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EX-32.1 - EXHIBIT 32.1 - PFO Global, Inc.ex32-1.htm
EX-31.2 - EXHIBIT 31.2 - PFO Global, Inc.ex31-2.htm
EX-31.1 - EXHIBIT 31.1 - PFO Global, Inc.ex31-1.htm

 



UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

Form 10-Q

 

(Mark One)

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

 

For the quarterly period ended March 31, 2016

 

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

 

For the transition period from              to            

 

Commission File Number 333-167380

 

PFO GLOBAL, INC.

(Exact Name of Registrant as Specified in Its Charter)

 

 Nevada

 

65-0434332

(State or other jurisdiction of incorporation or organization)  

 

(I.R.S. Employer Identification No.)  

 

14401 Beltwood Parkway, Suite 115, Dallas, TX 75244

(972) 573-6135 

(Address including zip code, and telephone number, including area code, of principal executive offices)

 

Not applicable

(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   ☐    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 during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  ☒    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 definition 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

Smaller reporting company

 

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

 

As of August 1, 2016 there were 20,917,506 shares of the registrant's common stock, par value $0.0001 per share, outstanding, including preferred stock convertible into common stock on an as is converted basis. 


 

 * The registrant has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended, but is not required to file such reports under such sections.

 



 

 
1

 

 

TABLE OF CONTENTS

 

 

 

Page

 

PART I — FINANCIAL INFORMATION 

 

Item 1.

Condensed Consolidated Financial Statements

3

Item 2.

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

29

Item 3.

Quantitative and Qualitative Disclosures about Market Risk

33

Item 4.

Controls and Procedures

34

 

PART II — OTHER INFORMATION 

 

Item 1.

Legal Proceedings

35

Item 1A.

Risk Factors

36

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

48

Item 3.

Defaults Upon Securities

48

Item 4.

Mine Safety Disclosure

48

Item 5.

Other Information

48

Item 6.

Exhibits

49

SIGNATURES

 

  

 
2

 

 

PART I

 

Item 1.      Condensed Consolidated Financial Statements 

 

PFO Global, inc.

CONDENSED CONSOLIDATED BALANCE SHEETS

 

   

March 31

2016

   

December 31

2015

 
   

(Unaudited)

         

ASSETS

               
                 

CURRENT ASSETS

               

Cash

  $ 25,807     $ 26,250  

Accounts receivable

    445,737       485,192  

Inventories

    659,569       724,009  

Prepaid expenses and other assets

    50,656       104,546  

Total current assets

    1,181,769       1,339,997  
                 

Property and equipment, net

    97,744       152,031  

Deferred costs

    293,732       293,732  

Other assets

    126,534       85,462  
                 

Total assets

  $ 1,699,779     $ 1,871,222  
                 

LIABILITIES AND STOCKHOLDERS' (DEFICIT) EQUITY

               
                 

CURRENT LIABILITIES

               

Accounts payable

  $ 2,230,075     $ 2,348,824  

Accrued Liabilities

    2,354,542       2,145,442  

Accrued interest, related parties

    1,266,192       1,188,182  

Note payable, net of discount - current portion

    7,825,000       6,705,000  

Royalty obligation

    1,750,000       1,750,000  

Derivative obligation

    1,233,000       1,769,000  

General unsecured claims - current portion

    16,660       26,641  

Total current liabilities

    16,675,469       15,933,089  
                 

Note payable, related parties - net of current portion

    4,679,397       4,677,630  

Note payable, net of discount - net of current portion

    3,695,281       3,214,591  

Deferred revenue

    2,582,198       2,582,198  

General unsecured claims - net of current portion

    12,478       12,662  

Total long term debt

    10,969,354       10,487,081  
                 

Total liabilities

    27,644,823       26,420,170  
                 

Commitments and contingencies

    -       -  
                 

STOCKHOLDERS' (DEFICIT)

               

Preferred stock, $0.001 par value; 5,000,000 preferred shares authorized, 23.988 shares preferred issued and outstanding as of March 31, 2016 and December 31, 2015, respectively

    -       -  

Common stock, $.0001 par value, 500,000,000 shares authorized, 18,417, 506 shares issued and outstanding as of March 31, 2016 and December 31, 2015, respectively

    1,842       1,842  

Additional paid in capital

    9,234,702       9,215,458  

Accumulated deficit

    (35,181,588 )     (33,766,248 )

Total stockholders' deficit

    (25,945,044 )     (24,548,948 )
                 

Total liabilities and stockholders' deficit

  $ 1,699,779     $ 1,871,222  

 

see accompanying notes to unaudited interim Condensed Consolidated Financial Statements

 

 
3

 

 

PFO GLOBAL, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

FOR THE THREE MONTHS ENDED MARCH 31, 2016 AND 2015

(Unaudited)

 

   

2016

   

2015

 
                 

REVENUE:

               

Sales

  $ 1,085,387     $ 988,037  
                 

COST OF GOODS SOLD (excluding depreciation shown below)

    575,299       526,918  
                 

Gross profit

    510,088       461,119  
                 

OPERATING EXPENSES:

               

Selling, general and administrative expenses

    1,249,979       2,087,332  

Depreciation

    54,287       68,156  

Total operating expenses

    1,304,266       2,155,488  
                 

Loss from operations

    (794,178 )     (1,694,369 )
                 

OTHER INCOME (EXPENSE):

               

Other income

    32,115       (33 )

Gain on change in fair value derivative liabilities

    536,000       776,810  

Interest expense, related parties

    (78,010 )     (74,726 )

Interest expense, others

    (1,111,267 )     (1,571,616 )

Total other expense

    (621,162 )     (869,565 )
                 

Net loss before provision for income taxes

    (1,415,340 )     (2,563,934 )
                 

PROVISION FOR INCOME TAXES

               

Income tax (benefit)

    -       -  
                 

NET LOSS

  $ (1,415,340 )   $ (2,563,934 )
                 

Net loss per common share, basic and diluted

  $ (0.07 )   $ (0.17 )
                 

Weighted average number of common shares outstanding, basic and diluted

    20,917,506       14,755,357  

 

see accompanying notes to unaudited interim Condensed Consolidated Financial Statements

 

 
4

 

  

PFO GLOBAL, INC.

CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ DEFICIT

(Unaudited)

FOR THE THREE MONTHS ENDED MARCH 31, 2016

 

    Preferred Stock     Common Stock    

Additional Paid

in

    Accumulated     Total Stockholders  
    Shares     Amount     Shares     Amount     Capital     Deficit     (Deficit)  

Balance, December 31, 2015

    24     $ -       18,417,506     $ 1,842     $ 9,215,458     $ (33,766,248 )   $ (24,548,948 )

Common stock issued for services rendered

    -       -       -       -       19,244       -       19,244  

Net loss

    -       -       -       -       -       (1,415,340 )     (1,415,340 )

Balance, March 31, 2016

    24     $ -       18,417,506     $ 1,842     $ 9,234,702     $ (35,181,588 )   $ (25,945,044 )

 

see accompanying notes to unaudited interim Condensed Consolidated Financial Statements

  

 
5

 

 

PFO GLOBAL, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

FOR THE THREE MONTHS ENDED MARCH 31, 2016 AND 2015

 

   

2016

   

2015

 

CASH FLOWS FROM OPERATING ACTIVITIES:

               

Net loss

  $ (1,415,340 )   $ (2,563,934 )

Adjustments to reconcile net loss to net cash used in operating activities:

               

Depreciation and amortization

    54,287       68,156  

Stock based compensation

    19,244       -  

Provision for doubtful accounts

    57,068       2,044  

Change in fair value of derivative liability

    (536,000 )     (776,810 )

Interest expense, related parties

    78,010       74,726  

Interest expense, others

    480,273          

Amortization of debt issue costs

    175,069       306,623  

Amortization of debt discount

    456,941       900,183  

Changes in operating assets and liabilities:

               

Accounts receivable

    (17,613 )     (250,044 )

Inventories

    64,440       (33,073 )

Prepaid expenses

    53,890       (43,041 )

Other assets

    (41,072 )     282  

Accounts payable and accrued expenses

    (389,919 )     1,039,363  

Net cash used in operating activities

    (960,722 )     (1,275,525 )
                 

CASH FLOWS FROM FINANCING ACTIVITIES:

               

Proceeds from long term debt

    1,001,765       1,476,677  

Debt issue costs

    (31,320 )     (188,516 )

Payments on long term debt

    (10,166 )     (40,132 )

Net cash provided by financing activities

    960,279       1,248,029  
                 

Net decrease in cash

    (443 )     (27,496 )
                 

Cash beginning of period

    26,250       75,536  

Cash end of period

  $ 25,807     $ 48,040  
                 

Supplemental disclosures of cash flow information:

               

Interest paid

    -       123,846  

Non-cash investing and financing activities:

               

Debt issuance costs related to issuance of warrants

    -       9,765  

Debt discount related to issuance of warrants

    -       122,064  

Debt discount related to original issue discount on Hillair notes

    120,000       -  

Derivative obligation related to issuance of warrants

    -       131,829  

Cancellation of shares subscribed

    -       440,000  

 

see accompanying notes to unaudited interim Condensed Consolidated Financial Statements

  

 
6

 

  

PFO GLOBAL, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

FOR THE THREE MONTHS ENDED MARCH 31, 2016 AND 2015

 

Note 1 - Summary of Significant Accounting Policies

 

Description of the Business

 

On June 30, 2015 (the “Effective Date”), Pro Fit Optix Holding Company, LLC (“Holding”) entered into an Agreement and Plan of Merger (the “Merger Agreement”) with PFO Global, Inc., formerly Energy Telecom, Inc. (the “Company”), and PFO Acquisition Corp., a wholly-owned subsidiary of the Company (“Merger Sub”). Pursuant to the Merger Agreement, on the Effective Date, the Company completed the acquisition of Holding by means of a merger of Merger Sub with and into Holding, such that Holding became a wholly-owned subsidiary of the Company (the “Merger”). Immediately following the Merger, the former PFO Global, Inc. equity holders owned approximately 8% of the outstanding shares of the Company’s common stock.

 

For accounting purposes, the Merger was recognized in accordance with ASC 805-40, Reverse Acquisitions. Accordingly, PFO Global, Inc. has been recognized as the accounting acquiree in the Merger, with Holding being the accounting acquirer. As such, the historical financial statements of Holding will be treated as the historical financial statements of the combined company. Accordingly, the financial position as of December 31, 2015 presented in the condensed consolidated financial statements reflect the operations of Holding for the period from January 1, 2015 through June 30, 2015, and the operations of the post-combination Company for the period of June 30, 2015 through December 31, 2015.

 

On the Effective Date, the Company had outstanding 23.988 shares Series A Convertible Preferred Stock (“Preferred Stock”). Pursuant to the Merger Agreement, on the Effective Date, the Preferred Stock was amended such that the 23.988 shares are convertible into 2,500,000 of common stock at the instruction of the holder. Further, the holder was required to assign the Preferred Stock to be held in escrow by Escrow Agent (“Escrow Shares”). On June 30, 2015, Holding, Merger Sub, PFO Global, Inc., a third party (the “Account Advisor”) and an escrow agent (the “Escrow Agent”), entered into an Escrow Agreement (the “Escrow Agreement”). Pursuant to the Escrow Agreement, the Escrow Agent will hold the Escrow Shares for release pursuant to written instructions provided from time to time by the Account Advisor. The Escrow Agreement expires December 31, 2016, any Escrow Shares remaining will be cancelled. As of March 31, 2016, no shares were released by the Escrow Agent.

 

PFO Global, Inc., formerly Energy Telecom, Inc., was incorporated in Florida on September 7, 1993 and reincorporated in Nevada on June 2, 2015 pursuant to an agreement and plan of merger between Energy Telecom, Inc. and its wholly owned subsidiary, Energy Telecom Reincorporation Sub, Inc., a Nevada corporation (“ET-NV”), whereby our Company merged with and into ET-NV with ET-NV as the surviving corporation that operates under the name “PFO Global, Inc.” Prior to the Merger, our mission was to monetize our global utility patent portfolio with claims covering certain features of intelligent eyewear.

 

The Company completed the Merger with Holding on June 30, 2015. Following the Merger, we began focusing its resources on the manufacturing and distribution of eyewear through proprietary manufacturing, ordering and delivery systems that reduce cost to eyewear providers, through Pro Fit Optix, Inc. (“Optix”), Holding’s wholly-owned subsidiary.

 

Optix, a Wyoming corporation, was incorporated on May 7, 2009. On February 9, 2011, Optix filed a voluntary petition for reorganization pursuant to a Chapter 11 Plan of Reorganization as entered in Optix’s bankruptcy in case no. 11~13387 under Chapter 11 of Title 11 of the United States Code in the United States Bankruptcy Court for the Southern District of Florida. On May 2, 2011, Optix filed a Plan of Reorganization which was approved in August 2011. Pursuant to the Plan of Reorganization, debtor-in-possession financing was provided by HCA DIP Capital Fund, LLC.

 

Holding, a Florida limited liability company, was formed on February 9, 2011. Holding was previously known as HCA DIP Capital Fund, LLC which was formed to provide and did provide debtor-in-possession financing as a lender to Optix. The members of HCA DIP Capital Fund, LLC were majority stockholders of Optix prior to its reorganization.

 

On May 17, 2012, Optix successfully emerged from bankruptcy and, in exchange for the outstanding debtor-in-possession financing, issued all of the outstanding shares of its new common stock to Holding and became a wholly owned subsidiary of Holding.

 

Three additional wholly-owned subsidiaries of Holding, PFO Technologies, LLC (“Tech”), PFO Optima, LLC (“Optima”), and PFO MCO, LLC (“MCO”), were incorporated on February 17, 2014, May 23, 2013 and July 5, 2013, respectively.

 

The Company manufactures and delivers complete eyewear, prescription lenses and related services to the managed care insurance industry, which services the Medicaid and Medicare entitlement programs, independent eye care providers and accountable care organizations. Optima distributes distortion free polycarbonate lenses under the Resolution® brand name. Tech’s focus is on the development of disruptive technologies for the eyewear industry and supports the research and development of other business units of the Company.

 

 
7

 

 

The developed products currently include:

 

 

SmartCalc - proprietary software used to manufacture fully digital lens designs. Certain Company lenses are produced following the SmartCalc software calculation.

 

 

SmartEyewear Online Ordering System - a business-to-business online ordering software system which allows eye care providers to quickly provide all necessary information for each patient’s eyewear package and unique use. It integrates the optical provider directly with the PFO worldwide lab system. The Company utilizes this system for all of its electronic ordering.

 

The Company is headquartered in Dallas, Texas where primarily all corporate functions are performed as well as the support, sales and warehousing for all MCO and Tech products and services. Optima has a facility in Stratford, Connecticut of which the primary function is to support the sales, administration and warehousing of the Optima products. The Company utilizes a third party frame provider, Hong Kong Optical Lens Co. in Shenzhen, China (“HKO”) which sells frames to the Company and warehouses them in their facility until such time as the frames are released to designated laboratories to be fit with a lens. HKO is responsible to track and manage inventory on behalf of the Company from the point of purchase to the shipment of the frames to the laboratories.

 

All membership unit amounts have been restated to reflect the equivalent number of common shares to provide comparative information. All per share amounts are post Merger and post the stock split that occurred on July 6, 2015.

  

Basis of Presentation and Principles of Consolidation

 

The accompanying unaudited condensed consolidated financial statements include the accounts of PFO Global, Inc. and its wholly owned subsidiaries: Pro Fit Optix Holding Company, LLC, Pro Fit Optix, Inc., PFO MCO, LLC, PFO Optima, LLC and PFO Technologies, LLC, have been prepared in accordance with accounting principles generally accepted in the United States of America and the rules and regulations of the Unites States Securities and Exchange Commission (“SEC”) for interim financial information. The accompanying unaudited Condensed Consolidated financial statements should be read in conjunction with the Company’s audited financial statements and footnotes thereto for the fiscal year ended December 31, 2015.

 

Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America ("GAAP") have been omitted pursuant to such rules and regulations. The condensed consolidated financial statements reflect all adjustments (consisting primarily of normal recurring adjustments) that are, in the opinion of management, necessary for a fair presentation of the Company’s consolidated financial position and the results of operations. The operating results for the three months ended March 31, 2016 are not necessarily indicative of the results to be expected for the full fiscal year 2016 or for any other interim period.

 

The December 31, 2015 condensed consolidated balance sheet has been derived from the audited financial statements as of that date, but does not include all disclosures required by GAAP. All membership unit amounts have been restated to reflect the equivalent number of common shares to provide comparative information. All per share amounts are post merger amounts. Certain prior period amounts have been reclassified to conform to the current period presentation. All significant intercompany transactions and balances have been eliminated in consolidation.

  

Segment Information

 

Operating segments are identified as components of an enterprise about which separate discrete financial information is available for evaluation by the chief operating decision maker, or decision-making group, in making decisions on how to allocate resources and assess performance. The Company’s chief operating decision maker is its Chief Executive Officer. The Company and its Chief Executive Officer view the Company’s operations and manage its business as one operating segment. All revenues and long-lived assets of the Company are earned and reside in the United States.

 

Use of Estimates

 

The preparation of condensed consolidated financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the condensed consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. The Company’s significant estimates include the allowance for doubtful accounts, sales allowances, recoverability of long lived assets and goodwill, valuation allowance for deferred income tax assets, fair value of assets acquired and liabilities assumed, fair value of derivative liabilities and valuation of stock options and equity transactions. Actual results could differ from those estimates.

 

 
8

 

 

Concentration of Credit Risk

 

Financial instruments that potentially subject the Company to concentrations of credit risk consist primarily of cash and cash equivalents and accounts receivable.

 

Cash and Cash Equivalents

 

For purposes of the consolidated statements of cash flows, the Company considers all highly liquid financial instruments purchased with a maturity of three months or less to be cash equivalents. The Company maintains its cash and cash equivalents with financial institutions which balances may exceed the federally insured limits. Federally insured limits are $250,000 for interest and noninterest deposits. At March 31, 2016, the Company had no deposits in excess of federally insured limits.

 

Accounts Receivable

 

The Company does business and extends credit based on an evaluation of the customers’ financial condition, generally without requiring collateral. Exposure to losses on receivables is expected to vary by customer due to the financial condition of each customer. The Company monitors exposure to credit losses and maintains allowances for anticipated losses considered necessary under the circumstances. The Company’s allowance for doubtful accounts was approximately $267,000 and $275,000 at March 31, 2016 and December 31, 2015, respectively.

 

 Inventories

 

Inventory is comprised of finished goods frame and lens inventory at March 31, 2016 and December 31, 2015. In assessing the value of inventories, the Company makes estimates and judgments regarding aging of inventories and other relevant issues potentially affecting the saleable condition of products and estimated prices at which those products will sell. On an ongoing basis, the Company reviews the carrying value of its inventory, measuring number of months on hand and other indications of salability. The Company reduces the value of inventory if there are indications that the carrying value is greater than market, resulting in a new, lower-cost basis for that inventory. Subsequent changes in facts and circumstances do not result in the restoration or increase in that newly established cost basis. Inventories consist of finished product and are stated at the lower of cost, determined using the first-in first-out method, or market.

 

Debt Issue Costs

 

The Company amortizes debt issue costs to interest expense over the life of the associated debt instrument.

 

Shipping and Handling Costs

 

The Company charges customers for shipping and handling costs except for orders that are shipped directly to customers from the Company’s third party lens provider, HKO. Shipping and handling costs are classified as Revenues and Cost of Goods Sold in the Condensed Consolidated Statements of Operations.

 

Property and Equipment

 

Property and equipment are stated at cost. Depreciation on property and equipment is calculated on the straight-line basis over the estimated useful lives of the assets. Leasehold improvements are amortized over the shorter of the lease term or their estimated useful life. Maintenance and repairs are expensed as incurred; expenditures that enhance the value of property or extend the useful lives are capitalized. When assets are sold or returned, the cost and related accumulated depreciation are removed from the accounts and the resulting gain or loss is included in income.

 

The Company capitalizes certain website development costs incurred in designing, developing, testing and implementing enhancements to its website. These website development costs are amortized over the enhancement’s estimated useful life.

 

In addition to website development costs, capitalized software includes internally developed software to be sold, licensed or leased. The Company capitalizes internally developed software costs under the provisions of Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 985, “Software” which prescribes that capitalization of development costs of software products begins once the technological feasibility of the product is established. Capitalization ceases when such software is ready for general release, at which time amortization of the capitalized costs begins. Amortization of capitalized internally developed software is computed as the greater of: (a) the amount determined by the ratio of the product’s current revenue to its total expected future revenue or (b) the straight-line method over the product’s estimated useful life, generally three years. The Company has used the straight-line method to amortize such capitalized costs.

 

 
9

 

   

Impairment of Long-Lived Assets

 

The Company evaluates its long-lived assets for possible impairment whenever circumstances indicate that the carrying amount of the asset, or related group of assets, may not be recoverable from estimated future cash flows in accordance with accounting guidance. If circumstances suggest the recorded amounts cannot be recovered, based upon estimated future undiscounted cash flows, the carrying values of such assets are reduced to fair value. No impairment charges were recorded for long-lived assets for the periods ended March 31, 2016 and 2015.

 

Income Taxes

 

The Company accounts for income taxes under the provisions of Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 740, “Accounting for Income Taxes,” which requires that the Company recognize deferred tax liabilities and assets for the expected future tax consequences of events that have been recognized in the Company’s consolidated financial statements and tax returns. Deferred tax liabilities and assets are determined based on the difference between the financial statement carrying amounts and tax bases of assets and liabilities using enacted tax rates in effect in the years in which the differences are expected to reverse. The Company provides a valuation allowance against deferred tax assets if it is more likely than not that some or all of the deferred tax assets will not be realized.

 

The Company recognizes the tax benefit from an uncertain tax position only if it is more likely than not that the tax position will be sustained upon examination by taxing authorities, based on technical merits of the tax position. The evaluation of an uncertain tax position is based on factors that include, but are not limited to, changes in the tax law, the measurement of tax positions taken or expected to be taken in tax returns, the effective settlement of matters subject to audit and changes in facts or circumstances related to a tax position. Any changes to these estimates based on the actual results obtained and or a change in assumptions, could impact the Company’s tax provision in future periods. The Company accounts for interest and penalties related to uncertain tax positions as part of its provision for federal and state income taxes. The Company did not record any interest or penalties on uncertain tax positions in the accompanying condensed consolidated balance sheets and statements of operations for the periods ended March 31, 2016 and 2015, respectively. Federal, state and local authorities may examine the Company’s income tax returns for three years from the date of filing. The December 31, 2015 tax returns and prior three years remain subject to examination as of March 31. 2016.

 

Loss Per Share

 

Basic loss per share is computed by dividing the net loss by the weighted average number of common shares outstanding during the period. Diluted loss per share is computed by dividing net loss by the weighted average number of common shares and dilutive shares outstanding. As of March 31, 2016 and 2015, respectively, dilutive shares outstanding, whose impact was antidilutive, include options to purchase the Company’s common stock (“Options”) and warrants to purchase the Company’s common stock (“Warrants”). The dilutive impact of the Options and Warrants is determined by applying the “treasury stock” method.

 

The computation of the loss per share for the periods ended March 31, 2016 and 2015, respectively, and excludes the following Options and Warrants because their inclusion would be anti-dilutive:

  

   

March 31,
2016

   

March 31,
2015

 
                 

Options

    1,414,052       75,130  

Warrants

    12,939,297       5,869,681  

Total

    14,353,349       5,944,811  

 

Revenue Recognition

 

Revenue is derived from eyewear sales, technology sales, software revenue and term licensing revenue and is recorded in the period in which the goods are delivered or services are rendered and when all of the following criteria are met: persuasive evidence of an arrangement exists, delivery has occurred or services have been rendered, the sales price to the customer is fixed or determinable, and collection is reasonably assured. The Company reduces revenue for estimated discounts, sales incentives, estimated customer returns, and other allowances and presents revenue, net of taxes collected from customers and remitted to governmental authorities.

 

 
10

 

 

Eyewear Sales

 

The Company recognizes product revenue upon shipment provided that there is persuasive evidence of an arrangement, there are no uncertainties regarding customer acceptance, the sales price is fixed and determinable, and collection of the resulting receivable is reasonably assured.

 

Technology Sales

 

Revenue and the related cost of sales on sales of the Company’s laser tracing system, eyeX3, are recognized when risk of loss and title passes, which is generally at the time of shipment. This product was discontinued in 2015 due to poor market demand.

 

Term Licensing Revenue

 

The Company applies the provisions of ASC 985-605, Software Revenue Recognition, to all transactions involving the licensing of software products.

 

Term license revenue includes arrangements where the Company’s customers receive license rights to use its software along with bundled maintenance and support services for the term of the contract. The majority of the Company’s contracts provide customers with the right to use one or more products up to a specific license capacity. Certain of the Company’s license agreements stipulate that customers can exceed pre-determined base capacity levels, in which case additional fees are specified in the license agreement. Term license revenue is recognized ratably over the term of the license contract.

 

Deferred Revenue and Costs

 

On April 20, 2012, the Company sold software technology to VSP Labs, Inc. (“VSP”) pursuant to a Technology Transfer and Development Agreement (“TTDA”) (see Note 9). In accordance with the TTDA, the Company was required to perform additional production and customization of the software technology over the agreement term. The software technology required significant customization and development on the effective date and in accordance with ASC 605-35, the Company has accounted for the TTDA under the completed contract method. The Company and VSP are currently in litigation regarding the TTDA and the outcome is uncertain. Because of the uncertainties that exist under the contract, payments received and costs incurred under the TTDA have been deferred and will be recognized when the TTDA is considered complete and the litigation with VSP is settled.

 

In addition to the TTDA, the Company maintained a Purchase and Supply Agreement (“VSP Supply Agreement”) with VSP whereby the Company provided eyewear to VSP customers throughout California. In accordance with the VSP Supply Agreement, VSP was required to prepay for the orders of frame inventory. Payments received for prepaid orders are recorded in deferred revenue until such time inventory is shipped to VSP.

 

Equity-Based Compensation

 

Compensation expense for all stock-based employee and director compensation awards granted is based on the grant date fair value estimated in accordance with the provisions of ASC Topic 718, Stock Compensation (“ASC Topic 718”). The Company recognizes these compensation costs on a straight-line basis over the requisite service period of the award, which is generally the vesting term. Vesting terms vary based on the individual grant terms.

 

Advertising Costs

 

Advertising expenses are charged to expense as incurred. Advertising expense included in selling, general and administrative expenses in the accompanying condensed consolidated statements of operations amounted to approximately $8,600 and $22,000, for the periods ended March 31, 2016 and 2015, respectively.

 

Derivative Financial Instruments

 

The Company reviews its financial instruments for the existence of embedded derivatives that may require bifurcation if certain criteria are met. These criteria include circumstances in which (i) the economic characteristics and risks of the embedded derivative instrument are not clearly and closely related to the economic characteristics of the host contract, (ii) the hybrid financial instrument that embodies both the embedded derivative instrument and the host contract is not remeasured at fair value under other applicable GAAP with changes in fair value reported in earnings as they occur and (iii) a separate instrument with the same terms as the embedded derivative instrument would be considered a derivative instrument subject to certain requirements (except for which the host instrument is deemed conventional). A bifurcated derivative financial instrument is required to be recorded at fair value and adjusted to market at each reporting period end date.

 

 
11

 

  

 Fair Value Measurements

 

In accordance with ASC 820, “Fair Value Measurements and Disclosures,” fair value is defined as the exit price, or the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants as of the measurement date.

 

The guidance also establishes a hierarchy for inputs used in measuring fair value that maximizes the use of observable inputs and minimizes the use of unobservable inputs by requiring that the most observable inputs be used when available. Observable inputs are inputs market participants would use in valuing the asset or liability and are developed based on market data obtained from sources independent of the Company. Unobservable inputs are inputs that reflect the Company’s assumptions about the factors market participants would use in valuing the asset or liability. The guidance establishes three levels of inputs that may be used to measure fair value:

 

 

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

 

Level 2: Observable market-based inputs or unobservable inputs that are corroborated by market data.

 

Level 3: Unobservable inputs reflecting the reporting entity’s own assumptions.

 

The carrying amounts of cash and cash equivalents, accounts receivables, and accounts payable and accrued expenses approximate their fair value due to their short-term nature or market terms. However, considerable judgment is involved in making fair value determinations and current estimates of fair value may differ significantly from the amounts presented herein. The fair value of the Company’s derivative obligation liability is classified as Level 3 within the fair value hierarchy since the valuation model of the derivative obligation is based on unobservable inputs.

 

Recently Issued Accounting Pronouncements

 

In May 2014, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update No. 2014-09, "Revenue from Contracts with Customers," ("ASU 2014-09") providing common revenue recognition guidance for U.S. GAAP. Under ASU 2014-09, an entity recognizes revenue when it transfers promised goods or services to customers in an amount that reflects what it expects in exchange for the goods or services. It also requires additional detailed disclosures to enable users of financial statements to understand the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers. ASU 2014-09 will become effective for public companies during interim and annual reporting periods beginning after December 15, 2017. We are currently evaluating the impact this standard will have on our condensed consolidated financial statements.

 

In August 2014, the FASB issued ASU 2014-15, “Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern” (“ASU 2014-15”). ASU 2014-15 provides guidance on management’s responsibility in evaluating whether there is substantial doubt about a company’s ability to continue as a going concern and about related footnote disclosures. For each reporting period, management will be required to evaluate whether there are conditions or events that raise substantial doubt about a company’s ability to continue as a going concern within one year from the date the financial statements are issued. The amendments in ASU 2014-15 are effective for annual reporting periods ending after December 15, 2016, and for annual and interim periods thereafter. Early adoption is permitted. The Company will adopt the methodologies prescribed by ASU 2014-15 by the date required, and does not anticipate that the adoption of ASU 2014-15 will have a material effect on its financial position or results of operations.

 

In February 2015, FASB issued ASU No. 2015-02 (“ASU 2015-02”), “Consolidation (Topic 810): Amendments to the Consolidation Analysis.” ASU 2015-02 changes the analysis that a reporting entity must perform to determine whether it should consolidate certain types of legal entities. It is effective for annual reporting periods, and interim periods within those years, beginning after December 15, 2015. Early adoption is permitted, including adoption in an interim period. The Company adopted this new standard as of January 1, 2016. The implementation of this standard did not have a material impact on the Company’s condensed consolidated financial statements and disclosures. 

 

In July 2015, the FASB issued ASU No. 2015-11, "Simplifying the Measurement of Inventory" simplifying the measurement of inventory. The guidance requires an entity to measure inventory at the lower of cost or net realizable value, which consists of estimated selling prices in the ordinary course of business, less reasonably predictable cost of completion, disposal, and transportation. The new guidance eliminates unnecessary complexity that exists under current "lower of cost or market" guidance. For public entities, ASU No.2015-11 is effective for fiscal years beginning after December 15, 2016, including interim periods within those fiscal years. The guidance is to be applied prospectively as of the beginning of an interim or annual reporting period, with early adoption permitted. The Company does not believe the implementation of this standard will have a material impact on its condensed consolidated financial statements and disclosures

 

 
12

 

 

In September 2015, the FASB issued Accounting Standards Update No. 2015-16, “Simplifying the Accounting for Measurement Period Adjustments” (“ASU 2015-16”) which requires that adjustments to provisional amounts identified during the measurement period of a business combination be recognized in the reporting period in which those adjustments are determined, including the effect on earnings, if any, calculated as if the accounting had been completed at the acquisition date. This eliminates the previous requirement to retrospectively account for such adjustments. ASU 2015-16 also requires additional disclosures related to the income statement effects of adjustments to provisional amounts identified during the measurement period. ASU 2015-16 became effective for public companies during interim and annual reporting periods beginning after December 15, 2015 with early adoption permitted. Accordingly, the Company adopted this new standard on January 1, 2016. The implementation of this standard did not have a material impact on the Company’s condensed consolidated financial statements and disclosures.

 

In November 2015, the FASB issued ASU No. 2015-17, `Balance Sheet Classification of Deferred Taxes" (“ASU 2015-17”) simplifying the balance sheet classification of deferred taxes. To simplify the presentation of deferred income taxes, ASU 2015-17 requires that deferred tax liabilities and assets be classified as non-current in a classified statement of financial position. Under prior guidance, an entity was required to separate deferred income tax liabilities and assets into current and non-current amounts. The current requirement that deferred tax liabilities and assets of a tax-paying component of an entity be offset and presented as a single amount is not affected. For public entities, the guidance is effective for fiscal years beginning after December 15, 2016, including interim periods within those fiscal years, with early adoption permitted. The guidance maybe applied either prospectively to all deferred tax liabilities and assets or retrospectively to all periods presented. The Company adopted the new guidance on a prospective basis for its year ending December 31, 2015. Financial statements for prior periods were not retrospectively adjusted. The new guidance had no impact on the Company's condensed consolidated financial statements.

 

In February 2016, the FASB issued new lease accounting guidance ASU No. 2016-02, “Leases” (“ASU 2016-02”). Under the new guidance, at the commencement date, lessees will be required to recognize a leases liability, which is a lessee’s obligation to make lease payments arising from a leases, measured on a discounted basis,; and a right-to-use asset, which is an asset that represented the lessee’s right to use, or control the use of, a specified asset for the lease term. The new guidance is not applicable for leases with a term of 12 months or less. Lessor accounting is largely unchanged. Public business entities should apply the amendments in ASU 2016-02 for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. Early application is permitted upon issuance. Lessees (for capital and operating leases) and lessors (for sales-type, direct financing, and operating leases) must apply a modified retrospective transition approach for leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements. The modified retrospective approach would not require any transition accounting for leases that expired before the earliest comparative period presented. Lessees and lessors may not apply a full retrospective transition approach. The Company is currently evaluating the impact of the new guidance on its condensed consolidated financial statements.

 

Note 2 – Going Concern

 

As of March 31, 2016, the Company had cash of $25,807. As reflected in the accompanying condensed consolidated financial statements, the Company had a net loss of approximately $1.4 million and net cash and cash equivalents used in operations of approximately $1.0 million for the three month period ended March 31, 2016. The Company has a working capital deficit of approximately $15.5 million and stockholders’ deficit of approximately $26 million as of March 31, 2016. These factors raise substantial doubt about the Company’s ability to continue as a going concern.

 

Historically, the Company has been dependent upon its ability to raise sufficient capital to continue its product and business development efforts. The ability of the Company to continue as a going concern is dependent upon its ability to raise additional capital, increase its revenue and develop its technologies to the point of revenue recognition.

  

The Company’s primary source of operating funds since inception has been cash proceeds from issuance of notes payable. The Company intends to raise additional capital through private placements of debt and equity securities, but there can be no assurance that these funds will be available on terms acceptable to the Company, or will be sufficient to enable the Company to fully complete its development activities or sustain operations. The Company has raised approximately $.96 million, net of repayments and debt issuance costs, in the three month period ended March 31, 2016, through the issuance of promissory notes (see Note 5). However, there can be no assurance that the Company will be successful in raising additional funds.

 

Management believes that the actions presently being taken by the Company will provide sufficient liquidity for the Company to continue to execute its business plan. However, there can be no assurances that management’s plans will be achieved. If the Company is unable to raise sufficient additional funds, it will have to develop and implement a plan to further extend payables, reduce overhead, or scale back its current business plan until sufficient additional capital is raised to support further operations. There can be no assurance that such a plan will be successful.

 

Accordingly, the accompanying condensed consolidated financial statements have been prepared in conformity with GAAP, which contemplate continuation of the Company as a going concern and the realization of assets and satisfaction of liabilities in the normal course of business. The carrying amounts of assets and liabilities presented in the financial statements do not necessarily purport to represent realizable or settlement values. The financial statements do not include any adjustment that might result from the outcome of this uncertainty.

 

 
13

 

 

Note 3 – Accounts Receivable

 

Accounts receivable consist of the following as of:

 

   

March 31, 2016

   

December 31, 2015

 
                 

Accounts receivable, trade

  $ 712,680     $ 756,788  

Other receivables

    -       3,646  
      712,680       760,434  

Less allowance for doubtful accounts

    (266,943

)

    (275,242

)

    $ 445,737     $ 485,192  

 

 

Note 4 Accrued Liabilities

Accrued liabilities consist of the following as of:

 

   

March 31

2016

   

December 31

2015

 
                 

Payroll and related taxes

  $ 317,742     $ 641,622  

Accrued interest, third parties

    1,660,267       1,179,994  

Accrued other

    376,533       323,826  
    $ 2,354,542     $ 2,145,442  

 

 

Note 5– Notes Payable

 

Notes payable consist of the following as of:

 

   

March 31, 2016

   

December 31, 2015

 

Notes payable

  $ 225,000     $ 225,000  

Convertible promissory note

    200,000       200,000  

Promissory note

    50,000       50,000  

Series A notes

    3,002,500       3,002,500  

Secured bridge notes

    943,370       943,370  

Convertible notes

    2,045,000       2,045,000  

Senior Secured Convertible Debentures

    7,700,000       6,580,000  
      14,165,870       13,045,870  

Less debt issuance costs

    (650,992 )     (794,741 )

Less debt discounts

    (1,994,597 )     (2,331,538 )
      11,520,281       9,919,591  

Less current maturities

    (7,825,000 )     (6,705,000 )

Notes payable, less current maturities

  $ 3,695,281     $ 3,214,591  

 

The following table provides information regarding annual required repayments under the notes payable as of March 31, 2016:

 

2016

  $ 7,825,000  

2017

    3,170,434  

2018

    3,170,436  
    $ 14,165,870  

 

 
14

 

  

Amortization of debt discount and debt issuance costs was approximately $632,000 and $1,207,000 for the three months ended March 31, 2016 and 2015, respectively.

 

Notes Payable

 

In May 2015, the Company entered into a promissory note (“Short-Term Promissory Note”) for a principal amount of $100,000 with a stated interest rate of 9%.

 

In June 2015, the Company amended the maturity date of the Short-Term Promissory Note such that half of the principal matures on July 1, 2017 and the remainder matures on January 1, 2018, unless earlier converted into equity. Such amendment was accounted for as a modification of debt.

 

In conjunction with the Short-Term Promissory Note, the Company issued (i) five year Class A Warrants to purchase an aggregate of 62,500 common shares at an exercise price of $1.60 per share and (i) five year Class B Warrants to purchase an aggregate of 17,566 common shares at an exercise price of $0.01 per share. In conjunction with the amendment, in June 2015, the Company issued five year Class A Warrants to purchase an aggregate of 62,500 common shares to the note holder and approximately 5,000 common shares to the private placement agent.

 

The terms of the Class A Warrants provide that, in the event the Company receives gross proceeds of at least $1,000,000 in a qualified financing (as defined therein) at a per share price of less than $1.60 per share, the exercise price will reset to 80% of the financing price. At the time of issuance, the Company determined that the price protection feature on the Class A Warrants constituted a derivative liability because the price protection feature represents a variable conversion feature.

 

The Company accounted for the borrowing under the Short-Term Promissory Note, the Class A Warrants and the Class B Warrants in accordance with the guidance prescribed in ASC 470-20, “Debt with Conversion and other Options.” In accordance with ASC 470-20, the fair value of the Class A Warrants and the relative fair value of the Class B Warrants are considered an original issue discount which is required to be amortized over the life of the note as interest expense using the effective interest rate method.

 

The relative fair value of the Class B Warrants was recorded in stockholders’ deficit on the issuance date. The Company used the Black-Scholes pricing model to calculate the fair value of the Class B Warrants.

 

The Company used a Binomial Lattice Valuation Model to calculate the fair value of the Class A Warrants on the issuance date and is re-measured at each reporting period (see Note 8).

 

In June 2015, the Company entered into a promissory note for a principal amount of $400,000 with the Royalty Obligation Purchaser (see Note 6). $275,000 of principal was repaid, as well as a $50,000 interest payment, in July 2015; and the remaining $125,000 principal amount was due on July 1, 2016.

 

The Company was unable to make the July 1, 2016 principal payment. Based on the Company’s current financial condition, there can be no certainty that the Company will be able to make the payment and is currently negotiating with the Royalty Obligation purchaser for an extension of the maturity date.

 

Convertible Promissory Note

 

On January 28, 2014, the Company entered into a convertible promissory note (“Convertible Note”) for a principal amount of $200,000 with a stated interest rate of 18%. On January 20, 2015 and April 2015 the maturity date of the Convertible Note was extended to June 30, 2015 and May 1, 2016, respectively. On June 29, 2015, the maturity date of the Convertible Note was further amended such that half of the principal matures on July 1, 2017 and the remainder matures on January 1, 2018. All obligations under the Convertible Promissory Note were secured by a first priority security interest in all inventory of Optima. In conjunction with the Convertible Note, the Company issued a five year warrant to purchase 57,820 common shares (approximately 0.4% of the Company's then total issued and outstanding common shares) for an exercise price of $1.00 per share.

 

Because of the variable nature of the embedded warrants, the Convertible Note has been accounted for in accordance with ASC 815.However, the fair value of the warrants of the Convertible Note (as determined using the Black Scholes valuation model) was determined to be nominal, therefore, no derivative liability or offsetting debt discount was included in the Company's condensed consolidated balance sheet as of March 31, 2016 and December 31, 2015. Management will continue to measure the fair value of this instrument each reporting period through maturity date and record the impact under ASC 815 should the value become meaningful to the Company's consolidated condensed financial statements.

 

 
15

 

 

Promissory Note

 

On February 12, 2014, the Company entered into a promissory note (“Promissory Note”) for a principal amount of $50,000 with a stated interest rate of 18%. In April 2015, the maturity date of the Convertible Note was amended to May 1, 2016. On June 29, 2015, the maturity date of the Convertible Note was further amended such that half of the principal matures on July 1, 2017 and the remainder matures on January 1, 2018.

 

Series A Private Placement

 

On various dates from May 1, 2014 through September 19, 2014, the Company issued and sold 299.25 investment units to accredited investors (the “Series A Private Placement”). Each investment unit was sold at a purchase price of $10,000 and consisted of (i) a Series A secured promissory note in the principal amount of $10,000 (the “Series A Note”), (ii) five year Class A warrants to purchase 6,250 common shares at an exercise price of $1.60 per share, exercisable in whole or in part as of the date of issuance (the “Class A Warrants”), and (iii) five-year Class B warrants (“Class B Warrants”) to purchase 1,756.6 common shares at an exercise price of $0.01 per share, exercisable in whole or in part as of the date of issuance. Proceeds received from the Series A Private Placement were approximately $2,633,000 net of related costs of approximately $360,000.

 

In January 2015, the Company amended certain of the Series A Notes. Note holders representing $2,255,000 of outstanding principal entered into amendments whereby (a) each Series A Note matures on the earlier of (i) the 12-month anniversary of the issuance date and (ii) the completion of any merger with or acquisition by a third party; and (b) upon an initial public offering or cash acquisition of the Company, the outstanding principal and interest will automatically convert into Common Stock at a per share conversion price equal to (i) in the event of an initial public offering, 100% of the offering price of the Common Stock in the Public Offering or (ii) in the event of an acquisition, 80% of the per share valuation of the Company in connection with the acquisition.

 

In conjunction with the amendments, the Company issued five year Class A Warrants to purchase an aggregate of 1,039,063 common shares to note holders and 83,125 common shares to the private placement agent at an exercise price of $1.60 per share, exercisable in whole or in part as of the date of issuance. The fair value of the Class A Warrants was included in derivative liabilities on the Company’s condensed consolidated balance sheet at the issuance date and re-measured at each reporting period.

 

Also, in May 2015, the Company amended certain of the Series A Notes whereby each Series A Note matures on the earlier of: (i) the 24-month anniversary of the issuance date; (ii) the completion of any acquisition, merger or consolidation of the Company in which the collective ownership of the Company in the transaction would own, in the aggregate, a lower percentage of the total combined voting power of the surviving entity than the acquiring company’s collective ownership; (iii) thirty (30) days following the funding of any financing that results in a listing on a national exchange (i.e., the Nasdaq or NYSE); or (iv) the sale by the Company of all or substantially all the Company’s assets in one transaction or in a series of related transactions.

 

The Company accounted for the borrowing under the Series A Notes, the Class A Warrants and the Class B Warrants in accordance with the guidance prescribed in ASC 470-20, `Debt with Conversion and other Options.” In accordance with ASC 470-20, the fair value of the Class A Warrants and the relative fair value of the Class B Warrants are considered an original issue discount which is required to be amortized over the life of the note as interest expense using the effective interest rate method.

 

In conjunction with the amendments, the Company issued (i) five year Class A Warrants to purchase an aggregate of 1,876,563 common shares to note holders and approximately 149,625 common shares to the private placement agent and (i) five year Class B Warrants to purchase an aggregate of 527,421 common shares to note holders and approximately 42,053 common shares to the private placement agent. The fair value of the Class A Warrants was included in derivative liability on the Company's condensed consolidated balance sheet at the issuance date and re-measured at each reporting period (see Note 8). The fair value of the Class B Warrants was included in stockholders’ deficit in the Company's condensed consolidated balance sheet at March 31, 2016.

 

In June 2015, the Company amended the maturity date of each Series A Note such that half of the principal matures on July 1, 2017 and the remainder matures on January 1, 2018. Such amendments were accounted for as modifications of debt. In conjunction with the amendments, the Company issued five year Class A Warrants to purchase an aggregate of 150,125 common shares to the private placement agent. The fair value of the Class A Warrants was included in derivative liability on the Company's condensed consolidated balance sheet and re-measured at each reporting period (see Note 8).

 

 
16

 

 

Secured Bridge Private Placement

 

On various dates from September 19, 2014 through November 18, 2014, the Company issued and sold 115.5 investment units to accredited investors (the “Secured Bridge Private Placement”). Each investment unit was sold at a purchase price of $10,000 and consisted of (i) a secured promissory note in the principal amount of $10,000 (the “Bridge Note”), (ii) five-year Class A Warrants to purchase 6,250 common shares, and (iii) five-year Class B Warrants to purchase 1,756.6 common shares. The Class A Warrants and Class B Warrants had exercise prices of $1.60 and $.01 per share, respectively.

 

In May 2015, the notes were amended, modifying the maturity date of the notes whereby each Bridge Note matures on the earlier of: (i) the receipt of funds from accounts receivable in the aggregate principal amount then outstanding of all Bridge Notes; (ii) the receipt of gross proceeds from any accounts receivable financing or factoring financing in an amount equal to at least the aggregate Bridge Note principal; (iii) thirty (30)days following the funding of any financing that results in a listing on a national exchange; (iv) the sale by the Company of all or substantially all the Company’s assets in one transaction or in a series of related transactions; (v) the completion of any acquisition, merger or consolidation of the Company in which the collective ownership of the Company in the transaction would own, in the aggregate, a lower percentage of the total combined voting power of the surviving entity than the acquiring company’s collective ownership; and (vi) January 1, 2016.

 

The Company accounted for the borrowing under the Secured Bridge Notes, the Class A Warrants and the Class B Warrants in accordance with the guidance prescribed in ASC 470-20, `Debt with Conversion and other Options.” In accordance with ASC 470-20, the fair value of the Class A Warrants and the relative fair value of the Class B Warrants are considered an original issue discount which is required to be amortized over the life of the note as interest expense using the effective interest rate method.

 

In conjunction with the amendments, the Company issued (i) five year Class A Warrants to purchase an aggregate of 721,875 common shares to note holders and approximately 57,750 common shares to the private placement agent and (i) five year Class B Warrants to purchase an aggregate of 202,888 common shares to note holders and approximately 16,231 common shares to the private placement agent. The fair value of the Class A Warrants was included in derivative liability on the issuance date and re-measured as of the reporting period (see Note 8). The fair value of the Class B Warrants was included in stockholders’ deficit on the issuance date.

 

In June 2015, the Company further amended the maturity date of certain Bridge Notes such that half of the principal matures on July 1, 2017 and the remainder matures on January 1, 2018. In July 2015, a note with an original principal amount of $125,000 was repaid. In conjunction with the amendments, the Company issued five year Class A Warrants to purchase an aggregate of 643,750 common shares to note holders and approximately 57,750 common shares to the private placement agent. The fair value of the Class A Warrants was included in derivative liability at the issuance date and re-measured as of the reporting period.

 

Convertible Notes Private Placement

 

On various dates from January 1, 2015 through June 30, 2015, the Company issued and sold 179.5 investment units to accredited investors (the “Convertible Notes Private Placement”). Each investment unit was sold at a purchase price of $10,000 and consisted of (i) a Convertible promissory note in the principal amount of $10,000 (the “Convertible Note”) and (ii) five year Class C warrants to purchase 1,502.6 common shares, exercisable in whole or in part as of the date of issuance (the “Class C Warrants”). As a result of the Convertible Notes Private Placement, the Company issued warrants to purchase an aggregate of 269,717 common shares. In connection with the Convertible Note Private Placement, the Company issued to the placement agent (i) five-year Class C Warrants to purchase an aggregate of 21,577 common shares.

 

Each Convertible Note bears interest at a rate of 9% per annum and matures on the 12-month anniversary of the issuance date unless converted into equity upon an initial public offering of the Company’s securities or a cash acquisition of the Company. The terms of the Convertible Notes provide that the unpaid principal and interest amounts will automatically convert into Common Stock at a per share conversion price equal to (i) in the event of an initial public offering, eighty percent (80%) of the offering price of the Common Stock in the Public Offering (such price, the “Discounted IPO Price”) or (b) in the event of an acquisition, 80% of the per share valuation of the Company in connection with the acquisition.

 

The terms of the Class C Warrants provide that the exercise price of each warrant shall mean (i) if the warrant becomes exercisable on the Company’s initial public offering date, 110% of the per warrant share offering price of the Company’s securities in its initial public offering, (ii) if the warrant becomes exercisable upon the occurrence of an acquisition of the Company, the lower of (x) 20% discount to the warrant share valuation in the acquisition and (y) a per warrant share price based on a fully diluted market capitalization value of one hundred million dollars ($100,000,000) on the date of the acquisition, and (iii) if the warrant becomes exercisable on the June 30, 2015, a per warrant share price based on a fully diluted market capitalization value of one hundred million dollars ($100,000,000) on June 30, 2015. At the time of issuance, the Company determined that the variable exercise price feature on the Class C Warrants constituted a derivative liability because the variable exercise price feature represents a variable conversion feature.

 

 
17

 

 

The Company accounted for the borrowing under the Convertible Notes and the Class C Warrants in accordance with the guidance prescribed in ASC 470-20, “Debt with Conversion and other Options.” In accordance with ASC 470-20, the fair value of the Class C Warrants is considered an original issue discount which is required to be amortized over the life of the note as interest expense using the effective interest rate method.

 

The fair value of the Class C Warrants was immaterial on the issuance dates and March 31, 2016 (see Note 9). The Company used a Binomial Lattice Valuation Model to calculate the fair value of the Class C Warrants.

 

Proceeds received from the Convertible Note Private Placement was approximately $1,565,000, net of related costs of approximately $230,000.

 

In June 2015, the Company amended the maturity date of each Convertible Note such that half of the principal matures on July 1, 2017 and the remainder matures on January 1, 2018, unless earlier converted into equity.

 

In conjunction with the amendments, the Company issued five year Class A Warrants to purchase an aggregate of 102,250 common shares to the private placement agent. The fair value of the Class A Warrants was included in derivative liability at the issuance date and re-measured as of the reporting period (see Note 9).

 

Securities Purchase Agreement

 

On various dates from June 30, 2015 through December 31, 2015, we entered into a certain Securities Purchase Agreement (the “Securities Purchase Agreement”) with Hillair Capital Investment L.P. (the “Investor”), pursuant to which we sold an aggregate of $6,580,000 in principal amount of an 8% original issue discount senior secured convertible debenture, dated July 1, 2015 (the “Debenture”), for an aggregate purchase price of $6,145,000 to the Investor. Pursuant to the Securities Purchase Agreement, we also issued to the Investor warrants, (the “SPA Warrant”), to purchase an aggregate of 3,290,000 shares of our common stock (subject to adjustment). The Debenture matures on January 1, 2017, and accrues interest at the rate of 8% per annum. One quarter of the original principal amount of the Debenture is payable on each of July 1, 2016 and October 1, 2016, and the remaining principal amount of the Debenture is payable on January 1, 2017. 8% Accrued interest on the Debenture is payable on January 1, April 1, July 1 and October 1 of each year, commencing on April 1, 2016.

 

The Company was unable to make its April 1, 2016 and July 1, 2016 interest payments under the Debenture and the principal payment due on July 1, 2016. The Company has received a waiver from the Investor extending the interest and principal payments to January 1, 2017. Based on the Company’s current financial condition, there can be no certainty that the Company will be able to make the delinquent interest and principal payments and accordingly the outstanding principal amount due under the Debenture has been presented as current in the Company’s condensed consolidated balance sheets.

 

On January 7, 2016 we entered into an additional Securities Purchase Agreement with the Investor, pursuant to which we sold an aggregate of $504,000 in principal amount of a Debenture for an aggregate purchase price of $450,000 to the Investor. The Debenture matures on February 1, 2017, and accrues interest at the rate of 8% per annum. No warrants were granted related to these issuances in 2016.

 

On February 17, 2016, we entered into an additional Securities Purchase Agreement with the Investor, pursuant to which we sold an aggregate of $616,000 in principal amount of a Debenture for an aggregate purchase price of $550,000 to the Investor. The Debenture matures on March 1, 2017, and accrues interest at the rate of 8% per annum. No warrants were granted related to these issuances in 2016.

 

Proceeds received from the Debentures were approximately $975,000, net of related costs of approximately $25,000 and original discounts of $120,000 respectively, during the three months ended March 31, 2016. Debt issuance costs will be amortized to interest expense over the life of the Debentures.

 

Amounts of principal and accrued interest under the Debenture are convertible at the option of the Investor at any time into shares of our common stock at an initial conversion price (as may be adjusted, the “Conversion Price”) of $2.00 per share, subject to certain ownership limitations and adjustment provisions. The Conversion Price is subject to reduction to an amount equal to 90% of the effective price per share of securities issued by PFGB (i) in a registered offering of our common stock or securities convertible into or exchangeable for shares of our common stock (collectively “Common Stock Equivalents”) or (ii) in any other financing or series of financings of our common stock or Common Stock Equivalents with gross proceeds of $4,000,000 or more (each, a “Triggering Event”). Beginning six months after the Effective Date of the original Securities Purchase Agreement (the “Effective Date”), the Company has the option, subject to certain conditions, to redeem some or all of the then outstanding principal amount of the Debenture for cash in an amount equal to the sum of (i) 120% of the then outstanding principal amount of the Debenture, (ii) accrued but unpaid interest and (iii) any liquidated damages and other amounts due in respect of the Debenture.

 

 
18

 

 

Pursuant to the terms of the Debenture, we have agreed to certain negative covenants, including not to incur or repay any other indebtedness, for so long as any portion of the Debenture remains outstanding.

 

The SPA Warrant is exercisable for a period of five years from the Effective Date, at an initial exercise price (the “SPA Warrant Exercise Price”) of $2.40 per share. In addition to customary adjustments for stock splits and the like, if a Triggering Event occurs, the SPA Warrant Exercise Price is subject to reduction to the Conversion Price applicable as a result of such Triggering Event, in which event the number of shares of our common stock issuable under the SPA Warrant would be increased such that the aggregate SPA Warrant Exercise Price payable under the SPA Warrant, after taking into account the decrease in the SPA Warrant Exercise Price, would be equal to the aggregate SPA Warrant Exercise Price prior to such adjustment. If at any time after the six month anniversary of the Effective Date there is no effective registration statement registering, or no current prospectus available for, the resale of the shares of our common stock underlying the SPA Warrant, then the SPA Warrant may be exercised, in whole or in part, at such time on a “cashless exercise” basis.

 

Our obligations under the Debenture are secured by a lien on all of our assets, including a pledge of the securities of our subsidiaries, pursuant to the terms of a Security Agreement (the “Security Agreement”) entered into as of the Effective Date between us and the Investor.

 

Pursuant to the terms of the Securities Purchase Agreement, the Investor received a right of first refusal to purchase up to 100% of the securities offered by us in future private placement offerings through the first anniversary of the Effective Date. In addition, from the Effective Date until the 12-month anniversary of the date our common stock is listed on Nasdaq or NYSE MKT, the Investor may, in its sole determination, elect to purchase, in one or more purchases, additional debentures with an aggregate subscription amount of up to $4,000,000, and SPA Warrants to purchase that number of shares of our common stock equal to the original principal amount of such additional debentures divided by $2.00. Subject to certain exceptions, the Company agreed (i) for a period of 180 days following the Effective Date, not to issue, enter into any agreement to issue or announce the issuance or proposed issuance of any shares of our common stock or any securities convertible into or exchangeable for shares of our common stock, and (ii) until such time as the Debenture and SPA Warrant are no longer outstanding, not to issue any shares of our common stock or any securities convertible into or exchangeable for shares of our common stock at an effective per share purchase price of less than $2.40 (subject to adjustment for stock splits and the like), provided that after the time that the Debenture is no longer outstanding, the Company may receive a waiver from such restriction by paying the Investor an amount in cash equal to 15% of the purchase price paid by the Investor for the Debenture. If at any time during the period beginning on the six-month anniversary of the Effective Date and ending at such time as all of the shares of our common stock underlying the Debenture and the SPA Warrant (collectively, the “Securities”) can be sold without restriction or limitation pursuant to Rule 144 promulgated under the Securities Act of 1933, as amended (the “Securities Act”), if we either (i) shall fail for any reason to satisfy the current public information requirements contained in Rule 144 or (ii) has ever been, or becomes in the future, an issuer described in section (i)(1)(i) of Rule 144, then we shall be obligated to pay to the Investor an amount in cash, as liquidated damages and not as a penalty, equal to 2% of the purchase price paid by the Investor for the Debenture per month until the applicable event giving right to such payments is cured (or the Investor is nonetheless able to transfer its Securities pursuant to Rule 144).

  

Also on the Effective Date, pursuant to the terms of the Securities Purchase Agreement, the Investor entered into a lock-up agreement (the “Investor Lock-Up Agreement”), pursuant to which it agreed, subject to certain exceptions and conditions, not to sell any of the Securities for a period commencing on the Effective Date and ending on the earlier of (i) the first anniversary of the Effective Date, (ii) the date on which we notify the Investor of our intention to redeem some or all of the outstanding principal amount of the Debenture pursuant to the terms thereof or (iii) a trading day on or after the nine month anniversary of the Effective Date on which either: (x) the aggregate dollar trading volume of our common stock since the Effective Date equals or exceeds $10,000,000 (provided that since the Effective Date, the closing bid price of our common stock has been equal to or exceeded $4.00 for a period of 30 consecutive trading days) or (y) the closing bid price of our common stock equals or exceeds $8.00 for a period of 30 consecutive trading days.

 

At the time of issuance, we determined that (i) the net share settlement (cashless exercise) provision on the SPA Warrants and (ii) the variable Debenture conversion price constituted derivative liabilities because the variable exercise price and variable Debenture conversion price features represent variable conversion features.

 

We accounted for the borrowing under the Debentures, the SPA Warrants and the conversion rights in accordance with the guidance prescribed in ASC 470-20, “Debt with Conversion and other Options.” In accordance with ASC 470-20, the fair value of the SPA Warrants and the conversion rights are considered original issue discounts, required to be amortized over the life of the note as interest expense using the effective interest rate method.

 

 
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The fair value of the SPA Warrants and conversion rights were recorded on the issuance dates using a Binomial Lattice Valuation Model, which was included in derivative liability on our consolidated balance sheets, and re-measured as of March 31, 2016 (see Note 9).

 

 

Note 6 – Royalty Obligation

 

The Company entered into a Royalty Purchase Agreement with a third party (“Purchaser”). Under the terms of the Royalty Purchase Agreement, the Company was advanced $1,750,000 by the Purchaser and in return, the Company agreed to pay the Purchaser a royalty amount equal to 3.09% of monthly revenue generated from products or services that incorporate any of the Company's intellectual property ("IP Revenue") including patents, copyrights and trademarks in perpetuity ("Royalty Payments"). No monthly Royalty Payments for any calendar month will be less than $36,458.

 

In May and June 2015, the Company amended its Royalty Obligation to borrow an additional $250,000. The royalty rate was amended to 3.09% of monthly IP Revenue; the minimum monthly royalty amount was amended to $36,458; and the monthly royalty payments were deferred from April 2015 through June 2016 and were due on July 1, 2016.

 

The Company was unable to make the July 1, 2016 royalty payment under its Royalty Obligation. The Company is negotiating an extension to the due date. Based on the Company’s current financial condition, there can be no certainty that the Company will be able to make the delinquent royalty payments and accordingly the outstanding royalty amount due under the Royalty Obligation has been presented as current in the Company’s condensed consolidated balance sheets.

 

Royalty expense of approximately $109, 000 and $94,000 is included in Interest Expense, other on the Company’s condensed consolidated statement of operations for the three months ended March 31, 2016 and 2015, respectively.

 

Approximately $230,000 and $290,000 of accrued royalty expense was included in accounts payable and accrued liabilities on the Company’s condensed consolidated balance sheets as of March 31, 2016 and December 31, 2015, respectively. As of March 31, 2016 and December 31, 2015, $1,750,000 and $1,750,000 respectively was outstanding under the Royalty Obligation.

 

 
20

 

 

Note 7 – Related Party Transactions

 

Long-term notes due to related parties consist of the following:

 

   

March 31, 2016

   

December 31, 2015

 

Unsecured note payable with HP Equity Fund LLC pursuant to Plan of Reorganization dated May 2, 2011. The note does not carry any cross default provisions. In June 2015, the Company amended the maturity date of the note such that half of the principal matures on July 1, 2017 and the remainder matures on January 1, 2018. Interest continues to accrue at 4.5% per annum.

  $ 1,030,639     $ 1,030,639  
                 

Note payable with HCA Capital Fund LLC pursuant to Plan of Reorganization dated May 2, 2011. The note payable is secured by substantially all of the assets of the Company. In June 2015, the Company amended the maturity date of the note such that half of the principal matures on July 1, 2017 and the remainder matures on January 1, 2018. Interest continues to accrues at 9.5% per annum.

    448,993       448,993  
                 

Unsecured note payable with PFO Fund LLC pursuant to Plan of Reorganization dated May 2, 2011. The note does not carry any cross default provisions. In June 2015, the Company amended the maturity date of the note such that half of the principal matures on July 1, 2017 and the remainder matures on January 1, 2018. Such amendment was accounted for as a modification of debt. Interest continues to accrues at 4.5% per annum.

    206,565       206,565  
                 

Promissory note with Transition Capital, LLC dated September 1, 2012, as amended. In June 2015, the Company amended the maturity date of the note such that half of the principal matures on July 1, 2017 and the remainder matures on January 1, 2018. Such amendment was accounted for as a modification of debt. Interest continues to accrue at 5.5% per annum

    1,550,200       1,550,200  
                 

The Company has an unsecured promissory note with Atlas Technologies, AG which is owned by a relative of the Company’s former Chief Executive Officer (“CEO”) dated December 30, 2012 at a stated annual interest rate of 5.5%. In June 2015, the Company amended the maturity date of the note such that half of the principal matures on July 1, 2017 and the remainder matures on January 1, 2018.

    117,700       117,700  

  

 
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March 31, 2016

   

December 31, 2015

 

The Company has an agreement with the former CEO effective February 2011 to pay an automobile allowance of $1,633 per month through the date of termination. In June 2015, the Company amended the maturity date of the note such that half of the principal matures on July 1, 2017 and the remainder matures on January 1, 2018. The Note was repaid in the second quarter of 2016.

    53,875       52,108  
                 

The Company has a promissory note with a relative of the former CEO effective September 6, 2011 at a stated annual interest rate of 0%. In June 2015, the Company amended the maturity date of the note such that half of the principal matures on July 1, 2017 and the remainder matures on January 1, 2018.

    47,210       47,210  
                 

The Company has three promissory notes with three stockholders dated July 2011 at a stated annual interest rate of 9.5%. In June 2015, the Company amended the maturity date of the July 2011 notes such that half of the principal matures on July 1, 2017 and the remainder matures on January 1, 2018.

    1,134,215       1,134,215  
                 

The Company has four promissory notes with four stockholders dated May 2015 at a stated annual interest rate of 4.5%. In June 2015, the Company amended the maturity date of the July 2011 notes such that half of the principal matures on July 1, 2017 and the remainder matures on January 1, 2018.

    90,000       90,000  
                 

Total long term notes to related parties

    4,679,397       4,677,630  

Less current maturities

    -          

Total long term notes to related parties, net of current maturities

  $ 4,679,397     $ 4,677,630  

 

      The following table provides information regarding annual required repayments under the notes payable, as amended, as of March 31, 2016:

 

2016

  $ -  

2017

    2,339,699  

2018

    2,339,698  
    $ 4,679,397  

 

The Company incurred interest expense of approximately $78,000 and $75,000 for the three months ended March 31, 2016 and 2015, respectively, which is presented in interest expense – related parties, in the accompanying condensed consolidated statements of operations. As of March 31, 2016 and December 31, 2015, approximately $1,130,400 and $1,188,000 of accrued but unpaid interest is presented in accrued interest, related parties in the accompanying condensed consolidated balance sheets, respectively.

 

Approximately $240,000 was due to the Chairman, a related party, as of March 31, 2016 and December 31, 2015, respectively for consulting fees.

 

The Company paid PFO Europe, a company owned by a relative of the Company’s former CEO, approximately $0 and $12,000 in fees and expenses during the three months ended March 31, 2016 and 2015, respectively, to market the Company’s products and services in Europe.

 

 
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Note 8- Derivative Obligation

 

Class A Warrants

 

 As of March 31, 2016, 5,011,750 Class A Warrants were issued and outstanding. The Company did not grant any Class A Warrants during the three months ended March 31, 2016. The Company determined that the price protection feature on the Class A Warrants constituted a derivative liability because the price protection feature represents a variable conversion feature, and estimated the fair value of the derivative liability of approximately $877,000 using a Binomial Lattice Valuation Model and the following assumptions as of March 31, 2016:

 

 

Present Value of Share

      $0.14    

Expected Volatility

    101.18% - 102.49%  

Expected Term (in years)

    3.1 - 4.2  

Discount Rate

    0.87% - 1.03%  

Dividend Rate

      0%    

Exercise Price

      $0.08    

 

Expected volatilities are based on the historical volatilities of comparable companies, industry indexes, and other factors. Expected term is based on remaining term of the Class A Warrants. The discount rate represents the yield on U.S. Treasury bonds with a maturity equal to the expected term. The present value of a share is based upon management’s estimate of the equity value of the Company and the number of shares outstanding.

 

The Company recorded a gain of approximately $159,000 during the three months ended March 31, 2016 and a gain of approximately $776,800 during the three months ended March 31, 2015, representing the net change in the fair value of the derivative liability for such periods, which are presented as fair value changes of derivative instruments, net in the accompanying condensed consolidated statements of operations.

 

In accordance with accounting principles generally accepted in the United States, the following table represents the Company’s fair value hierarchy for its Class A Warrants measured at fair value on a recurring basis as of March 31, 2016:

 

   

Balance at
3/31/2016

   

Level 1

   

Level 2

   

Level 3

 
                                 

Derivative Obligation

  $ 877,000     $ -     $ -     $ 877,000  

 

The following table reflects the change in fair value of the Company’s Class A Warrants for the period ended March 31, 2016:

 

   

Amount

 

Balance – January 1, 2016

  $ 1,036,000  

Addition of derivative obligation at fair value on date of issuance

    -  

Change in fair value of derivative obligation

    (159,000 )

Balance – March 31, 2016

  $ 877,000  

 

Class C Warrants

 

As of March 31, 2016, 291,294, Class C Warrants were issued and outstanding The Company did not grant any Class C Warrants during the 3 months ended March 31, 2016.

 

The Company determined that the price protection feature on the Class C Warrants constituted a derivative liability because the variable exercise price represents a variable conversion feature.

  

 

As of March 31, 2016, the Company determined that the fair value of the derivative liability pertaining to the Class C Warrants was immaterial as of such date. The fair value of the derivative obligation was estimated using Binomial Lattice Valuation Model and the following assumptions:

 

Present Value of Share

      $0.14    

Expected Volatility

      101.18%    

Expected Term (in years)

    3.7 - 4.2  

Discount Rate

      1.03%    

Dividend Rate

      0%    

Exercise Price

      $2.20    

 

Expected volatilities are based on the historical volatilities of comparable companies, industry indexes, and other factors. Expected term is based on remaining term of the Class C Warrants. The discount rate represents the yield on U.S. Treasury bonds with a maturity equal to the expected term. The present value of a share is based upon management’s estimate of the equity value of the Company and the number of shares outstanding.

 

 
23

 

 

The fair value of the derivative liability related to the Class C Warrants did not change materially from the date of issuance to March 31, 2016.

 

SPA Warrants

 

As of December 31, 2015, 3,290,000 SPA warrants were issued and outstanding. The Company did not grant any SPA Warrants during the 3 months ended March 31, 2016. The Company determined that the net settlement (cashless exercise) feature on the SPA Warrants constituted a derivative liability because the net settlement feature represents a variable conversion feature. As of March 31, 2016 the Company estimated the fair value of the derivative liability of approximately $356,000 using a Binomial Lattice Valuation Model and the following assumptions:

 

 

Present Value of Share

      $0.14    

Expected Volatility

    98.96% - 101.18%  

Expected Term (in years)

    4.25 - 4.7  

Discount Rate

    1.03% - 1.20%  

Dividend Rate

      0%    

Exercise Price

      $0.09    

 

Expected volatilities are based on the historical volatilities of comparable companies, industry indexes, and other factors. Expected term is based on remaining term of the SPA Warrants. The discount rate represents the yield on U.S. Treasury bonds with a maturity equal to the expected term. The present value of a share is based upon management’s estimate of the equity value of the Company and the number of shares outstanding.

 

The Company recorded a gain of approximately $71,000 and $0 during the three months ended March 31, 2016 and 2015, respectively, representing the net change in the fair value of the derivative liability for such periods, which are presented as fair value changes of derivative instruments, net in the accompanying condensed consolidated statements of operations.

 

In accordance with accounting principles generally accepted in the United States, the following table represents the Company’s fair value hierarchy for its SPA Warrants measured at fair value on a recurring basis as of March 31, 2016:

 

   

Balance at
3/31/2016

   

Level 1

   

Level 2

   

Level 3

 
                                 

Derivative Obligation

  $ 356,000     $ -     $ -     $ 356,000  

 

The following table reflects the change in fair value of the Company’s derivative liabilities for the period ended March 31, 2016:

 

   

Amount

 

Balance – January 1, 2016

  $ 427,000  

Addition of derivative obligation at fair value on date of issuance

     -  

Change in fair value of derivative obligation

    (71,000

)

Balance – March 31, 2016

  $ 356,000  

 

Debenture Conversion Feature

 

The Debentures issued during the year ended December 31, 2015 (see Note 6) and the three months ended March 31, 2016, include a conversion feature whereby they can be converted into 3,290,000 and 560,000 common shares, subject to certain adjustments. At the time of issuance, the Company determined that the variable nature of the conversion feature constituted a derivative liability. During the three months ended March 31, 2016, the Company estimated the fair value of the derivative liability of approximately $0 using a Binomial Lattice Valuation Model and the following assumptions:

 

 

Present Value of Share

  $ 0.14  

Expected Volatility

    84 %

Expected Term (in years)

    0.8  

Discount Rate

    0.59 %

Dividend Rate

    0 %

Exercise Price

  $ 2.00  

 

 
24

 

 

Expected volatilities are based on the historical volatilities of comparable companies, industry indexes, and other factors. Expected term is based on the expected remaining term of the conversion feature. The discount rate represents the yield on U.S. Treasury bonds with a maturity equal to the expected term. The present value of a share is based upon management’s estimate of the equity value of the Company and the number of shares outstanding.

 

The Company recorded a gain of approximately $306,000 and $0 during the three months ended March 31, 2016 and 2015, respectively, representing the net change in the fair value of the derivative liability for such periods, which are presented as fair value changes of derivative instruments, net in the accompanying condensed consolidated statements of operations.

 

In accordance with accounting principles generally accepted in the United States, the following table represents the Company’s fair value hierarchy for its debenture conversion feature measured at fair value on a recurring basis as of March 31, 2016:

 

   

Balance at
3/31/2016

   

Level 1

   

Level 2

   

Level 3

 
                                 

Derivative Obligation

  $ -     $ -     $ -     $ -  

 

The following table reflects the change in fair value of the Company’s Debenture Conversion Feature for the period ended March 31, 2016:

 

   

Amount

 

Balance – January 1, 2016

  $ 306,000  

Addition of derivative obligation at fair value on date of issuance

    -  

Change in fair value of derivative obligation

    (306,000 )

Balance – March 31, 2016

  $ -  

 

The following table reflects the fair value of the Company’s derivative liabilities as of March 31, 2016:

 

   

Amount

 

Class A Warrants

  $ 877,000  

SPA Warrants

    356,000  

Debenture Conversion Feature

    -  
    $ 1,233,000  

 

 

Note 9 - Commitment and Contingencies

 

Operating Lease Agreements

 

During 2015 we leased 4,500 square feet at 7501 Esters Boulevard, Suite 100, Irving, Texas 75063 at approximately $11,300 per month. The lease expired on March 31, 2016. On March 8, 2016, we moved our corporate office to 14401 W. Beltwood Parkway, Farmers Branch, TX 75244.

 

In conjunction with our acquisition of Optima in March 2013, we assumed a facility lease with an unrelated third party at 111 Research Drive, Stratford, CT 06615. The current office space at this location consists of approximately 10,200 square feet and costs us approximately $8,513 per month. The lease expired on May 31, 2016 

 

We consolidated facilities into a new location at 14401 W. Beltwood Parkway, Farmers Branch, TX 75244 and completed the consolidation May 2016. We believe that both our existing and new facilities are suitable and adequate to meet our current business requirements. The current office space at this location consists of approximately 15,500 square feet and costs us approximately $10,400 per month. The lease is set to expire on February 29, 2019.

 

Approximate annual future minimum lease payments under all operating leases, as amended, subsequent to March 31, 2016 are as follows:

 

2016

  $ 107,800  

2017

    124,800  

2018

    124,800  

2019

    20,800  

Total minimum lease payments

  $ 378,200  

 

Rental expense for the three months ended March 31, 2016 and 2015 was approximately $70,000 and $68,000 respectively.

 

 
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Litigation

 

From time to time, the Company is subject to lawsuits and claims that arise out of its operations in the normal course of business. The Company is a plaintiff or a defendant in various litigation matters in the ordinary course of business, some of which involve claims for damages that are substantial in amount. The Company believes that the disposition of any claims that arise out of operations in the normal course of business will not have a material adverse effect on the Company’s financial position or results of operations.

 

VSP Labs, Inc.

 

On April 20, 2012, Pro Fit Optix, Inc. (“Optix”) sold software technology to VSP Labs, Inc. (“VSP”) pursuant to a Technology Transfer and Development Agreement (“TTDA”) for $6,000,000 payable in bi-annual installments of $1,000,000 through October 15, 2014 net of credits and incentives as defined in the TTDA. In accordance with the TTDA, Optix was required to perform additional production and customization of the software technology over the agreement term. The software technology required significant customization and development on the effective date and in accordance with ASC 605-35, the Company has accounted for the TTDA under the completed contract method.

 

On October 25, 2013, VSP filed a lawsuit against Optix in the Superior Court of California, County of Sacramento – Unlimited Civil Division. The lawsuit alleges, among other things, that Optix has failed to provide certain services under the TTDA between the parties which allegedly triggered the right of VSP to perform such services on its own or to engage third parties to render such services. The lawsuit seeks declaratory relief to establish that VSP was entitled to perform the services that the Company allegedly failed to perform and also seeks to establish that VSP is entitled to deduct the fees and expenses associated with the performance of such services from the payments that VSP is otherwise required to make under the terms of the TTDA, in addition to recovery of attorneys’ fees and costs associated with the lawsuit. On December 23, 2014, the Company filed a cross complaint against VSP seeking damages based on breach of contract and unfair business practices. On June 17, 2015 the Company and VSP participated in a mediation to resolve the case. A trial date of October 31, 2016 has been set by the court.  The Company plans to vigorously protest VSP’s claim and continue to pursue the uncollected portions under the TTDA as well as damages under its cross complaint. The Company is unable to express an opinion as to the likely outcome of this claim. An unfavorable outcome could have a materially adverse effect on the Company’s financial position and results of operations.

 

Deferred revenue, which is comprised of payments received under the TTDA and prepaid orders of frame inventories were approximately $2,582,000 as of March 31, 2016 and December 31, 2015. Deferred costs, comprised of costs incurred related to the TTDA, were approximately $294,000 as of March 31, 2016 and December 31, 2015.

 

 

Claim Investment Agreement

 

On March 4, 2016, Pro Fit Optix, Inc., a subsidiary of the Company, and Hillair Capital Management LLC (“Hillair”) entered into a claim investment agreement (the “Claim Investment Agreement”). Pursuant to the Claim Investment Agreement, Optix may from time to time submit to Hillair directions to pay, or fund in advance, the legal fees and expenses of Optix’s attorney of record in that certain lawsuit captioned VSP Labs, Inc. v. Pro Fit Optix, Inc., pending in the Sacramento Superior Court, Sacramento County, California, Action No. 34-2013-00153788 (the “Lawsuit”), to which Optix is a party, and Hillair will cause Hillair Capital Investment L.P. (“HCI”) to pay such legal fees and expenses on Optix’s behalf. Each payment made pursuant to the Claims Investment Agreement shall constitute an “Investment”, and the sum of all Investments made shall be referred to as the “Investment Amount”.

 

In consideration for the Investment, if a final disposition or settlement of any claim in connection with the Lawsuit (“Claims”) results in a Recovery (as defined in the Claim Investment Agreement) to Optix, Optix shall first pay to HCI 100% of any Recovery until HCI has received an amount equal to the Investment Amount, and second, 50% of the amount of any Recovery in excess of the Investment Amount (collectively, the “Hillair Return”). In the event payment is not made to HCI in accordance with the Claims Investment Agreement, Optix shall pay to HCI interest of 24% per annum on any unpaid balances until paid in full.

 

The Investment is being made on a non-recourse basis to Optix; however, Pro Fit Optix has granted to HCI a security interest in the amount of the Hillair Return against Optix’s portion of any Recovery. In addition, the non-recourse limitation shall not apply at any time an Event of Default (as defined in the Claims Investment Agreement) exists or has occurred and is continuing.

 

 
26

 

  

If for any reason Hillair does not fulfill its obligation to cause HCI pay legal fees or expenses, Optix’s sole and exclusive remedy is termination of the Claim Investment Agreement. No termination of the Claims Investment Agreement shall relieve Optix of its obligations thereunder until the Hillair Return has been fully and finally discharged and paid. In addition, pursuant to the Claims Investment Agreement, Hillair has the right, in its sole and absolute discretion, to cease and revoke its funding obligations in the event of any unfavorable procedural or substantive outcome occurred in furtherance of the Claims, including but not limited to motions, petitions, verdicts, judgments, orders or appeals granted against Optix.

 

Optix granted Hillair an exclusive right of first refusal for any additional funding that Optix may desire in connection with the Claims. In addition, Optix agreed to limit all advances, including those already taken against the Claims, to a total of $250,000, and Optix may not receive funding in excess of such amount from any source other than HCI without Hillair’s express written consent.

 

The Claim Investment Agreement contains customary representations, warranties and covenants of Optix and Hillair, and each party agreed to keep confidential and not use or disclose the confidential information of the other party.

 

 

Waud Capital Partners, L.L.C.

 

On May 22, 2014, Waud Capital Partners, L.L.C. (“Waud”) filed a breach of contract suit against Optix in the Circuit Court of Cook County, Illinois. In its complaint, Waud alleges that pursuant to the terms of the letter agreement between the parties, it is entitled to reimbursement of certain expenses in the amount of approximately $111,000 that Waud incurred in connection with its proposed investment in Optix, in addition to recovery of attorneys’ fees and costs associated with the lawsuit. In May 2015, the lawsuit was settled for $120,000 to be paid via twelve monthly payments beginning June 1, 2015, and such cost, net of payments, is included in accounts payable and accrued liabilities on the Company’s condensed consolidated balance sheets as of March 31, 2016 and December 31, 2015, respectively. As of March 31, 2016, the outstanding balance was $70,000. The Company is currently in default under this agreement and Waud has instituted legal proceedings to obtain a judgement.

 

Denton-Harvest

 

Rudolf Suter, our former Chief Executive Officer, is the defendant in a civil action in the United States District Court for the Northern District of Texas, Dallas Division. The plaintiffs, Peter Denton and Harvest Investors, L.P., since January 27, 2012, have filed garnishments related to payments from Pro Fit Optix, Inc. to Mr. Suter on several occasions. The plaintiffs have also alleged fraudulent conveyances of funds from Mr. Suter to his wife through a “conspiracy” with us. Plaintiffs seek approximately $676,000 plus costs from us, Mr. Suter and his wife. We plan to protest the plaintiffs’ claims. We are unable to express an opinion as to the likely outcome of this claim. A trial date of June 5, 2017 has been set by the court.  

 

HKO Purchase and Supply Agreement

 

On August 31, 2010, the Company entered into a Purchase and Supply Agreement with HKO (“HKO Supply Agreement”) with headquarters in Shenzhen, China.

 

In accordance with the HKO Supply Agreement, HKO sells eyewear, which consists of frames and lenses, and provides frame inventory management services to the Company. The Company provides frames to HKO to fulfill future orders of eyewear and maintains title and risk of loss to these frames while the frames reside in HKO’s warehouse in accordance with the HKO Supply Agreement. Once the frames are used by HKO to fulfill orders of eyewear, risk of loss transfers until such time the eyewear is received by the Company at its facility in Texas or a designated third party which is typically within 2-3 days of order fulfillment. As of March 31, 2016 and December 31, 2015, approximately $167,000 and $208,000, respectively, of inventory pertains to frame inventory maintained in HKO’s warehouse for frames that have not yet been used to fulfill orders of eyewear.

 

The Company or HKO has the option to terminate the HKO Supply Agreement if either of the following were to occur (i) the other party breaches any material provision of the agreement and the breaching party fails to cure such material breach within thirty days following written notice; or (ii) the other party becomes the subject of any voluntary or involuntary proceeding under the applicable national, federal, or state bankruptcy or insolvency laws and such proceeding is not terminated within sixty (60) days of its commencement. Any change in the relationship with HKO, which in the opinion of management is unlikely, could have an adverse effect on the Company’s business.

 

Purchases from HKO represented approximately 67% ($386,000) and 47% ($249,000) of the Company’s total purchases for the three months ended March 31, 2016 and 2015, respectively. As of March 31, 2016 and December 31, 2015, approximately $359,000 and $357,000, respectively, was due to HKO which is presented in accounts payable in the accompanying condensed consolidated balance sheets.

 

 
27

 

  

Note 10 – Customer and Vendor Concentrations

 

During the three month periods ended March 31, 2016 and 2015, there were one and two customers which accounted for approximately 17% and 47% of the Company’s net sales, respectively. Approximately $160,000 and $186,000 which accounts for approximately 24% and 25% of accounts receivable, trade was due from these customers as of March 31, 2016 and December 31, 2015, respectively.

 

The main materials used in the Company’s products are polycarbonate and plastic. The Company has many suppliers and sources for these materials to meet their purchasing needs at prices which would not significantly impair their ability to compete effectively. During the three month periods ended March 31, 2016 and 2015, there were three suppliers which accounted for approximately 98% and 82% of the Company’s net purchases, respectively. Approximately $437,000 and $450,000 which accounts for approximately 20% and 19% of accounts payable was due to the Company’s major vendors as of March 31, 2016 and December 31, 2015, respectively.

 

Note 11 – EQUITY COMPENSATION PLAN

 

 

 

OPTIONS GRANTED

 

 

The Company did not grant any options during the three month period ended March 31, 2016. The following table summarizes the Option activity for the three months ended March 31, 2016:

   

Number of
Options

   

Weighted

Average

Exercise Price

   

Weighted
Average
Remaining
Contractual
Life (in
Years)

   

Aggregate

Intrinsic

Value

 

Outstanding as of December 31, 2015

    1,444,104     $ 0.46       5.03     $  

Granted

                       

Exercised

                       

Expired or forfeited or cancelled

    (30,052

)

    3.33       6.9        

Outstanding as of March 31, 2016

    1,414,052     $ 0.36       4.8     $  

Exercisable at March 31, 2016

    1,291,719     $ 0.37       4.8     $  

 

The following table summarizes the Company’s option activity for non-vested options for the three months ended March 31, 2016:

 

   

Number of
Options

   

Weighted

Average
Grant
Date

Fair
Value

 

Nonvested as of December 31, 2015

    305,833     $ 0.11  

Granted

           

Vested

    (183,500

)

    0.12  

Expired or forfeited or cancelled

           

Nonvested as of March 31, 2016

    122,333     $ 0.12  

 

 

Stock based compensation was approximately $19,000 and $0 for the 3 months ended March 31, 2016 and 2015, respectively. Total equity based compensation related to non-vested awards not yet recognized as of March 31, 2016 and March 31, 2015 was approximately $13,000 and $0, respectively.

 

 
28

 

 

Note 12– Stockholders’ Equity / Deficit

 

Warrants

 

 

The Company did not grant any warrants during the three month period ended March 31, 2016. The following summarizes the Company’s warrant activity for the period ended March 31, 2016:

 

   

Number

of

Warrants

   

Weighted

Average

Exercise

Price

   

Weighted

Average

Remaining

Contractual

Life

(in Years)

 

Outstanding as of January 1, 2015

    12,939,297     $ 1.73       4.23  

Granted

    -       -       -  

Exercised

    -       -       -  

Canceled/Forfeited

    -       -       -  

Outstanding as of March 31, 2016

    12,939,297     $ 1.73       3.98  

Exercisable as of March 31, 2016

    11,863,127     $ 1.89       4.11  

 

 

As of March 31, 2016, approximately 1,076,000 remain unvested. The fair value of the warrants will be expensed based on vesting or probable vesting of such warrants. The following summarizes the Company’s outstanding warrants as of March 31, 2016:

 

   

Number

of

Warrants

 

Class A Warrants

    8,183,446  

Class C Warrants

    331,861  

SPA Warrants

    3,290,000  

Other Warrants

    1,133,990  

Outstanding as of March 31, 2016

    12,939,297  

 

 

 

Note 13– Subsequent Events

 

On April 14, 2016, the Company entered into an additional Securities Purchase Agreement with the Investor, pursuant to which the Company sold an aggregate of $828,000 in principal amount of a Debenture for an aggregate purchase price of $740,000 to the Investor. The Debenture matures on May 1, 2017, and accrues interest at the rate of 8% per annum. After taking into account legal and diligence fees of $27,500 reimbursed to the Purchaser, the net proceeds received by the Company was $712,500.

 

On June 13, 2016, the Company entered into an additional Securities Purchase Agreement with the Investor, pursuant to which the Company sold an aggregate of $252,000 in principal amount of a Debenture for an aggregate purchase price of $225,000 to the Investor. The Debenture matures on July 1, 2017, and accrues interest at the rate of 8% per annum.

 

On July 8, 2016, the Company entered into an additional Securities Purchase Agreement with the Investor, pursuant to which the Company sold an aggregate of $616,000 in principal amount of a Debenture for an aggregate purchase price of $550,000 to the Investor. The Debenture matures on July 1, 2017, and accrues interest at the rate of 8% per annum.

 

 

 

Departure of Chief Executive Officer

 

On February 29, 2016, Rudolf Suter retired from his position as Chief Executive Officer of the Company. On April 1, 2016, the Company entered into a consulting agreement with Mr. Suter pursuant to which Mr. Suter will provide certain advisory services in exchange for 3% of net sales that he generates. Such commission will be paid in the form of options. In addition the Company agreed to pay $65,000 in cash and 400,000 options under the 2015 Stock Option Plan to be exercised at $0.30 per share in full and final settlement of deferred salary and allowances, net of fees and other amounts due to the Company.

 

 
29

 

  

Stock Option award to the Chief Executive Officer

 

On June 29, 2016, the Company issued Mr. Cevasco an option to purchase 945,448 shares of the Company’s common stock under the 2015 Option Plan and an option to purchase 100,427 shares of the Company’s common stock outside of the 2015 Option Plan. Each option has an exercise price of $0.30 per share and is subject to vesting requirements over a five-year period and the terms and conditions of the stock option award agreements.

 

Mr. Cevasco does not have any family relationships with any of the Company’s directors or executive officers, nor is he a party to any transactions of the type listed in Item 404(a) of Regulation S-K.

 

 

 

Item 2. 

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

 

The information set forth below should be read in conjunction with our condensed consolidated financial statements and related notes thereto included elsewhere in this Quarterly Report on Form 10-Q. Unless otherwise stated, references in this Quarterly Report on Form 10-Q to “us,” “we,” “our,” or our “Company” refer to PFO Global, Inc. and its subsidiaries.

 

Forward-Looking Statements

 

This Quarterly Report on Form 10-Q (including the section entitled Management’s Discussion and Analysis of Financial Condition and Results of Operations) contains “forward-looking statements” regarding our business, financial condition, results of operations and prospects. All statements other than statements of historical fact contained herein, including statements regarding our business plans or strategies, projected or anticipated benefits or other consequences of our plans or strategies, projected or anticipated benefits from acquisitions to be made by us, or projections involving anticipated revenues, earnings or other aspects of our operating results, are forward-looking statements. Words such as “expect,” “anticipate,” “intend,” “plan,” “believe,” “seek,” “estimate,” “assume,” “can,” “could,” “forecast,” “guide,” “may,” “project,” “target,” “would” and similar expressions or variations of such words are intended to identify forward-looking statements, but are not deemed to represent an all-inclusive means of identifying forward-looking statements as denoted in this Quarterly Report on Form 10-Q. Additionally, statements concerning future matters are forward-looking statements.

 

Although forward-looking statements in this Quarterly Report on Form 10-Q reflect the good faith judgment of our management, such statements can only be based on facts and factors currently known by us. Consequently, forward-looking statements are inherently subject to risks and uncertainties and actual results and outcomes may differ materially from the results and outcomes discussed in or anticipated by the forward-looking statements. Factors that could cause or contribute to these differences include those set forth under “Risk Factors” in Part II, Item 1.A of this Quarterly Report on Form 10-Q, as well as those discussed elsewhere in this Quarterly Report on Form 10-Q.

 

Readers are urged not to place undue reliance on these forward-looking statements, which speak only as of the date of this Quarterly Report on Form 10-Q. We undertake no obligation to revise or update any forward-looking statements in order to reflect any event or circumstance that may arise after the date of this Quarterly Report on Form 10-Q. Readers are urged to carefully review and consider the various disclosures made throughout the entirety of this Quarterly Report on Form 10-Q, which attempt to advise interested parties of the risks and factors that may affect our business, financial condition, results of operations and prospects.

 

Overview

 

We are an innovative manufacturer and commercial provider of advanced prescription lenses, finished eyewear and vision technologies targeted towards the global optometrists’ marketplace. Our uniquely interactive manufacturing, fulfillment and proprietary online ordering systems combine with our eyewear lens product lines, are intended to meet the needs of a broad array of eyewear markets, from the offices of independent eye care professional to U.S. healthcare entitlement programs, such as Medicaid and Medicare.

 

Headquartered in Dallas, Texas, we provide eyewear and prescription lenses to eye care professionals and prescription laboratories. We have developed proprietary cloud based software and electronic devices to streamline logistics and reduce costs for our customers. Additionally, we offer a high-resolution polycarbonate lens that we believe has lower distortion than competing lenses. We believe that the combination of high quality lenses at low price points combined with our proprietary software and electronic devices enable independent eye care professionals to compete more effectively with large retail chains in the eyewear industry. Further, we believe that our low price points enable us to participate in the United States Medicaid and Medicare programs, as well as insurance programs mandated by the Patient Protection and Affordable Care Act which requires pediatric vision coverage.

 

We have losses from inception and have an accumulated deficit of $35.18 million as of March 31, 2016. Until we are able to generate revenues that result in positive margins from the sale of eyewear and prescription lenses that exceed operating costs, profitable operations will not be attained. We will have to continue funding future cash needs through financing activities. In the event that we choose or need to raise additional capital, we may be required to do so in such a manner that will result in further dilution of an investor’s ownership and voting interest. Also, any new securities may have rights, preferences or privileges senior to those of our current common stockholders. Furthermore, sales of substantial amounts of our common stock in the public market could have an adverse effect upon the market price of our common stock and make it more difficult for us to sell equity securities in the future and at prices we deem appropriate.

 

The market price of our common stock is volatile because we have a very small public float and a limited trading market. Future announcements concerning our major customers or competitors, the results of product testing, technological innovations or commercial products, government rules and regulations, developments concerning proprietary rights, and litigation may have a significant impact on the market price of the shares of our common stock.

 

 
30

 

 

Summary of Recent Developments

 

Completion of Merger

 

On June 30, 2015 (the “Effective Date”), Pro Fit Optix Holding Company, LLC (“Holding”) entered into an Agreement and Plan of Merger (the “Merger Agreement”) with PFO Global, Inc., formerly Energy Telecom, Inc. (the “Company”), and PFO Acquisition Corp., a wholly-owned subsidiary of the Company (“Merger Sub”). Pursuant to the Merger Agreement, on the Effective Date, the Company completed the acquisition of Holding by means of a merger of Merger Sub with and into Holding, such that Holding became a wholly-owned subsidiary of the Company (the “Merger”). Immediately following the Merger, the former PFO Global, Inc. equity holders owned approximately 8% of the outstanding shares of the Company’s common stock.

 

For accounting purposes, the Merger was recognized in accordance with ASC 805-40, Reverse Acquisitions. Accordingly, PFO Global, Inc. has been recognized as the accounting acquiree in the Merger, with Holding being the accounting acquirer. As such, the historical financial statements of Holding will be treated as the historical financial statements of the combined company.

 

Debt Financing

 

Subsequent to the Merger, we have sold an aggregate of approximately $7.7 million in principal amount of an 8% original issue discount senior secured convertible debenture, and incurred debt issuance costs of $0.8 million. For further details on the senior secured convertible debenture, refer to Note 5 of the notes to the condensed consolidated financial statements.

 

Critical Accounting Estimates and Policies

 

In response to financial reporting release FR-60, Cautionary Advice Regarding Disclosure About Critical Accounting Policies, from the Securities and Exchange Commission ("SEC"), we have selected our more subjective accounting estimation processes for purposes of explaining the methodology used in calculating the estimate, in addition to the inherent uncertainties pertaining to the estimate and the possible effects on our financial condition. The accounting estimates are discussed below and involve certain assumptions that if incorrect could have a material adverse impact on our results of operations and financial condition. See Note 2 to our condensed consolidated financial statements contained herein for further discussion regarding our critical accounting policies and estimates.

 

Our condensed consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles, which require management to make estimates, judgments and assumptions that affect the reported amounts of assets, liabilities, net revenue and expenses, and the disclosure of contingent assets and liabilities. Management bases its estimates on historical experience and on various other assumptions that it believes to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Senior management has discussed the development, selection and disclosure of these estimates with our board of directors and our audit committee.

 

An accounting policy is deemed to be critical if it requires an accounting estimate to be made based on assumptions about matters that are highly uncertain at the time the estimate is made, if different estimates reasonably could have been used, or if changes in the estimate that are reasonably likely to occur could materially impact the financial statements. We believe that the application of these policies on a consistent basis enables us to provide useful and reliable financial information about our operating results and financial condition.

 

Recent Accounting Pronouncements

 

See Note 1 of the Notes to our condensed consolidated financial statements information about recent accounting pronouncements.

 

 
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Results of Operations

 

Three months ended March 31, 2016 compared to three months ended March 31, 2015

 

The financial information presented in the tables below is comprised of the unaudited condensed consolidated financial information of the Company for the three months ended March 31, 2016 and 2015.

 

 

   

Three months Ended March 31,

 
   

2016

   

2015

   

% Change

 

Net sales

  $ 1,085,387     $ 988,037       10 %

Cost of sales

    575,299       526,918       9 %

Gross profit

    510,088       461,119       11 %
      47 %     47 %        

Operating expenses, depreciation and amortization

    1,304,266       2,155,488       -39 %

Operating loss

    (794,178 )     (1,694,369 )     -53 %

Other (income) / expense

    (621,162 )     (869,565 )     -29 %

Net loss

  $ (1,415,340 )   $ (2,563,934 )     -45 %

 

 

 

Net sales. Net sales was $1.1 million and $1.0 million for the three months ended March 31, 2016 and 2015, respectively. The 10% increase was due primarily to an increase in sales of prescription lenses and complete eyewear partially offset by a decrease in safety kiosk software development.

 

Cost of Sales. Cost of sales was $0.58 million and $0.53 million for the three months ended March 31, 2016 and 2015, respectively. The increase was primarily due to increased volume of prescription lenses and complete eyewear, offset by a reduction in eyewear frame kit samples and other costs.

 

Gross Profit. Gross profit was $0.51 million and $0.46 million for the three months ended March 31, 2016 and 2015, respectively. The increase was due primarily to increased sales and a reduction in eyewear frame kit samples.

 

Operating Expenses. Operating expenses, exclusive of cost of sales, were $1.30 million and $2.16 million for the three months ended March 31, 2016 and 2015, respectively. This decrease was due primarily to a $0.63 million decrease in personnel costs, and a $0.26 million decrease in selling, legal, general and administrative expenses, partially offset by $0.06 million increase in bad debt expenses. These changes are illustrated in the table below.

 

   

Three months Ended March 31,

 
   

2016

   

2015

   

% Change

 

Personnel costs

  $ 474,735     $ 1,103,394       -57 %

General and administrative

    429,680       626,633       -31 %

Legal and professional

    233,133       198,204       18 %

Sales and marketing

    55,361       152,725       -64 %

Research and development

    -       4,333       -100 %

Depreciation and amortization

    54,287       68,156       -20 %

Bad debt expense

    57,069       2,044       2692 %

Total operating expenses

  $ 1,304,266     $ 2,155,488       -39 %

 

 

Other Income. Other Income was $0.62 million and $0.87 million for the three months ended March 31, 2016 and 2015, respectively. This decrease is due primarily to a $0.24 million decrease in the change in the fair value of derivative instruments and a $0.03 million increase in related parties interest expense, excluding non-related parties interest expense, amortization of debt discount and debt issuance costs, offset by a $0.4 million decrease in non-related parties interest expense, amortization of debt discount and debt issuance costs.

 

 
32

 

  

Liquidity and Capital Resources

 

The following table sets forth the major sources and uses of cash for each of the periods set forth below:

 

   

Three Months Ended March 31,

 
   

2016

   

2015

 
                 

Cash and cash equivalents

  $ 25,807     $ 48,040  
                 

Net cash used in operating activities

    (960,722

)

    (1,275,525

)

Net cash used in investing activities

    -       -  

Net cash provided by financing activities

    960,279       1,248,029  

Net increase in cash and cash equivalents

  $ (443 )   $ (27,496 )

 

Historically, we have financed our operations primarily through private placements of our equity and borrowings under various debt instruments. For the three months ended March 31, 2016, we used $0.9 million for operating activities and ended the period with $25,807 in cash and cash equivalents. As of March 31, 2016, we had a working capital deficit of approximately $15.5 million. We currently use approximately $643,000 per month for continuing operations, which includes general operating expenses (office lease, utilities, salary and insurance), promotion and marketing (travel, entertainment, meals and website development), prototype development (parts, engineering and testing), and professional services (accounting, legal, professional and state fees and intellectual property fees). We expect this rate to remain relatively consistent for the next twelve months.

 

We believe that we have the ability to raise additional capital that will be sufficient to meet our anticipated cash needs for at least the next 12 months, although there are no assurances that we will be able to raise the capital on terms acceptable to us or at all. The Company has raised approximately $1.5 million, net of debt discounts, through the issuance of convertible debentures subsequent to March 31, 2016. If we are unable to raise additional capital, our business, operating results, and financial condition would be materially adversely affected. These factors raise substantial doubt about our ability to continue as a going concern. For information regarding our ability to continue as a going concern, please refer to Note 2 to our condensed consolidated financial statements contained in this Quarterly Report on Form 10-Q.

 

Operating Activities

 

For the three months ended March 31, 2016, operating activities used $0.96 million in cash as a result of (a) a net loss of $1.42 million, adjusted by non-cash items such as amortization of debt discount and debt issuance costs of $0.63 million, change in the fair value of derivative instruments of $(0.5) million, shares issued in exchange for compensation and services of $0.02 million, accrual of interest due to related parties of $0.08 million, depreciation and amortization of $0.54 million and provision for doubtful accounts of $0.05 million and (b) a decrease in working capital of $0.3 million.

 

For the three months ended March 31, 2015, operating activities used $1.27 million in cash as a result of (a) a net loss of $2.5 million, adjusted by non-cash items such as amortization of debt discount and debt issuance costs of $1.2 million, change in the fair value of derivative instruments of $(0.8) million, accrual of interest due to related parties of $0.07 million, depreciation and amortization of $0.07 million, and (b) an increase in working capital of $0.7 million.

 

Investing Activities

 

For the three months ended March 31, 2016 and March 31, 2015 respectively, we did not use any cash for investing activities.

  

Financing Activities

 

Our financing activities for the three months ended March 31, 2016, resulted in net cash of $0.96 million related to net proceeds of $1 million from issuance of various notes payable, partially offset by $0.04 in loan repayments and debt issue costs.

 

Our financing activities for the three months ended March 31, 2015, resulted in net cash of $1.25 million related to net proceeds of $1.47 million from issuance of various notes payable, partially offset by $0.2 million of loan repayments and debt issuance costs.

 

 
33

 

 

Debt Obligations

 

As of March 31, 2016, the principal amount due under the Company’s promissory notes was $20.6 million, before debt discounts and debt issuance costs of $2.6 million. For information regarding such notes, please refer to Notes 5 and 7 to our condensed consolidated financial statements. The following table provides information regarding annual required repayments under the promissory notes, as of March 31, 2016.

  

 

2016

  $ 9,591,660  

2017

    5,522,612  

2018

    5,510,134  
    $ 20,624,406  

 

As of March 31, 2016, the principal amount due under the Company’s related party notes was $4.7 million. For information regarding such notes, please refer to Note 7 to our condensed consolidated financial statements contained in this Report. The following table provides information regarding annual required repayments under the related party notes as of March 31, 2016:

  

2016

  $ -  

2017

    2,339,699  

2018

    2,339,698  

Total

  $ 4,679,397  

 

As of March 31, 2016, the amount outstanding under the Company’s royalty obligation agreement was $1.875 million. For information regarding such notes, please refer to Note 6 to our condensed consolidated financial statements contained in this Report.

 

Off-Balance Sheet Arrangements

 

We do not engage in any off-balance sheet financing activities, nor do we have any interest in entities referred to as variable interest entities.

 

Impact of Inflation

 

We believe that inflation has not had a material impact on our results of operations for the three months ended March 31, 2016 and 2015. We cannot assure you that future inflation will not have an adverse impact on our operating results and financial condition.

 

 

Item 3.      Quantitative and Qualitative Disclosures about Market Risk 

 

Market risk represents the risk of loss that may result from the change in value of financial instruments due to fluctuations in market prices. Market risk is inherent in all financial instruments. Market risk may be exacerbated in times of trading illiquidity when market participants refrain from transacting in normal quantities and/or at normal bid-offer spreads. Our exposure to market risk is directly related to derivatives, debt and equity linked instruments related to our financing activities.

 

Our assets and liabilities are overwhelmingly denominated in U.S. dollars. We do not use foreign currency contracts or other derivative instruments to manage changes in currency rates. We do not now, nor do we plan to, use derivative financial instruments for speculative or trading purposes. However, these circumstances might change.    

 

We do not hold or issue derivatives, derivative commodity instruments or other financial instruments for speculative trading purposes. Further, we do not believe our cash equivalents have significant risk of default or illiquidity. Although we believe our cash equivalents and investment securities do not contain excessive risk, we cannot provide absolute assurance that in the future our investments will not be subject to adverse changes in market value. All of our cash equivalents are recorded at fair value.

 

We do not believe that inflation has had a material effect on our business, financial condition or results of operations. If our costs were to become subject to significant inflationary pressures, we might not be able to fully offset such higher costs through price increases. Our inability or failure to do so could harm our business, financial condition and results of operations.

 

 
34

 

 

Item 4.      Controls and Procedures 

 

Evaluation of Disclosure Controls and Procedures

 

Our Principal Executive Officer and Principal Financial Officer conducted an evaluation of the effectiveness of our disclosure controls and procedures as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934 (the “Exchange Act”). Based on this evaluation, our Principal Executive Officer and Principal Financial Officer concluded that as of March 31, 2016, in light of the material weaknesses described below, our disclosure controls and procedures were not effective as of March 31, 2016. See material weaknesses discussed below in Management’s Report on Internal Control over Financial Reporting.

 

Management’s Report on Internal Control over Financial Reporting

 

Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rules 13a-15(f) and 15d-15(f). Our management conducted an evaluation of the effectiveness of our internal control over financial reporting based on the framework in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission in 2013 as of December 31, 2015.

  

Our internal control over financial reporting is a process designed under the supervision of our Principal Executive Officer and Principal Financial Officer to provide reasonable assurance regarding the reliability of financial reporting and the preparation of our financial statements for external reporting purposes in accordance with GAAP. Internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of our assets; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with GAAP, and that receipts and expenditures are being made only in accordance with authorizations of our management and directors; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of our assets that could have a material effect on the financial statements.

 

A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of our annual or interim financial statements will not be prevented or detected on a timely basis.

 

 

Our Company did not maintain, in all material respects, effective internal control over financial reporting as of March 31, 2016, because we continued to have the following material weaknesses:

 

 

Did not maintain sufficient and competent personnel with an appropriate level of experience and training in the application of US GAAP and SEC rules and regulations

 

Did not have sufficient segregation of duties or compensating controls in the accounting and finance function due to limited personnel

 

Did not maintain adequately designed internal controls in order to prevent or detect and correct material misstatements to the financial statements, including internal controls related to complex or nonroutine transactions

 

Lacked documentation to support occurrences of monitoring processes and approval procedures, in order to demonstrate that internal controls were operating effectively

 

Management believes that despite our material weaknesses, our consolidated financial statements for the three months ended March 31, 2016 are fairly stated, in all material respects, in accordance with GAAP.

 

 

Changes in Internal Control over Financial Reporting

 

Other than as described above, there were no changes in our internal control over financial reporting, as defined in Rules 13a-15(f) and 15d-15(f) of the Exchange Act, that occurred during the quarter ended March 31, 2016 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

Limitations on the Effectiveness of Controls

 

Management, including our CEO and CFO, does not expect that disclosure controls and internal controls will prevent all errors and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people or by management override of the controls.

 

 
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The design of any system of controls also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving our stated goals under all potential future conditions; over time, a control may become inadequate because of changes in conditions or the degree of compliance with the policies or procedures may deteriorate. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and may not be detected.

 

PART II

 

Item 1.      Legal Proceedings 

 

From time to time, we have been and may become involved in legal proceedings arising in the ordinary course of our business. Although the results of litigation and claims cannot be predicted with certainty, except as described below we are not presently involved in any legal proceeding in which the outcome, if determined adversely to us, would be expected to have a material adverse effect on our business, operating results, or financial condition. Regardless of the outcome, litigation can have an adverse impact on us because of defense and settlement costs, diversion of management resources, and other factors.

 

VSP Labs, Inc.

 

On April 20, 2012, Pro Fit Optix, Inc. (“Optix”) sold software technology to VSP Labs, Inc. (“VSP”) pursuant to a Technology Transfer and Development Agreement (“TTDA”) for $6,000,000 payable in bi-annual installments of $1,000,000 through October 15, 2014 net of credits and incentives as defined in the TTDA. In accordance with the TTDA, Optix was required to perform additional production and customization of the software technology over the agreement term. The software technology required significant customization and development on the effective date and in accordance with ASC 605-35, the Company has accounted for the TTDA under the completed contract method.

 

On October 25, 2013, VSP filed a lawsuit against Optix in the Superior Court of California, County of Sacramento – Unlimited Civil Division. The lawsuit alleges, among other things, that Optix has failed to provide certain services under the TTDA between the parties which allegedly triggered the right of VSP to perform such services on its own or to engage third parties to render such services. The lawsuit seeks declaratory relief to establish that VSP was entitled to perform the services that the Company allegedly failed to perform and also seeks to establish that VSP is entitled to deduct the fees and expenses associated with the performance of such services from the payments that VSP is otherwise required to make under the terms of the TTDA, in addition to recovery of attorneys’ fees and costs associated with the lawsuit. On December 23, 2014, the Company filed a cross complaint against VSP seeking damages based on breach of contract and unfair business practices. On June 17, 2015 the Company and VSP participated in a mediation to resolve the case. A trial date of October 31, 2016 has been set by the court.  The Company plans to vigorously protest VSP’s claim and continue to pursue the uncollected portions under the TTDA as well as damages under its cross complaint. The Company is unable to express an opinion as to the likely outcome of this claim. An unfavorable outcome could have a materially adverse effect on the Company’s financial position and results of operations.

 

Deferred revenue, which is comprised of payments received under the TTDA and prepaid orders of frame inventories were approximately $2,582,000 as of March 31, 2016 and December 31, 2015. Deferred costs, which are comprised of costs incurred related to the TTDA, were approximately $294,000 as of March 31, 2016 and December 31, 2015.

 

During the three months ended March 31, 2016 and 2015, the Company recorded no revenue relating to the VSP Supply Agreement.

 

Claim Investment Agreement

 

On March 4, 2016, Pro Fit Optix, Inc., a subsidiary of the Company, and Hillair Capital Management LLC (“Hillair”) entered into a claim investment agreement (the “Claim Investment Agreement”). Pursuant to the Claim Investment Agreement, Optix may from time to time submit to Hillair directions to pay, or fund in advance, the legal fees and expenses of Optix’s attorney of record in that certain lawsuit captioned VSP Labs, Inc. v. Pro Fit Optix, Inc., pending in the Sacramento Superior Court, Sacramento County, California, Action No. 34-2013-00153788 (the “Lawsuit”), to which Optix is a party, and Hillair will cause Hillair Capital Investment L.P. (“HCI”) to pay such legal fees and expenses on Optix’s behalf. Each payment made pursuant to the Claims Investment Agreement shall constitute an “Investment”, and the sum of all Investments made shall be referred to as the “Investment Amount”.

 

 
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In consideration for the Investment, if a final disposition or settlement of any claim in connection with the Lawsuit (“Claims”) results in a Recovery (as defined in the Claim Investment Agreement) to Optix, Optix shall first pay to HCI 100% of any Recovery until HCI has received an amount equal to the Investment Amount, and second, 50% of the amount of any Recovery in excess of the Investment Amount (collectively, the “Hillair Return”). In the event payment is not made to HCI in accordance with the Claims Investment Agreement, Optix shall pay to HCI interest of 24% per annum on any unpaid balances until paid in full.

 

The Investment is being made on a non-recourse basis to Optix; however, Pro Fit Optix has granted to HCI a security interest in the amount of the Hillair Return against Optix’s portion of any Recovery. In addition, the non-recourse limitation shall not apply at any time an Event of Default (as defined in the Claims Investment Agreement) exists or has occurred and is continuing.

 

If for any reason Hillair does not fulfill its obligation to pay legal fees or expenses, Optix’s sole and exclusive remedy is termination of the Claim Investment Agreement. No termination of the Claims Investment Agreement shall relieve Optix of its obligations thereunder until the Hillair Return has been fully and finally discharged and paid. In addition, pursuant to the Claims Investment Agreement, Hillair has the right, in its sole and absolute discretion, to cease and revoke its funding obligations in the event of any unfavorable procedural or substantive outcome occurred in furtherance of the Claims, including but not limited to motions, petitions, verdicts, judgments, orders or appeals granted against Optix.

 

Optix granted Hillair an exclusive right of first refusal for any additional funding that Optix may desire in connection with the Claims. In addition, Optix agreed to limit all advances, including those already taken against the Claims, to a total of $250,000, and Optix may not receive funding in excess of such amount from any source other than HCI without Hillair’s express written consent.

 

The Claim Investment Agreement contains customary representations, warranties and covenants of Optix and Hillair, and each party agreed to keep confidential and not use or disclose the confidential information of the other party.

 

For the three months ended March 31, 2016, Hillair incurred approximately $41,500 in legal fees that will be recovered from any future settlement proceeds.

 

 

Waud Capital Partners, L.L.C.

 

On May 22, 2014, Waud Capital Partners, L.L.C. (“Waud”) filed a breach of contract suit against Optix in the Circuit Court of Cook County, Illinois. In its complaint, Waud alleges that pursuant to the terms of the letter agreement between the parties, it is entitled to reimbursement of certain expenses in the amount of approximately $111,000 that Waud incurred in connection with its proposed investment in Optix, in addition to recovery of attorneys’ fees and costs associated with the lawsuit. In May 2015, the lawsuit was settled for $120,000 to be paid via twelve monthly payments beginning June 1, 2015, and such cost, net of payments, is included in accounts payable and accrued liabilities on the Company’s condensed consolidated balance sheets as of March 31, 2016 and December 31, 2015, respectively. As of March 31, 2016, the outstanding balance was $70,000. The Company is currently in default under this agreement and Waud has instituted legal proceedings to obtain a judgement.

  

Denton-Harvest

 

Rudolf Suter, the Company’s former Chief Executive Officer, is the defendant in a civil action in the United States District Court for the Northern District of Texas, Dallas Division. The plaintiffs, Peter Denton and Harvest Investors, L.P., since January 27, 2012, have filed garnishments related to payments from Optix to Mr. Suter on several occasions. The plaintiffs have also alleged fraudulent conveyances of funds from Mr. Suter to his wife through a “conspiracy” with the Company. Plaintiffs seek approximately $676,000 plus costs from the Company, Mr. Suter and his wife. The Company plans to protest the plaintiffs’ claims. The Company is unable to express an opinion as to the likely outcome of this claim. A trial date of June 5, 2017 has been set by the court.  

 

Item 1A.   Risk Factors 

 

In addition to other information in this Quarterly Report on Form 10-Q, you should carefully consider the following risk factors. The risks described below are not the only ones facing us. Our business is also subject to the risks that affect many other companies, such as competition, technological obsolescence, labor relations, general economic conditions and geopolitical changes. Additional risks not currently known to us or that we currently believe are immaterial also may impair our business operations and our liquidity. If any of the following risks, either alone or taken together, or other risks not presently known to us or that we currently believe to not be significant, develop into actual events, then our business, financial condition, results of operations or prospects could be materially adversely affected. If that happens, the market price of our common stock could decline, and stockholders may lose all or part of their investment.

 

 
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We have not been able, and may continue to be unable, to timely file periodic reports with the SEC.

 

We did not file our annual report on Form 10-K for the year ended December 31, 2015, and our quarterly report on Form 10-Q for the quarter ended March 31, 2016 on a timely basis. If we are not able to file any future periodic reports in the time specified by the Securities Exchange Act of 1934, stockholders and potential investors will not have current public information about us, which will likely have a negative effect on our obtaining future capital. Failure to make timely filings also impairs our ability to conduct certain kinds of public offerings on short form registration statements that provide more efficient automatic forward incorporation of future SEC filings. More broadly, our inability to maintain current public information pursuant to SEC reporting rules will have a negative impact on how we are viewed by our shareholders, potential financing sources, the investing public and strategic and commercial parties with whom we do business. Failure to maintain current public information is in circumvention of certain contractual obligations of the Company and could result in an event of default under certain of our indebtedness. Additionally, if our SEC filing delinquencies are prolonged, the SEC could institute administrative proceedings to revoke our registration under the Securities Exchange Act and suspend the trading of our common stock. Our inability to timely file periodic reports now and in the future could materially and adversely affect our continuing business and operations, as well as our future business growth and financial condition

 

The report of our independent registered public accounting firm on our 2015 and 2014 consolidated financial statements contains an explanatory paragraph regarding going concern, and we will need additional financing to execute our business plan, to fund our operations and to continue as a going concern.

 

As a result of our recurring net losses, our independent registered public accounting firm has included an explanatory paragraph in its report on our financial statements for the years ended December 31, 2015 and 2014, expressing substantial doubt as to our ability to continue as a going concern. The inclusion of a going concern explanatory paragraph in the report of our independent registered public accounting firm may make it more difficult for us to secure additional financing or enter into strategic relationship on terms acceptable to us, if at all, and may materially and adversely affect the terms of any financing that we might obtain.

 

We have limited cash on hand and we continue to have significant net losses on a monthly basis.

 

We have limited cash available and anticipate running out of cash on hand prior to the end of June 2016. If we are unable to close on new financing, we may not be able to continue our operations, in which case the value of our business enterprise would be materially and adversely affected.

 

Our sales growth is currently lower than we projected, which has increased our need for additional financing.

 

Our sales growth is currently lower than forecasted, thereby reducing the anticipated cash flow and increasing the requirement for additional financing. If our sales do not increase, our needs for new financing will increase and we will run out of cash on hand sooner than currently projected. If our sales do increase, such increase may not be adequate to offset our negative cash flow. Inadequate sales growth could result in material adverse consequences to our ability to continue to operate.

 

We have a history of annual net losses which may continue and thus may negatively affect our ability to achieve our business objectives.

 

For the three months ended March 31, 2016, we had revenue of $1 million and a net loss of $1.4 million. At March 31, 2016, we had a stockholders’ deficit of $25 million. For the year ended December 31, 2015, we had revenue of $3.4 million and a net loss of $15.7 million. At December 31, 2015, we had a stockholders’ deficit of $24.5 million.

 

There can be no assurance that our future operations will result in net income. Our failure to increase our revenues or improve our gross margins will harm our business. We may not be able to sustain or increase profitability in the future. If our revenues grow more slowly than we anticipate, our gross margins fail to improve, or our operating expenses exceed our expectations, our operating results will suffer. If we are unable to sell our products and services at acceptable prices relative to our costs, or if we fail to develop and introduce on a timely basis new products and services from which we can derive additional revenues, our financial results will suffer.

 

 
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If we fail to maintain proper and effective internal controls, our ability to produce accurate financial statements could be impaired, which could adversely affect our business, financial condition or results of operations.

 

As a voluntary filer, we are required to maintain internal control over financial reporting and to report any material weaknesses in such internal control. In addition, we are required to furnish a report by management on the effectiveness of our internal control over financial reporting pursuant to Section 404 of the Sarbanes-Oxley Act. We are in the process of designing, implementing and testing the internal control over financial reporting required to comply with this obligation, which process is time consuming, costly and complicated. In addition, our independent registered public accounting firm is required to attest to the effectiveness of our internal control over financial reporting. If we identify material weaknesses in our internal control over financial reporting, if we are unable to comply with the requirements of Section 404 in a timely manner or assert that our internal control over financial reporting is effective, or if our independent registered public accounting firm is unable to express an opinion as to the effectiveness of our internal control over financial reporting when required, investors may lose confidence in the accuracy and completeness of our financial reports and the market price of our notes could be negatively affected, and we could become subject to investigations by the Securities and Exchange Commission, or the SEC, or other regulatory authorities, which could require additional financial and management resources.

 

 

We evaluated deficiencies identified in connection with the preparation of our financial statements for the quarter ended March 31, 2016 in accordance with the framework developed by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control—Integrated Framework. Our management concluded that we did not maintain, in all material respects, effective internal control over financial reporting as of March 31, 2016, because we:

 

 

Did not maintain sufficient and competent personnel with an appropriate level of experience and training in the application of US GAAP and SEC rules and regulations.

     
 

Did not have sufficient segregation of duties or compensating controls in the accounting and finance function due to limited personnel.

     
 

Did not maintain adequately designed internal controls in order to prevent or detect and correct material misstatements to the financial statements, including internal controls related to complex or nonroutine transactions.

     
 

Lacked documentation to support occurrences of monitoring processes and approval procedures, in order to demonstrate that internal controls were operating effectively.

 

Accordingly, we concluded that our internal controls over financial reporting were not effective as of March 31, 2016.

 

Our actions to improve internal financial accounting controls may not be sufficient to mitigate these material weaknesses. There may be additional material weaknesses in our control environment now or in the future, requiring corrective action to improve our financial and accounting controls. In addition, implementing any appropriate changes to our internal controls may entail substantial costs in order to modify our existing accounting and information technology systems, may take a significant period of time to complete and may distract our officers, directors and employees from the operation of our business. Any failure to maintain adequate internal control over financial reporting, could increase our operating costs and could materially impair our ability to operate our business.

 

 

We will need to raise additional capital, which may not be available on favorable terms, if at all, and which may cause dilution to stockholders, restrict our operations or adversely affect our ability to operate our business.

 

We will need to raise additional funds through debt or equity financing or through other means. We may be unable to obtain additional financing on favorable terms, or at all, and any additional financings could result in additional dilution to our then existing stockholders or restrict our operations or adversely affect our ability to operate our business. If we are unable to obtain needed financing on acceptable terms, we may not be able to implement our business plan, which will have a material adverse effect on our business, financial condition and results of operations. If we are not able to meet our business objectives, our equity value will decrease and investors may lose some or all of their investment. If we raise funds by issuing equity securities, the percentage ownership of our then stockholders will be reduced. If we raise funds by issuing debt, the ability of our stockholders to receive earnings or distributions may be adversely affected and we may be subject to additional covenants and restrictions.

 

We are dependent on a limited number of suppliers which subjects our business and results of operations to risks of supplier business interruptions.

 

We currently purchase significant amounts of several key products and product components from a limited number of suppliers and anticipate that we will do so for future products as well. Any delays in delivery of or shortages in those or other products and components could interrupt and delay manufacturing of our products and result in the cancellation of orders for our products. Any or all of these suppliers could discontinue the manufacture or supply of these products and components at any time. Due to certain business considerations, we may not be able to identify and integrate alternative sources of supply in a timely fashion or at all. Any transition to alternate suppliers may result in production delays and increased costs and may limit our ability to deliver products to our customers. Furthermore, if we are unable to identify alternative sources of supply, we would have to modify our products to use substitute components, which may cause delays in shipments, increased design and manufacturing costs and increased prices for our products. If we are unable to obtain additional financing, we may be unable to pay our suppliers for product and therefore may be unable to continue to operate our business.

 

 
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If our independent contract manufacturers fail to timely deliver to us sufficient quantities of some of our products and components in a timely manner, our operations may be harmed.

 

Our reliance on independent contract manufacturers to manufacture most of our products and components involves several risks, including:

 

 

inadequate capacity of our manufacturer’s facilities;

     
 

interruptions in access to certain process technologies; and

     
 

reduced control over product availability, quality, delivery schedules, manufacturing yields and costs.

 

Shortages of raw materials, production capacity constraints or delays by our contract manufacturers could negatively affect our ability to meet our production obligations and result in increased prices for affected parts. Any such reduction, constraint or delay may result in delays in shipments of our products or increases in the prices of components, either of which could have a material adverse effect on our business. We do not have supply agreements with all of our current contract manufacturers and we often utilize individual purchase orders, which are subject to acceptance by the supplier. Failure to accept purchase orders could result in an inability to obtain adequate supply of our product or components in a timely manner or on commercially reasonable terms. An unanticipated loss of any of our contract manufacturers could cause delays in our ability to deliver our products while we identify and qualify a replacement manufacturer, which delays could negatively impact our revenues. If we are unable to obtain additional financing, we may be unable to pay our contract manufacturers and therefore may be unable to continue to operate our business.

 

We may be unable to successfully implement our business plan or accurately predict our future operating expenses, which could cause us to experience cash shortfalls in future periods.

 

In order to substantially grow our business, we will require additional funding. There can be no assurance that we will be able to raise any additional needed funds on acceptable terms or at all. The procurement of any such additional financing may result in the dilution of your ownership interest in us. Furthermore, our prospects must be considered in light of the risks, expenses and difficulties frequently encountered by companies engaged in the development of a new business. Some of the specific risks associated with our business include our:

 

 

need to manage our expanding operations;

     
 

continuing need to raise additional capital; and

     
 

dependence upon and need to hire key personnel.

 

To address these risks, we must, among other things, respond to our competitors, attract, retain and motivate qualified personnel, and market and sell our lenses, eyewear and related products to eye care providers. We cannot guarantee that we will be successful in addressing any or all of these risks and the other risks described herein, or that we will generate significant revenues or achieve or sustain significant profitability. The failure to address one or more of these risks and successfully implement our strategy could have a material adverse effect on our financial condition or results of operations.

 

We have a significant amount of indebtedness. Our leverage and debt service obligations may adversely affect our financial condition, results of operations and business prospects, and we may have difficulty paying our debts as they become due.

 

As of March 31, 2016, we had approximately $20.6 million in principal amount of debt. Approximately $9.6 million of debt is current, $5.5 million principal amount of debt matures or can be put to us in 2017 and approximately $5.5 million principal amount of debt matures or can be put to us in 2018. We also had a net working capital deficit of approximately $15.5 million as of March 31, 2016. We have been unable to make interest payments on $6,580,000 in debt, under the Securities Purchase Agreement, due on April 1, 2016 and July 1, 2016 and principal payments due on July 1, 2016. We have also been unable to make $125,000 principal payment and outstanding royalty payments due on July 1, 2016 under our Royalty Obligation. The level of and terms and conditions governing our debt:

 

 

require us to dedicate a substantial portion of future cash flow from operations to service our existing debt obligations and could limit our flexibility in planning for or reacting to changes in our business and the industry in which we operate;

     
 

increase our vulnerability to economic downturns or adverse developments in our business;

     
 

limit our ability to access the capital markets to refinance our existing indebtedness, to raise capital on favorable terms or to obtain additional financing for working capital, capital expenditures, acquisitions, debt service requirements or execution of our business strategy or for other purposes;

 
 

 

 

place restrictions on our ability to obtain additional financing, make investments, lease equipment, sell assets and engage in business combinations;

     
 

place us at a competitive disadvantage relative to competitors with lower levels of indebtedness in relation to their overall size or that have less restrictive terms governing their indebtedness and, therefore, that may be able to take advantage of opportunities that our indebtedness prevents us from pursuing;

     
 

limit management’s discretion in operating our business; and

     
 

Increase our cost of borrowing.

 

Any of the above listed factors could have a material adverse effect on our business, financial condition, cash flows and results of operations. Our ability to pay our expenses and fund our working capital needs and debt obligations will depend on our future performance, which will be affected by financial, business, economic, regulatory and other factors. We will not be able to control many of these factors, such as commodity prices, other economic conditions and governmental regulation. To the extent that the value of the collateral pledged under the existing debt declines, we may not be able to pledge additional collateral, and we cannot assure you that we will be able to maintain a sufficiently high valuation to maintain the full commitments. In addition, we cannot be certain that our cash flow will be sufficient to allow us to pay the principal and interest on our debt and meet our other obligations. If we are unable to service our indebtedness and other obligations, we may be required to restructure or refinance all or part of our existing debt, sell assets, reduce capital expenditures, borrow more money or raise equity. We may not be able to restructure or refinance our debt, reduce capital expenditures, sell assets, borrow more money or raise equity on terms acceptable to us, if at all, or such alternative strategies may yield insufficient funds to make required payments on our indebtedness. In addition, our ability to comply with the financial and other restrictive covenants in our indebtedness is uncertain and will be affected by our future performance and events or circumstances beyond our control. Failure to comply with these covenants would result in an event of default under such indebtedness, the potential acceleration of our obligation to repay outstanding debt and the potential foreclosure on the collateral securing such debt. Any of the above risks could materially adversely affect our business, financial condition, cash flows and results of operations and could lead to a restructuring, which may include bankruptcy filing.

 

We have significant capital needs, and our ability to access the capital and credit markets to raise capital on favorable terms is limited by our debt level and industry conditions.

 

Disruptions in the capital and credit markets could limit our ability to access these markets or may significantly increase our cost to borrow. Our current financial situation could cause lenders to increase interest rates, enact tighter lending standards which we may not satisfy as a result of our debt level or otherwise, refuse to refinance existing debt around maturity on favorable terms or at all and may reduce or cease to provide funding to borrowers. Accordingly, even if we were able to access the capital markets, any attempt to do so could be more expensive or subject to significant delays. If we are unable to access the capital and credit markets on favorable terms or at all, it could materially adversely affect our business, financial condition, results of operations, cash flows and liquidity and our ability to repay or refinance our debt.

 

We may be unsuccessful in managing our growth, which could prevent us from becoming profitable.

 

We are planning for significant growth in the foreseeable future, although such growth may not be realized. If we are successful in developing our business plan, our anticipated future growth may place a significant strain on our managerial, financial, human and operational resources. Failure to manage this growth effectively could have a material adverse effect on our financial condition or results of operations. Part of our business strategy may be to acquire assets that will complement our existing business. We are unable to predict whether or when any such acquisitions will be completed. If we proceed with any such transaction, we may not effectively integrate the acquired assets into our existing operations. We also may seek to finance any such acquisition by debt financings or issuances of equity securities, and such financing may not be available on acceptable terms, if at all.

 

If we are unable to solve development challenges as they arise, our future prospects may be materially adversely affected.

 

We may experience delays or be unable to develop the processes, systems and technologies we utilize in our business. Our success will depend largely upon our ability to monitor rapidly emerging or changing technologies; a converging industry; and changing and emerging needs of existing and new customers. The process of internally researching and developing, launching, gaining acceptance and establishing profitability for a new product or service is inherently risky and costly. Unless we are able to verify and/or commercialize some or all of our technology, our future prospects, business and results of operations will be materially adversely affected.

 

 
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If we cannot meet international product standards, we will be unable to distribute our products outside of the United States, which could cause our business to suffer.

 

Distribution of our products in countries other than the United States may be subject to regulation in those countries. Failure to satisfy these regulations would impact our ability to sell our products in these countries and could cause our business to suffer.

 

We are a smaller company competing against large, well-established companies that are fiercely competitive, and we may not be able to compete effectively.

 

We are a smaller company operating in a market currently dominated by much larger companies including Essilor, Hoya, Zeiss and Luxottica. The size and financial strength of these competitors may enable them to offer incentives such as large scale free demonstrations that we may not be able to offer. In addition, these large corporations have the ability to spend significantly more on research and development and may develop a technology superior to that employed by us. In addition, these corporations have large, established sales forces that are highly-experienced in fending off competing, superior technologies. This is especially true in the optical and eyewear industry, which is very risk averse and where long-standing trusted supplier relationships are common.

 

In order to effectively compete, we believe that we will need to successfully market our products and services and to anticipate and respond to various competitive factors affecting the relevant markets, such as the introduction of new products and services by our competitors, implementation of pricing strategies adopted by our competitors and changes in fee schedules, or other actions or pressures reducing payment schedules as a result of increased or additional competition, as well as general economic, political and social conditions. If we are unable to effectively compete, it could result in price reductions, lower revenues, under-utilization of the products and services we anticipate providing, reduced operating margins and loss of market share, any of which could have a material adverse effect on our business, financial condition, results of operations and cash flow.

 

If we fail to develop or market new products and adequately commercialize our existing products in development, we could lose market share to our competitors and our results of operations could suffer.

 

The market for our eyewear technology and products is characterized by rapid technological change, new product introductions, technological improvements, changes in medical requirements and evolving industry standards. To be successful, we must continue to develop and commercialize new products and to enhance versions of our existing products. Our products are technologically complex and require significant research, planning, design, development and testing before they may be marketed. This process can take a significant amount of time. In addition, product life cycles may be relatively short because competitors continually seek to develop more effective and less expensive versions of existing products in response to market demand. Our success in developing and commercializing new and enhanced versions of our products is affected by our ability to:

 

 

recruit engineers;

     
 

timely and accurately identify new market trends;

     
 

accurately assess customer needs;

     
 

adopt competitive pricing;

     
 

timely manufacture and deliver products;

     
 

accurately predict and control costs associated with the development, manufacturing and support of our products; and

     
 

anticipate and compete effectively with our competitors’ efforts.

 

Market acceptance of our eyewear and related products depends in part on our ability to demonstrate that our products are more efficient, meet performance requirements, are cost-effective and easier to use, as well as offer technological advantages. Additionally, we may experience design, manufacturing, marketing or other difficulties that could delay or prevent our development, introduction or marketing of new products or new versions of our existing products. As a result of such difficulties and delays, our development expenses may increase and, as a consequence, our results of operations could suffer.

 

Our lengthy sales cycle may increase our exposure to customer cancellations and other risks.

 

Our product sales cycle has been and is expected to continue to be lengthy and variable. We generally need to educate our potential customers about the use and benefits of our products, which can require the investment of significant time and resources. This lengthy sales cycle creates risks related to customer decisions to cancel or change product plans, which could result in the loss of anticipated sales. We may incur significant research and development, selling and general and administrative expenses as part of this process before we can generate the related revenues from any such customer.

 

 
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Failure to establish, and perform to, appropriate quality standards to assure the highest level of quality in the design, manufacture and marketing of our products could adversely affect the results of our operations and adversely impact our reputation.

 

Manufacturing or design defects, unanticipated use of our products, or inadequate disclosure of risks relating to the use of our products can lead to injury or other adverse events. These events could lead to recalls or safety alerts relating to our products (either voluntary or required by governmental authorities) and could result, in certain cases, in the removal of a product from the market. Any recall could result in significant costs as well as negative publicity that could reduce demand for our products. In some circumstances, such adverse events could also cause delays in new product approvals.

 

Personal injuries relating to the use of our products can also result in product liability claims being brought against us. Damages assessed in connection with, and the costs of defending, any legal action could be substantial. Our insurance coverage may not be adequate to cover all or any part of the claims asserted against us. A successful claim brought against us that is in excess of, or excluded from, our insurance coverage could have a material adverse effect on our business and results of operations. In addition, litigation could have a material adverse effect on our business if it impacts our existing and potential customer relationships, creates adverse public relations, diverts management resources from the operation of the business, or hampers our ability to otherwise conduct our business.

 

Our business has certain risk factors that differ from the core optical lens businesses operated by our competitors, including an unproven business model, and may produce operational results that are less than anticipated and result in the loss of market share to our competitors.

 

We have an unproven business model and operate in the new and largely untested market for cross-border optical hardware manufacturing and distribution services. As such, we are subject to all of the business risks and uncertainties associated with any new business enterprise and may not be able to operate successfully. We have generated losses since inception. We anticipate that we will continue to generate losses for the foreseeable future and will need additional funding to support the development of our business model. Although we believe that there will be demand for our services, no assurances can be made that we will ever generate positive cash flows or that we will produce the results anticipated in a timely fashion or ever.

 

Our future success and profitability depends on the continued services of members of our management and our ability to hire additional skilled personnel, as necessary.

 

The loss of key management personnel or the inability to attract and retain experienced and qualified employees at our laboratories and research centers could adversely affect our business. Our success is dependent in part on the efforts of key members of our management team. Our future success also depends on our continuing ability to attract, hire, efficiently train, and retain skilled research professionals, marketing personnel, as well as other qualified technical and managerial personnel. In the future, if competition for the services of these professionals increases, we may not be able to continue to attract and retain individuals in our market. Furthermore, if we had to replace any of our key employees, we would not be able to replace the significant amount of knowledge that such individual has about our operations or products. In addition, we would be forced to expend significant time and money in the pursuit of replacements, which would result in both a delay in the implementation of our business plan and the diversion of working capital. Our net revenues and earnings could be adversely affected if a significant number of professionals terminate their relationship with us or become unable or unwilling to continue their employment.

 

Our company and our management team have exposure for potential litigation that may have an impact on our financial performance.

 

We have exposure for potential litigation that may have an impact on our financial performance and we make no assurances regarding any potential incidences or outcomes of any liability lawsuits and litigation. We have no assurance that any indemnification or insurance we have available to us will be adequate to fully protect our interests.

 

Our company has been the subject of litigation, which could adversely affect our business.

 

We could be adversely affected by future legal actions that could subject us to prolonged litigation that could adversely affect our business, results of operations and financial condition. In addition, litigation matters confronting members of the management team could adversely affect our human resources. See “Item 3 – Legal Proceedings” for additional information.

 

Our resources may not be sufficient to manage our expected growth; failure to manage our potential growth properly would be detrimental to our business.

 

We may fail to adequately manage our anticipated future growth. Any growth in our operations will place a significant strain on our administrative, financial and operational resources, and increase demands on our management and on our operational and administrative systems, controls and other resources. We cannot assure you that our existing personnel, systems, procedures or controls will be adequate to support our operations in the future or that we will be able to successfully implement appropriate measures consistent with our growth strategy. As part of this growth, we may have to implement new operational and financial systems, procedures and controls to expand, train and manage our employee base, and maintain close coordination among our technical, accounting, finance, marketing, and sales staff. We cannot guarantee that we will be able to do so, or that if we are able to do so, we will be able to effectively integrate them into our existing staff and systems. If we are unable to manage growth effectively, such as if new employees are unable to achieve performance levels, our business, operating results and financial condition could be materially and adversely affected.

 

 
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Risks Related to Our Industry

 

We face the risk of product liability or other claims and may not be able to obtain sufficient insurance coverage, if at all, to cover such claims.

 

Our business exposes us to the risk of product liability claims that is inherent in the testing, manufacturing and marketing of any product. We may be subject to product liability claims if our products cause, or merely appear to have caused, an injury or death. Claims may be made by patients, consumers or healthcare providers. Although we have product liability insurance that we believe is appropriate for our current level of operations, this insurance is subject to deductibles and coverage limitations. Our current product liability insurance may not continue to be available to us on acceptable terms, or at all, and, if available, the coverages may not be adequate to protect us against any future product liability claims. If we are unable to obtain insurance at acceptable cost or on acceptable terms with adequate coverage or otherwise protect against potential product liability claims, we could be exposed to significant financial and other liabilities, which may materially harm our business. A product liability claim, product recall or other claim with respect to uninsured liabilities or for amounts in excess of insured liabilities could have a material adverse effect on our business, operating results and prospects. We may be subject to claims even if the apparent injury is due to the actions of others. For example, we rely on the expertise of eye doctors such as optometrists, ophthalmologists and opticians, nurses and other associated medical personnel in connection with manufacturing of our products. Injuries that are caused by the activities of our suppliers may also be the basis for a claim against us. These liabilities could prevent, delay or otherwise adversely interfere with our product commercialization efforts, as well as result in judgments, fines, damages and other financial liabilities to us which would have a material adverse effect on our business, operating results and prospects. Defending a suit, regardless of merit, could be costly, could divert management’s attention from our business and might result in adverse publicity, which could result in reduced acceptance of our products in the market. In addition to adversely impacting our business and prospects, such adverse publicity could materially adversely affect the value of our stock.

 

Our business, and that of physicians using our products, is subject to significant governmental healthcare regulation and noncompliance with such regulations, or substantial changes in these regulations, could cause our financial condition to suffer.

 

The healthcare industry is heavily regulated and changes in laws and regulations can be significant. Both us and the physicians who use our products must maintain and safeguard the confidentiality of all patient records, charts and other information generated in connection with the professional medical services provided by such physician, in accordance with federal and state confidentiality laws and regulations, the federal Health Insurance Portability and Accountability Act of 1996 (“HIPAA”) and the regulations promulgated thereunder. In addition, the development, marketing and use of our products is subject to various federal and state regulations, including laws and regulations prohibiting the practice of medicine by non-physicians, prohibitions concerning the kickback, rebate or division of fees between physicians and non-physicians, the manner in which a prospective user of our products may be solicited, the receipt or offering of remuneration as an inducement to refer patients, and self-referral for any person in connection with the furnishings of goods, services or supplies prescribed for medical diagnosis, care or treatment. Many of these laws and regulations are ambiguous, and courts and regulatory authorities have provided little clarification. Moreover, state and local laws vary from jurisdiction to jurisdiction. As a result, we may not always be able to accurately interpret applicable law, and some of our activities could be challenged. Any failure to comply with applicable regulations can result in substantial civil and criminal penalties. Non-compliance by us could have a material adverse effect on our financial condition and could result in the cessation of our business.

 

In addition, the regulatory environment in which we and physicians using our products operate may change significantly in the future. Numerous legislative proposals have been introduced in Congress and in various state legislatures over the past several years that could cause major reforms of the United States healthcare system, inclusive of both state and federal systems. We cannot predict whether any of these proposals will be adopted or the full extent of how they might affect our business. New or revised legislation could have a material adverse effect on our business, financial condition and results of operations.

 

 
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We may be subject to or otherwise affected by federal and state healthcare laws, including fraud and abuse and health information privacy and security laws, and could face substantial penalties if we are unable to fully comply with such laws.

 

Healthcare regulation by federal and state governments could significantly impact our business. Healthcare fraud and abuse and health information privacy and security laws potentially applicable to our operations include:

 

 

the federal Anti-Kickback Law, which constrains our marketing practices and those of our independent sales agents and distributors, educational programs, pricing policies, and relationships with healthcare providers, by prohibiting, among other things, soliciting, receiving, offering or providing remuneration, intended to induce the purchase or recommendation of an item or service reimbursable under a federal healthcare program (such as the Medicare or Medicaid programs);

     
 

federal false claims laws which prohibit, among other things, knowingly presenting, or causing to be presented, claims for payment from Medicare, Medicaid, or other third-party payors that are false or fraudulent;

     
 

HIPAA and its implementing regulations, which created federal criminal laws that prohibit executing a scheme to defraud any healthcare benefit program or making false statements relating to healthcare matters and which also imposes certain regulatory and contractual requirements regarding the privacy, security and transmission of individually identifiable health information; and

     
 

state laws analogous to each of the above federal laws, such as anti-kickback and false claims laws that may apply to items or services reimbursed by any third-party payor, including commercial insurers, and state laws governing the privacy of certain health information, many of which differ from each other in significant ways and often are not preempted by HIPAA, thus complicating compliance efforts.

 

If our past or present operations, or those of our independent sales agents and distributors, are found to be in violation of any of such laws or any other governmental regulations that may apply to us, we may be subject to penalties, including civil and criminal penalties, damages, fines, exclusion from federal healthcare programs and/or the curtailment or restructuring of our operations. Similarly, if the healthcare providers or entities with whom we do business are found to be non-compliant with applicable laws, they may be subject to sanctions, which could also have a negative impact on us. Any penalties, damages, fines, curtailment or restructuring of our operations could adversely affect our ability to operate our business and our financial results. The risk of our being found in violation of these laws is increased by the fact that many of them have not been fully interpreted by the regulatory authorities or the courts, and their provisions are open to a variety of interpretations. Any action against us for violation of these laws, even if we successfully defend against them, could cause us to incur significant legal expenses and divert our management’s attention from the operation of our business.

 

Risks Related to Our Intellectual Property

 

If we are unable to maintain intellectual property protection or if we infringe on the intellectual property of others, our competitive position could be harmed.

 

Our ability to protect our proprietary discoveries and technologies affects our ability to compete and to achieve sustained profitability. Currently, we rely on a combination of U.S. patent applications, confidentiality or non-disclosure agreements, licenses, work-for-hire agreements and invention assignment agreements and other methods to protect our intellectual property rights. We also maintain certain company know-how, trade secrets and technological innovations designed to provide us with a competitive advantage in the market place. Currently, we have five pending U.S. patent applications and three pending international patent applications relating to various aspects of our business. While we may pursue additional patent applications, it is possible that our pending patent applications and any future applications may not result in issued patents. Even if patents are issued, third parties may independently develop similar or competing technology that avoids our patents. The expiration of patents upon which we may rely for protection of key products could also diminish our competitive advantage and adversely affect our business and our prospects. Further, we cannot be certain that the steps we have taken will prevent the misappropriation of our trade secrets and other confidential information as well as the misuse of our pending patents and other intellectual property, particularly in foreign countries where we have not filed for patent protection. We may not be able to properly execute our business plan if we do not obtain adequate protection of our intellectual property.

 

Companies in the prescription eyewear industry typically obtain patents and frequently engage in substantial intellectual property litigation. Patent prosecution, related proceedings, and litigation in the United States and in other countries may be expensive, time consuming and ultimately unsuccessful. In addition, our products and technologies could infringe on the rights of others. If a third party successfully asserts a claim for infringement against us, we may be liable for substantial damages, be unable to sell products using that technology, or have to seek a license or redesign the related product. These alternatives may be uneconomical or impossible. Intellectual property litigation could be costly, result in product development delays and divert the efforts and attention of management from our business.

 

While we do not believe that our products and technologies infringe on any existing patents or intellectual property rights of third parties, there can be no assurance that such infringement has not occurred or will not occur. The costs of defending an intellectual property claim could be substantial and could adversely affect our business, even if we were ultimately successful in defending any such claims. If our products or technologies were found to infringe the rights of a third party, we would be required to pay significant damages or license fees or cease production, any of which could have a material adverse effect on our business.

 

 
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We may not be able to secure all rights to our intellectual property.

 

We are relying on a combination of any applicable U.S. patent, trade secret, trademark and copyright laws, as well as employee and third-party non-disclosure agreements and other protective measures to protect intellectual property rights pertaining to our products and technologies both in the United States and abroad. There can be no assurance, however, that these measures will provide meaningful protection of our technology, trade secrets, know-how, or other intellectual property in the event of any unauthorized use, misappropriation, or disclosure. There can also be no assurance that others will not independently develop similar technologies or duplicate any technology we develop or have developed without violating our intellectual property rights. In addition, there can be no assurance our intellectual property rights will be held to be valid, will not be successfully challenged or will otherwise be of value.

 

Our pending patent applications or any future patent applications may not be approved or may be successfully challenged by others or invalidated through administrative processes or litigation. If our applications are not approved, we may not be able to enter into arrangements to allow us to continue to use our technology on commercially reasonable terms.

 

Obtaining and maintaining a patent portfolio entails significant expense and resources. Part of the expense includes periodic maintenance fees, renewal fees, annuity fees, various other governmental fees on patents and/or patent applications due in several stages over the lifetime of patents and/or applications, as well as the cost associated with complying with numerous procedural steps during the patent application process. We may or may not choose to pursue or maintain protection for particular inventions. In addition, there are situations in which failure to make certain payments or noncompliance with certain requirements in the patent process can result in abandonment or lapse of a patent or patent application, resulting in partial or complete loss of patent rights in the relevant jurisdiction. If we choose to forgo patent protection or allow a patent application or patent to lapse purposefully or inadvertently, our competitive position could suffer.

 

We depend on patents and other means to protect our intellectual property which may not be adequate.

 

The law of patents and trade secrets is constantly evolving and often involves complex legal and factual questions. The coverage we seek in our patent applications can either be denied or significantly reduced before or after a patent is issued. Consequently, we cannot be sure that any particular patent we apply for will be issued, that the scope of the patent protection will exclude our competitors, that interference proceedings regarding any of our patent applications will not be filed, or that a patent will provide any other competitive advantage to us. In addition, we cannot be sure that any of our patents will be held valid if challenged or that others will not claim rights in or ownership of the patents and other proprietary rights held by us.

 

Because patent applications are secret until published 18 months after the filing date of the earliest application to which each claims priority and the publication of discoveries in the scientific or patent literature lags behind actual discoveries, we cannot be certain if our patent application was the first application filed covering a particular invention. If another party’s rights to an invention are superior to ours, we may not be able to obtain a license to use that party’s invention on commercially reasonable terms, if at all. In addition, our competitors, many of which have greater resources than we do, could seek to apply for and obtain patents that will prevent, limit or interfere with our ability to make use of our inventions either in the United States or in international markets. Further, the laws of some foreign countries do not always protect intellectual property rights to the same extent as do the laws of the United States. Litigation or regulatory proceedings in the United States or foreign countries also may be necessary to enforce our patent or other intellectual property rights or to determine the scope and validity of our competitors’ proprietary rights. These proceedings can be costly, result in product development delays, and divert our management’s attention from our business.

 

Even if we have or obtain patents covering our products and technologies, we may still be barred from making, using and selling our products or technologies because of the patent rights of others. Others may have filed patent applications covering products or technologies that are similar or identical to ours and, in the future, may file applications that issue as patents and our products or technologies read on claims of those patents. There are many issued U.S. and foreign patents relating to prescription eyewear. Numerous U.S. and foreign issued patents and pending patent applications owned by others exist in the prescription eyewear field. These could materially affect our ability to develop our products and technologies. Because patent applications can take many years to issue, there may be currently pending applications unknown to us that may later result in issued patents that our products and technologies may infringe. These patent applications may have priority over patent applications filed by us.

 

Legal actions to enforce our patent rights can be expensive and may involve the diversion of significant management time. In addition, these legal actions could be unsuccessful and could also result in the invalidation of our patents or a finding that they are unenforceable. We may or may not choose to pursue litigation or other actions against those that have infringed on our patents, or used them without authorization, due to the associated expense and time commitment of monitoring these activities. If we fail to protect or to enforce our intellectual property rights successfully, our competitive position could suffer, which could harm our results of operations.

 

 
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We may also rely upon unpatented proprietary technology, and we cannot assure you that others will not independently develop substantially equivalent technology or otherwise gain access to or disclose our proprietary technology. We may not be able to meaningfully protect our rights in this proprietary technology, which would reduce our ability to compete in the market.

  

We will need to operate without infringing the proprietary rights of others.

 

Although we do not believe that our activities infringe the intellectual property rights of others, we cannot be certain that U.S. or foreign patents or patent applications of other companies do not exist or will not be issued that would materially and adversely affect our ability to commercialize our products. We may be sued for infringing or misappropriating the patent or other intellectual property rights of others. Intellectual property litigation is costly and, even if we prevail, the cost of this litigation could negatively affect our business. If we do not prevail in litigation, in addition to any damages we might have to pay, we could be required to stop the infringing activity or obtain a license requiring us to make royalty payments. Any license we are required to obtain may not be available to us on commercially acceptable terms, if at all. In addition, any license we are required to obtain may be non-exclusive, and therefore our competitors may have access to the same technology licensed to us. If we fail to obtain a required license or are unable to design around another company’s patent, we may be unable to make use of some of our technologies or distribute our products.

 

Although we have confidentiality agreements in place with our employees, these agreements may not adequately prevent disclosure of proprietary information.

 

Our policy is to execute confidentiality agreements with our employees and consultants upon the commencement of their employment or consulting arrangement with us. These agreements generally require that all confidential information developed by an individual or to which the individual is exposed during the course of his or her relationship with us must be kept confidential even after the individual has left our employment. These agreements also generally provide that inventions conceived by the individual in the course of rendering services to us shall be our exclusive property. We cannot be sure that these agreements will provide meaningful protection of our proprietary and other confidential information. In addition, in some situations, these agreements may conflict with, or be subject to, the rights of third parties with whom our employees or consultants have prior employment or consulting relationships. We may be forced to engage in costly and time-consuming litigation to determine the scope of and to enforce our proprietary rights. Even if successful, any litigation could divert our management’s attention from our business.

 

Developments in patent law could have a negative impact on our business.

 

From time to time, the United States Supreme Court, the U.S. Court of Appeals for the Federal Circuit, other federal courts, the United States Congress or the United States Patent and Trademark Office (“USPTO”) may change the standards of patentability and any such changes could have a negative impact on our business.

 

In addition, the Leahy-Smith America Invents Act, or the America Invents Act, which was signed into law in 2011, includes a number of significant changes to U.S. patent law. These changes include a transition from a “first-to-invent” system to a “first-to-file” system, changes to the way issued patents are challenged, and changes to the way patent applications are disputed during the examination process. These changes may favor larger and more established companies that have greater resources to devote to patent application filing and prosecution. The USPTO has developed new and untested regulations and procedures to govern the full implementation of the America Invents Act, and many of the substantive changes to patent law associated with the America Invents Act, and, in particular, the first-to-file provisions, became effective on March 16, 2013. Substantive changes to patent law associated with the America Invents Act may affect our ability to obtain patents, and if obtained, to enforce or defend them. Accordingly, it is not clear what, if any, impact the America Invents Act will ultimately have on the cost of prosecuting our patent applications, our ability to obtain patents based on our discoveries and our ability to enforce or defend any patents that may issue from our patent applications, all of which could have a material adverse effect on our business.

 

 

Risks Related to Our Securities

 

We do not intend to pay dividends on our common stock so any returns will be limited to changes in the value of our common stock.

 

We have never declared or paid any cash dividends on our common stock. We currently anticipate that we will retain future earnings for the development, operation, and expansion of our business, and do not anticipate declaring or paying any cash dividends for the foreseeable future. In addition, our ability to pay cash dividends on our common stock is restricted by our current debt agreements and may be prohibited or limited by the terms of our current and future debt financing arrangements. Any return to stockholders will therefore be limited to the increase, if any, of our stock price, which may never occur.

 

 
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An active trading market for our securities may not develop and we expect that our stock price will be volatile and could decline, resulting in a substantial loss in your investment.

 

Prior to the Merger, there has not been a public market for our securities. Our shares of common stock are thinly traded. Due to the illiquidity, the current stock price may not necessarily reflect the current value of the securities and should not be regarded as an indicator of any future market performance or value thereof. An active trading market for our securities may never develop or if it develops it may not be sustained, which could affect your ability to sell your securities and could depress the market price of your securities.

 

In addition, the stock market can be highly volatile. As a result, the market price of our securities can be similarly volatile, and investors in our securities may experience a decrease in the value of their securities, including decreases unrelated to our operating performance or prospects. The market price of our common stock may fluctuate significantly in response to numerous factors, many of which are beyond our control, including:

 

 

actual or anticipated fluctuations in our operating results;

     
 

the financial projections we may provide to the public, any changes in these projections or our failure to meet these projections;

     
 

failure of securities analysts to initiate or maintain coverage of our Company, changes in financial estimates by any securities analysts who follow our Company, or our failure to meet these estimates or the expectations of investors;

     
 

ratings changes by any securities analysts who follow our Company;

     
 

announcements by us or our competitors of significant technical innovations, acquisitions, strategic partnerships, joint ventures, or capital commitments;

     
 

changes in operating performance and stock market valuations of other medical technology companies generally, or those in our industry in particular;

     
 

price and volume fluctuations in the overall stock market from time to time, including as a result of trends in the economy as a whole;

     
 

changes in accounting standards, policies, guidelines, interpretations, or principles;

     
 

actual or anticipated developments in our business or our competitors’ businesses or the competitive landscape generally;

     
 

developments or disputes concerning our intellectual property or our products, or third-party proprietary rights;

     
 

announced or completed acquisitions of businesses or technologies by us or our competitors;

     
 

new laws or regulations or new interpretations of existing laws or regulations applicable to our business;

     
 

any major change in our board of directors or management;

     
 

future sales of shares of our common stock by us or our stockholders;

     
 

changes in the general economy and in the local economies in which we operate;

     
 

lawsuits threatened or filed against us; and

     

 

other events or factors, including those resulting from war, incidents of terrorism, or responses to these events.

 

In addition, the stock markets, and in particular the market on which our common stock trades, have experienced extreme price and volume fluctuations that have affected and continue to affect the market prices of equity securities of many medical technology companies. Stock prices of many similar companies have fluctuated in a manner unrelated or disproportionate to the operating performance of those companies. In the past, stockholders have instituted securities class action litigation following periods of market volatility. If we were to become involved in securities litigation, it could subject us to substantial costs, divert resources and the attention of management from operating our business and adversely affect our business, results of operations, financial condition and cash flows.

 

“Penny stock” rules may make buying or selling our securities difficult, which may make our stock less liquid and make it harder for investors to buy and sell our securities.

 

Our shares trade on the OTCQB tier of the OTC Markets Group, Inc. Trading in our securities will be subject to the “penny stock” rules of the SEC, and it is anticipated that trading in our securities will continue to be subject to the penny stock rules for the foreseeable future. The SEC has adopted regulations that generally define a penny stock to be any equity security that has a market price of less than $5.00 per share, subject to certain exceptions. These rules require that any broker-dealer who recommends our securities to persons other than prior customers and accredited investors must, prior to the sale, make a special written suitability determination for the purchaser and receive the purchaser’s written agreement to execute the transaction. Unless an exception is available, the regulations require the delivery, prior to any transaction involving a penny stock, of a disclosure schedule explaining the penny stock market and the risks associated with trading in the penny stock market. In addition, broker-dealers must disclose commissions payable to both the broker-dealer and the registered representative and current quotations for the securities they offer. The additional burdens imposed upon broker-dealers by these requirements may discourage broker-dealers from recommending transactions in our securities, which could severely limit the liquidity of our securities and consequently adversely affect the market price for our securities.

 

 
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The exercise and sale of shares of our common stock issuable pursuant to our stock options and warrants may adversely affect the market price of our common stock.

 

As of March 31, 2016, we had outstanding under our 2012 and 2015 Stock Option Plans, stock options to purchase an aggregate of approximately 2,860,000 shares of common stock at a weighted average exercise price of $0.12 per share and outstanding warrants to purchase approximately 12,939,000 shares of common stock at a weighted average exercise price of $1.89 per share. The exercise of the stock options and warrants and the sale of shares of our common stock issuable pursuant to them would reduce a stockholder’s percentage voting and ownership interest.

 

The stock options and warrants are likely to be exercised