principal amount of $830,000 with the Seller (Note 8), in respect of payments previously made by Seller to Southwest in connection with acquiring the Farm. Interest on the outstanding principal balance of the Unsecured Note shall accrue at the rate of six percent per annum. The Unsecured Note shall be payable by EWSD in thirty-five payments of principal and interest, which shall be calculated based upon an amortization period of thirty years, commencing on September 1, 2015 and continuing thereafter on the first day of each calendar month through and including July 1, 2018; and one final balloon payment of all unpaid principal and accrued but unpaid interest on August 1, 2018.

 

Farming Agreement

 

On December 18, 2015, the Company and its subsidiary EWSD I, LLC (“EWSD”), entered into a Farming Agreement (the “Farming Agreement”) with Whole Hemp Company (“Whole Hemp” now known as “Folium Biosciences”), pursuant to which Folium Biosciences would manufacture products from hemp and cannabis crops it would grow on EWSD farmland, and the Company would build greenhouses for such activities up to an aggregate size of 200,000 square feet. Folium Biosciences would pay all preapproved costs of such construction on or before September 30, 2017 as partial consideration for a revocable license to use the greenhouses and a separate 10 acre plot of EWSD farmland (the “10 Acres”). EWSD would retain ownership of the greenhouses. For the first growing season commencing October 1, 2016, the Company would receive a percentage of gross sales of all Folium Bioscience's products on a monthly basis, and the Company’s share would increase incrementally based on the extent of crops planted on EWSD farmland according to a mutually agreed schedule. In addition, the Company would receive 50% of Folium Biosciences gross profits from the farming activities on the 10 Acres. The Company planned to recognize all revenue from the Farming Agreement at the net amount received when it has been earned and determined collectable.

 

Pursuant to the Farming Agreement, the Company also granted Folium Biosciences a warrant to purchase 4,000,000 shares of Company common stock at an exercise price of $0.50 per share, exercisable at any time within 5 years. The warrants were valued at $76,000, using a Black Scholes Merton Model, with key valuation assumptions used that consist of the price of the Company’s stock at settlement date, a risk free interest rate based on the average yield of a 5 year Treasury note and expected volatility of the Company’s common stock all as of the measurement date. The fair value of the warrants is included in deferred costs and will be recognized over the life of the Farming Agreement. Due to the termination of the Farming and Growers Distribution Agreements, as discussed below, as of June 30, 2016, this amount has been fully amortized.

 

On March 11, 2016, the Company and EWSD entered into a First Amended and Restated Farming Agreement with Whole Hemp, amending and restating in certain respects the Farming Agreement. The First Amended and Restated Farming Agreement clarifies that EWSD, rather than the Company, would be responsible for the building of greenhouses to be utilized by Whole Hemp for growing hemp and cannabis crops pursuant to the agreement, and that EWSD would be the recipient of all payments by Whole Hemp (including all revenue sharing arrangements) under the agreement.

 

On or about May 7, 2016, the Company determined that Folium Biosciences was in default of the Farming Agreement, principally because they abandoned their obligation to provide farming activities under the First Amended and Restated Farming Agreement. On May 13, 2016, EWSD notified Folium Biosciences of its defaults under the First Amended and Restated Farming Agreement and EWSD’s election to terminate the First Amended and Restated Farming Agreement.

 

By its terms, the First Amended and Restated Farming Agreement may be terminated at any time by either party, if the other party was in material breach of any obligation under the First Amended and Restated Farming Agreement, which breach continued uncured for 30 days following written notice thereof.

 

On June 1, 2016, a complaint was filed by Whole Hemp on this matter, naming Notis Global, Inc. and EWSD I, LLC, as defendants. See Whole Hemp Complaint, below.

 

Growers’ Distributor Agreement

 

On December 18, 2015, the Company also entered into a Growers’ Agent Agreement with Folium Biosciences, which was amended on March 11, 2016, to change the name of the agreement to Growers’ Distributor Agreement, (“Distributor Agreement”) as well clarify some terms. Pursuant to the Distributor Agreement, the Company would provide marketing, sales, and related services on behalf of Folium Biosciences in connection with the sale of its Cannabidiol oil product ("CBD oil"), from which the Company would receive a percentage of gross revenues (other than the sale of such product generated from the EWSD 10 Acres and the Folium Biosciences 40 acre plot subject to the Farming Agreement). The Growers’ Agent Agreement was effective until September 30, 2025. The Company would sell the product on behalf of Folium Biosciences on a commission basis. The Company may not act as agent of any other grower, distributor or manufacturer of the same product unless such other party agrees.

 

 13 

 

 

On March 11, 2016, the Company and EWSD entered into a First Amended and Restated Grower’s Distributor Agreement with Whole Hemp, amending and restating in certain respects the Grower’s Agent Agreement, including by substituting EWSD as a party in-place of the Company.

 

Because the Company believes Folium Biosciences is in default, principally because they abandoned their obligation to provide farming activities under the First Amended and Restated Farming Agreement since May 7, 2016, EWSD notified Whole Hemp on May 13, 2016 of its election to terminate the Restated Grower’s Distributor Agreement.

 

By its terms, the Restated Grower’s Distributor Agreement could be terminated at any time by either party, if the other party was in material breach of any obligation under the Restated Grower’s Distributor Agreement, which breach continued uncured for 30 days following written notice thereof.

 

As the Company continued to navigate the nascent world of hemp and CBD growing, cultivation, production and sales, it became clear that controlling all aspects of the business is the best strategy to ensure that the Company’s goals are met. Again, the Company is taking action now to protect the investment all the stakeholders have made in Notis Global.

 

Whole Hemp complaint

 

A complaint was filed by Whole Hemp Company, LLC d/b/a Folium Biosciences (“Whole Hemp”) on June 1, 2016, naming Notis Global, Inc. and EWSD I, LLC (collectively, “Notis”), as defendants in Pueblo County, CO district court.  The complaint alleges five causes of action against Notis:  misappropriation of trade secrets, civil theft, intentional interference with prospective business advantage, civil conspiracy, and breach of contract.  All claims concern contracts between Whole Hemp and Notis for the Farming Agreement and the Distributor Agreement. 

 

The court entered an ex parte temporary restraining order on June 2, 2016, and a modified temporary restraining order on July 14, 2016, enjoining Notis from disclosing, using, copying, conveying, transferring, or transmitting Whole Hemp’s trade secrets, including Whole Hemp’s plants.  On June 13, 2016, the court ordered that all claims be submitted to arbitration, except for the disposition of the temporary restraining order. 

 

On August 12, 2016, the court ordered that all of Whole Hemp’s plants in Notis’ possession be destroyed, which occurred by August 24, 2016, at which time the temporary restraining order was dissolved and the parties will soon file a motion to dismiss the district court action. 

 

In light of the Whole Hemp plants all being destroyed per the court order, the Company has immediately expensed all Capitalized agricultural costs as of June 30, 2016, as all costs as of that date related to Whole Hemp plants.

 

Notis commenced arbitration in Denver, CO on August 2, 2016, seeking injunctive relief and alleging breaches of the contracts between the parties.  Whole Hemp filed is Answer and counterclaims on September 6, 2016, asserting similar allegations that were asserted to the court.

 

On September 30, 2016, the arbitrator held an initial status conference and agreed to allow EWSD and Notis to file a motion to dismiss some or all of Whole Hemp’s claims by no later than October 28, 2016. The parties were also ordered to make initial disclosures of relevant documents and persons with knowledge of relevant information by October 21, 2016.

 

NOTE 4 – INVENTORY

 

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

 

Inventory at June 30, 2016 and December 31, 2015 consists of the following:

 

   June 30, 2016   December 31, 2015 
Vaporizers and accessories  $      $81,934 
CBD Oil   32,300    35,889 
Light Bulbs for cultivation centers       33,000 
           
Total inventory, net  $32,300   $150,823 

 

The Company did not write down any slow moving or obsolete inventory during the six months ended June 30, 2016 and 2015.

 

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NOTE 5 – DISPENSARIES

 

Portland

 

The Company held a license to operate a dispensary in Portland, Oregon, and a master lease on the property in which the dispensary is located. In April 2015, the Company entered into an Operating Agreement (“Original Agreement”) with an unrelated party (the “Operator”) in which the Operator was to manage and operate the Dispensary. The Original Agreement also included an annual Licensor Fee of 5% of the annual Gross Revenues, which would have begun after the additional fees related to the startup of the new venture had been paid in full.

 

On December 3, 2015 the Company replaced the original operator of the Portland dispensary with another operator under a new Operator Agreement (the “Agreement”). Per the terms of the Agreement, the Dispensary was “under the exclusive supervision and control of Operator, which shall be responsible for the proper and efficient operation of the Dispensary”. The term of the Agreement includes an initial term of five years, and a renewal term for an additional five years. The renewal term is at the discretion of the Operator. There is a License fee, which is based on a flat 10% of Gross Revenues. The Company’s management has determined that under this Agreement they do not hold the controlling financial interest in the Dispensary and are not the primary beneficiary, and therefore did not consolidate the Dispensary in their consolidated financial statements.

 

On June 30, 2016, the Company entered into an Assignment Agreement whereby they sold and assigned all of its rights in the Operating Agreement, including but not limited to the assets and liabilities the Company held in relation to the Portland Dispensary, including the license to operate a dispensary in Portland, Oregon. The assets consisted mainly of tenant improvements and other capitalized costs incurred in connection with the Portland dispensary, categorized as Deferred Costs on the Company's Balance Sheet, at a carrying value of approximately $270,000. The gross consideration paid for the assets and liabilities as stated in the agreement was $150,000, with approximately $58,000 of this amount paid to the State of Oregon for outstanding sales taxes, resulting in net proceeds of approximately $92,000, providing for a net loss of $178,000 on sale of assets.

 

Sunrise Property Investments, LLC

 

On December 3, 2015, the Company entered into an Operating Agreement with PSM Investment Group, LLC (“PSM”), for the governance of Sunrise Property Investments, LLC (“Sunrise”). Pursuant to the agreement, each of the two members contributed 50% of the capital of Sunrise. The Company’s contribution to the investment was the conditional use permit for the location, which was determined to have a zero cost basis, based on its carrying value in the Company’s financial statements. Sunrise acquired the property on which a dispensary will be located in San Diego on December 31, 2015. The Company has determined it should not consolidate the financial position and results of operations in its consolidated financial statements as it does not hold greater than 50% voting interest or is able to exercise influence over the operations and management in Sunrise. Instead, the Company accounts for Sunrise as an equity method investment. No income or loss has been recognized from Sunrise for the year ending December 31, 2015.

 

Alternative Health Cooperative, Inc. (“Alternative”) is a not-for-profit corporation, managed by an employee of Notis Global, which holds the conditional user permit (“CUP”) to run the dispensary. On January 1, 2016, Sunrise entered into an Operator Agreement with Alternative for Sunrise to operate the dispensary located on the Sunrise property. The Operator Agreement engages Sunrise to “supervise, direct and control the management of the dispensary”. The Agreement also states that the operation of the dispensary shall be under the exclusive supervision and control of Sunrise which shall be responsible for the proper and efficient operation of the dispensary. The Company had determined that under the operating agreement neither it nor Alternative hold the controlling financial interest in the dispensary, but that Sunrise is the controlling entity. Therefore, the Company did not consolidate the dispensary in its consolidated financial statements.

 

The Company incorporated a new wholly owned subsidiary, San Diego Sunrise, LLC (“San Diego Sunrise”), on February 22, 2016, in order to enter into a partnership agreement with PSM Investments to create an entity which would control the dispensary operations. Thereafter, Sunrise Dispensary LLC (“Dispensary”) was incorporated by PSM Investments and San Diego Sunrise on February 24, 2016, with each party holding a 50% ownership interest in the new entity. Immediately after which, Sunrise assigned the Operating Agreement with Alternative to Dispensary. The Company therefore indirectly held a 50% interest in the Sunrise Dispensary, through its subsidiary, San Diego Sunrise.

 

In February 2016, the Company sold 70% of its ownership interest in San Diego Sunrise for approximately $299,000. As of June 30, 2016, the Company owned 50% of Sunrise and 30% of San Diego Sunrise. These investments are accounted for under the equity method, with the Company’s proportionate share of the income or losses of the investments reflected in the Company’s financial statements. There has been no activity, aside from the sale of the Company’s ownership interests, in these investees as of, and for the three months ended, June 30, 2016.

 

On April 6, 2016, the Company sold its remaining 30% interest in San Diego Sunrise, as well as all of its interest in Sunrise Property Investments, LLC, the entity that owns underlying real estate related to the San Diego dispensary, for net proceeds of $331,000.

 

 15 

 

 

Sunrise Delivery

 

On November 24, 2015, the Company entered into a Management Agreement (“the Agreement”) with Rise Industries (“the Operator”) for a delivery service to be called Sunrise Delivery, operating under the conditional use permit awarded to the Sunrise Dispensary. The delivery service began operations on December 19, 2015 and, due to the short period between commencement of operations and the year end, the results of operations were not material for the year ended December 31, 2015.

 

Under the Agreement, the Operator is fully and solely responsible to collect all revenue and pay all expenses arising from the delivery service, including acquisition of inventory. The Company’s name is not being used in connection with any advertising, marketing, product or delivery services provided by the Operator. The Company determined that under the Agreement they do not hold the controlling financial interest in the delivery service and the Operator is the controlling entity. Therefore, the Company did not consolidate Sunrise Delivery in their financial statements. The Company also evaluated whether the revenue earned from the delivery service should be recognized at the gross or net amount. As the Company meets the three indicators of being an agent, the Company will report the earnings or losses from the delivery service on a net basis, under the equity method of accounting.

  

On December 9, 2015, the Company provided a $60,000 loan to Sunrise Delivery for working capital, with interest at prime and payable in one year and added an additional advance of $10,000 in the first quarter of 2016. In connection with the sale of their interests in the San Diego dispensary, the Company wrote off the loans totaling $70,000 as uncollectible at the end of the first quarter of 2016.

 

Washington

 

In the course of seeking licenses for new locations, the Company has to enter into real estate purchase agreements in order to secure the sites to be developed for clients’ dispensaries and cultivation centers. During the second quarter of 2014, one of the Company’s subsidiaries entered into a real estate purchase agreement for a property in the State of Washington. The purchase transaction was closed during the third quarter of 2014 for a total purchase price of $399,594, partially financed by a promissory note for $249,000. The note was due January 30, 2015 and bore interest at twelve percent (12%). The Company did not repay the note on its maturity date, and therefore began incurring interest at the default interest rate of eighteen percent (18%) per annum. On September 30, 2015, the Company, through its subsidiary MJ Property Investments, and the seller of the property entered into an amendment to the Note Payable, whereby the maturity date was extended to April 1, 2017, and the interest rate returned to twelve percent (12%) per annum (see Note 8). The Company did not make their May or June interest payments, and on July 26, 2016 they were notified they were in default on the note, which resulted in the Company incurring interest at the default interest rate of 18%, beginning in May 2016. The Company is in discussions regarding settlement of this note.

 

NOTE 6 – VAPORFECTION INTERNATIONAL, INC.

 

The Company acquired certain intangible assets with its purchase of 100% of the outstanding common stock of Vaporfection International Inc. (“VII”) on April 1, 2013. The Company accounts for intangible assets acquired in a business combination, if any, under the purchase method of accounting at their estimated fair values at the date of acquisition. Intangibles are either amortized over their estimated lives, if a definite life is determined, or are not amortized if their life is considered indefinite.

 

On December 31, 2015, the Company re-evaluated the future value of the intangible assets and determined none of the carrying value of the intangible assets were recoverable, and its carrying value exceeded its fair value. Therefore, the Company recognized an impairment loss on Intangibles of $586,000.

 

On December 31, 2015, the Company also performed the first step of the Goodwill impairment test, and, based on the same conclusions as above, determined there were indications of impairment of the Goodwill and they had to perform the second step of the impairment test, which compares the carrying value of the Goodwill to the implied Goodwill. The Company re-evaluated the fair value of all the associated assets of VII at December 31, 2015 and determined that there was no implied Goodwill. As there is no implied Goodwill, the impairment loss recognized was the entire carrying value of Goodwill, approximately $1,260,000.

 

In light of these impairments, as discussed above, the Company wrote down all other assets related to the business, such as fixed assets and costs to develop the website as of December 31, 2015, resulting in a impairment of approximately $80,000. The Company also wrote down the Inventory of VII to its estimated fair value of $82,000.

 

The Board made a decision the last week of January 2016, to sell the assets of Vaporfection and exit the vaporizer business and sell the remaining inventory and related assets during the first half of 2016. The Company analyzed if Vaporfection should be presented as a Discontinued Operation under the guidance of ASC 205, Presentation of Financial Statements, 20, Discontinued Operations, (“ASC 205-20”), and determined the decision to exit the Vaporfection business was not a strategic shift in the Company’s business, as the Board and management did not consider the strategy for the business to be built around the sale of vape machines or peripherals.

 

On March 28, 2016, the Company sold the assets of the subsidiary for $70,000, which was payable $35,000 at the closing and with a 6% Note Payable, due September 30, 2016. The Company recognized approximately $6,000 as a gain on sale of the assets of their subsidiary for the six months ended June 30, 2016.

 

 16 

 

 

NOTE 7 – CONVERTIBLE NOTES PAYABLE AND DERIVATIVE LIABILITY

 

July and September 2014 Debentures

 

On July 21, 2014, as amended on September 19, 2014 and October 20, 2014, the Company entered into a Securities Purchase Agreement whereby the Company agreed to issue convertible debentures (“July 2014 Debentures”) in the aggregate principal amount of $3,500,000, in five tranches. The July 2014 Debentures bore interest at the rate of 10% per year. The debt was due July 21, 2015.

  

Also on September 19, 2014, as amended on October 20, 2014, the Company entered into a securities purchase agreement pursuant to which it agreed to issue convertible debentures (“September 2014 Debentures”) in the aggregate principal amount of $2,500,000, in two tranches. The September 2014 Debentures bore interest at the rate of 5% per year. The debt was due September 19, 2015.

 

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

 

All amounts are convertible at any time, in whole or in part, at the option of the holders into shares of the Company’s common stock at a conversion price. The Notes were initially convertible into shares of the Company’s common stock at the initial Fixed Conversion Price of $11.75 per share. The Fixed Conversion Price is subject to adjustment for stock splits, combinations or similar events. If the Company makes any subsequent equity sales (subject to certain exceptions), under which an effective price per share is lower than the Fixed Conversion Price, then the conversion price will be reduced to equal such price. The Company may make the amortization payments on the debt in cash, prompting a 30% premium or, subject to certain conditions, in shares of common stock valued at 70% of the lowest volume weighted average price of the common stock for the 20 prior trading days.

 

The conversion feature of the July 2014 Debenture and the September 2014 Debenture meets the definition of a derivative and due to the reset provision to occur upon subsequent sales of securities at a price lower than the fixed conversion price, requires bifurcation and is accounted for as a derivative liability, with a discount created on the Debentures that would be amortized over the life of the Debentures using the effective interest rate method. The fair value of the embedded derivative is measured and recognized at fair value each subsequent reporting period and the changes in fair value are recognized in the Statement of Operations as Change in fair value of derivative liability. See Note 2 Fair value of financial instruments for additional information on the fair value and gains or losses on the embedded derivative.

 

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

 

On January 30, 2015, the Company and certain of 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. The Modification also eliminated the amortization payments discussed above, and provided for accrued and unpaid interest to be payable upon conversion or maturity rather than on specified payment dates. The Company was also required to open a new dispensary in Portland, Oregon through a licensed operator during the first calendar quarter of 2015 (which was later modified to April 30, 2015). The Company also had to file the Registration Statement by March 8, 2015 (later amended), and it had to be declared effective by June 15, 2015 in order to avoid default and acceleration under the Amended and Restated Debenture. As noted above, the Registration Statement was filed on April 9, 2015, and became effective June 11, 2015.

 

As part of the January 30, 2015 Modification, the parties entered into a Modified Debenture Agreement for the $200,000 that was funded at the Closing and agreed to use the same form of Modified Debenture for each of the other foregoing Modified Closings (collectively, the “Modified Debentures”). The fixed conversion price of the Modified Debenture on January 30, 2015 was the lower of $5.00 or 51% of the lowest volume weighted average price for the 20 consecutive trading days prior to the applicable conversion date. This new fixed conversion price was a dilutive issuance to the outstanding July 2014 and September 2014 Debentures, thereby triggering a reset of the older fixed conversion price. As a result of the reset to the conversion price, at January 30, 2015, the derivative liability was re-measured to a fair value of approximately $2,690,000, using a weighted probability model as estimated by management. A decrease in fair value of the derivative liability of approximately $1,072,000 was recognized as a gain on the Statement of Consolidated Comprehensive Loss, in the three months ended March 31, 2015.

 

The additional Modified Debentures under the July 2014 Debentures as of closing dates had a fixed conversion price of the lower of $1.83 or 51% of the VWAP for the last 20 days prior to the conversion. This new fixed conversion price was a dilutive issuance to the outstanding July 2014 and September 2014 Debentures, thereby triggering a reset of the previous $5 fixed conversion price. This reset resulted in the derivative liability being revalued at February 27, 2015, using a weighted probability model for a fair value of $2,720,000.

 

 17 

 

 

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 September 2014 Debentures, thereby triggering a reset of the previous $5.00 fixed conversion price. The resulting reset and re-measurement of the fair value of the derivative liability is included in the amounts of the change to fair value discussed above.

 

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

 

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

 

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

 

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

 

August 2015 Debentures

 

On August 14, 2015, the Company entered into a Securities Purchase Agreement whereby they agreed to issue convertible debentures in the aggregate principal amount of up to $3,979,877 to certain Investors. The initial closing in the aggregate principal amount of $650,000 occurred on August 14, 2015. An additional 11 payments were made in the total amount of $2,434,143 through December 31, 2015. The August 2015 Debentures bear interest at the rate of 10% per year. During the first quarter of 2016, an additional approximately $895,000 was funded.

 

On August 20, 2015, the Company also entered into a Securities Purchase Agreement with 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.

 

The August 2015 Debentures contain the following significant terms:

 

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

 

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

 

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

 

 18 

 

 

The conversion feature of the August 2015 Debenture meets the definition of a derivative and due to the reset provision to occur upon subsequent sales of securities at a price lower than the fixed conversion price, requires bifurcation and is accounted for as a derivative liability. The derivatives related to all closings on the August 2015 debentures were initially recognized at estimated fair values of approximately $11,205,000 and created a discount on the Debentures that will be amortized over the life of the Debentures using the effective interest rate method. The fair value of the embedded derivative is measured and recognized at fair value each subsequent reporting period and the changes in fair value are recognized in the Statement of Comprehensive Income (Loss) as Change in fair value of derivative liability. For the year ended December 31, 2014, and the interim periods through September 30, 2015, the Company estimated the fair value of the conversion feature derivatives embedded in the convertible debentures based on weighted probabilities of assumptions used in the Black Scholes pricing model. The key valuation assumptions used consists, in part, of the price of the Company’s common stock, ranging from $8.81 down to $0.05; a risk free interest rate ranging from 0.41% to 0.12% and expected volatility of the Company’s common stock, ranging from 196.78% to 106.38%, and the various estimated reset exercise prices weighted by probability.

 

As of December 31, 2015, and for new issuances of convertible debentures during the fourth quarter of fiscal 2015, the Company estimated the fair value of the conversion feature derivatives embedded in the convertible debentures based on a Monte Carlo Simulation model (“MCS”). The MCS model was used to simulate the stock price of the Company from the valuation date through to the maturity date of the related debenture and to better estimate the fair value of the derivative liability due to the complex nature of the convertible debentures and embedded instruments. Management believes that the use of the MCS model compared to the black Scholes model as previously used would provide a better estimate of the fair value of these instruments. Beginning in the fourth quarter of 2015, using the MCS model, the Company valued these embedded derivatives using a “with-and-without method,” where the value of the Convertible Debentures including the embedded derivatives, is defined as the “with”, and the value of the Convertible Debentures excluding the embedded derivatives, is defined as the “without.” This method estimates the value of the embedded derivatives by observing the difference between the value of the Convertible Debentures with the embedded derivatives and the value of the Convertible Debentures without the embedded derivatives. The Company believes the “with-and-without method” results in a measurement that is more representative of the fair value of the embedded derivatives.

 

For each simulation path, the Company used the Geometric Brownian Motion (“GBM”) model to determine future stock prices at the maturity date. The inputs utilized in the application of the GBM model included a starting stock price ranging from $0.03 to $0.10, an expected term of each debenture remaining from the valuation date to maturity ranging from .24 years to 1.04 years, an estimated volatility of ranging from 193% to 219%, and a risk-free rate ranging from .20% to .70%. See Note 2 Fair value of financial instruments for additional information on the fair value and gains or losses on the embedded derivative.

 

For the six months ended June 30, 2016, the Company estimated the fair value of the conversion feature derivatives embedded in the convertible debentures based on an internally calculated adjustment to the MCS valuation determined at December 31, 2015. This adjustment took into consideration the changes in the assumptions, such as market value and expected volatility of the Company’s common stock, and the discount rate used in the December 31, 2015 valuation as compared to June 30, 2016. The valuation also took into consideration the term in the debentures which limits the amounts converted to not result in the investor owning more than 4.99% of the outstanding common stock of the Company, after giving effect to the converted shares. The Company believes this methodology results in a reasonable fair value of the embedded derivatives for the interim period.

 

Entry into Security Agreement

 

In connection with entry into the August 20 Purchase Agreement and August 14 Purchase Agreement, the Investors and the Company entered into a Security Agreement, dated August 21, 2015, securing the amounts underlying the August 14 Debentures and the August 20 Debentures. The Security Agreement grants a security interest in all assets and personal property of the Company, subject to certain excluded real property assets. The security interests under the Security Agreement terminated following the date that the registration statement registering the shares underlying the Convertible Debentures was declared effective, which occurred on December 15, 2015.

 

July 2015 Debenture

 

On July 10, 2015, another accredited Investor and affiliate of the July 2014 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.

 

 19 

 

 

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

 

October 2015 Debentures

 

On October 14, 2015, the Company issued seven debentures in the aggregate of $2,000,000 to a service provider (the “October 2015 Investor”) as consideration for services previously rendered to the Company on the same terms as the August 14 Debentures and August 14 Purchase Agreement (the “October 2015 Debentures” and “October 2015 Purchase Agreement”, respectively) except that the October 2015 Purchase Agreement does not provide for registration rights to the October 2015 Investor with regard to the shares underlying the October 2015 Debentures. The service provider has agreed with the Company not to convert the October 2015 Debentures for any amount in excess of fees payable for services previously rendered to the Company at the time of conversion. To the extent that the sale of shares underlying the October 2015 Debentures do not satisfy outstanding amounts payable to the service provider, such amounts will remain payable to the service provider by the Company. In the three months ending June 30, 2016, funding closed on $425,000 of the October 2015 debentures.

 

December 28, 2015 Amendment and Restriction Agreement

 

On December 28, 2015, the Company, the August 14 Investor and the August 20 Investor entered into a Debenture Amendment and Restriction Agreement (the “Agreement”), pursuant to which (1) the August 14 Investor agreed to be restricted from converting any of its convertible debentures into common stock until February 21, 2016, subject to certain limitations set forth below (the “Restriction”) and (2) the August 14 Investor agreed to assign, as of the effective date of the Agreement approximately $390,000 of its convertible debentures to the August 20 Investor in exchange for the amount of principal outstanding under such debenture plus a premium in cash from the August 20 Investor (the “Assigned Debentures”). The accrued and unpaid interest under the Assigned Debentures remained payable by the Company to the August 14 Investor.

 

The August 14 Investor also agreed to amend the terms of each of its debentures (other than the debentures that were assigned) such that the debenture is convertible at a 40% discount to the lowest trading price of the Company’s common stock during the 30 consecutive prior trading days rather than at a 49% discount to the lowest ‘volume weighted-average price’ during the 30 consecutive prior trading days. This was not considered to be a modification of the terms of the conversion feature, requiring evaluation of the debenture to determine if it was modified or extinguished, as the conversion feature is separately accounted for as a derivative, and is outside of the scope of the guidance on debt modifications. The change in the conversion price will be reflected in its fair value under derivative accounting.

 

As consideration for entering into the Agreement, the August 14 Investor was issued a promissory note from the Company in the principal amount of $700,000 (the “Promissory Note”). The Promissory Note has a term of ten months, accrues interest at a rate of 10% per annum, and outstanding principal and accrued interest under the Promissory Note may be pre-paid at any time by the Company without penalty. The Promissory Note is not convertible other than in an event of default, in which case it is convertible on the terms of the other debentures held by the August 14 Investor. This conversion feature was considered to be a contingent conversion feature, and therefore the conversion feature would not be bifurcated and accounted for as a derivative, as are the conversion features of all other debentures, until such time as and if the Company is in an event of default. The Promissory Note is being accounted for as a finance expense of the December 28, 2015 transaction, similar to a debt discount, and will be amortized to financing expense over the ten month life of the note (Note 8).

 

 20 

 

 

The August 20 Investor shall also acquire from the August 14 Investor an additional $650,000 of the convertible debentures held by the August 14 Investor (1) upon the declaration of effectiveness of a post-effective amendment (the “POSAM”) to the Company’s Registration Statement on Form S-1 originally filed by the Company on October 16, 2015 and declared effective by the Securities and Exchange Commission on December 15, 2015 (the “Registration Statement”) reflecting the terms of the Agreement, or (2) at the option of the August 20 Investor (the “Option”), at an earlier time. The August 14 Investor exercised the Option on January 25, 2016. The POSAM was declared effective on February 3, 2016.

 

At March 31, 2016, the Company had not paid the principal due of $9,600 on a convertible debenture which was due on March 27, 2016. The Company was in default and obtained a waiver from the lender on May 11, 2016 waiving all rights relating to the nonpayment and extending the maturity date of the convertible debenture to August 1, 2016. In the same waiver agreement, the terms of five additional convertible debentures with maturity dates in May and June of 2016 totaling $122,084 were also extended to a maturity date of August 1, 2016.

 

At June 30, 2016, the Company had not paid the total principal due of $225,700 on convertible debenture which was due on July 10, 2016. The Company was in default and obtained a waiver from the lender on August 3, 2016 waiving all rights relating to the nonpayment and extending the maturity date of the convertible debenture to October 31, 2016. In the same waiver agreement, the terms of thirteen additional convertible debentures with maturity dates in July and August of 2016 totaling approximately $1,260,000 were also extended to a maturity date of October 31, 2016. (Note 12)

 

February 10, 2016 Financing

 

On February 10, 2016, the Company entered into a Note Purchase Agreement (the “Purchase Agreement”) with an accredited investor (the “Investor”), pursuant to which the Company agreed to sell, and the Investor agreed to purchase, a promissory note (the “Note”) in the aggregate principal amount of $275,000. The closing occurred on February 11, 2016.

 

The Investor deducted a commitment fee in the amount of $25,000 at the closing. The Note bears interest at the rate of 10% per year and matures on October 31, 2016. The Company may prepay all or any part of the outstanding balance of the Note at any time without penalty. In the event that the Company or any of its subsidiaries becomes subject to bankruptcy, insolvency, liquidation, or similar proceedings or takes certain related corporate actions, all outstanding principal and accrued interest under the Note will immediately and automatically become due and payable. In addition, the Note identifies certain other events of default, the occurrence of which would entitle the Investor to declare the outstanding principal and accrued interest immediately due and payable or to convert the Note, in whole or in part, into shares of the Company’s common stock at a conversion price that is the lower of (a) $0.75, or (b) a 51% discount to the lowest daily volume weighted average price of the Company’s common stock during the 20 trading days prior to the conversion date.

 

This conversion feature was considered to be a contingent conversion feature, and therefore the conversion feature would not be bifurcated and accounted for as a derivative, as are the conversion features of all other debentures, until such time as and if the Company is in an event of default. The balance of this note is included with Notes Payable on the accompanying condensed consolidated Balance Sheet (Note 8).

 

February 18, 2016 Financing

 

On February 18, 2016, the Company entered into a securities purchase agreement (the “Purchase Agreement”) with an accredited investor (the “Investor”) pursuant to which the Company agreed to sell, and the Investor agreed to purchase, convertible debentures (the “Debentures”) in the aggregate principal amount of $420,000, in two tranches.

 

The initial closing in the aggregate principal amount of $210,000 occurred on February 18, 2016. The second closing in the amount of $210,000 occurred on March 18, 2016 ($125,000) and March 22, 2016 ($85,000). The Debentures bear interest at the rate of 10% per year and mature after one year and are subject to a financing fee of 5%.

 

Each of the Debentures are convertible at the option of the holders into shares of the common stock of the Company at a conversion price that is lower of (a) $0.75, or (b) a 40% discount to the lowest traded price of the common stock of the Company during the 30 trading days prior to the conversion date. The Company may prepay the Debentures in cash, prompting a 30% premium.

 

The conversion feature of the Debentures meets the definition of a derivative and due to the reset provision to occur upon subsequent sales of securities at a price lower than the fixed conversion price, requires bifurcation and is accounted for as a derivative liability.

 

 21 

 

 

March 15 2016 Financing

 

The Company entered into a Note Purchase Agreement, effective as of March 14, 2016 (the “Effective Date”), with an Investor (the “March 15 Investor”) pursuant to which the March 15 Investor purchased and the Company issued and sold a promissory note in the original principal amount of $140,000 (the “First Promissory Note”), which matures on September 14, 2016.. Upon satisfaction of certain conditions set forth in the Note Purchase Agreement, the Company will issue and sell a second promissory note in the original principal amount of $137,500 (the “Second Promissory Note”). Each Promissory Note matures six (6) months after the date of its issuance. The First Promissory Note carries an original issue discount of $12,500 (the “First Promissory Note OID”). In addition, Company agreed to pay $5,000 towards the March 15 Investor’s legal fees incurred in connection with the purchase and sale of the First Promissory Note and the Second Promissory Note, $2,500 of which was paid to the March 15 Investor prior to the Effective Date and $2,500 of which amount (the “Carried Transaction Expense Amount”) is included in the initial principal balance of the First Promissory Note. The purchase price of the First Promissory Note was $125,000, computed as follows: $140,000 initial principal balance, less the First Promissory Note OID, less the Carried Transaction Expense Amount. The Second Promissory Note, if issued, also carries an original issue discount of $12,500 (the “Second Promissory Note OID”). The purchase price of the Second Promissory Note shall be $125,000, computed as follows: $137,500 initial principal balance, less the Second Promissory Note OID (the “Second Promissory Note Purchase Price”).

 

On March 15, 2016, the Company issued and sold the First Promissory Note to the March 15 Investor. Upon satisfaction of the terms (the “Mandatory Second Promissory Note Conditions”), the Company shall issue and sell the Second Promissory Note to the March 15 Investor. The Mandatory Second Promissory Note Conditions means that each of the following conditions has been satisfied on or before the date that is ninety (90) days from the Effective Date: (i) the Share Reserve (as defined in the First Promissory Note) for the First Promissory Note shall have been established; (ii) no Event of Default (as defined in the First Promissory Note) shall have occurred under the First Promissory Note; (iii) the median daily dollar volume of the Common Stock on its principal market for the nineteen (19) Trading Days (as defined in the First Promissory Note) immediately preceding the Share Reserve Date is greater than $75,000 per Trading Day; and (iv) the Company has notified Investor in writing that it has elected to require that Investor pay the Second Promissory Note Purchase Price. If the Mandatory Second Promissory Note Conditions are not satisfied as of the date that is ninety (90) days from the Effective Date, then the March 15 Investor shall not be obligated to pay the Second Promissory Note Purchase Price and the Second Promissory Note shall not be considered a valid, binding, or enforceable obligation of the Company, and, thereafter, the Second Promissory Note shall only be issued and the Second Promissory Note Purchase Price will only be payable upon the mutual written agreement of Company and the March 15 Investor. The First Promissory Note and/or the Second Promissory Note may be prepaid at any time by the Company in the sole discretion of the Company at a 25% premium to the outstanding balance under the applicable Promissory Note.

 

 22 

 

 

In the event that the First Promissory Note and/or the Second Promissory Note is not paid in full on or before maturity by the Company, then the March 15 Investor shall have the right at any time thereafter until such time as the First Promissory Note and/or the Second Promissory Note is paid in full, at the March 15 Investor’s election, to convert (each instance of conversion being a “Conversion”) all or any part of the outstanding balance into shares (“Conversion Shares”) of fully paid and non-assessable Common Stock of the Company as per the following conversion formula: the number of Conversion Shares equals the amount being converted divided by 50% multiplied by the lowest daily volume weighted average price of the Common Stock in the twenty (20) Trading Days immediately preceding the applicable Conversion. At any time and from time to time after the March 15 Investor becoming aware of the occurrence of any event of default, the March 15 Investor may accelerate the First Promissory Note and/or the Second Promissory by written notice to the Company, with the outstanding balance of the respective Note becoming immediately due and payable in cash at 125% of the outstanding balance.

 

This conversion feature was considered to be a contingent conversion feature, and therefore the conversion feature would not be bifurcated and accounted for as a derivative, as are the conversion features of all other debentures, until such time as and if the Company is in an event of default. The balance of the First Promissory Note is included with Notes Payable on the accompanying condensed consolidated Balance Sheet (Note 8).

 

The Company is currently in default on the March 15 note (Note 12).

 

April 2016 Financing

 

On April 13, 2016, the Company entered into a note purchase agreement (the “Purchase Agreement”) with an accredited investor (the “Investor”) pursuant to which the Company agreed to sell, and the Investor agreed to purchase, a convertible promissory note (the “Note”) in the aggregate principal amount of $225,000.

 

The Note bears interest at the rate of 5% per year and matures on July 13, 2016. The Note is convertible at any time, in whole or in part, at the option of the holders into shares of the common stock of the Company at a conversion price that is the lower of (a) $0.75, or (b) a 49% discount to the lowest traded price of the common stock of the Company during the 20 trading days prior to the conversion date. The Company may prepay the Note in cash, prompting a 30% premium.

 

The Company will, within thirty (30) days, grant a security interest to the Investor and its affiliates over the Company’s assets, including its stock ownership in its subsidiary, ESWD I, LLC (but not the assets of ESWD I, LLC). Furthermore, in connection with the next $1.5 million of equity capital raised by the Company, the Company shall use one third of such funds to make principal repayment of amounts owed to the Investor, plus a redemption premium of 30% of such amounts.

 

March 15, 2016 Financing – Second Promissory Note

 

On or about April 20, 2016 it was mutually determined by the parties involved that the median daily dollar volumes requirement of the Mandatory Second Promissory Note Conditions was not met and the Second Promissory Note would not be issued.

 

May 2016 Financings

 

The Company received an additional $100,000 through the issuance of two convertible debentures of $50,000 each, on May 13, 2016 and May 20, 2016. The Notes bears interest at the rate of 10% per year and mature on July 13, 2016 and July 20, 2016, respectively. The Notes are convertible at any time, in whole or in part, at the option of the holders into shares of the common stock of the Company at a conversion price that is the lower of (a) $0.75, or (b) a 40% discount to the lowest traded price of the common stock of the Company during the 20 trading days prior to the conversion date. The remaining terms of the debentures are the same as all other convertible debentures, and have also been determined to require derivative accounting. The Company may prepay the Note in cash, prompting a 30% premium.

 

June 22, 2016 Financing

 

Entry into Securities Purchase Agreement and Equity Purchase Agreement

 

On June 22, 2016, the Company entered into a securities purchase agreement (the “Securities Purchase Agreement”) with an accredited investor (the “Investor”) pursuant to which the Company agreed to sell, and the Investors agreed to purchase, convertible debentures (the “Convertible Bridge Debentures”) in the aggregate principal amount of $240,000, in two tranches. The initial closing in the aggregate principal amount of $120,000 occurred on June 22, 2016, and the second closing in the aggregate principal amount of $120,000 was scheduled to occur on July 8, 2016 . As of the date these consolidated financial statements were issued, the second closing has not occurred.

 

 23 

 

 

The Convertible Commitment Debenture and the Convertible Bridge Debenture accrue interest at a rate of 10% per annum. Each of the debentures are convertible at any time, in whole or in part, at the option of the holders into shares of the Company’s common stock at a conversion price that is the lower of (a) $0.75, or (b) a 40% discount to the lowest traded price of the Company’s common stock during the 30 trading days prior to the conversion date.

 

The Company and the Investor also entered into an Equity Purchase Agreement (the “Equity Purchase Agreement”, "EQP"), pursuant to which, following the filing and declaration of effectiveness of a registration statement by the Company (the “Registration Statement”) and the availability of authorized stock, the Company may “put” its shares of common stock to the Investor at a 20% discount to lowest traded price over the prior 10 trading days for up to the higher of $50,000 or 300% of the average daily trading volume over the previous 10 trading days, for up to an aggregate of $5,000,000 in aggregates “puts”.

 

In connection with the Equity Purchase Agreement, the Company entered into a registration rights agreement (the “Registration Rights Agreement”) with the Investors, pursuant to which the Company agreed to file the Registration Statement for the resale of shares of common stock put to the Investor under the Equity Purchase Agreement, within 30 days of the closing date of the Equity Purchase Agreement, and to have such registration statements become effective within 60 days of the closing date of the Purchase Agreement.

 

The Investor shall have a right of first refusal to participate in future equity financings of the Company on the same terms as any new investors for a period of twelve months from the closing of the last Convertible Bridge Debenture. The Company also shall not enter into other variable rate transactions other than with pre-existing investors, so long as the Investors hold more than $2,000,000 in debentures of the Company, including pre-existing debentures. The Company also may not enter into any equity line of credit with any other investor during the term of the Equity Purchase Agreement, which expires on December 22, 2017.

 

No amounts have been funded under the Equity Purchase Agreement to date. The Company and the Investor have entered into a verbal agreement to terminate the EQP, and the parties are working on finalized a formal termination agreement.

 

To induce the Investor to purchase the Equity Purchase Agreement (described below), the Company issued an additional $100,000 convertible debenture, on the same terms of the Convertible Bridge Debentures to the Investor (the “Convertible Commitment Debenture”). The Company will not receive any cash for the Convertible Commitment Debentures.

 

The Company entered into a Convertible Debenture with the above Investor for an additional $10,000 on June 14, 2016. The convertible debenture is due on June 14, 2017 and accrues interest at a rate of 10% per annum. The debenture is convertible at any time, in whole or in part, at the option of the holder into shares of the Company’s common stock at a conversion price that is the lower of (a) $0.75, or (b) a 40% discount to the lowest traded price of the Company’s common stock during the 30 trading days prior to the conversion date.

 

June 30, 2016 Financing

 

On June 30, 2016, the Company entered into a securities purchase agreement (the “Securities Purchase Agreement”) with an accredited investor (the “Investor”) pursuant to which two wholly-owned subsidiaries of the Company, EWSD I, LLC (“EWSD I”) and Pueblo Agriculture Supply and Equipment, LLC (“Pueblo”, and together with EWSD I, the ‘Subsidiaries”) agreed to jointly sell, and the Investors agreed to purchase, convertible debentures (the “Convertible Debentures”) in the aggregate principal amount of $1,500,000, in six tranches over the following 90-day period. The Company guaranteed the issuance of the Convertible Debentures and, upon notice from the Investor, the Convertible Debentures are convertible in to the Common Stock of the Company. The initial closing in the aggregate principal amount of $125,000 occurred on June 30, 2016, with additional closings subsequent to June 30, 2016, of approximately $1,266,000, net, received through the issuance of these condensed consolidated financial statements. The Company agreed to pay an aggregate of the Investor’s legal fees of $40,000 ($10,000 per tranche) in connection with the closing of each of tranches three through six. The June 30, 2016 financing was subsequently assigned to a new investor (Note 12).

 

The Company and the Subsidiaries also entered into a Security Agreement (the “Security Agreement”) and Parent Guarantee (the “Guarantee”), securing a lien for the Investor on EWSD I’s assets on a secondary basis to the primary lien holder and securing a lien for the Investor on Pueblo’s assets on a primary basis and with the Company guaranteeing all obligations of EWSD I and Pueblo to the Investor. Pursuant to the Security Agreement, the Company agreed to, within 14 calendar days, negotiate and enter into an Intercreditor Agreement among the other secured creditors of the Company and EWSD I. The Company subsequently entered into a Subordination Agreement, which replaced the Intercreditor Agreement, on August 23, 2016.

 

 24 

 

 

The Convertible Debentures accrue interest at a rate of 10% per annum. Each of the debentures are convertible at any time into shares of common stock of the Company, in whole or in part, at the option of the holders into shares of the Company’s common stock at a conversion price that is the lower of (a) $0.75, or (b) a 40% discount to the lowest traded price of the Company’s common stock during the 30 trading days prior to the conversion date.

 

The Investor shall have a right of first refusal to participate in future equity financings of the Company on the same terms as any new investors for a period of twelve months from the closing of the last Convertible Debenture. The Company and the Subsidiaries also shall not enter into other variable rate transactions other than with pre-existing investors, so long as the Investors hold more than $2,000,000 in debentures of the Company, including pre-existing debentures.

 

The conversion feature of the Debentures meets the definition of a derivative and due to the reset provision to occur upon subsequent sales of securities at a price lower than the fixed conversion price, requires bifurcation and is accounted for as a derivative liability.

 

The derivatives related to the above convertible debentures were initially recognized at their estimated fair values as described previously, which amounted to approximately $4,932,000 in the six months ended June 30, 2016 and $1,885,000 for the same period of 2015. The resulting debt discount is amortized as over the life of the convertible debenture, or until conversion if earlier, which resulted in amortization expense of $2,086,000 and $6,050,000, for the three months ended June 30, 2016 and 2015, respectively. Additionally, the current year closings to convertible debentures resulted in the calculated fair value of the debt being greater than the face amounts of the debt by approximately $2,627,000, with this excess amount being immediately expensed as financing costs. Financing costs for the six months ended June 30, 2015, were approximately $3,061,000. The fair value of the embedded derivative consisting of all related convertible debentures is measured and recognized at fair value each subsequent reporting period and the changes in fair value for all derivatives for six months ended June 30, 2016 and 2015, resulted in a gain of approximately $9,320,000 and $3,053,000, respectively, which are recognized in the condensed consolidated Statement of Comprehensive Income (Loss) as Change in fair value of derivative liability.

 

Related Party Financing

 

One of the directors on the Company’s Board entered into three separate subordinated convertible promissory notes convertible at $0.01 with the Company on March 4, 2016, March 10, 2016 and March 15, 2016, respectively, each in the principal amount of $25,000, for a total of $75,000. Also on March 15, 2016, another of the Company’s directors entered into a subordinated convertible promissory note convertible at $0.01 with the Company in the principal amount of $25,000, and two other of the Company’s directors each entered into a subordinated convertible promissory note convertible at $0.01 with the Company in the principal amount of $2,500. All of the foregoing convertible promissory notes have three year terms and an interest rate of 8% per annum. The debentures were evaluated to determine if the conversion feature fell within the guidance for derivative accounting, and as the debentures are convertible at a fixed conversion price, and do not include a the reset provision to occur upon subsequent sales of securities at a price lower than the fixed conversion price, the Company concluded the conversion feature did not qualify as a derivative.

 

 25 

 

 

In connection with their funding of the Notes (collectively the “Notes”), the directors each receive a warrant, exercisable for a period of three (3) years from the date of Notes, to purchase an amount of Company Common Stock equal to 50% of the principal sum under each of the director notes, at an exercise price equal to 200% of the applicable Conversion Price. The exercise price of the warrants is $0.02. The warrants were determined to have a fair value of $42,000, calculated with the Black Sholes Merton model, with the following key valuation assumptions: estimated term of three years, annual risk-free rate of .93%, and annualized expected volatility of 172%.

 

Conversions

 

During the six months ended June 30, 2016 and 2015, respectively, approximately $1,904,000 and $4,000,000 of principal and approximately $14,000 and $27,000, of accrued interest were converted into approximately 2,648,938,000 and 12,383,229 of the Company’s common shares at an average price of $0.0007 and $0.74, based on 51% of the calculated VWAP. Upon conversion, the derivative fair value for the amounts converted were re-measured through the date of conversion, with the conversion date fair value reclassified to equity, amounting to approximately $3,200,000 and $1,160,000 in the six months ended June 30, 2016 and 2015, respectively. As a result of the conversions, the resulting decrease of fair value of approximately $1,885,000 of the related debt discount was recognized on the Condensed Consolidated Statement of Comprehensive Income (Loss).

 

Warrants

 

The warrants issued under all debentures, and other agreements, are summarized below:

 

Date issued  Number of
warrants
   Exercise
price
   December 18,
2015 re-price
   Fair Value at issuance 
July 2014 Modified Debentures                    
January 30, 2015   40,552    4.93    .06   $159,601 
February 26, 2015   45,537    2.20    .06    79,904 
March 13, 2015   21,151    2.36    .06    39,965 
March 16, 2015   10,575    2.36    .06    19,981 
March 20, 2015   41,946    1.79    .06    59,942 
March 27, 2015   75,758    1.98    .06    119,888 
April 2, 2015   60,386    1.66    .06    74,025 
April 2, 2015   30,193    1.66    .06    37,012 
April 10, 2015   107,914    1.39    .06    112,460 
April 17, 2015   41,667    1.20    .06    37,680 
April 24, 2015   127,119    1.18    .06    112,635 
April 24, 2015   21,186    1.18    .06    18,772 
May 1, 2015   156,250    .96    .06    113,133 
May 7, 2015   134,615    .78    .06    79,234 
May 8, 2015   42,000    .75    .06    23,768 
May 15, 2015   200,000    .75    .06    113,365 
May 22, 2015   250,000    .60    .06    113,366 
May 29, 2015   258,621    .58    .06    112,537 
June 5, 2015   288,462    .52    .06    120,738 
June 12, 2015   930,233    .43    .06    303,246 
June 19, 2015   3,448,276    .29    .06    751,159 
September 2014 Modified Debentures                    
January 28, 2015   18,038    5.54    .06    80,156 
February 13, 2015   57,870    1.73    .06    96,689 
April 2, 2015   181,159    1.66    .06    222,109 
April 24, 2015   90,579    1.10    .06    80,548 
May 15, 2015   200,000    .75    .06    113,365 

 

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Date issued  Number of
warrants
   Exercise
price
   December 18,
2015 re-price
   Fair Value at issuance 
June 12, 2015   1,744,186    .43    .06    570,248 
                     
August 2015 Debentures                    
August 24, 2015   6,666,667    .06         321,757 
September 18, 2015   588,235    .17         82,804 
October 28, 2015   4,166,667    .12         363,306 
November 16, 2015   1,785,714    .07         92,798 
November 23, 2015   2,083,333    .06         68,988 
November 30,2015   2,500,000    .05         81,988 
December 7, 2015   6,250,000    .02         163,382 
December 17, 2015   10,000,000    .02         76,376 
                     
Directors                    
January 5, 2015   129,305    .40         39,901 
January 30, 2015   129,917    .40         39,916 
February 2, 2015   237,778    .22         16,619 
March 4, 2016   1,250,000    .02         10,000 
March 10, 2016   1,250,000    .02         10,000 
March 15, 2016   1,250,000    .02         10,000 
March 15, 2016   1,250,000    .02         10,000 
March 15, 2016   125,000    .02         1,000 
March 15, 2016   125,000    .02         1,000 
April 20, 2016   1,041,663    .02         4,000 
                     
June 8, 2016   5,000,000    .01         4,425 
June 8, 2016   2,691,250    .01         2,381 
June 8, 2016   1,500,000    .01         1,327 
June 8, 2016   3,343,750    .01         2,959 
                     
Other Agreements                    
December 18, 2015   4,000,000    .50         76,000 
April 13, 2016   500,000    .03         3,869 
May 5, 2016   590,625    .01         3,477 
June 8, 2016   2,678,571    .01         2,265 
                     
Total   69,757,748             $5,256,064 

 

Effective September 18, 2015, the holder of the September 2014 Debentures and the Company agreed to amend its September 2014 Warrants, to reduce the exercise price of the warrants to purchase an aggregate of 2,291,832 shares of the Company’s common stock to six cents per share. Additionally, the holder of the July 2014 Debentures and the Company agreed to amend its July 2014 Warrants, to reduce the exercise price of the warrants to purchase an aggregate of 6,332,441 shares of Common Stock to six cents per share. As a result of the amendment, the fair value of the warrants was remeasured as of September 18, 2015, for an additional fair value of approximately $38,000 recognized as a financing expense. During the year ended December 31, 2015, approximately 2,292,000 warrants were exercised for cash proceeds of $137,510 at an average exercise price of $0.06.

 

During the three and six months ended June 30, 2016 and 2015, there were no warrants exercised.

 

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

 

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

 

The Company reevaluated the warrants as of June 30, 2016 and determined that they did not have a sufficient number of authorized and unissued shares to settle all existing commitments, and the fair value of the warrants for which there was insufficient authorized shares, were reclassified out of equity to a liability. Under the sequencing policy, of the approximately 67,466,000 warrants outstanding at June 30, 2016, it was determined there was not sufficient authorized shares for approximately 53,970,000 of the outstanding warrants. The fair value of these warrants was re-measured on June 30, 2016 using the Black Scholes Merton Model, with key valuation assumptions used that consist of the price of the Company’s stock on June 30, 2016, a risk free interest rate based on the average yield of a 2 or 3 year Treasury note and expected volatility of the Company’s common stock, resulting in the fair value for the Warrant liability of approximately $6,000. The resulting change in fair value of approximately $441,000 and $931,000 was recognized as a gain in the Condensed consolidated statement of comprehensive income(loss).

 

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NOTE 8 – NOTES PAYABLE

 

Notes payable consists of:

 

   June 30,
2016
   December 31,
2015
 
Southwest Farms (Note 3)  $3,617,548   $3,645,163 
East West Secured Development (Note 3)   515,633    675,093 
Washington Property (Note 6)   199,000    208,605 
Investment funds (Note 8)   1,257,500     
           
Financial Freedom, LLC   62,500     
    5,652,181    4,528,861 
Less discounts   (323,924)    
Plus premium   10,000    16,667 
           
    5,338,257    4,545,528 
Less current maturities   1,294,051    256,897 
           
   $4,044,206   $4,288,631 

 

Maturities on Notes Payable are as follows:

 

Years ending:    
December 31, 2016  $1,045,988 
December 31, 2017   287,643 
December 31, 2018   4,004,626 
   $5,338,257 

 

The Company entered into a Securities Purchase Agreement dated May 20, 2016 (the “SPA”) with an investor (the “Investor”) pursuant to which it issued to the Investor a Convertible Promissory Note (the “Note”) in the principal amount of $1,242,500 that matures on July 20, 2017 and earns interest at the rate of 10% per annum. The Note carries an original issuance discount of $112,500 and the Company agreed to pay $5,000 in legal fees for the Investor. In exchange for the Note, the Investor (1) paid to the Company $125,000 less $6,250 in broker fees paid by the Company, and (2) issued to the Company eight (8) secured promissory notes in the principal amount of $125,000 each (each, a “Investor Note” and collectively the “Investor Notes”). This amount is included with Investment funds in schedule above.

 

The Company must begin repaying principal and interest on funded portions of the Note beginning 180 days after the date of the Note, and each month thereafter for a total period of 10 months, in fixed amounts of $124,250 per month. The Company has a right to prepay the total outstanding balance of the Note at any time (so long as it is not in default under the Note) in cash equal to 125% of the outstanding balance of the Note. Furthermore, for a period of sixty days from the date of entry into the Note, a third party has the right to prepay the outstanding balance of the Note in cash equal to 130% of the outstanding balance of the Note.

 

The notes become convertible into commons shares of the Company's stock upon an Event of Default, as set forth in the terms of the SPA. The conversion price shall be 50% of the lowest closing bid price during the twenty trading days immediately preceding the conversion. This conversion feature was considered to be a contingent conversion feature, and therefore the conversion feature would not be bifurcated and accounted for as a derivative, until such time as and if the Company is in an event of default. 

 

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In connection with any Event of Default by the Company, the Investor may accelerate the Note with the outstanding balance becoming immediately due and payable in cash at 125% of the outstanding balance. Furthermore, the Investor may elect to increase the outstanding balance by applying a 125% “default effect” (up to two applications for two defaults) without accelerating the outstanding balance, in which event the outstanding balance shall be increased as of the date of the occurrence of the applicable event of default. Furthermore, following the occurrence of an event of default interest shall accrue on the outstanding balance beginning on the date the applicable event of default occurring at an interest rate equal to the lesser of 22% per annum or the maximum rate permitted under applicable law.

 

In connection with entry into the SPA, the Company agreed to reserve 300% of the shares into which the Note can be converted for the Investor.

 

The Investor may, with the Company’s consent, prepay, without penalty, all or any portion of the outstanding balance of the Investor Notes at any time prior to the Investor Note Maturity Date. Notwithstanding the foregoing, beginning on the date that is 90 days from the date of the issuance of the Note, and then on the 6-month anniversary of the date of entry into the Note and monthly thereafter for a total of eight payments, the Investor shall be obligated to prepay one of the eight Investor Notes at each such occurrence, if at the time of such occurrence: (a) no event of default under the Note has occurred; (b) the average daily dollar volume of the Common Stock on its principal market for the twenty (20) trading days is greater than $55,000.00; (c) the market capitalization of the Common Stock on the date of the occurrence is greater than $3,000,000.00; and (d) the share reserve described below remains in place at the required thresholds.

 

The Company also made extensive representations and warranties relating to the transaction.

 

To date, no amounts have been received by the Company against the eight Investor Notes.

 

On April 6, 2016, the Company entered into a Promissory note for $85,000, which was issued with a $2,500 premium, and bears interest at 0.0%. The proceeds were to be used by the Farm, to pay for water usage. Additionally, the Company issued 600,000 of the Company's restricted common stock to the holder. The shares were valued at the market value of the common shares of the Company on the date of the issuance of the note. The payment terms called for $40,000 to be paid on or before April 21, 2016, $20,000 to be paid on or before May 6, 2016, and the final $27,500 to also be paid on or before May 6, 2016. The Note also allowed for the extension of the maturity date by 30 days, at the Company's request, in exchange for an additional $2,500 payment. The note and the $2,500 extension payment were paid during July, 2016.

 

Notes payable, related parties, consists of:

 

   June 30,
2016
   December 31,
2015
 
Directors Notes  $289,866   $ 
           
Less discounts   (12,000)     
           
    277,866      
           
Less current maturities   (277,866)    
           
   $    $ 

 

Maturities on Notes payable, related parties, are as follows:

 

Years ending:    
December 31, 2016  $39,166 
December 31, 2017   250,700 
   $289,866 

 

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On June 8, 2016, the Company issued Promissory Notes (the "Directors Notes"), in the amount of $250,700, to all the directors in exchange for various amounts outstanding for fees and reimbursements incurred during December 2015 and April 2016. The Notes have a term of six months and bear interest at 8% until the note is paid in full. The Directors Notes were each issued with a warrant for fifty percent of the face amount of the note, with an exercise price of $0.01 and exercisable for three years. The Company estimated the fair value of the warrants based on a Black Scholes valuation model. The warrants were determined to have a fair value of $12,000, calculated with the Black Sholes Merton model, with the following key valuation assumptions: estimated term of three years, annual risk-free rate of .93%, and annualized expected volatility of 172%. The $12,000 fair value was recognized as a debt discount and is being amortized over the six month term of the Directors Notes.

 

NOTE 9 – SHARE BASED AWARDS, RESTRICTED STOCK AND RESTRICTED STOCK UNITS (“RSUs”)

 

The Board resolved that, beginning with the fourth calendar quarter of 2015, the Company shall pay each member of the Company’s Board of Directors, who is not also an employee of the Company, for each calendar quarter during which such member continues to serve on the Board compensation in the amount of $15,000 in cash and 325,000 shares of Company common stock. The 975,000 shares issued to all the directors for the three months ended March 31, 2016 were valued at the market price of the Company’s common stock on March 31, 2016, for total compensation expense of $9,750. On March 31, 2016, the Board awarded the Chairman a cash bonus of approximately $89,000 and, 2,230,000 shares of Company common stock for his service in the three months ended March 31, 2016,

 

The Board authorized grants of approximately 2,761,000 shares of the Company common stock during the second quarter of 2016, which were valued at the market price of the Company's common stock on date of grant, for total compensation expense of approximately $13,000. On June 8, 2016, the Board also awarded the Chairman a cash bonus of approximately $89,200 and 6,027,000 shares of Company common stock, valued at approximately $8,000.

 

The Board also voted on June 8, 2016, to increase the shares available for grant under the 2014 Equity Incentive Plan to 125,000,000. The Company intends to file a Form S-8 regarding the increased shares available for grant now that the increase in authorized shares has been approved.

 

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A summary of the activity related to RSUs for the three months ended June 30, 2016 and 2015 is presented below:

 

Restricted stock units (RSU’s)  Total shares   Grant date fair
value
 
RSU’s non-vested at January 1, 2016   152,823    $0.51 - $1.88 
RSU’s granted   14,285,714   $0.007 
RSU’s vested   (125,431)   $0.51- $1.88 
RSU’s forfeited      $— 
           
RSU’s non-vested June 30, 2016   14,313,106    $0.51 - $1.88 

 

Restricted stock units (RSU’s)  Total shares   Grant date fair
value
 
RSU’s non-vested at January 1, 2015   199,584   $10.70 
RSU’s granted   177,633    $1.88 - $6.70 
RSU’s vested   (135,135)   $1.88 - $6.70 
RSU’s forfeited      $— 
           
RSU’s non-vested June 30, 2015   242,082    $1.88 - $11.00 

 

A summary of the expense related to restricted stock, RSUs and stock option awards for the three and six months ended June 30, 2016 is presented below:

 

   Three months ended
June 30, 2016
   Six months ended
June 30, 2016
 
Restricted Stock  $   $390,000 
RSU’s   38,144    192,192 
Stock options        
Common stock   30,281    62,331 
           
Total  $68,425   $644,523 

 

NOTE 10 – RELATED PARTY TRANSACTIONS

 

During the first quarter of 2015, the Company issued two convertible notes to one of its directors in the aggregate principal amount of $100,000 and one convertible note to another of its director in the aggregate principal amount of $50,000. These notes were all converted to common stock during the third quarter of 2015.

 

During the first quarter of 2016, the Company issued three convertible notes to one of its directors in the aggregate principal amount of $75,000 and one convertible note to another of its director in the aggregate principal amount of $25,000, plus a convertible note to each of its other two directors, in the amount of $2,500 each. See Note 7 for a description of these notes.

 

In the second quarter of 2016, the Company issued promissory notes to all of the directors, in exchange for past unpaid cash bonuses, board compensation and expenses. See Note 8 for a description of these notes

 

NOTE 11 – COMMITMENTS AND CONTINGENCIES

 

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

 

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Entry into Agreement to Acquire Real Property

 

On June 17, 2016, EWSD I, LLC, a wholly owned subsidiary of the Company, entered into a Contract to Buy and Sell Real Estate (the “Acquisition Agreement”) with Tammy J. Sciumbato and Donnie J. Sciumbato (collectively, the “Sellers”) to purchase certain real property comprised of 116-acres of agricultural land, a barn and a farmhouse in Pueblo, Colorado (the “Property”). The closing of the Acquisition Agreement is scheduled to occur on or about September 22, 2016 (the “Closing”), with possession of the land and barn occurring twelve (12) days after the Closing and possession of the farm house occurring on or before January 1, 2017. The Sellers will were to rent back the farm house from the Company until January 1, 2017. The purchase price to acquire the Property is $650,000, including $10,000 paid by the Company as a deposit into the escrow for the Property. The $10,000 is recognized as Deposits in Escrow on the accompanying Condensed Consolidated Balance Sheet.

 

Office Leases

 

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

 

The landlord for the West Hollywood space has filed a suit against the Company and independent guarantors on the West Hollywood lease. The Company has expensed all lease payments due under the West Hollywood lease. The Company’s liability for the West Hollywood lease will be adjusted, if required, upon settlement of the suit with the landlord. On September 8, 2016, the court approved the landlord's application for writ of attachment in the State of California in the amount of $374,402 against Prescription Vending Machines, Inc. (“PVM”). A trial date has been set for May 2017 (Note 12).

 

Total rent expense under operating leases for the three months ended June 30, 2016 and 2015 was $23,000 and $66,000, respectively. Rent expense for the six months ended June 30, 2016 and 2015 was approximately $376,000 and $110,000, 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. Deposits in escrow consist of amounts paid to open escrow accounts for the purchase of multiple properties to be used to develop retail dispensary or product cultivation facilities.

 

The following table is a summary of our material contractual lease commitments as of June 30, 2016:

 

Year Ending  Office Rent   Retail/Cultivation
Facility Lease
 
2016  $22,458   $44,400 
2017       88,800 
2018       88,800 
2019       29,600 
           
Total   $22,458   $251,600 

 

Consulting Agreements

 

On December 7, 2015, the Company entered into a consulting agreement for marketing and PR services, for a term of six months, which was subsequently extended through August 30, 2016. Compensation under this agreement through May 30, 2016 was $25,000 per month, with twenty percent, or $5,000, of this amount to be paid in shares of the Company's common stock. Per the terms of the agreement, the number of shares issued is determined at the end of each quarter. Upon extension, the terms were adjusted to $15,000 per month for services, with $5,000 to be paid in shares of the Company's common stock.

 

On March 1, 2016, the Company entered into a consulting agreement for corporate financial advisory services, for a term of twelve months, which is cancellable anytime with thirty days written notice after the first ninety days. Compensation under this agreement consists of a retainer of $3,500 per month, plus 1,500,000 shares of common stock issuable in 375,000 share tranches on a quarterly basis.

 

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Litigation

 

On May 22, 2013, Medbox (now known as Notis Global, Inc.) initiated litigation in the United States District Court in the District of Arizona against three 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 and Medvend seek to have the transaction performed, or alternatively be awarded damages for the alleged breach of the agreement by Medbox. Medvend and the shareholder defendants seek $4.55 million in damages, plus costs and attorneys’ fees. Medbox has denied liability with respect to all such claims. On June 5, 2014, the Company entered into a purchase and sale agreement (the “Medvend PSA”) with PVM International, Inc. (“PVMI”) concerning this matter. Pursuant to the Medvend PSA, the Company sold to PVMI the Company’s rights and claims attributable to or controlled by the Company against those three certain stockholders of Medvend, known as Kaplan, Tartaglia and Kovan (the “Medvend Rights and Claims”), in exchange for the return by PVMI to the Company of 30,000 shares of the Company’s common stock. PVMI is owned by Vincent Mehdizadeh, formerly the Company’s largest stockholder. On December 17, 2015, the Company entered into a revocation of the Medvend PSA, which provided that from that date forward, Medbox would take over the litigation and be responsible for the costs and attorneys’ fees associated with the Medvend Litigation from December 17, 2015 forward. All costs and attorneys’ fees through December 16, 2015 will be borne by PVMI. After the filing of a motion for substitution of Medbox n/k/a Notis Global, Inc. for PVMI, Defendants’ agreed, via a stipulated order, to permit the substitution. The Court entered the order substituting Notis Global, Inc. for PVMI on February 17, 2016. A new litigation schedule was recently issued which resulted in an adjournment of the trial. A new trial date will be set by the court following its ruling on a motion for summary judgment filed by Defendants and Medvend, which is set for hearing on November 16, 2016. At this time, the Company cannot determine whether the likelihood of an unfavorable outcome of the dispute is probable or remote, nor can they reasonably estimate a range of potential loss, should the outcome be unfavorable.

 

On February 20, 2015, Michael A. Glinter, derivatively and on behalf of nominal defendants Medbox, Inc. the Board and certain executive officers (Pejman Medizadeh, Matthew Feinstein, Bruce Bedrick, Thomas Iwanskai, Guy Marsala, J. Mitchell Lowe, Ned Siegel, Jennifer Love, and C. Douglas Mitchell) filed a suit in the Superior Court of the State of California for the County of Los Angeles. The suit alleges breach of fiduciary duties and abuse of control by the defendants. Relief is sought awarding damages resulting from breach of fiduciary duty and to direct the Company and the defendants to take all necessary actions to reform and improve its corporate governance and internal procedures to comply with applicable law. The Company has entered into a Stipulation and Agreement of Settlement on October 16, 2015. See more detailed discussion below under Derivative Settlements.

 

On January 21, 2015, Josh Crystal on behalf of himself and of all others similarly situated filed a class action lawsuit in the U.S. District Court for Central District of California against Medbox, Inc., and certain past and present members of the Board (Pejman Medizadeh, Bruce Bedrick, Thomas Iwanskai, Guy Marsala, and C. Douglas Mitchell). The suit alleges that the Company issued materially false and misleading statements regarding its financial results for the fiscal year ended December 31, 2013 and each of the interim financial periods that year. The plaintiff seeks relief of compensatory damages and reasonable costs and expenses or all damages sustained as a result of the wrongdoing. On April 23, 2015, the Court issued an Order consolidating the three related cases in this matter: Crystal v. Medbox, Inc., Gutierrez v. Medbox, Inc., and Donnino v. Medbox, Inc., and appointing a lead plaintiff. On July 27, 2015, Plaintiffs filed a Consolidated Amended Complaint. The Company has entered into a Stipulation and Agreement of Settlement on October 16, 2015. See more detailed discussion below under Class Settlement.

 

On January 18, 2015, Ervin Gutierrez filed a class action lawsuit in the U.S. District Court for the Central District of California. The suit alleges violations of federal securities laws through public announcements and filings that were materially false and misleading when made because they misrepresented and failed to disclose that the Company was recognizing revenue in a manner that violated US GAAP. The plaintiff seeks relief for compensatory damages and reasonable costs and expenses or all damages sustained as a result of the wrongdoing. On April 23, 2015, the Court issued an Order consolidating the three related cases in this matter: Crystal v. Medbox, Inc., Gutierrez v. Medbox, Inc., and Donnino v. Medbox, Inc., and appointing a lead plaintiff. On July 27, 2015, Plaintiffs filed a Consolidated Amended Complaint. The Company has entered into a Stipulation and Agreement of Settlement on October 16, 2015. See more detailed discussion below under Class Settlement.

 

On January 29, 2015, Matthew Donnino filed a class action lawsuit in the U.S. District Court for Central District of California. The suit alleges that the Company issued materially false and misleading statements regarding its financial results for the fiscal year ended December 31, 2013 and each of the interim financial periods that year. The plaintiff seeks relief for compensatory damages and reasonable costs and expenses or all damages sustained as a result of the wrongdoing. On April 23, 2015, the Court issued an Order consolidating the three related cases in this matter: Crystal v. Medbox, Inc., Gutierrez v. Medbox, Inc., and Donnino v. Medbox, Inc., and appointing a lead plaintiff. On July 27, 2015 Plaintiffs filed a Consolidated Amended Complaint. The Company has entered into a Stipulation and Agreement of Settlement on October 16, 2015. See more detailed discussion below under Class Settlement.

 

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On February 12, 2015, Jennifer Scheffer, derivatively on behalf of Medbox, Guy Marsala, Ned Siegel, Mitchell Lowe and C. Douglas Mitchell filed a lawsuit in the Eighth Judicial District Court of Nevada seeking damages for breaches of fiduciary duty regarding the issuance and dissemination of false and misleading statements and regarding allegedly improper and unfair related party transactions, unjust enrichment and waste of corporate assets. On April 17, 2015, Ned Siegel and Mitchell Lowe filed a Motion to Dismiss. On April 20, 2015, the Company filed a Joinder in the Motion to Dismiss. On July 27, 2015, the Court held a hearing on and granted the Motion to Dismiss without prejudice. The Company has entered into a Stipulation and Agreement of Settlement on October 16, 2015. See more detailed discussion below under Derivative Settlements.

 

On March 10, 2015, Robert J. Calabrese, derivatively and on behalf of nominal defendant Medbox, Inc., filed a suit in the United States District Court for the District of Nevada against certain Company officers and/or directors (Ned L. Siegel, Guy Marsala, J. Mitchell Lowe, Pejman Vincent Mehdizadeh, Bruce Bedrick, and Jennifer S. Love). The suit alleges breach of fiduciary duties and gross mismanagement by issuing materially false and misleading statements regarding the Company’s financial results for the fiscal year ended December 31, 2013 and each of the interim financial periods. Specifically the suit alleges that defendants caused the Company to overstate the Company’s revenues by recognizing revenue on customer contracts before it had been earned. The plaintiff seeks relief for compensatory damages and reasonable costs and expenses for all damages sustained as a result of the alleged wrongdoing. The Company has entered into a Stipulation and Agreement of Settlement on October 16, 2015. See more detailed discussion below under Derivative Settlements.

 

On March 27, 2015, Tyler Gray, derivatively and on behalf of nominal defendant Medbox, Inc., filed a suit in the United States District Court for the District of Nevada against the Company’s Board of Directors and certain executive officers (Pejman Vincent Mehdizadeh, Matthew Feinstein, Bruce Bedrick, Thomas Iwanski, Guy Marsala, J. Mitchell Lowe, Ned Siegel, Jennifer S. Love, and C. Douglas Mitchell). The suit alleges breach of fiduciary duties and abuse of control. The plaintiff seeks relief for compensatory damages and reasonable costs and expenses for all damages sustained as a result of the alleged wrongdoing. Additionally the plaintiff seeks declaratory judgments that plaintiff may maintain the action on behalf of the Company, that the plaintiff is an adequate representative of the Company, and that the defendants have breached and/or aided and abetted the breach of their fiduciary duties to the Company. Lastly the plaintiff seeks that the Company be directed to take all necessary actions to reform and improve its corporate governance and internal procedures to comply with applicable law. The Company has entered into a Stipulation and Agreement of Settlement on October 16, 2015. See more detailed discussion below under Derivative Settlements.

 

On May 20, 2015, Patricia des Groseilliers, derivatively and on behalf of nominal defendant Medbox, Inc., filed a suit in the United States District Court for the District of Nevada against the Company’s Board of Directors and certain executive officers (Pejman Vincent Mehdizadeh, Ned Siegel, Guy Marsala, J. Mitchell Lowe, Bruce Bedrick, Jennifer S. Love, Matthew Feinstein, C. Douglas Mitchell, and Thomas Iwanski). The suit alleges breach of fiduciary duties and unjust enrichment. The plaintiff seeks relief for compensatory damages and reasonable costs and expenses for all damages sustained as a result of the alleged wrongdoing. Additionally the plaintiff seeks declaratory judgments that plaintiff may maintain the action on behalf of the Company, that the plaintiff is an adequate representative of the Company, and that the defendants have breached and/or aided and abetted the breach of their fiduciary duties to the Company. Lastly the plaintiff seeks that the Company be directed to take all necessary actions to reform and improve its corporate governance and internal procedures to comply with applicable law. The Company has entered into a Stipulation and Agreement of Settlement on October 16, 2015. See more detailed discussion below under Derivative Settlements.

 

On June 3, 2015, Mike Jones, derivatively and on behalf of nominal defendant Medbox, Inc., filed a suit in the U.S. District Court for Central District of California against the Company’s Board of Directors and certain executive officers (Guy Marsala, J. Mitchell Lowe, Ned Siegel, Jennifer S. Love, C. Douglas Mitchell, Pejman Vincent Mehdizadeh, Matthew Feinstein, Bruce Bedrick, and Thomas Iwanski). The suit alleges breach of fiduciary duties, abuse of control, and breach of duty of honest services. The plaintiff seeks relief for compensatory damages and reasonable costs and expenses for all damages sustained as a result of the alleged wrongdoing. Additionally the plaintiff seeks declaratory judgments that plaintiff may maintain the action on behalf of the Company, that the plaintiff is an adequate representative of the Company, and that the defendants have breached and/or aided and abetted the breach of their fiduciary duties to the Company. Lastly the plaintiff seeks that the Company be directed to take all necessary actions to reform and improve its corporate governance and internal procedures to comply with applicable law. On July 20, 2015, the Court issued an Order consolidating this litigation with those previously consolidated in the Central District (Crystal, Gutierrez, and Donnino). On October 7, 2015, the Court issued an Order modifying the July 20, 2015 Order consolidating the litigation so that the matters remain consolidated for the purposes of pretrial only. The Company has entered into a Stipulation and Agreement of Settlement on October 16, 2015. See more detailed discussion below under Derivative Settlements.

 

On July 20, 2015, Kimberly Freeman, derivatively and on behalf of nominal defendant Medbox, Inc., filed a suit in the Eighth Judicial District Court of Nevada against the Company’s Board of Directors and certain executive officers (Pejman Vincent Mehdizadeh, Guy Marsala, Ned Siegel, J. Mitchell Lowe, Jennifer S. Love, C. Douglas Mitchell, and Bruce Bedrick). The suit alleges breach of fiduciary duties and unjust enrichment. The plaintiff seeks relief for compensatory damages and reasonable costs and expenses for all damages sustained as a result of the alleged wrongdoing. Additionally the plaintiff seeks declaratory judgments that plaintiff may maintain the action on behalf of the Company, that the plaintiff is an adequate representative of the Company, and that the defendants have breached and/or aided and abetted the breach of their fiduciary duties to the Company. Lastly the plaintiff seeks that the Company be directed to take all necessary actions to reform and improve its corporate governance and internal procedures to comply with applicable law. The Company has entered into a Stipulation and Agreement of Settlement on October 16, 2015. See more detailed discussion below under Derivative Settlements.

 

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On October 16, 2015, solely to avoid the costs, risks, and uncertainties inherent in litigation, the parties to the class actions and derivative lawsuits named above entered into settlements that collectively effect a global settlement of all claims asserted in the class actions and the derivative actions. The global settlement provides, among other things, for the release and dismissal of all asserted claims. The global settlement is contingent on final court approval, respectively, of the settlements of the class actions and derivative actions. If the global settlement does not receive final court approval, it could have a material adverse effect on the financial condition, results of operations and/or cash flows of the Company and their ability to raise funds in the future.

 

On October 27, 2015, separate from the above lawsuits and settlement, Richard Merritts, derivatively and on behalf of nominal defendant Medbox, Inc., filed a suit in the Superior Court of the State of California for the County of Los Angeles against the Board and certain executive officers (Guy Marsala, J. Mitchell Lowe, Ned Siegel, Jennifer S. Love, C. Douglas Mitchell, Pejman Vincent Mehdizadeh, Matthew Feinstein, Bruce Bedrick, Jeff Goh, and Thomas Iwanski). The suit titled Merritts v. Marsala, et al., Case No. BC599159 (the “Merritts Action”), alleges breach of fiduciary duties by the defendants. Relief is sought awarding damages resulting from breach of fiduciary duty and to direct the Company and the defendants to take all necessary actions to reform and improve its corporate governance and internal procedures to comply with applicable law. On February 16, 2016, the court issued an order staying the litigation pending final court approval of the settlement of the other pending derivative actions involving Medbox, Inc., as nominal defendant, and former and current officers and directors. The settlement of the other derivative actions has been preliminarily approved by the court in Jones v. Marsala, et al., Case No. 15-cv-4170 BRO (JEMx), in the U.S. District Court for the Central District of California. On March 25, 2016, Merritts filed a Motion to Intervene in the case filed by Mike Jones in the U.S. District Court for the Central District of California. By his Motion, Merritts seeks limited intervention in the Jones shareholder derivative action in order to seek confirmatory information and discovery regarding the Stipulation and Agreement of Settlement preliminarily approved by the Court on February 3, 2016. On April 4, 2016, Plaintiff Jones and the Company separately filed oppositions to the Motion to Intervene. On April 22, 2016, the Court issued an Order granting, without a hearing, shareholder Richard Merritts’ Motion to Intervene in the lawsuit titled Mike Jones v. Guy Marsala, et al. , in order to conduct limited discovery. On September 16, 2016, solely to avoid the costs, risks, and uncertainties inherent in litigation, the parties entered into a settlement regarding Merritts’ claims. See more detailed discussion below under Derivative Settlements.

 

Class Settlement

 

On December 1, 2015, Medbox and the class plaintiffs in Josh Crystal v. Medbox, Inc., et al., Case No. 2:15-CV-00426-BRO (JEMx), pending before the United States District Court for the Central District of California (the “Court”) notified the Court of the settlement. The Court stayed the action pending the Court’s review of the settlement and directed the parties to file a stipulation of settlement. On December 18, 2015, plaintiffs filed the Motion for Preliminary Approval of Class Action Settlement that included the stipulation of settlement. On February 3, 2016, the Court issued an Order granting preliminary approval of the settlement. The settlement provides for notice to be given to the class, a period for opt outs and a final approval hearing. The Court originally scheduled the Final Settlement Approval Hearing to be held on May 16, 2016 at 1:30 p.m., but continued it to August 15, 2016 at 1:30 p.m. to be heard at the same time as the Final Settlement Approval Hearing for the derivative actions, discussed below. The principal terms of the settlement are:

 

a cash payment to a settlement escrow account in the amount of $1,850,000 of which $150,000 will be paid by the Company and $1,700,000 will be paid by the Company’s insurers;

 

a transfer of 2,300,000 shares of Medbox common stock to the settlement escrow account, of which 2,000,000 shares would be contributed by Medbox and 300,000 shares by Bruce Bedrick;

 

the net proceeds of the settlement escrow, after deduction of Court-approved administrative costs and any Court-approved attorneys’ fees and costs would be distributed to the Class; and

 

releases of claims and dismissal of the action.

 

By entering into the settlement, the settling parties have resolved the class claims to their mutual satisfaction. However, the final determination is subject to approval by the Federal Courts. Defendants have not admitted the validity of any claims or allegations and the settling plaintiffs have not admitted that any claims or allegations lack merit or foundation. If the global settlement does not receive final court approval, it could have a material adverse effect on the financial condition, results of operations and/or cash flows of the Company and their ability to raise funds in the future.

 

Derivative Settlements

 

As previously announced on October 22, 2015, on October 16, 2015, the Company, in its capacity as a nominal defendant, entered into a memorandum of understanding of settlement (the “Settlement”) in the following shareholder derivative actions: (1) Mike Jones v. Guy Marsala, et al., in the U.S. District Court for Central District of California; (2) Jennifer Scheffer v. P. Vincent Mehdizadeh, et al., in the Eighth Judicial District Court of Nevada; (3) Kimberly Y. Freeman v. Pejman Vincent Mehdizadeh, et al., in the Eighth Judicial District Court of Nevada; (4) Tyler Gray v. Pejman Vincent Mehdizadeh, et al., in the U.S. District Court for the District of Nevada; (5) Robert J. Calabrese v. Ned L. Siegel, et al., in the U.S. District Court for the District of Nevada; (6) Patricia des Groseilliers v. Pejman Vincent Mehdizadeh, et al., in the U.S. District Court for the District of Nevada; (7) Michael A. Glinter v. Pejman Vincent Mehdizadeh, et al., in the Superior Court of the State of California for the County of Los Angeles (the “Shareholder Derivative Lawsuits”). In addition to the Company, Pejman Vincent Mehdizadeh, Matthew Feinstein, Bruce Bedrick, Thomas Iwanski, Guy Marsala, J. Mitchell Lowe, Ned Siegel, and C. Douglas Mitchell were named as defendants in all of the lawsuits, and Jennifer S. Love was named in all of the lawsuits but the Scheffer action (the “Individual Defendants”).

 

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On December 3, 2015, the parties in the Jones v. Marsala action advised the Court of the settlements in the Shareholder Derivative Lawsuits and that the parties would be submitting the settlement to the Court in the Jones action for approval. The Court thereafter issued an order vacating all pending dates in the action and ordered Plaintiff to file the Stipulation and Agreement of Settlement for the Court’s approval. On December 18, 2015, plaintiffs filed the Motion for Preliminary Approval of Derivative Settlement that included the Stipulation and Agreement of Settlement. On February 3, 2016, the Court issued an Order granting preliminary approval of the settlement. 

 

The Court originally scheduled a final Settlement Hearing to be held on May 16, 2016, but subsequently continued that hearing to October 17, 2016. By the terms of the settlement, a final Court approval would provide for a release of the claims in the Shareholder Derivative Actions and a bar against continued prosecution of all claims covered by the release. By entering into the Settlement, the settling parties have resolved the derivative claims to their mutual satisfaction. The Individual Defendants have not admitted the validity of any claims or allegations and the settling plaintiffs have not admitted that any claims or allegations lack merit or foundation.

 

The final Settlement Hearing was held on October 17, 2016, and the Court has taken the settlement under review.

 

Under the terms of the Settlement, the Company agrees to adopt and adhere to certain corporate governance processes in the future. In addition to these corporate governance measures, the Company’s insurers, on behalf of the Individual Defendants, will make a payment of $300,000 into the settlement escrow account and Messrs. Mehdizadeh and Bedrick will deliver 2,000,000 and 300,000 shares, respectively, of their Medbox, Inc. common stock into the settlement escrow account. Subject to Court approval, the funds and common stock in the settlement escrow account will be paid as attorneys’ fees and expenses, or as service awards to plaintiffs.

 

On September 16, 2016, solely to avoid the costs, risks, and uncertainties inherent in litigation, the parties entered into a settlement regarding the Merritts Action. The settlement provides, among other things, for the release and dismissal of all asserted claims. Under the terms of the settlement, the Company agrees to adopt and to adhere to certain corporate governance processes in the future. In addition to these corporate governance measures, the Company will make a payment of $135,000 in cash to be used to pay Merritts’ counsel for any attorneys’ fees and expenses, or as service awards to plaintiff Merritts, that are approved and awarded by the Court. The settlement is contingent on final court approval. The final Settlement Hearing was held on October 17, 2016, at the same date and time as the final Settlement Hearing for the Shareholder Derivative Lawsuits. The Court has taken the settlement under review.

 

The Settlements remain subject to approval by the Court. The Court must determine whether (1) the terms and conditions of the Settlements are fair, reasonable, and adequate in the best interest of the Company and its stockholders, (2) if the judgment, as provided for in the Settlements, should be entered, and (3) if the request of plaintiff’s counsel for an award of attorneys’ fees and reimbursement of expenses should be granted.

 

The Company’s responsibilities as to the proposed settlements of the Class Action and the Shareholder Derivative Lawsuits have been accrued and included in Accrued settlement and severance expenses on the accompanying consolidated balance sheet as of December 31, 2015. If the settlements of the Class Action, the Shareholder Derivative Lawsuits, or the Merritts Action do not receive final court approval, it could have a material adverse effect on the financial condition, results of operations and/or cash flows of the Company and their ability to raise funds in the future.

 

SEC Investigation

 

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

 

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In March 2016, the staff of the Los Angeles Regional Office of the U.S. Securities and Exchange Commission advised counsel for the Company in a telephone conversation, followed by a written “Wells” notice, that it is has made a preliminary determination to recommend that the Commission file an enforcement action against the Company in connection with misstatements by prior management in the Company’s financial statements for 2012, 2013 and the first three quarters of 2014. A Wells Notice is neither a formal allegation of wrongdoing nor a finding that any violations of law have occurred. Rather, it provides the Company with an opportunity to respond to issues raised by the Staff and offer its perspective prior to any SEC decision to institute proceedings. These proceedings could result in the Company being subject to an injunction and cease and desist order from further violations of the securities laws as well as monetary penalties of disgorgement, pre-judgment interest and a civil penalty. The Company has responded in writing to the “Wells” notice. Under current management, the Company restated the relevant financial statements and took other remedial action, and has been cooperating with the SEC’s investigation since November 2014, including the appointment of a Special Committee of the Board to investigate the conduct of prior management and disclose this conduct to the SEC. The Company has also produced documents to the SEC and has made witnesses available, both voluntarily and for sworn testimony pursuant to subpoena. The Company is unable to predict the outcome of the investigation, any potential enforcement actions or any other impact on the Company that may arise as a result of such investigation. The Company has not established a liability for this matter, because it believes that the probability of loss related to this matter and an estimate of the amount of loss, if any, are not determinable at this time. An adverse judgment or action of the SEC could have a material adverse effect on the financial condition, results of operations and/or cash flows of the Company and their ability to raise funds in the future.

 

Other litigation

 

Whole Hemp complaint

 

A complaint was filed by Whole Hemp Company, LLC d/b/a Folium Biosciences (“Whole Hemp”) on June 1, 2016, naming Notis Global, Inc. and EWSD I, LLC (collectively, “Notis”), as defendants in Pueblo County, CO district court.  The complaint alleges five causes of action against Notis:  misappropriation of trade secrets, civil theft, intentional interference with prospective business advantage, civil conspiracy, and breach of contract.  All claims concern contracts between Whole Hemp and Notis for the Farming Agreement and the Distributor Agreement. 

 

The court entered an ex parte temporary restraining order on June 2, 2016, and a modified temporary restraining order on July 14, 2016, enjoining Notis from disclosing, using, copying, conveying, transferring, or transmitting Whole Hemp’s trade secrets, including Whole Hemp’s plants.  On June 13, 2016, the court ordered that all claims be submitted to arbitration, except for the disposition of the temporary restraining order. 

 

On August 12, 2016, the court ordered that all of Whole Hemp’s plants in Notis’ possession be destroyed, which occurred by August 24, 2016,, at which time the temporary restraining order was dissolved and the parties will soon file a motion to dismiss the district court action.    

 

In light of the Whole Hemp plants all being destroyed per the court order, the Company has immediately expensed all Capitalized agricultural costs as of June 30, 2016, as all costs as of that date related to Whole Hemp plants.

 

Notis commenced arbitration in Denver, CO on August 2, 2016, seeking injunctive relief and alleging breaches of the contracts between the parties.  Whole Hemp filed is Answer and counterclaims on September 6, 2016, asserting similar allegations that were asserted to the court. . 

 

On September 30, 2016, the arbitrator held an initial status conference and agreed to allow EWSD and Notis to file a motion to dismiss some or all of Whole Hemp’s claims by no later than October 28, 2016. The parties were also ordered to make initial disclosures of relevant documents and persons with knowledge of relevant information by October 21, 2016.

 

West Hollywood Lease

 

The lease for the former office at 8439 West Sunset Blvd. in West Hollywood, CA has been partially subleased. The Company plans to sublease the remainder of the office in West Hollywood, CA and continues to incur rent expense while the space is being marketed. The landlord for the prior lease filed a suit in Los Angeles Superior Court in April 2015 against the Company for damages they allege have been incurred from unpaid rent and otherwise. In January 2016, the landlord filed a first amended complaint adding the independent guarantors under the lease as co-defendants and specifying damages claim of approximately $300,000. On September 8, 2016, the court approved the landlord's application for writ of attachment in the State of California in the amount of $374,402 against Prescription Vending Machines, Inc. (“PVM”). A trial date has been set in May 2017. The Company is presently unable to determine whether the likelihood of an unfavorable outcome of the dispute is probable or remote, nor can it reasonably estimate a range of potential loss, should the outcome be unfavorable.

 

Los Angeles Lease

 

The Company’s former landlord, Bank Leumi, filed an action against the Company in Los Angeles Superior Court for breach of lease on August 31, 2016, seeking $29,977 plus fees and interest, in addition to rent payment for September 2016. The Company filed a response to the complaint on September 21, 2016, and a case management conference is scheduled for December 9, 2016. The Company is presently trying settle the dispute with the landlord.

 

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NOTE 12 – SUBSEQUENT EVENTS

 

Letter agreements

 

On August 3, 2016, Notis Global, Inc. executed letter agreements with each of the Company’s two largest investors (the “First Investor” and the “Second Investor”, respectively) (Note 7).

 

First Investor Letter Agreement

Pursuant to the letter agreement with the First Investor (the “First Investor Letter Agreement”), the First Investor agreed to waive, until October 31, 2016, any defaults relating to the requirement to reserve shares of common stock in excess of shares presently held in the First Investor’s reserve with the Company’s transfer agent, as required pursuant to all securities purchase agreements between the Company and the First Investor, debentures issued by the Company to the First Investor and promissory notes issued by the Company to the First Investor (collectively, the “First Investor Credit Agreements”). The First Investor Letter Agreement also extended the maturity dates of certain debentures issued to the First Investor dated July 10, 2015, August 24, 2015, August 28, 2015, May 13, 2016 and May 20, 2016 from their original maturity dates (occurring between July 10, 2016 and August 28, 2016) to October 31, 2016.

 

Additionally, the parties to the First Investor Letter Agreement agreed that any payments made to the First Investor pursuant to Section 4.16 (Profit Sharing) of that certain Stock Purchase Agreement among the First Investor, the Company, EWSD I LLC, a subsidiary of the Company (“EWSD”), and Pueblo Agriculture Supply and Equipment, LLC, a subsidiary of the Company (“PASE”) dated as of June 30, 2016 (the “EWSD SPA”) (Note 7), shall be applied as repayments of any redemption premium, accrued and unpaid interest, and outstanding principal owed to the First Investor under the First Investor Credit Agreements, and that the provisions of Section 4.16 of the EWSD SPA are only applicable until the First Investor has been repaid required principal, interest, fees and premiums under the EWSD SPA and any related debentures issued by the Company pursuant thereto.

 

Second Investor Letter Agreement

Pursuant to the letter agreement with the Second Investor (the “Second Investor Letter Agreement”), the Second Investor (on behalf of itself and its affiliates) also agreed to waive, until October 31, 2016, any defaults relating to the requirement to reserve shares of common stock in excess of shares presently held in the Second Investor’s reserve with the Company’s transfer agent, as required pursuant to all securities purchase agreements between the Company and the Second Investor, debentures issued by the Company to the Second Investor and promissory notes issued by the Company to the Second Investor (collectively, the “Second Investor Credit Agreements”). The Second Investor Letter Agreement also extended the maturity dates of certain debentures issued (or assigned) to the Second Investor (or its affiliates) dated August 24, 2015, March 27, 2015, May 7, 2015, May 15, 2015, May 22, 2015 and August 14, 2015 from their original maturity dates (occurring between July 10, 2016 and August 24, 2016) to October 31, 2016.

 

Pursuant to the Second Investor Letter Agreement, the Company agreed to pay the Second Investor within five (5) days of the end of each fiscal quarter, (i) 20% of all distributed cash flow from PASE and EWSD to the Company after taking into account amounts owed to First Investor pursuant to Section 4.16 (Profit Sharing) of the EWSD SPA, and (ii) 20% of any money raised at either EWSD or PASE that is distributable or paid to the Company. Such payments will be credited as repayments of amounts owed to the Second Investor under all securities purchase agreements between the Company and the Second Investor, debentures issued by the Company to the Second Investor and promissory notes issued by the Company to the Second Investor (collectively, the “Second Investor Credit Agreements”) including towards any redemption, premium accrued and unpaid interest, and outstanding principal thereunder, and such payments shall only occur until the Second Investor has been repaid the sum of $500,000 of principal under the Second Investor Credit Agreements, plus a 30% premium on such amount.

 

Subsequent funding

 

Subsequent to June 30, 2016, the Company has received approximately $1,266,000, net of approximately $40,000 in withholdings, in additional closings under the June 30, 2016 funding (Note 7).

 

Additionally, the Company has received approximately $650,000 under the September 30, 2016 financing discussed below.

 

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Event of Default

 

On September 22, 2016, Notis Global, Inc. received notice of an Event of Default and Acceleration (the “Notice Letter”) in connection with the promissory note (the "Note"), dated March 14, 2016, in the original principal amount of $140,000 (Note 8). Pursuant to the Notice Letter, (1) beginning on September 14, 2016, the maturity date of the Note, the Note began to accrue interest at a default rate of 22% per annum (the “Default Rate Adjustment”), (2) the noteholder declared all unpaid principal, accrued interest and other amounts due and payable at 125% of the outstanding balance of the Note (the “Mandatory Default Amount”), and (3) the noteholder declared the outstanding balance of the Note immediately due and payable (the “Acceleration Payment”).

 

On September 23, 2016, the noteholder agreed to forebear the Acceleration Payment for a period of 30 days, and is in the process with the Company of negotiating a forbearance agreement reflecting the 30-day forbearance. Regardless of such forbearance, the Default Rate Adjustment and the application of the Mandatory Default Amount formula shall remain in effect. As a result of the application of the Mandatory Default Amount formula, the outstanding balance of the Note increased to $184,022 from $147,217.

 

As a result of the effect of the Notice Letter, other of the Company’s lenders could issue similar notices of events of default or acceleration or penalties due to the Company’s Event of Default set forth in the Notice Letter.

 

Entry into Note Purchase Agreement, Exchange Agreement, and Security Agreement

 

On September 30, 2016, the Company entered into a securities purchase agreement (the “Securities Purchase Agreement”) with a new investor (the “Investor”) pursuant to which two wholly-owned subsidiaries of the Company, EWSD I, LLC (“EWSD I”) and Pueblo Agriculture Supply and Equipment, LLC (“Pueblo”, and together with EWSD I, the “Subsidiaries”) agreed to jointly sell, and the Investor agreed to purchase, an aggregate of up to $3,349,599 in subscription amount of convertible secured promissory notes (plus the Investor Subscription Amount of $1,431,401, described below, which was tendered with the first tranche of the Securities Purchase Agreement) (collectively, the “New Notes”) in seven tranches (each, a “Closing”).

 

The Investor’s commitment to purchase the New Notes may, at the option of the Investor, be reduced by up to $700,000 for monies raised by the Company or the Subsidiaries. The Investor Note Subscription Amount refers to $1,431,401 of 10% convertible notes of the Company previously issued to the Company's major investor ("First Investor") pursuant to that certain Securities Purchase Agreement dated on or about June 30, 2016 (the “July SPA”) (Note 11). The debentures issued pursuant to the July SPA were subsequently assigned to the Investor and were tendered for cancellation to the Company for the Investor Subscription Amount portion of the New Notes.

 

The New Notes accrue interest at a rate of 5% per annum and are issued at a 40% discount to purchase price. Therefore, if each of the seven tranches described below are fully funded, the Company would receive cash in the aggregate of $1,983,599 in exchange for the issuance of New Notes with a face value of $3,349,599 in principal to be repaid to the Investor. The first New Note issued in the first tranche under the Securities Purchase Agreement was for an original purchase price of $1,881,401 (representing the Investor Note Subscription Amount of $1,431,401 plus $450,000 funded purchase price) and an original principal amount of $2,633,961. The New Notes may be prepaid inclusive of interest of the greater of one year or the current amount of time that the New Note has been outstanding.

 

The funding of New Notes under the Securities Purchase Agreement are as follows: The first tranche of up to $539,306 plus the Investor Note Subscription Amount, the second tranche of up to $100,000 being closed upon on or about October 1, 2016, the third tranche of up to $208,424 being closed upon on or about October 17, 2016, the fourth tranche of up to $100,000 being closed upon on or about November 1, 2016, the fifth tranche of up to $188,818 being closed upon on or about November 15, 2016, the sixth tranche of up to $182,051 being closed upon on or about December 15, 2016, and the seventh tranche of up to $665,000, the closing of which is contingent upon, among other things, the purchase of that certain parcel of land located at 212 39th Ln, Pueblo CO 81006 referred to as "Farm#2", upon terms and conditions that are satisfactory to the Investor and the assignment of a 20% ownership interest in that certain 320-acres of agricultural land in Pueblo, Colorado (the "Farm") and Farm #2 to the Investor. As of October 20, 2016 the new investor has funded $650,000 in cash for New Notes with the total face value of $910,000, excluding the Investor Note Subscription Amount.

 

Upon retirement of the New Notes, the Company or its Subsidiaries or affiliates as applicable, shall assign twenty percent (20%) of their respective ownership interest in the Farm and Farm #2 to the Investor.

 

The Company and Ned Siegel, Jeffrey Goh, and Clinton Pyatt, each an executive officer of the Company or member of the Company’s Board shall enter into management contracts with the Company upon terms and subject to conditions that are reasonably acceptable to the Investor.

 

Furthermore, the Company shall pay to the Investor as partial repayment of the New Notes or other indebtedness at the end of each calendar month:

 

(a)     Out of the first $1,000,000 in the aggregate of combined revenues received from all sources, including, without limitation, any revenue from any legal settlement, judgment, or other legal proceeding (collectively, a “Legal Matter”), received of the Company and all of its Subsidiaries net of any payments to an ‘outside farmer’ (collectively, the “Combined Revenues”), 80% of the Combined Revenues, except to the extent the Combined Revenues are from a Legal Matter, in which event, the percentage shall be 50% (collectively, the “Combined Net Revenues”).

 

(b)    Out of the second $1,000,000 in the aggregate of Combined Revenues, 70% of the Combined Net Revenues, except to the extent the Combined Revenues are from a Legal Matter, in which event, the percentage shall be 50%.

 

(c)     Out of any Combined Revenues in excess of $2,000,000, 60% of the Combined Net Revenues, except to the extent the Combined Revenues are from a Legal Matter, in which event, the percentage shall be 50%.

 

(d)     Upon full satisfaction of the New Notes, 60% of the Combined Net Revenues shall be used to redeem any outstanding indebtedness owed to the Investor.

 

(e)     The foregoing amounts may, at the Investor’s option, be reduced to allow EWSD to meet its overhead not to exceed $120,000 per month plus a maximum of $100,000 per month to the Company beginning January 15, 2017.

 

(f)      The Company shall be permitted to enter into one or more agreements with third parties to allocate to such third parties up to no more than 20% of the Combined Net Revenues. Any such agreements shall reduce the percentage of the Combined Net Revenues to be paid by the Companies to the Investor.

 

The Company agreed to use commercially reasonable efforts to amend the Subordination Agreement (referred to above) to reflect the issuance of New Notes to the Investor within 14 days of the date of the Securities Purchase Agreement. The First Investor and the Investor are affiliates of one another.

 

The Company and the Subsidiaries also entered into an Exchange Agreement with First Investor, pursuant to which the First Investor agreed to exchange each of the Company’s outstanding debentures issued in their favor (in the principal outstanding balance amount of approximately $5,882,242 (plus accrued interest) (the “Original Debentures”) for certain 10% Convertible Debentures issued by the Subsidiaries, due June 30, 2017, on substantially the same terms as the Original Debentures (the “Subsidiary Debentures”).

 

 The Company and the Subsidiaries also entered into a Security Agreement (the “Security Agreement”), securing a lien for the Investor on the Farm (subject to the rights of the primary lien holder in the Farm pursuant to the Subordination Agreement (as defined above)) and securing a lien for the Investor on Subsidiaries’ other assets on a primary basis. Pursuant to the Security Agreement, the Company agreed to, within 14 calendar days, negotiate and enter into an amendment to the Subordination Agreement to reflect the rights of the Investor set forth in the Security Agreement. The Company also intends to negotiate related waivers with its other creditors.

 

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In the instance of an Event of Default, as such term is defined in the New Note, the Investor has the right to convert all or any portion of principal and/or interest of the New Notes into shares of Common Stock of the Company in accordance with the terms of the form of 10% Convertible Debenture dated as of June 30, 2016 issued under the July SPA.

 

The Investor shall have a right of first refusal to participate in future equity financings of the Company on the same terms as any new investors for a period of twelve months from the closing of the last Convertible Debenture.

 

Grant of Second Deed of Trust and Assignment of Rents

 

On September 30, 2016, EWSD I, LLC (“EWSD I”), a wholly-owned subsidiary of the Company granted a junior lender (the “Junior Lender”) a Second Deed of Trust, Security Agreement and Financing Statement (the “Second Trust Deed”) and an Assignment of Rents and Leases (the “Assignment of Rents”). The Second Trust Deed and the Assignment of Rents encumber the Farm, and the rents payable by tenants under any current and future leases of and from the Farm. The Second Trust Deed and the Assignment of Rents secure the payment of all obligations of EWSD I pursuant to any debentures issued to the Junior Lender in accordance with the Securities Purchase Agreement dated June 30, 2016 by and among EWSD I, Junior Lender, and Company (the “Securities Purchase Agreement”).

The security granted to the Junior Lender pursuant to the Second Trust Deed and the Assignment of Rents is subordinate to the rights of Southwest Farms, Inc. (the “Senior Lender”) as set forth in the Deed of Trust, Security Agreement and Financing Statement dated as of August 7, 2015 granted by EWSD I in favor of Senior Lender and the Assignment of Rents and Leases by and between EWSD I and Senior Lender dated as of August 7, 2015. Such subordination is documented in a Subordination Agreement dated as of August 23, 2016 by and among Senior Lender, Junior Lender, Company, EWSD I, and Pueblo Agriculture Supply and Equipment, LLC, another wholly-owned subsidiary of the Company, as amended by a First Amendment to Subordination Agreement dated as of September 19, 2016 (collectively, the “Subordination Agreement”) pursuant to which Senior Lender consented to the Second Trust Deed and the Assignment of Rents. The Subordination Agreement also provides that the Junior Lender may not increase the principal amount of indebtedness pursuant to the Securities Purchase Agreement beyond $1,500,000.

 

On September 9, 2016, the Company received notice from the OTC Markets that OTC Markets would move the Company’s listing from the OTCQB market to OTC Pink Sheets market, if the Company had not filed its Quarterly Report on Form 10-Q for the period ended June 30, 2016 by September 30, 2016. On or about October 1, 2016, the Company moved to the OTC Pink Sheets market. This might also impact the Company's ability to obtain funding. 

 

Entry into Note Purchase Agreement and Global Debenture Amendment

 

On October 10, 2016, the Company entered into a Note Purchase Agreement (the “Purchase Agreement”) with an accredited investor (the “Investor”), pursuant to which the Company agreed to sell, and the Investor agreed to purchase, a secured convertible promissory note (the “Note”) in the aggregate principal amount of $53,000.

 

The Investor deducted a commitment fee in the amount of $3,000 at the closing. The Note bears interest at the rate of 5% per annum and matures on April 30, 2017. The Company may not prepay any part of the outstanding balance of the Note at any time prior to maturity without the written consent of the Investor. At any time or from time to time, the Investor may convert the Note, in whole or in part, into shares of the Company's common stock at a conversion price that is the lower of (a) $0.75, or (b) 51% of the lowest volume weighted average price for the 30 consecutive trading days prior to the conversion date.

 

In connection with entry into the Note Purchase Agreement, the parties also entered into a Global Debenture Amendment (the “Debenture Amendment”), pursuant to which the Investor shall be entitled to the same “look-back” period on establishing the conversion price of a Note as any other Investor is entitled to pursuant to notes or debentures held by such Investor. Based on the terms of the Company's other convertible notes and debentures, other investors shall be entitled to the same rights established in the Debenture Amendment. Therefore, each of the company's investors holding convertible debt shall be entitled to the same “look-back” period when establishing the conversion price for their respective notes or debentures.

 

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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, 2015, filed with the Securities and Exchange Commission (the “SEC”) on April 13, 2016. 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

 

Notis Global enters into joint ventures and operating and management agreements with its partners and acts as a distributor of hemp products processed by our contract partners. Furthermore, we own and manage real estate used by our contract partners for cultivation centers and dispensaries.

 

We are building a consistent, predictable and valuable revenue model as we refocus the Company to create a sustainable business model to grow crops and manufacture products from hemp farmland and to market, sell and distribute CBD oil. State and local laws regarding farming and growing marijuana and cultivation centers for marijuana vary.

 

With an eye focused on the future-and ultimately anticipated FDA approval of hemp and CBD oil production and sales in the United States-we are honing our focus to controlling our supply chain. From “Seed to Sale,” Notis Global will influence its own destiny by controlling our ecosystem. We intend to oversee and execute everything from growing and cultivating the highest quality plants to managing extraction and production of our products. We believe this tight control of our supply chain will eventually be mandated by the Federal Government as a condition of legalizing hemp and CBD oil production, manufacturing and distribution in the United States. We have elected to take action now, and intend to lead our industry by doing so. As we continue to navigate the emerging world of hemp and CBD growing, cultivation, production and sales, it is clear that controlling all aspects of the business is the best strategy to meet our goals.

 

In August 2015, we purchased a 320 acre farm located outside of Pueblo, CO, in order to cultivate hemp for our products.

 

Whole Hemp Agreement

 

In December 2015, we entered into a Farming Agreement with Whole Hemp Company (“Whole Hemp”), now known as Folium Biosciences, pursuant to which Whole Hemp would manufacture products from hemp and cannabis crops that it would grow on our farm, and the Company would build greenhouses for such activities up to an aggregate size of 200,000 square feet. Whole Hemp would pay all preapproved costs of such construction on or before September 2017 as partial consideration for a revocable license to use the greenhouses and a separate 10-acre plot of our farmland. We would retain ownership of the greenhouses. Under the 10 year amended agreement with Whole Hemp, Notis Global would receive a percentage of gross sales of all Whole Hemp products paid on a monthly basis. The Farming Agreement was amended and restated in March 2016.

 

Since May 7, 2016, we believe Whole Hemp has been in default, principally because they abandoned their obligation to perform farming activities under the First Amended and Restated Farming Agreement. On May 13, 2016, EWSD notified Whole Hemp of its defaults under the First Amended and Restated Farming Agreement and EWSD’s election to terminate the First Amended and Restated Farming Agreement.

 

By its terms, the First Amended and Restated Farming Agreement may be terminated at any time by either party, if the other party was in material breach of any obligation under the First Amended and Restated Farming Agreement, which breach continued uncured for 30 days following written notice thereof.

 

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In addition, in December 2015, we entered into a Grower’s Distributor Agreement with Whole Hemp, pursuant to which we would provide marketing, sales, and related services on behalf of Whole Hemp in connection with the sale of its Cannabidoil oil product, and pursuant to which the Company would receive a percentage of gross revenues. The Grower’s Distributor Agreement was effective until September 30, 2025. The Grower’s Distributor Agreement was amended and restated in March 2016.

 

Because we believe Whole Hemp has been in default, principally because they abandoned their obligation to perform farming activities under the First Amended and Restated Farming Agreement since May 7, 2016, EWSD notified Whole Hemp on May 13, 2016 of its election to terminate the Restated Grower’s Distributor Agreement.

 

By its terms, the Restated Grower’s Distributor Agreement could be terminated at any time by either party, if the other party was in material breach of any obligation under the Restated Grower’s Distributor Agreement, which breach continued uncured for 30 days following written notice thereof.

 

Whole Hemp complaint

 

A complaint was filed by Whole Hemp Company, LLC d/b/a Folium Biosciences (“Whole Hemp”) on June 1, 2016, naming Notis Global, Inc. and EWSD I, LLC (collectively, “Notis”), as defendants in Pueblo County, CO district court.  The complaint alleges five causes of action against Notis:  misappropriation of trade secrets, civil theft, intentional interference with prospective business advantage, civil conspiracy, and breach of contract.  All claims concern contracts between Whole Hemp and Notis for the Farming Agreement and the Distributor Agreement. 

 

The court entered an ex parte temporary restraining order on June 2, 2016, and a modified temporary restraining order on July 14, 2016, enjoining Notis from disclosing, using, copying, conveying, transferring, or transmitting Whole Hemp’s trade secrets, including Whole Hemp’s plants.  On June 13, 2016, the court ordered that all claims be submitted to arbitration, except for the disposition of the temporary restraining order. 

 

On August 12, 2016, the court ordered that all of Whole Hemp’s plants in Notis’ possession be destroyed, which occurred by August 24, 2016,, at which time the temporary restraining order was dissolved and the parties will soon file a motion to dismiss the district court action.    

 

Notis commenced arbitration in Denver, CO on August 2, 2016, seeking injunctive relief and alleging breaches of the contracts between the parties.  Whole Hemp filed is Answer and counterclaims on September 6, 2016, asserting similar allegations that were asserted to the court. . 

 

On September 30, 2016, the arbitrator held an initial status conference and agreed to allow EWSD and Notis to file a motion to dismiss some or all of Whole Hemp’s claims by no later than October 28, 2016. The parties were also ordered to make initial disclosures of relevant documents and persons with knowledge of relevant information by October 21, 2016.

 

In light of the court order to destroy all Whole Hemp plants, the Company has immediately expensed all Capitalized agricultural costs as of June 30, 2016, as all costs as of that date related to Whole Hemp plants.

 

As noted above, our long term strategy is to maintain tight control of our supply chain. The continuing default by Whole Hemp was conductive to our efforts to eliminate outside vendors in the supply chain and control production from “Seed to Sale.” Our decision to terminate the Whole Hemp Agreements comports with our long term strategy to maintain tight control of our supply chain.

 

Historically, we generated revenue from various sources on a “one-time basis” for services that we provided to clients in helping them obtain licenses, build out and open dispensaries and cultivation centers. During this period we obtained five licenses or registrations in the States of Oregon, Illinois, Washington and California for or on behalf of clients or for potential clients. Most of the current dispensary and cultivation sites that are opening under these licenses began conducting business in 2015. As of the second quarter of 2016, we have sold all of our interests and rights as concerns the dispensaries.

 

In the second quarter of 2015, we contracted with an independent operator to operate a dispensary in Portland, Oregon. In December 2015, we terminated the operator due to low sales volume and entered an operating agreement with a new partner to operate the Portland dispensary. Under the management of our new partner, the dispensary reached expected sales volume levels in December 2015 through March 2016 and is rated as the top dispensary in Portland, Oregon according to Leafly.com. On June 30, 2016, we entered into an assignment agreement whereby we sold and assigned all of our rights in the operating agreement, including but not limited to the assets and liabilities we held in relation to the Portland dispensary, resulting in a net loss of $178,000 on sale of assets.

 

On December 31, 2015, our operating partner made a matching investment to close on our escrow for a dispensary site in San Diego, CA. Notis Global, through an affiliated company, holds the approved conditional use permit to operate a dispensary on this site. In two transactions in February and April 2016 we sold our interest in the operating entity for approximately $299,000 and our interest in the underlying real estate for $335,000 to our operating partner and other third parties along with a forgiveness of $65,000 owed by Notis for improvements on the property, recognizing a gain of approximately $631,000. After the April 6, 2016 transaction, we have no further interest in the dispensary in San Diego, CA.

 

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In the State of Washington, we hold two licenses to operate dispensaries. These two dispensaries will be operated by an independent operating partner, with whom we have entered into operating contracts as of August 31, 2015. We receive a fixed fee from the operating partner of $1,000 per dispensary, which is paid monthly. We also hold the underlying real estate for one of the two dispensaries, for which we receive monthly rental income of $2,500. On July 25, 2016, we were notified that we are in default on the Note payable related to the underlying property, and are incurring interest at the default rate of 18%. The Company is in discussions regarding settlement of this note.

 

During January and February 2016 we were selling a line of portable vaporizers and accessories under the brand name Vaporfection. In January 2016, we decided to exit the portable vaporizer business in 2016 so that the Company can more aggressively pursue additional business opportunities in its core business. On March 28, 2016 we sold our assets in Vaporfection for $70,000, which is payable $35,000 upon the sale and $35,000 was loaned to the buyer under a 6% note payable due September 30, 2016.

  

Comparison of the three months ended June 30, 2016 and 2015

 

The Company reported consolidated net income of approximately $6,549,000 for the three months ended June 30, 2016 and loss of approximately $11,395,000, for the three months ended June 30, 2015. The change from net loss to income of approximately $17,944,000 was due significantly to the change in fair value of the derivative liability of $9,940,000 resulting in income, as well as to the decreases in amortization of debt discount by approximately $3,485,000, general and administrative expenses by approximately $2,753,000, and financing cost of approximately $1,230,000.

 

Revenue

 

Total revenue consisted of revenue from CBD oil sales generated from our Grower’s Distribution agreement with Whole Hemp, deferred revenue which was recognized in the current period for consulting agreements, sale of territory rights to a related party, rental income, Company’s share of dispensary revenue and in 2015 the revenue from sales of vaporizers. During the first quarter of 2016, the Company launched its CBD oil sales program under the Grower’s Distribution agreement. As noted under the Overview above, this agreement was terminated in May 2016.

 

The increase by approximately $187,000 in total revenue is due to an increase of approximately $107,000 from CBD oil sales generated from our Grower’s Distribution agreement and an increase of approximately $92,000 from rental income and Company’s share of dispensary revenue earned our Oregon and Washington operations compared to $16,000 in rental income for the same period of 2015. This increase was offset by a decrease by $17,000 in vaporizer sales and accessories due to the Company exiting the business as of March 31, 2016.

 

Costs of revenue

 

Costs of revenues decreased by approximately $673,000 for the three months ended June 30, 2016 as compared to the same period of 2015.

 

During the three months ended June 30, 3015, the manufacturing partner of the Company announced that they had filed for restructuring and court protection under Chapter 11 of the United States Bankruptcy Code. The Company had Inventory and deposits on dispensing machines connected to this manufacturing partner. As a result, the Company wrote down both the inventory of the dispensing machines and deposits, for a total charge to Costs of revenues of approximately $355,000. There were no similar transactions during the same period of 2016.

 

In light of the court order to destroy all Whole Hemp plants (Note 3), during the three months ended June 30, 2016, the Company immediately expensed all Capitalized agricultural costs of approximately $73,000 to Costs of revenue.

 

New market development costs decreased by approximately $234,000 during three months ended June 30, 2016 as compared to the same period of 2015. 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. The Company was not active in developing new market areas in the second quarter of 2016, leading to the aforementioned decrease.

 

During the second quarter of 2015, the Company forfeited $240,000 in earnest money due to unfavorable terms demanded by the sellers to extend the escrow and closing date. There were no corresponding charges in the second quarter of 2016.

 

As result of our CBD oil sale program launched in the first quarter of 2016 the Company incurred cost of revenue related to procurement of CBD oils in the amount of approximately $93,000 during the second quarter of 2016. There were no corresponding costs for the same period of 2015.

 

Rental expenses on the master lease and tenant improvement amortization related to the Oregon rental income was approximately $23,000 and $15,000 for the three months ended June 30, 2016 and 2015, respectively.

 

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Operating Expenses

 

Operating expenses consist of all other costs incurred during the period other than cost of revenue. The Company incurred approximately $2,524,000 in operating expenses for the three months ended June 30, 2016 compared to approximately $5,395,000 for the three months ended June 30, 2015. The decrease of approximately $2,871,000 was primarily due to the decrease in general and administrative expenses of $2,753,000.

 

Sales and Marketing expenses

 

Sales and marketing expenses include employee costs, outside services for sales and marketing consultants, travel and entertainment and sales lead generation. The Company incurred approximately $41,000 and $159,000 in sales and marketing expenses for the three months ended June 30, 2016 and 2015, respectively. The decrease was a result of the Company’s effort to decrease expenses in these areas.

 

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 months ended June 30, 2016 and 2015 are summarized and described below:

 

Salary costs

 

Employee costs and bonuses increased by approximately $55,000 for the three months ended June 30, 2016 as compared to the same period in 2016. During 2016, there was an increase of approximately $108,000 in salaries, due to the addition of our Chief Operating Officer and Vice President of Operations. This salary increase was offset by bonuses of approximately $53,000 in the three months ended June 30, 2015, while there were no cash bonuses for the same period in 2016.

 

The Company’s stock based compensation decreased by approximately $1,712,000 due to lower cost for director’s fees in the second year of their term. The director’s retention agreements specify higher stock grants in their first year of service (two Directors commenced service in the middle of 2014 and received inducement grants for their first year of service; their related costs were expensed over the year that included the first quarter of 2015). Additionally, the new grants expensed in 2016, were valued at a significantly lower share price.

 

Professional costs

 

Professional costs decreased approximately $1,072,000 for three months ended June 30, 2016, as compared to the same period of 2015. A significant portion of the decrease was due to the settlement expense of approximately $515,000 recognized in the three months ended June 30, 2015, related to the severance payments and related costs payable to Guy Marsala, former CEO of the Company. There were no similar expenses during the same period of 2016.

 

Legal costs decreased by $453,000 during the three months ended June 30, 2016, as compared to the same period of 2015 mostly due to the recognition during the second quarter of 2015, of a liability of $430,000 to indemnify its former CEO Dr. Bruce Bedrick for legal expenses, principally in connection with shareholders law suits.

 

The costs of being public include legal fees for our corporate securities counsel, filing fees, independent directors’ fees and bonuses and investor relations costs. A portion of the periods decrease was due to the reduction by approximately $221,000 of costs associated with being a public company and accounting and audit fees as the corresponding period reflects the additional costs of the Company’s filing of a registration statement on Form S-1, offset by independent director’s bonuses of approximately $89,000.

 

Other costs

 

Due to the Company’s development of the farm in Colorado, fund raising activities and exploration and development of international markets travel and related expenses increased by approximately $117,000 as compared to the same period in 2015.

 

As part of the transactions with Whole Hemp (Note 3), the Company issued a warrant to purchase 4,000,000 shares of Company common stock valued at $76,000. The fair value of the warrants was included in deferred costs and due to the termination of the Farming and Growers Distribution Agreements this amount has been fully amortized during the second quarter of 2016.

 

Insurance costs decreased by approximately $214,000 for the three months ended June 30, 2016, as compared to the same period of 2015, as the Company reduced their coverage to decrease on expenses.

 

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Other Income (Expense)

 

Other income (expense) includes the financing costs associated with our financing activities, including the amortization of the debt discount and the change in fair value of the derivative liability. As disclosed in Note 7 of the Company’s 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 re-measured each period end, with the net change in fair value for the three months ended June 30, 2016 and 2015 of gains of approximately $9,940,000 and $814,000, respectively, being recognized in Other income (expense). This derivative feature 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 with the convertible debentures, as well as the discounts offered to the face value of the notes payable. This debt discount is amortized as “other expense” over the life of the convertible debenture, or until conversion, if earlier, which amounted in approximately $745,000 for the three months ended June 30, 2016 and $4,230,000 for the same period of 2015. Additionally, the current period closings of the convertible debentures resulted in the calculated fair value of the discount being greater than the face amount of the debt by approximately $335,000, with this excess amount being immediately expensed as Financing costs. Financing costs also includes the amortization of $210,000 relating to a note issued as an incentive to amend the terms of certain convertible debentures (Note 7). As the Company determined there is not sufficient authorized shares at quarter-end for conversion of all the convertible debentures and exercise of the warrants, under their sequencing policy (Note 7), the Company has recognized a warrant liability. The warrant liability is remeasured to its fair value at the end of every period, which resulted in the Company recognizing a net gain from the change in fair value of the warrant liability of approximately $441,000 for three months ended June 30, 2016.

 

Interest expense for the stated interest on our convertible debentures and notes payable incurred during three months ended June 30, 2016 amounted to approximately $206,000. In addition to the foregoing, the Company incurred approximately $15,000 in interest offset by $3,000 premium amortization on the promissory note issued in relation to the purchase of the property in the State of Washington and approximately $54,000 related to notes for the purchase of the land in Colorado. All of the above resulted in interest expense of approximately $272,000 for the three months ended June 30, 2016. Interest expense for the stated interest on our July 2014 and September 2014 convertible debentures incurred in the three months ended June 30, 2015 amounted to approximately $78,000.

 

As result of the Company’s sale of its interest in the operating entity and its interest in the underlying real estate in San Diego, the Company recorded a net gain of approximately $331,000. In addition, on June 30, 2016, the Company entered into an assignment agreement whereby we sold and assigned all of our rights in the operating agreement, including but not limited to the assets and liabilities we held in relation to the Portland dispensary, resulting in a net loss of $178,000 on sale of assets.

 

Net Income (Loss)

 

As a result of the factors set forth above, our net loss changed to net income, with a fluctuation of approximately $17,994,000 for the three months ended June 30, 2016, resulting in net income of approximately $6,549,000 for the three months ended June 30, 2016.

 

Comparison of the six months ended June 30, 2016 and 2015

 

The Company reported a consolidated net income of approximately $7,796,000 for the six months ended June 30, 2016 and consolidated net loss of approximately $15,829,000, for the six months ended June 30, 2015. The fluctuation of approximately $23,625,000 was significantly due to the change in fair value of the derivative liabilities of approximately $18,820,000, as well as an increase in gross profit by approximately $1,184,000 offset by various decreases in expenses. These expenses primarily include decreases in the fair value of the warrant liability by approximately $997,000, decreased amortization of debt discount of approximately $3,436,000 and reduced general and administrative expenses of approximately $2,888,000.

 

Revenue

 

Total revenue consisted of revenue from CBD oil sales generated from our Grower’s Distribution agreement, deferred revenue which was recognized in the current period for consulting agreements, sale of territory rights to a related party, rental income, Company’s share of dispensary revenue and in 2015 the revenue from sales of vaporizers. During the first quarter of 2016, the Company launched its CBD oil sales program under the Grower’s Distribution agreement. As noted under the Overview above, this agreement was terminated in May 2016.

 

The increase by approximately $373,000 in total revenue is due to an increase of approximately $239,000 from CBD oil sales generated from our Grower’s Distribution agreement and an increase of approximately $147,000 from rental income and Company’s share of dispensary revenue earned our Oregon and Washington operations compared to $16,000 in rental income for the same period of 2015. This increase was offset by a decrease by $16,000 in vaporizer sales and accessories due to the Company exiting the business as of March 31, 2016.

 

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Costs of revenue

 

Costs of revenues decreased by approximately $811,000 for the six months ended June 30, 2016 as compared to the same period of 2015.

 

New market development costs decreased by approximately $538,000 during six months ended June 30, 2016 as compared to the same period of 2015. 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. The Company was not active in developing new market areas in 2016, leading to the aforementioned decrease.

 

During the three months ended June 30, 3015, the manufacturing partner of the Company announced that they had filed for restructuring and court protection under Chapter 11 of the United States Bankruptcy Code. The Company had Inventory and deposits on dispensing machines connected to this manufacturing partner. As a result, the Company wrote down both the inventory of the dispensing machines and deposits, for a total charge to Costs of revenues of approximately $355,000. There were no similar transactions during the same period of 2016.

 

During the second quarter of 2015, the Company forfeited $240,000 in earnest money due to unfavorable terms demanded by the sellers of real property to extend the escrow and closing date on the sale of the property. There were no corresponding charges in the second quarter of 2016.

 

The reduction of the above three categories of costs of revenue are the cause of the increase in our gross profit for the six months ended June 30, 2016. As result of our CBD oil sale program launched in the first quarter of 2016 the Company incurred cost of revenue related to procurement of CBD oils in the amount of approximately $195,000 during the second quarter of 2016. There were no corresponding costs for the same period of 2015. The gross profit on our CBD oil sales is approximately $44,000 or 18.5%.

 

In light of the court order to destroy all Whole Hemp plants, the Company has immediately expensed all Capitalized agricultural costs of $75,000 as of June 30, 2016, as all costs as of that date related to Whole Hemp plants.

 

Rental expenses on the master lease and tenant improvement amortization related to the Oregon rental income was approximately $46,000 and $23,000 for the three months ended June 30, 2016 and 2015, respectively. There were no corresponding costs for the same period of 2015.

 

Operating Expenses

 

Operating expenses consist of all other costs incurred during the period other than cost of revenue. The Company incurred approximately $6,457,000 in operating expenses for the six months ended June 30, 2016 compared to approximately $9,460,000 for the six months ended June 30, 2015. The decrease of approximately $3,004,000 was primarily due to the decrease in general and administrative expenses of $2,888,000.

 

Sales and Marketing expenses

 

Sales and marketing expenses include employee costs, outside services for sales and marketing consultants, travel and entertainment and sales lead generation. The Company incurred approximately $223,000 and $338,000 in sales and marketing expenses for the three months ended June 30, 2016 and 2015, respectively. The decrease was a result of the Company’s effort to cutback on expenses.

  

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 six months ended June 30, 2016 and 2015 are summarized and described below:

 

Salary costs

 

Employee costs and bonuses increased by approximately $209,000 for the six months ended June 30, 2016 as compared to the same period in 2016. During 2016, there was an increase of approximately $263,000 in salaries, primarily due to the addition of our Chief Operating Officer and Vice President of Operations. This salary increase was offset by bonuses of approximately $53,000 in the three months ended June 30, 2015, while there were no cash bonuses for the same period in 2016.

 

The Company’s stock based compensation decreased by approximately $1,712,000 due to lower cost for director’s fees in the second year of their term. The director’s retention agreements specify higher stock grants in their first year of service (two Directors commenced service in the middle of 2014 and received inducement grants for their first year of service; their related costs were expensed over the year that included the first quarter of 2015). Additionally, the new grants expensed in 2016, were valued at a significantly lower share price.

 

Professional costs

 

Professional costs decreased approximately $16,000 for the six months ended June 30, 2016, as compared to the same period of 2015.

 

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Legal costs increased by $189,000 during the six months ended June 30, 2016, as compared to the same period of 2015 mostly due to costs related to preparation of a Private Placement Memorandum to be offered by the Company’s subsidiary EWSD I and legal expenses related to the sale of our interest in the operating entity and our interest in the underlying real estate in San Diego offset by the recognition during the second quarter of 2015, of a liability of $430,000 to indemnify the Company's former CEO Dr. Bruce Bedrick for legal expenses, principally in connection with shareholders law suits.

 

Independent contractors cost increased by approximately $212,000 for the first six months of 2016 compared to the same period of 2015 due to consulting expenses incurred in connection with costs related to exploration and development of international markets and the preparation of a Private Placement Memorandum to be offered by the Company’s subsidiary, EWSD I.

 

The costs of being public include legal fees for our corporate securities counsel, filing fees, independent directors’ fees and bonuses and investor relations costs. There was an increase in these cost of approximately $145,000 comprised of a reduction by approximately $33,000 of the costs associated with being a public company and accounting and audit fees as the corresponding period reflects the additional costs of the Company’s filing of a registration statement on Form S-1, offset by independent director’s bonuses of approximately $178,000 .

 

These increases were offset by a decrease in costs related to the settlement expense of approximately $515,000 recognized in the six months ended June 30, 2015, related to the severance payments and related costs payable to Guy Marsala, former CEO of the Company. There were no similar expenses during the same period of 2016.

 

Rent

 

The increase in rent by approximately $202,000 during the six months of 2016 as compared to the same period of 2015 is due to recording the lease liability to the end of lease term, reflecting a continuing dispute with the landlord, for the Company’s previous headquarters in West Hollywood, California.

 

Other costs

 

Due to the Company’s development of the farm in Colorado, fund raising activities and exploration and development of international markets travel and related expenses increased by approximately $248,000.

 

In addition, as a part of the Company’s sale of our interest in the operating entity and our interest in the underlying real estate in San Diego, the Company wrote off $70,000 of uncollectable notes receivable from a previously associated partner of San Diego operating entity.

 

As part of the transactions with Whole Hemp (Note 3), the Company issued a warrant to purchase 4,000,000 shares of Company common stock valued at $76,000. The fair value of the warrants was included in deferred costs and due to the termination of the Farming and Growers Distribution Agreements this amount has been fully amortized during the six months ended June 30, 2016.

 

During the six months ended June 30, 2016 the Company incurred approximately $130,000 in new G&A costs related to the daily operations of the farm.

 

These increases were offset by a decrease in insurance costs by approximately $141,000 for the six months ended June 30, 2016, as compared to the same period of 2015, as the Company reduced their coverage to reduce on expenses.

 

Other Income (Expense)

 

Other income (expense) includes the financing costs associated with our financing activities, including the amortization of the debt discount and the change in fair value of the derivative liability. As disclosed in Note 7 of the Company’s 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 re-measured each period end, with the net change in fair value for the six months ended June 30, 2016 and 2015 of gains of approximately $18,820,000 and $3,053,000, respectively, being recognized in Other income (expense). This gain is a result of the decrease in the fair value of the derivative liability created by the drop in our stock price. This derivative feature 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 with the convertible debentures, as well as the discounts offered to the face value of the notes payable. This debt discount is amortized as “other expense” over the life of the convertible debenture, or until conversion, if earlier, which amounted in approximately $2,613,000 for the six months ended June 30, 2016 and $6,050,000 for the same period of 2015. Additionally, when the debt discount is greater than the face amount of the debenture, the effective interest method gives rise to the amortization being immediately amortized in full. The fundings during both the six months ended June 30, 2016 and 2015 were immediately amortized under this guidance. The approximately $3,436,000 reduction in amortization is the result of there being less external financing in 2016, and therefore less discounts being immediately amortized. Additionally, the current period closings of the convertible debentures resulted in the calculated fair value of the discount being greater than the face amount of the debt by approximately $2,641,000, with this excess amount being immediately expensed as Financing costs. Financing costs also includes the amortization of $420,000 relating to a note issued as an incentive to amend the terms of certain convertible debentures (Note 7). As the Company determined there is not sufficient authorized shares at quarter-end for conversion of all the convertible debentures and exercise of the warrants, under their sequencing policy (Note 7), the Company has recognized a warrant liability. The warrant liability is remeasured to its fair value at the end of every period, which resulted in the Company recognizing a gain from the change in fair value of the warrant liability of approximately $997,000 for six months ended June 30, 2016.

 

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The change in fair value of the derivative liability for the six months ended June 30, 2015 was approximately $3,053,000 . The debt discount amounted to approximately $6,050,000 for the six months ended June 30, 2015. Additionally, the period closings to the July 2014 and September 2014 convertible debentures in the six months ended June 30, 2015 resulted in the calculated fair value of the debt being greater than the face amounts of the debt by approximately $2,300,000 with this excess amount being immediately expensed as Financing costs.

 

Interest expense for the stated interest on our convertible debentures and notes payable incurred during six months ended June 30, 2016 amounted to approximately $398,000. In addition to the foregoing, the Company incurred approximately $20,000 in interest offset by $7,000 premium amortization on the promissory note issued in relation to the purchase of the property in the State of Washington and approximately $111,000 related to notes for the purchase of the land in Colorado. All of the above resulted in interest expense of approximately $522,000 for the six months ended June 30, 2016.

 

Interest expense for the stated interest on our July 2014 and September 2014 convertible debentures incurred in the six months ended June 30, 2015 amounted to approximately $166,000. The Company incurred approximately $21,000 interest on the promissory note issued in relation to the purchase of property in Washington State. All of the above resulted in interest expense (including immaterial other amounts of interest expense) of approximately $94,000 for the period ending June 30, 2015.

 

As result of the Company’s sale of its interest in the operating entity and its interest in the underlying real estate in San Diego, the Company recorded a net gain of approximately $631,000. In addition, on June 30, 2016, the Company entered into an assignment agreement whereby we sold and assigned all of our rights in the operating agreement, including but not limited to the assets and liabilities we held in relation to the Portland dispensary, resulting in a net loss of $178,000 on sale of assets.

 

Net Income (Loss)

As a result of the factors set forth above, our net loss decreased by approximately $23,625,000 for the six months ended June 30, 2016, resulting in net income of approximately $7,796,000 for the six months ended June 30, 2016.

 

Liquidity and Capital Resources

 

As of June 30, 2016, the Company had cash on hand of approximately $22,000 compared to approximately $92,000 at June 30, 2015.

 

Cash Flow

 

During the six months ended June 30, 2016, cash was primarily used to fund operations of the Company, as well as operations and development of the Farm.

 

   For the six
months ended June 30,
 
Cash flow  2016   2015 
Net cash used in operating activities  $(2,637,202)  $(4,166,781)
Net cash provided by investing activities   218,294     
Net cash provided by financing activities   2,321,631    4,629,866 
           
Net (decrease) increase in cash  $(97,277)  $463,085 

 

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Cash Flows – Operating Activities

 

During the six months ended June 30, 2016, cash flows used in operating activities were approximately $2,637,000, consisting primarily of the net income for the six months ended June 30, 2016 of approximately $7,796,000, increased for non-cash financing costs of approximately $3,061,000, amortization of the debt discount of approximately $2,613,000, stock based compensation of approximately $645,000, and reduced for non-cash adjustments for the change in fair value of the derivative liability of approximately $18,820,000 and change in fair value of the warrant liability of approximately $997,000. Additional significant components of cash used in operating activities included the accrued settlement expenses for rental expense under the lease for the previous office in West Hollywood of approximately $227,000, offset by an increase of approximately $3,445,000 due to the timing and deferral of the payment of trade payables, and an increase in accrued interest of approximately $394,000.

 

Cash Flows – Investing Activities

 

During the six months ended June 30, 2016, cash flows provided by investing activities was approximately $218,000, consisting primarily of the $529,000 in costs related to construction in progress for the build out of greenhouses on the Farm, offset by approximately $631,000 in proceeds from the sale of the Company’s interest in San Diego Sunset, as well as the proceeds from the sale of the assets of Varporfection, and approximately $92,000 in proceeds for the sale of the rights and assets of the Portland dispensary.

 

Cash Flows – Financing Activities

 

During the six months ended June 30, 2016, cash flows provided by financing activities were approximately $2,322,000, consisting mainly of approximately $1,816,000 of net proceeds from the issuance of convertible notes payable, approximately $569,000 from the issuance of notes payable and $105,000 in the issuance of convertible debentures to two of the Company’s Directors. This was offset mainly by approximately $223,000 in payments on the notes payable related to the Company’s land acquisition.

 

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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, if any, may not be sufficient to fund the Company’s net cash requirements through August 2017. As noted in the footnotes to the accompanying condensed consolidated financial statements, the Company is also in the process of obtaining final approval on a settlement agreement in their Class action and Derivative lawsuits (Note 11) and recently received a Wells Notice from the SEC (Note 11) in connection with misstatements by prior management in the Company’s financial statements for 2012, 2013 and the first three quarters of 2014, and recently received a Notice of Default from a creditor following non-payment of the balance under a certain promissory note at maturity thereof, pursuant to which the Company will incur penalties and an increased interest rate as well as potential legal expenses associated with the creditor’s legal actions.. The Company is unable to predict the outcome of these matters, nevertheless, a rejection of the settlement agreements or adverse action of the SEC or the failure to agree to additional waivers or forbearance by the creditor could have a material adverse effect on the financial condition, results of operations and/or cash flows of the Company and its ability to raise funds in the future. In order to execute the Company’s long-term growth strategy, which may include selected acquisitions of businesses or facilities that may bolster the the Company’s CBD oil extraction business or real estate for the cultivation of hemp , the Company will need to raise additional funds through public or private equity offerings, debt financings, or other means.

 

The Company's financial statements were prepared on a going concern basis. The going concern basis assumes that the Company will continue in operation for the foreseeable future and will be able to realize its assets and discharge its liabilities in the normal course of business. During the six months ended June 30, 2016, the Company had net income of approximately $7.8 million, negative cash flow from operations of $2.6 million and negative working capital of $19.7 million. 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 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 “Farm”). The Farm is expected to yield revenue and profits for the Company in future years, through farming hemp, extracting CBD oil and controlling the full production cycle to ensure consistent quality.

 

With an eye focused on the future — and ultimately anticipated FDA approval of hemp and CBD oil production and sales in the United States — we are honing our focus to controlling our supply chain initially through our production on the Farm in Pueblo, Colorado. From “Seed to Sale” — Notis Global will influence its own destiny by controlling our ecosystem. We intend to oversee and execute everything from growing and cultivating the highest quality plants to managing extraction and production of our products. We believe this tight control of our supply chain will eventually be mandated by the Federal Government as a condition of legalizing hemp and CBD Oil production, manufacturing and distribution in the United States. We have elected to take action now — and intend to lead our industry by doing so. Our decision to terminate the Whole Hemp Agreement comports with our long term strategy to maintain tight control of our supply chain.

 

Financing Plans:

 

During the first half of 2016, we received approximately $1.8 million in net financing from our lenders.

 

Subsequent to June 30, 2016, the Company has received approximately $1,266,000, net of approximately $40,000 in withholdings, in additional closings under the June 30, 2016 financing with our largest creditor (Note 7).

 

Additionally, on September 30, 2016, the Company entered into a securities purchase agreement with a new investor pursuant to which two wholly-owned subsidiaries of the Company, EWSD I and Pueblo agreed to jointly sell, and the Investor agreed to purchase, an aggregate of up to $3,350,000 in subscription amount of discounted promissory notes (that could raise approximately $2,000,000 in cash, of which the Company has already received approximately $650,000) (Note 12).

 

We are actively seeking additional financing over the next few months to fund operations.

 

On May 24, 2016, the Company received a notice from the OTC that the company’s bid price is below $.01 and does not meet the Standards for Continued Eligibility for OTCQB as per the OTCQB Standards. If the bid price has not closed at or above $.01 for ten consecutive trading days by November 20, 2016, the company will be moved to the OTC Pink marketplace. Additionally, on September 9th, the Company received notice from the OTC that OTC Markets would move the Company’s listing from the OTCQB market to OTC Pink Sheets market, if the Company had not filed this Quarterly Report on Form 10-Q for the period ended June 30, 2016 by September 30, 2016. On or about October 1, 2016, the Company moved to the OTC Pink Sheets market. These actions might impact the Company's ability to obtain funding.

 

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Special Meeting of the Stockholders to Increase Authorized Common Stock

 

On April 15, 2016, at a special meeting of the shareholders of the Company, the shareholders of the Company holding a majority of the total shares of outstanding common stock of the Company voted to amend the Company’s Articles of Incorporation to increase the number of authorized shares of common stock of the Company from 400,000,000 to 10,000,000,000 (the “Certificate of Amendment”). The Certificate of Amendment was filed with the Nevada Secretary of State and was declared effective on April 18, 2016.

 

Additionally, 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.

 

It is uncertain whether the Company can obtain financing to fund operating deficits until profitability is achieved or until revenues increase. This need may be adversely impacted by: unavailability of financing, uncertain market conditions, the success of the crop growing season, the demand for CBD oil, the ability of the Company to obtain financing for the equipment and labor needed to cultivate hemp and extract the CBD oil, and adverse operating results. The outcome of these matters cannot be predicted at this time.

 

Off Balance Sheet Transactions

 

We do not have any off-balance sheet credit exposure related to our customers.

 

Item 3.Quantitative and Qualitative Disclosures About Market Risk.

 

Not Applicable

 

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ITEM 4. CONTROLS AND PROCEDURES

 

Disclosure Controls and Procedures

 

Based on our management’s evaluation as of June 30, 2016, the end of the period covered by this Report, our Principal Executive Officer and Principal Financial Officer have concluded that our disclosure controls and procedures (as defined in Rule 13a-15(e) under the Exchange Act) were not effective to ensure that information required to be disclosed by us in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported to our management, including our Principal Executive Officer and Principal Financial Officer, as appropriate to allow timely decisions regarding required disclosure.

 

This conclusion was reached based on the material weakness in our internal control over financial reporting described below under the heading “Management’s Annual Report on Internal Control Over Financial Reporting.” We have undertaken remediation initiatives as discussed below.

 

Management’s Report on Internal Control over Financial Reporting

 

Our management is responsible for establishing and maintaining adequate internal control over financial reporting and for the assessment of the effectiveness of internal control over financial reporting. Our internal control over financial reporting is a process designed, as defined in Rule 13a-15(f) under the Exchange Act, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of consolidated financial statements for external purposes in accordance with generally accepted accounting principles.

 

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

 

In connection with the preparation of our annual consolidated financial statements, our management assessed the effectiveness of our internal control over financial reporting as of June 30, 2016. Management based this assessment on the criteria established in Internal Control over Financial Reporting Guidance for Smaller Public Companies issued by the Committee of Sponsoring Organizations of the Treadway Commission (which is sometimes referred to as the 1992 COSO Framework). Management believes that it is in the process of taking steps to remediate the material weakness which lead to the restatements of the Company’s financials for the first three quarters of 2014, however, management, with the help of our CEO, concluded that our internal controls over financial reporting as of June 30, 2016 remain ineffective, because of the departure of the Company’s Chief Financial Officer, Douglas C. Mitchell, on May 31, 2016, and because remediation efforts will continue during 2016.

 

Changes in Internal Controls; Plan of Remediation

 

Based on our management’s evaluation as of December 31, 2014, they determined that there was a deficiency in our internal control over financial reporting that constituted a material weakness at December 31, 2014. The Company took steps to remediate these issues during the year ending December 31, 2015. Management believes there have been improvements during the year ending December 31, 2015, but sufficient time has not lapsed to ensure the remediation and controls set in place are effective as of June 30, 2016. Furthermore, Douglas C. Mitchell, the Company’s Chief Financial Officer, resigned on May 31, 2016.  

 

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Other than as set forth above, there was no change in our internal control over financial reporting that occurred during the quarter ended June 30, 2016 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting, except as noted above.

 

The design of any system of controls and procedures is based in part upon certain assumptions about the likelihood of future events. There can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions, regardless of how remote.

 

PART II—OTHER INFORMATION

 

Item 1.Legal Proceedings.

 

On May 22, 2013, Medbox (now known as Notis Global, Inc.) initiated litigation in the United States District Court in the District of Arizona against three 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 and Medvend seek to have the transaction performed, or alternatively be awarded damages for the alleged breach of the agreement by Medbox. Medvend and the shareholder defendants seek $4.55 million in damages, plus costs and attorneys’ fees. Medbox has denied liability with respect to all such claims. On June 5, 2014, the Company entered into a purchase and sale agreement (the “Medvend PSA”) with PVM International, Inc. (“PVMI”) concerning this matter. Pursuant to the Medvend PSA, the Company sold to PVMI the Company’s rights and claims attributable to or controlled by the Company against those three certain stockholders of Medvend, known as Kaplan, Tartaglia and Kovan (the “Medvend Rights and Claims”), in exchange for the return by PVMI to the Company of 30,000 shares of the Company’s common stock. PVMI is owned by Vincent Mehdizadeh, formerly the Company’s largest stockholder. On December 17, 2015, the Company entered into a revocation of the Medvend PSA, which provided that from that date forward, Medbox would take over the litigation and be responsible for the costs and attorneys’ fees associated with the Medvend Litigation from December 17, 2015 forward. All costs and attorneys’ fees through December 16, 2015 will be borne by PVMI. After the filing of a motion for substitution of Medbox n/k/a Notis Global, Inc. for PVMI, Defendants’ agreed, via a stipulated order, to permit the substitution. The Court entered the order substituting Notis Global, Inc. for PVMI on February 17, 2016. A new litigation schedule was recently issued which resulted in an adjournment of the trial. A new trial date will be set by the court following its ruling on a motion for summary judgment filed by Defendants and Medvend, which is set for hearing on November 16, 2016. At this time, the Company cannot determine whether the likelihood of an unfavorable outcome of the dispute is probable or remote, nor can they reasonably estimate a range of potential loss, should the outcome be unfavorable.

 

On February 20, 2015, Michael A. Glinter, derivatively and on behalf of nominal defendants Medbox, Inc. the Board and certain executive officers (Pejman Medizadeh, Matthew Feinstein, Bruce Bedrick, Thomas Iwanskai, Guy Marsala, J. Mitchell Lowe, Ned Siegel, Jennifer Love, and C. Douglas Mitchell) filed a suit in the Superior Court of the State of California for the County of Los Angeles. The suit alleges breach of fiduciary duties and abuse of control by the defendants. Relief is sought awarding damages resulting from breach of fiduciary duty and to direct the Company and the defendants to take all necessary actions to reform and improve its corporate governance and internal procedures to comply with applicable law. The Company has entered into a Stipulation and Agreement of Settlement on October 16, 2015. See more detailed discussion below under Derivative Settlements.

 

On January 21, 2015, Josh Crystal on behalf of himself and of all others similarly situated filed a class action lawsuit in the U.S. District Court for Central District of California against Medbox, Inc., and certain past and present members of the Board (Pejman Medizadeh, Bruce Bedrick, Thomas Iwanskai, Guy Marsala, and C. Douglas Mitchell). The suit alleges that the Company issued materially false and misleading statements regarding its financial results for the fiscal year ended December 31, 2013 and each of the interim financial periods that year. The plaintiff seeks relief of compensatory damages and reasonable costs and expenses or all damages sustained as a result of the wrongdoing. On April 23, 2015, the Court issued an Order consolidating the three related cases in this matter: Crystal v. Medbox, Inc., Gutierrez v. Medbox, Inc., and Donnino v. Medbox, Inc., and appointing a lead plaintiff. On July 27, 2015, Plaintiffs filed a Consolidated Amended Complaint. The Company has entered into a Stipulation and Agreement of Settlement on October 16, 2015. See more detailed discussion below under Class Settlement.

 

On January 18, 2015, Ervin Gutierrez filed a class action lawsuit in the U.S. District Court for the Central District of California. The suit alleges violations of federal securities laws through public announcements and filings that were materially false and misleading when made because they misrepresented and failed to disclose that the Company was recognizing revenue in a manner that violated US GAAP. The plaintiff seeks relief for compensatory damages and reasonable costs and expenses or all damages sustained as a result of the wrongdoing. On April 23, 2015, the Court issued an Order consolidating the three related cases in this matter: Crystal v. Medbox, Inc., Gutierrez v. Medbox, Inc., and Donnino v. Medbox, Inc., and appointing a lead plaintiff. On July 27, 2015, Plaintiffs filed a Consolidated Amended Complaint. The Company has entered into a Stipulation and Agreement of Settlement on October 16, 2015. See more detailed discussion below under Class Settlement.

 

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On January 29, 2015, Matthew Donnino filed a class action lawsuit in the U.S. District Court for Central District of California. The suit alleges that the Company issued materially false and misleading statements regarding its financial results for the fiscal year ended December 31, 2013 and each of the interim financial periods that year. The plaintiff seeks relief for compensatory damages and reasonable costs and expenses or all damages sustained as a result of the wrongdoing. On April 23, 2015, the Court issued an Order consolidating the three related cases in this matter: Crystal v. Medbox, Inc., Gutierrez v. Medbox, Inc., and Donnino v. Medbox, Inc., and appointing a lead plaintiff. On July 27, 2015 Plaintiffs filed a Consolidated Amended Complaint. The Company has entered into a Stipulation and Agreement of Settlement on October 16, 2015. See more detailed discussion below under Class Settlement.

 

On February 12, 2015, Jennifer Scheffer, derivatively on behalf of Medbox, Guy Marsala, Ned Siegel, Mitchell Lowe and C. Douglas Mitchell filed a lawsuit in the Eighth Judicial District Court of Nevada seeking damages for breaches of fiduciary duty regarding the issuance and dissemination of false and misleading statements and regarding allegedly improper and unfair related party transactions, unjust enrichment and waste of corporate assets. On April 17, 2015, Ned Siegel and Mitchell Lowe filed a Motion to Dismiss. On April 20, 2015, the Company filed a Joinder in the Motion to Dismiss. On July 27, 2015, the Court held a hearing on and granted the Motion to Dismiss without prejudice. The Company has entered into a Stipulation and Agreement of Settlement on October 16, 2015. See more detailed discussion below under Derivative Settlements.

 

On March 10, 2015, Robert J. Calabrese, derivatively and on behalf of nominal defendant Medbox, Inc., filed a suit in the United States District Court for the District of Nevada against certain Company officers and/or directors (Ned L. Siegel, Guy Marsala, J. Mitchell Lowe, Pejman Vincent Mehdizadeh, Bruce Bedrick, and Jennifer S. Love). The suit alleges breach of fiduciary duties and gross mismanagement by issuing materially false and misleading statements regarding the Company’s financial results for the fiscal year ended December 31, 2013 and each of the interim financial periods. Specifically the suit alleges that defendants caused the Company to overstate the Company’s revenues by recognizing revenue on customer contracts before it had been earned. The plaintiff seeks relief for compensatory damages and reasonable costs and expenses for all damages sustained as a result of the alleged wrongdoing. The Company has entered into a Stipulation and Agreement of Settlement on October 16, 2015. See more detailed discussion below under Derivative Settlements.

 

On March 27, 2015, Tyler Gray, derivatively and on behalf of nominal defendant Medbox, Inc., filed a suit in the United States District Court for the District of Nevada against the Company’s Board of Directors and certain executive officers (Pejman Vincent Mehdizadeh, Matthew Feinstein, Bruce Bedrick, Thomas Iwanski, Guy Marsala, J. Mitchell Lowe, Ned Siegel, Jennifer S. Love, and C. Douglas Mitchell). The suit alleges breach of fiduciary duties and abuse of control. The plaintiff seeks relief for compensatory damages and reasonable costs and expenses for all damages sustained as a result of the alleged wrongdoing. Additionally the plaintiff seeks declaratory judgments that plaintiff may maintain the action on behalf of the Company, that the plaintiff is an adequate representative of the Company, and that the defendants have breached and/or aided and abetted the breach of their fiduciary duties to the Company. Lastly the plaintiff seeks that the Company be directed to take all necessary actions to reform and improve its corporate governance and internal procedures to comply with applicable law. The Company has entered into a Stipulation and Agreement of Settlement on October 16, 2015. See more detailed discussion below under Derivative Settlements.

 

On May 20, 2015, Patricia des Groseilliers, derivatively and on behalf of nominal defendant Medbox, Inc., filed a suit in the United States District Court for the District of Nevada against the Company’s Board of Directors and certain executive officers (Pejman Vincent Mehdizadeh, Ned Siegel, Guy Marsala, J. Mitchell Lowe, Bruce Bedrick, Jennifer S. Love, Matthew Feinstein, C. Douglas Mitchell, and Thomas Iwanski). The suit alleges breach of fiduciary duties and unjust enrichment. The plaintiff seeks relief for compensatory damages and reasonable costs and expenses for all damages sustained as a result of the alleged wrongdoing. Additionally the plaintiff seeks declaratory judgments that plaintiff may maintain the action on behalf of the Company, that the plaintiff is an adequate representative of the Company, and that the defendants have breached and/or aided and abetted the breach of their fiduciary duties to the Company. Lastly the plaintiff seeks that the Company be directed to take all necessary actions to reform and improve its corporate governance and internal procedures to comply with applicable law. The Company has entered into a Stipulation and Agreement of Settlement on October 16, 2015. See more detailed discussion below under Derivative Settlements.

 

On June 3, 2015, Mike Jones, derivatively and on behalf of nominal defendant Medbox, Inc., filed a suit in the U.S. District Court for Central District of California against the Company’s Board of Directors and certain executive officers (Guy Marsala, J. Mitchell Lowe, Ned Siegel, Jennifer S. Love, C. Douglas Mitchell, Pejman Vincent Mehdizadeh, Matthew Feinstein, Bruce Bedrick, and Thomas Iwanski). The suit alleges breach of fiduciary duties, abuse of control, and breach of duty of honest services. The plaintiff seeks relief for compensatory damages and reasonable costs and expenses for all damages sustained as a result of the alleged wrongdoing. Additionally the plaintiff seeks declaratory judgments that plaintiff may maintain the action on behalf of the Company, that the plaintiff is an adequate representative of the Company, and that the defendants have breached and/or aided and abetted the breach of their fiduciary duties to the Company. Lastly the plaintiff seeks that the Company be directed to take all necessary actions to reform and improve its corporate governance and internal procedures to comply with applicable law. On July 20, 2015, the Court issued an Order consolidating this litigation with those previously consolidated in the Central District (Crystal, Gutierrez, and Donnino). On October 7, 2015, the Court issued an Order modifying the July 20, 2015 Order consolidating the litigation so that the matters remain consolidated for the purposes of pretrial only. The Company has entered into a Stipulation and Agreement of Settlement on October 16, 2015. See more detailed discussion below under Derivative Settlements.

 

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On July 20, 2015, Kimberly Freeman, derivatively and on behalf of nominal defendant Medbox, Inc., filed a suit in the Eighth Judicial District Court of Nevada against the Company’s Board of Directors and certain executive officers (Pejman Vincent Mehdizadeh, Guy Marsala, Ned Siegel, J. Mitchell Lowe, Jennifer S. Love, C. Douglas Mitchell, and Bruce Bedrick). The suit alleges breach of fiduciary duties and unjust enrichment. The plaintiff seeks relief for compensatory damages and reasonable costs and expenses for all damages sustained as a result of the alleged wrongdoing. Additionally the plaintiff seeks declaratory judgments that plaintiff may maintain the action on behalf of the Company, that the plaintiff is an adequate representative of the Company, and that the defendants have breached and/or aided and abetted the breach of their fiduciary duties to the Company. Lastly the plaintiff seeks that the Company be directed to take all necessary actions to reform and improve its corporate governance and internal procedures to comply with applicable law. The Company has entered into a Stipulation and Agreement of Settlement on October 16, 2015. See more detailed discussion below under Derivative Settlements.

 

On October 16, 2015, solely to avoid the costs, risks, and uncertainties inherent in litigation, the parties to the class actions and derivative lawsuits named above entered into settlements that collectively effect a global settlement of all claims asserted in the class actions and the derivative actions. The global settlement provides, among other things, for the release and dismissal of all asserted claims. The global settlement is contingent on final court approval, respectively, of the settlements of the class actions and derivative actions. If the global settlement does not receive final court approval, it could have a material adverse effect on the financial condition, results of operations and/or cash flows of the Company and their ability to raise funds in the future.

 

On October 27, 2015, separate from the above lawsuits and settlement, Richard Merritts, derivatively and on behalf of nominal defendant Medbox, Inc., filed a suit in the Superior Court of the State of California for the County of Los Angeles against the Board and certain executive officers (Guy Marsala, J. Mitchell Lowe, Ned Siegel, Jennifer S. Love, C. Douglas Mitchell, Pejman Vincent Mehdizadeh, Matthew Feinstein, Bruce Bedrick, Jeff Goh, and Thomas Iwanski). The suit titled Merritts v. Marsala, et al., Case No. BC599159 (the “Merritts Action”), alleges breach of fiduciary duties by the defendants. Relief is sought awarding damages resulting from breach of fiduciary duty and to direct the Company and the defendants to take all necessary actions to reform and improve its corporate governance and internal procedures to comply with applicable law. On February 16, 2016, the court issued an order staying the litigation pending final court approval of the settlement of the other pending derivative actions involving Medbox, Inc., as nominal defendant, and former and current officers and directors. The settlement of the other derivative actions has been preliminarily approved by the court in Jones v. Marsala, et al., Case No. 15-cv-4170 BRO (JEMx), in the U.S. District Court for the Central District of California. On March 25, 2016, Merritts filed a Motion to Intervene in the case filed by Mike Jones in the U.S. District Court for the Central District of California. By his Motion, Merritts seeks limited intervention in the Jones shareholder derivative action in order to seek confirmatory information and discovery regarding the Stipulation and Agreement of Settlement preliminarily approved by the Court on February 3, 2016. On April 4, 2016, Plaintiff Jones and the Company separately filed oppositions to the Motion to Intervene. On April 22, 2016, the Court issued an Order granting, without a hearing, shareholder Richard Merritts’ Motion to Intervene in the lawsuit titled Mike Jones v. Guy Marsala, et al. , in order to conduct limited discovery. On September 16, 2016, solely to avoid the costs, risks, and uncertainties inherent in litigation, the parties entered into a settlement regarding Merritts’ claims. See more detailed discussion below under Derivative Settlements.

 

Class Settlement

 

On December 1, 2015, Medbox and the class plaintiffs in Josh Crystal v. Medbox, Inc., et al., Case No. 2:15-CV-00426-BRO (JEMx), pending before the United States District Court for the Central District of California (the “Court”) notified the Court of the settlement. The Court stayed the action pending the Court’s review of the settlement and directed the parties to file a stipulation of settlement. On December 18, 2015, plaintiffs filed the Motion for Preliminary Approval of Class Action Settlement that included the stipulation of settlement. On February 3, 2016, the Court issued an Order granting preliminary approval of the settlement. The settlement provides for notice to be given to the class, a period for opt outs and a final approval hearing. The Court originally scheduled the Final Settlement Approval Hearing to be held on May 16, 2016 but continued it to August 15, 2016 to be heard at the same time as the Final Settlement Approval Hearing for the derivative actions, discussed below. The principal terms of the settlement are:

 

  •   a cash payment to a settlement escrow account in the amount of $1,850,000 of which $150,000 will be paid by the Company and $1,700,000 will be paid by the Company’s insurers;

 

  •   a transfer of 2,300,000 shares of Medbox common stock to the settlement escrow account, of which 2,000,000 shares would be contributed by Medbox and 300,000 shares by Bruce Bedrick;

 

  •   the net proceeds of the settlement escrow, after deduction of Court-approved administrative costs and any Court-approved attorneys’ fees and costs would be distributed to the Class; and

 

  •   releases of claims and dismissal of the action.

 

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By entering into the settlement, the settling parties have resolved the class claims to their mutual satisfaction. However, the final determination is subject to approval by the Federal Courts. Defendants have not admitted the validity of any claims or allegations and the settling plaintiffs have not admitted that any claims or allegations lack merit or foundation. If the global settlement does not receive final court approval, it could have a material adverse effect on the financial condition, results of operations and/or cash flows of the Company and their ability to raise funds in the future.

 

Derivative Settlements

 

As previously announced on October 22, 2015, on October 16, 2015, the Company, in its capacity as a nominal defendant, entered into a memorandum of understanding of settlement (the “Settlement”) in the following shareholder derivative actions: (1) Mike Jones v. Guy Marsala, et al., in the U.S. District Court for Central District of California; (2) Jennifer Scheffer v. P. Vincent Mehdizadeh, et al., in the Eighth Judicial District Court of Nevada; (3) Kimberly Y. Freeman v. Pejman Vincent Mehdizadeh, et al., in the Eighth Judicial District Court of Nevada; (4) Tyler Gray v. Pejman Vincent Mehdizadeh, et al., in the U.S. District Court for the District of Nevada; (5) Robert J. Calabrese v. Ned L. Siegel, et al., in the U.S. District Court for the District of Nevada; (6) Patricia des Groseilliers v. Pejman Vincent Mehdizadeh, et al., in the U.S. District Court for the District of Nevada; (7) Michael A. Glinter v. Pejman Vincent Mehdizadeh, et al., in the Superior Court of the State of California for the County of Los Angeles (the “Shareholder Derivative Lawsuits”). In addition to the Company, Pejman Vincent Mehdizadeh, Matthew Feinstein, Bruce Bedrick, Thomas Iwanski, Guy Marsala, J. Mitchell Lowe, Ned Siegel, and C. Douglas Mitchell were named as defendants in all of the lawsuits, and Jennifer S. Love was named in all of the lawsuits but the Scheffer action (the “Individual Defendants”).

 

On December 3, 2015, the parties in the Jones v. Marsala action advised the Court of the settlements in the Shareholder Derivative Lawsuits and that the parties would be submitting the settlement to the Court in the Jones action for approval. The Court thereafter issued an order vacating all pending dates in the action and ordered Plaintiff to file the Stipulation and Agreement of Settlement for the Court’s approval. On December 18, 2015, plaintiffs filed the Motion for Preliminary Approval of Derivative Settlement that included the Stipulation and Agreement of Settlement. On February 3, 2016, the Court issued an Order granting preliminary approval of the settlement. 

 

The Court originally scheduled a final Settlement Hearing to be held on May 16, 2016 but subsequently continued that hearing to October 17, 2016. By the terms of the settlement, a final Court approval would provide for a release of the claims in the Shareholder Derivative Actions and a bar against continued prosecution of all claims covered by the release. By entering into the Settlement, the settling parties have resolved the derivative claims to their mutual satisfaction. The Individual Defendants have not admitted the validity of any claims or allegations and the settling plaintiffs have not admitted that any claims or allegations lack merit or foundation.

 

The final Settlement Hearing was held on October 17, 2016, and the Court has taken the settlement under review.

 

Under the terms of the Settlement, the Company agrees to adopt and adhere to certain corporate governance processes in the future. In addition to these corporate governance measures, the Company’s insurers, on behalf of the Individual Defendants, will make a payment of $300,000 into the settlement escrow account and Messrs. Mehdizadeh and Bedrick will deliver 2,000,000 and 300,000 shares, respectively, of their Medbox, Inc. common stock into the settlement escrow account. Subject to Court approval, the funds and common stock in the settlement escrow account will be paid as attorneys’ fees and expenses, or as service awards to plaintiffs.

 

On September 16, 2016, solely to avoid the costs, risks, and uncertainties inherent in litigation, the parties entered into a settlement regarding the Merritts Action. The settlement provides, among other things, for the release and dismissal of all asserted claims. Under the terms of the settlement, the Company agrees to adopt and to adhere to certain corporate governance processes in the future. In addition to these corporate governance measures, the Company will make a payment of $135,000 in cash to be used to pay Merritts’ counsel for any attorneys’ fees and expenses, or as service awards to plaintiff Merritts, that are approved and awarded by the Court. The settlement is contingent on final court approval. The final Settlement Hearing was held October 17, 2016 at the same date and time as the final Settlement Hearing for the Shareholder Derivative Lawsuits. The Court has taken the settlement under review.

 

The Settlements remain subject to approval by the Court. The Court must determine whether (1) the terms and conditions of the Settlements are fair, reasonable, and adequate in the best interest of the Company and its stockholders, (2) if the judgment, as provided for in the Settlements, should be entered, and (3) if the request of plaintiff’s counsel for an award of attorneys’ fees and reimbursement of expenses should be granted.

 

The Company’s responsibilities as to the proposed settlements of the Class Action and the Shareholder Derivative Lawsuits have been accrued and included in Accrued settlement and severance expenses on the accompanying consolidated balance sheet as of December 31, 2015. If the settlements of the Class Action, the Shareholder Derivative Lawsuits, or the Merritts Action do not receive final court approval, it could have a material adverse effect on the financial condition, results of operations and/or cash flows of the Company and their ability to raise funds in the future.

 

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SEC Investigation

 

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

 

In March 2016, the staff of the Los Angeles Regional Office of the U.S. Securities and Exchange Commission advised counsel for the Company in a telephone conversation, followed by a written “Wells” notice, that it is has made a preliminary determination to recommend that the Commission file an enforcement action against the Company in connection with misstatements by prior management in the Company’s financial statements for 2012, 2013 and the first three quarters of 2014. A Wells Notice is neither a formal allegation of wrongdoing nor a finding that any violations of law have occurred. Rather, it provides the Company with an opportunity to respond to issues raised by the Staff and offer its perspective prior to any SEC decision to institute proceedings. These proceedings could result in the Company being subject to an injunction and cease and desist order from further violations of the securities laws as well as monetary penalties of disgorgement, pre-judgment interest and a civil penalty. The Company has responded in writing to the “Wells” notice. Under current management, the Company restated the relevant financial statements and took other remedial action, and has been cooperating with the SEC’s investigation since November 2014, including the appointment of a Special Committee of the Board to investigate the conduct of prior management and disclose this conduct to the SEC. The Company has also produced documents to the SEC and has made witnesses available, both voluntarily and for sworn testimony pursuant to subpoena. The Company is unable to predict the outcome of the investigation, any potential enforcement actions or any other impact on the Company that may arise as a result of such investigation. The Company has not established a liability for this matter, because it believes that the probability of loss related to this matter and an estimate of the amount of loss, if any, are not determinable at this time. An adverse judgment or action of the SEC could have a material adverse effect on the financial condition, results of operations and/or cash flows of the Company and their ability to raise funds in the future.

 

Other litigation

 

Whole Hemp complaint

 

A complaint was filed by Whole Hemp Company, LLC d/b/a Folium Biosciences (“Whole Hemp”) on June 1, 2016, naming Notis Global, Inc. and EWSD I, LLC (collectively, “Notis”), as defendants in Pueblo County, CO district court.  The complaint alleges five causes of action against Notis:  misappropriation of trade secrets, civil theft, intentional interference with prospective business advantage, civil conspiracy, and breach of contract.  All claims concern contracts between Whole Hemp and Notis for the Farming Agreement and the Distributor Agreement. 

 

The court entered an ex parte temporary restraining order on June 2, 2016, and a modified temporary restraining order on July 14, 2016, enjoining Notis from disclosing, using, copying, conveying, transferring, or transmitting Whole Hemp’s trade secrets, including Whole Hemp’s plants.  On June 13, 2016, the court ordered that all claims be submitted to arbitration, except for the disposition of the temporary restraining order. 

 

On August 12, 2016, the court ordered that all of Whole Hemp’s plants in Notis’ possession be destroyed, which occurred by August 24, 2016,, at which time the temporary restraining order was dissolved and the parties will soon file a motion to dismiss the district court action.    

 

Notis commenced arbitration in Denver, CO on August 2, 2016, seeking injunctive relief and alleging breaches of the contracts between the parties.  Whole Hemp filed is Answer and counterclaims on September 6, 2016, asserting similar allegations that were asserted to the court. 

 

On September 30, 2016, the arbitrator held an initial status conference and agreed to allow EWSD and Notis to file a motion to dismiss some or all of Whole Hemp’s claims by no later than October 28, 2016. The parties were also ordered to make initial disclosures of relevant documents and persons with knowledge of relevant information by October 21, 2016.

 

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West Hollywood Lease

 

The lease for the former office at 8439 West Sunset Blvd. in West Hollywood, CA has been partially subleased. The Company plans to sublease the remainder of the office in West Hollywood, CA and continues to incur rent expense while the space is being marketed. The landlord for the prior lease filed a suit in Los Angeles Superior Court in April 2015 against the Company for damages they allege have been incurred from unpaid rent and otherwise. In January 2016, the landlord filed a first amended complaint adding the independent guarantors under the lease as co-defendants and specifying damages claim of approximately $300,000. On September 8, 2016, the court approved Mani Brothers’ application for writ of attachment in the State of California in the amount of $374,402 against Prescription Vending Machines, Inc. (“PVM”). A trial date has been set in May 2017. The Company is presently unable to determine whether the likelihood of an unfavorable outcome of the dispute is probable or remote, nor can it reasonably estimate a range of potential loss, should the outcome be unfavorable.

 

Los Angeles Lease

 

The Company’s former landlord, Bank Leumi, filed an action against the Company in Los Angeles Superior Court for breach of lease on August 31, 2016, seeking $29,977 plus fees and interest, in addition to rent payment for September 2016. The Company filed a response to the complaint on September 21, 2016, and a case management conference is scheduled for December 9, 2016. The Company is presently trying settle the dispute with the landlord.

 

Item 1A.Risk Factors.

 

One of the Company’s significant creditors has issued a Notice of Default to the Company, triggering penalties and the potential acceleration of amounts due under the defaulted Note.

 

On September 22, 2016, the Company received notice of an Event of Default and Acceleration (the “Notice Letter”) in connection with that certain Promissory Note (the “Note”) dated March 14, 2016 issued by the Company, in favor of Chicago Venture Partners, L.P., in the original principal amount of $140,000. The Note was issued pursuant to that certain Note Purchase Agreement between the Company and Chicago Ventures Partners of the same date.

 

Pursuant to the Notice Letter, (1) beginning on September 14, 2016, the maturity date of the Note, the Note began to accrue interest at a default rate of 22% per annum (the “Default Rate Adjustment”), (2) Chicago Venture Partners declared all unpaid principal, accrued interest and other amounts due and payable at 125% of the outstanding balance of the Note (the “Mandatory Default Amount”), and (3) Chicago Venture Partners declared the outstanding balance of the Note immediately due and payable (the “Acceleration Payment”).

 

On September 23, 2016, Chicago Venture Partners agreed to forebear the Acceleration Payment for a period of 30 days, and the Company and Chicago Venture Partners are in the process of negotiating a forbearance agreement reflecting the 30-day forbearance. Regardless of such forbearance, the Default Rate Adjustment and the application of the Mandatory Default Amount formula shall remain in effect. As a result of the application of the Mandatory Default Amount formula, the outstanding balance of the Note increased to $184,022.27 from $147,217.81.

 

As a result of the effect of the Notice Letter, other of the Company’s lenders could issue similar notices of events of default or acceleration or penalties due to the Company’s Event of Default set forth in the Notice Letter. Furthermore, the Company may incur additional penalties and fees after the conclusion of the period of forbearance if the Company cannot agree to additional waivers or forbearance by Chicago Venture Partners or Chicago Venture Partners takes legal action to enforce its rights under the Note and the Note Purchase Agreement. These penalties and fees, the acceleration of the note, and the incurrence of costs associated with defending itself in a legal action, could have a material adverse effect on the Company’s financial condition, results of operations and/or cash flows of the Company, and the Company’s ability to conduct its business, execute its operational strategies and continue as a going concern.

 

The Company was delayed in filing this Quarterly Report on Form 10-Q and such delays may have triggered other events of default under the Company’s credit agreements and existing debt instruments

 

The Company’s creditors may issue other notices of default and the Company may incur other penalties due to breach of covenants in the Company’s debt instruments with each of its lenders that the Company will maintain current public information filed with the SEC and comply with deadlines required to filed such information under the Securities Act of 1934. As a result of the Company’s delayed filing of this Quarterly Report, on September 9, 2016, the Company received notice from the OTC Markets that OTC Markets would move the Company’s listing from the OTCQB market to OTC Pink Sheets market, if the Company had not filed this Quarterly Report by September 30, 2016. The Company did not meet this deadline, and moving to the OTC Pink Sheets market could have an adverse effect on shareholders’ ability to trade the common stock of the Company in the marketplace, lower the volume of trading of the Company’s common stock during the time that the stock is quoted in the OTC Pink Sheets market, have an adverse effect on the price of the Company’s common stock, and result in fewer brokers covering information made public by the Company or executing trades on the stock for their clients. Each of the foregoing could have a material adverse effect on the Company’s financial condition, results of operations and/or cash flows, and the Company’s ability to conduct its business, execute its operational strategies and continue as a going concern.

 

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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 April 13, 2016, as amended on Form 10-K/A on April 29, 2016.

 

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

 

None.

 

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

     

3.1

 

Certificate of Amendment of Articles of Incorporation of Notis Global, Inc., dated April 15, 2016 (1) 

     
10.01   Securities Purchase Agreement, dated May 20, 2016, between the Company and the May 23 2016 Investor*
   
10.02   May 23 2016 Investor Convertible Promissory Note*
   
10.03   Form of May 23 2016 Investor Note*
   
10.04   Membership Interest Pledge Agreement, dated May 20, 2016, between the Company and the May 23 2016 Investor*
   
10.05   Securities Purchase Agreement, dated June 22, 2016, between the Company and the June 22 2016 Investor*
   
10.06   Equity Purchase Agreement, dated June 22, 2016, between the Company and the June 22 2016 Investor*
   
10.07   Registration Rights Agreement, dated June 22, 2016, between the Company and the June 22 2016 Investor*
   
10.08   June 22 2016 Investor Convertible Bridge Debenture*
   
10.09   June 22 2016 Investor Convertible Commitment Debenture*
   
10.10   Contract to Buy and Sell Real Estate, dated June 15, 2016*
   
10.11   Securities Purchase Agreement, dated June 30, 2016, between the Company and the June 30 2016 Investor*
   
10.12   Form of June 30 2016 Investor Convertible Debenture*
   
10.13   Security Agreement, dated June 30, 2016, between the Company and the June 30 2016 Investor*
   
10.14   June 30 2016 Investor Guarantee*
   
31.1   Certification of the Principal Executive Officer and Principal Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
   
32.1   Certification of the Principal Executive Officer and Principal Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
   
101.INS   XBRL Instance Document.
   
101.SCH   XBRL Taxonomy 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.

 

(1)

 

Incorporated by reference to the Registrant’s Current Report on Form 8-K (File No. 000-54928), filed with the Commission on April 19, 2016.

 

* 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.

 

  Notis Global, Inc.
       
Date: October 21, 2016 By:   /s/ Jeffrey Goh
      Jeffrey Goh
     

President and Chief Executive Officer

      (Principal Executive Officer and Principal Financial
Officer)

 

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