NOTE 1 – DESCRIPTION OF BUSINESS AND BASIS OF PRESENTATION

Description of Business

Solbright Group, Inc. (the “Parent”) was formed in the State of Delaware on May 7, 1998.  The Parent conducts business activities principally through its two wholly-owned subsidiaries, Arkados, Inc., a Delaware corporation, (“Arkados”) and SolBright Energy Solutions, LLC (“SES”), a Delaware limited liability company, formerly known as Arkados Energy Solutions, LLC (“AES”) (collectively, the “Company”).

Arkados – Arkados is the Company’s technology research and development subsidiary and has developed the Arktic™ software platform, a scalable and interoperable cloud-based system for sensing, gathering, storing and analyzing data as well as reporting critical information and implementing command and control.   On Arktic™, the Company delivers applications currently focused on measurement and verification and predictive maintenance which can be used on single machines or through an entire facility, campus or city. Its software platform and applications are implemented with hardware products, such as gateways, sensors and cameras, of its strategic partner, Tatung Company, and others.

SES – provides solar engineering, procurement and construction services, as well as energy conservation services and solutions to commercial and buildings throughout the eastern United States. These services include energy consumption assessments and recommendations, as well as acting as the general contractor for light-emitting diode (“LED”) lighting retrofits, oil-to-natural gas boiler conversions and solar photovoltaic (“PV”) system installation. SES also markets and sells the technology solutions of Arkados to help building owners save money. SES sells its services directly to building owners and managers.

Principles of Consolidation

The condensed consolidated financial statements include the accounts of the Parent, and its wholly-owned subsidiaries, which include SES and Arkados.  Intercompany accounts and transactions have been eliminated in consolidation.

Basis of Presentation

The accompanying condensed consolidated financial statements have been prepared by the Company pursuant to the rules and regulations of the Securities and Exchange Commission including Form 10-Q and Regulation S-X. The information furnished herein reflects all adjustments (consisting of normal recurring accruals and adjustments) which are, in the opinion of management, necessary to fairly state the operating results for the respective periods. Certain information and footnote disclosures normally present in annual financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been omitted pursuant to such rules and regulations. These financial statements and the information included under the heading “Management’s Discussion and Analysis of Financial Condition and Results of Operations” should be read in conjunction with the audited financial statements and explanatory notes for the year ended May 31, 2018 as disclosed in our annual report on Form 10-K for that year. The results of the three months ended August 31, 2018 (unaudited) are not necessarily indicative of the results to be expected for the pending full year ending May 31, 2019.

Liquidity and Going Concern

The Company’s primary need for liquidity is to fund the working capital needs of the business. The accompanying condensed consolidated financial statements have been prepared assuming that the Company will continue as a going concern. The Company has incurred net losses of approximately $68 million since inception, including a net loss of approximately $5 million for the three months ended August 31, 2018. Additionally, the Company had negative working capital at August 31, 2018 and May 31, 2018. The Company had negative cash flows from operations during the three months ended August 31, 2018. These conditions raise substantial doubt about the Company’s ability to continue as a going concern. Management expects to incur additional losses in the foreseeable future and recognizes the need to raise capital to remain viable. The accompanying condensed consolidated financial statements do not include any adjustments that might be necessary should the Company be unable to continue as a going concern.

The Company’s plan, through potential acquisitions and the continued promotion of its services to existing and potential customers, is to generate sufficient revenues to cover its anticipated expenses. The Company is currently exploring several options to meet its short-term cash requirements, including an equity raise or loan funding from third parties. During the three months ended August 31, 2018, the Company issued convertible notes totaling $5,000,000 of which it used $3,400,000 of the net proceeds to repay outstanding indebtedness and other obligations. In addition, the Company entered into a commitment letter with one of the existing noteholders to provide the Company with up to $2,500,000 of additional funding, subject to mutual acceptance of such funding, before December 31, 2018. On July 30, 2018, the Company entered into an Agreement and Plan of Merger and Reorganization with Iota Networks, LLC, an Arizona limited liability company, which the Company believes will ultimately benefit its revenues, operations and cash flows. Although no assurances can be given as to the Company’s ability to deliver on its revenue plans, or that unforeseen expenses may arise, the management of the Company believes that the revenue to be generated from operations together with potential equity and debt financing or other potential financing will provide the necessary funding for the Company to continue as a going concern.

As of September 20, 2018, the Company entered into a Securities Purchase Agreement (the “Purchase Agreement”) with an “accredited investor” (the “Buyer”), pursuant to which, for a purchase price of $400,000, the Buyer purchased (a) a Convertible Promissory Note in the principal amount of $440,000 (the “Note”), (b) warrants (the “Warrants”) to purchase 600,000 shares of the Company’s common stock, and (c) 100,000 restricted shares of the Company’s common stock (the “Shares”) (the “Purchase and Sale Transaction”).  The Company will use the net proceeds from the Purchase and Sale Transaction for working capital and general corporate purposes.

The Convertible Note has a principal balance of $440,000 (taking into consideration a $40,000 original issue discount received by the Buyer), and a stated maturity date of March 31, 2019.  Upon issuance of the Convertible Note, a one-time interest charge of 8% was applied to the principal amount of the Convertible Note, which is also payable on maturity.  Upon the occurrence of an event of default, which is not cured within 7 business days, the principal balance of the Convertible Note shall immediately increase to 140% of the outstanding balance immediately prior to the occurrence of the event of default.  In addition, upon the occurrence of an event of default, the entire unpaid principal balance of the Convertible Note, together with any accrued and unpaid interest thereon, will become due and payable, without presentment, demand, or protest of any kind.  Amounts due under the Convertible Note may be converted into shares (“Conversion Shares”) of the Company’s ocmmon tsock at any time, at the option of the holder, at a conversion price of $0.60 per share.  The Company has agreed to at all times reserve and keep available out of its authorized common stock a number of shares equal to at least two times the full number of Conversion Shares.  The Company may redeem the Convertible Note, upon 10 business days’ notice to the holder, by paying the holder: (i) if the redemption is within the first 90 days after the issuance of the Convertible Note, an amount equal to 100% of the outstanding balance of the Convertible Note, plus any accrued and unpaid interest, or (ii) if the redemption is on or after the 91st day after issuance of the Convertible Note, an amount equal to 120% of the outstanding balance of the Convertible Note, plus any accrued and unpaid interest.  If, while the Convertible Note is outstanding, the Company, or any of its subsidiaries, issues any security with any term more favorable to the holder of such security, or with a term in favor of the holder of such security that was not similarly provided to the Buyer, then the Company will notify the holder of the Convertible Note of such additional or more favorable term and such term, at holder’s option, shall become a part of the Convertible Note.  The Company has granted the holder piggyback registration rights with respect to the Conversion Shares.

The Warrants are exercisable for a period of three years from the date of issuance, at an exercise price of $0.60 per share.  The Warrants are exercisable for cash, or on a cashless basis.  The number of shares of common stock to be deliverable upon exercise of the Warrants is subject to adjustment for subdivision or consolidation of shares and other standard dilutive events.

Significant Accounting Policies

The Company’s significant accounting policies are disclosed in Note 2 – Summary of Significant Accounting Policies. On an ongoing basis, the Company evaluates its estimates and assumptions, including among other things, those related to revenue recognition, valuations of accounts receivable, long-lived assets, goodwill, and stock based compensation.

NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Revenue 

The Company accounts for revenue in accordance with ASC Topic 606, Revenue from Contracts with Customers, which the Company adopted on June 1, 2018, using the modified retrospective method.  The modified retrospective method requires the standard to be applied to contracts that are initiated after the effective date and contracts that have remaining obligations as of the effective date.  See Note 3 for the required disclosures for ASC 606, Revenue from Contracts with Customers.

Arkados

The Company enters into arrangements with end users for items which may include software license fees, services, maintenance and royalties or various combinations thereof. Revenues from software licensing are recognized in accordance with ASC Topic 606 as adopted on June 1, 2018. The Company did not have any material revenues from software licensing during the three months ended August 31, 2018 and 2017.

SES

Sales of products are recognized when the performance obligations are fulfilled, and the customer takes risk of ownership and assumes the risk of loss.  Service revenue is recognized when the service is completed under ASC Topic 606.  Deferred revenue represents revenues billed but not yet earned and included in contract liabilities on the accompanying condensed consolidated balance sheet.

Cash and Cash Equivalents

The Company considers investments in highly liquid instruments with a maturity of three months or less to be cash equivalents. The Company did not have any cash equivalents at both August 31 and May 31, 2018.

Accounts Receivable

Accounts receivable are reported at their outstanding unpaid principal balances net of allowances for uncollectible accounts. The Company provides for allowances for uncollectible receivables based on management’s estimate of uncollectible amounts considering age, collection history, and any other factors considered appropriate. The Company writes off accounts receivable against the allowance for doubtful accounts when a balance is determined to be uncollectible. As of August 31, 2018 and May 31, 2018, the Company’s allowance for doubtful accounts was $676,000.

Fair Value of Financial Instruments

The carrying value of cash, accounts receivable, other receivables, accounts payable and accrued expenses approximate their fair values based on the short-term maturity of these instruments. The carrying amounts of debt were also estimated to approximate fair value. As defined in ASC 820, "Fair Value Measurements and Disclosures," fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (exit price). The Company utilizes market data or assumptions that market participants would use in pricing the asset or liability, including assumptions about risk and the risks inherent in the inputs to the valuation technique. These inputs can be readily observable, market corroborated, or generally unobservable. ASC 820 establishes a fair value hierarchy that prioritizes the inputs used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (level 1 measurement) and the lowest priority to unobservable inputs (level 3 measurement). This fair value measurement framework applies at both initial and subsequent measurement.

The three levels of the fair value hierarchy defined by ASC 820 are as follows:

●     Level 1 – Quoted prices are available in active markets for identical assets or liabilities as of the reporting date. Active markets are those in which transactions for the asset or liability occur in sufficient frequency and volume to provide pricing information on an ongoing basis. Level 1 primarily consists of financial instruments such as exchange-traded derivatives, marketable securities and listed equities.

●     Level 2 – Pricing inputs are other than quoted prices in active markets included in Level 1, which are either directly or indirectly observable as of the reported date. Level 2 includes those financial instruments that are valued using models or other valuation methodologies. These models are primarily industry-standard models that consider various assumptions, including quoted forward prices for commodities, time value, volatility factors and current market and contractual prices for the underlying instruments, as well as other relevant economic measures. Substantially all of these assumptions are observable in the marketplace throughout the full term of the instrument, can be derived from observable data or are supported by observable levels at which transactions are executed in the marketplace. Instruments in this category generally include non-exchange-traded derivatives such as commodity swaps, interest rate swaps, options and collars.

●     Level 3 – Pricing inputs include significant inputs that are generally less observable from objective sources. These inputs may be used with internally developed methodologies that result in management’s best estimate of fair value.

Earnings (Loss) Per Share (“EPS”)

Basic EPS is computed by dividing net income (loss) by the weighted average number of shares of common stock outstanding. Diluted EPS includes the effect from potential issuance of common stock, such as stock issuable pursuant to the exercise of stock options and warrants and the assumed conversion of convertible notes. Dilutive EPS is computed by dividing net income (loss) by the sum of the weighted average number of common stock outstanding, and the dilutive shares,

The following table summarizes the securities that were excluded from the diluted per share calculation because the effect of including these potential shares was antidilutive even though the exercise price could be less than the average market price of the common shares:

Stock Based Compensation

In computing the impact, the fair value of each option and/or warrant is estimated on the date of grant based on the Black-Scholes options-pricing model utilizing certain assumptions for a risk-free interest rate; volatility; and expected remaining lives of the awards. The assumptions used in calculating the fair value of share-based payment awards represent management’s best estimates, but these estimates involve inherent uncertainties and the application of management judgment. As a result, if factors change and the Company uses different assumptions, the Company’s stock-based compensation expense could be materially different in the future. In addition, the Company is required to estimate the expected forfeiture rate and only recognize expense for those shares expected to vest. In estimating the Company’s forfeiture rate, the Company analyzed its historical forfeiture rate, the remaining lives of unvested options, and the amount of vested options as a percentage of total options outstanding. If the Company’s actual forfeiture rate is materially different from its estimate, or if the Company reevaluates the forfeiture rate in the future, the stock-based compensation expense could be significantly different from what the Company has recorded in the current period.

During the three months ended August 31, 2018, 1,000,000 shares of the Company’s common stock was issued for consulting services amounting to $554,750 in stock-based compensation. Additionally, the Company issued 900,000 shares to employees amounting to $927,000 in stock-based compensation.

Stock based compensation expense for the three months ended August 31, 2018 and 2017 was $1,481,750 and $236,320, respectively, and is included in selling, general and administrative expense.

Stock based compensation expense related to stock options for the three months ended August 31, 2018 and 2017 was $0 and $244,060, respectively, and is included in selling, general and administrative expense.

Use of Estimates

The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, equity-based transactions and disclosure of contingent liabilities at the date of the financial statements and revenues and expenses during the reporting period. Actual results could differ from those estimates.

The Company believes the following critical accounting policies affect its more significant judgments and estimates used in the preparation of the financial statements.  Significant estimates include the allowance for doubtful accounts, the useful life of plant and equipment, valuation of goodwill for impairment, and intangible assets, deferred tax asset and valuation allowance, and assumptions used in Black-Scholes-Merton, or BSM, valuation methods, such as expected volatility, risk-free interest rate, and expected dividend rate.

Property and Equipment

Property and equipment is recorded at cost. Depreciation is computed using straight-line and accelerated methods over the estimated useful lives of the related assets, generally three to fifteen years. Expenditures that enhance the useful lives of the assets are capitalized and depreciated. Maintenance and repairs are expensed as incurred. When properties are retired or otherwise disposed of, related costs and related accumulated depreciation are removed from the accounts.

Goodwill and Intangible Assets

The Company periodically reviews the carrying value of intangible assets not subject to amortization, including goodwill, to determine whether impairment may exist. Goodwill and certain intangible assets are assessed annually, or when certain triggering events occur, for impairment using fair value measurement techniques. These events could include a significant change in the business climate, legal factors, a decline in operating performance, competition, sale or disposition of a significant portion of the business, or other factors. Specifically, a goodwill impairment test is used to identify potential impairment by comparing the fair value of a reporting unit with its carrying amount, including goodwill. The Company uses level 3 inputs and a discounted cash flow methodology, along to estimate the fair value of a reporting unit. A discounted cash flow analysis requires one to make various judgmental assumptions including assumptions about future cash flows, growth rates, and discount rates. The assumptions about future cash flows and growth rates are based on the Company’s budget and long-term plans. Discount rate assumptions are based on an assessment of the risk inherent in the respective reporting units.

Convertible Instruments

The Company evaluates and accounts for conversion options embedded in its convertible instruments in accordance with accounting standards for “Accounting for Derivative Instruments and Hedging Activities.”

Accounting standards generally provides three criteria that, if met, require companies to bifurcate conversion options from their host instruments and account for them as free standing derivative financial instruments. These three criteria include circumstances in which (a) the economic characteristics and risks of the embedded derivative instrument are not clearly and closely related to the economic characteristics and risks of the host contract, (b) the hybrid instrument that embodies both the embedded derivative instrument and the host contract is not re-measured at fair value under otherwise applicable generally accepted accounting principles with changes in fair value reported in earnings as they occur, and (c) a separate instrument with the same terms as the embedded derivative instrument would be considered a derivative instrument. Professional standards also provide an exception to this rule when the host instrument is deemed to be conventional as defined under professional standards as “The Meaning of Conventional Convertible Debt Instrument.”

The Company accounts for convertible instruments (when it has determined that the embedded conversion options should not be bifurcated from their host instruments) in accordance with professional standards when “Accounting for Convertible Securities with Beneficial Conversion Features,” as those professional standards pertain to “Certain Convertible Instruments.” Accordingly, the Company records, when necessary, discounts to convertible notes for the intrinsic value of conversion options embedded in debt instruments based upon the differences between the fair value of the underlying common stock at the commitment date of the note transaction and the effective conversion price embedded in the note. Original issue discounts (“OID”) under these arrangements are amortized over the term of the related debt to their earliest date of redemption. The Company also records when necessary deemed dividends for the intrinsic value of conversion options embedded in preferred shares based upon the differences between the fair value of the underlying common stock at the commitment date of the note transaction and the effective conversion price embedded in the note.

ASC 815-40 provides that, among other things, generally, if an event is not within the entity’s control could or require net cash settlement, then the contract shall be classified as an asset or a liability.

Reclassifications

Certain reclassifications have been made to conform the prior period data to the current presentations.

Recent Accounting Pronouncements

On February 25, 2016, the FASB issued Accounting Standards Update No. 2016-02, Leases (Topic 842). The new guidance establishes the principles to report transparent and economically neutral information about the assets and liabilities that arise from leases. The new guidance is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. The Company is currently evaluating the impact of adopting this guidance.

In August 2015, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") 2015-14, Revenue from Contracts with Customers (Topic 606): Deferral of the Effective Date, which defers the effective date of ASU 2014-09 for all entities by one year. This update is effective for public business entities for annual reporting periods beginning after December 15, 2017, including interim periods within those reporting periods. Earlier application is permitted only as of annual reporting periods beginning after December 15, 2016, including interim reporting periods within that reporting period. ASU 2014-09 became effective for the Company on August 31, 2018 under the modified retrospective approach. The ASU also requires expanded disclosures relating to the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers. Additionally, qualitative and quantitative disclosures are required about customer contracts, significant judgments and changes in judgments, and assets recognized from the costs to obtain or fulfill a contract. The Company adopted this ASU on June 1, 2018.  See Note 3.

On May 10, 2017, the Financial Accounting Standards Board (“FASB”) issued an Accounting Standards Update (“ASU”) 2017-09 “Compensation—Stock Compensation (Topic 718): Scope of Modification Accounting”, which provides guidance to clarify when to account for a change to the terms or conditions of a share-based payment award as a modification. Under the new guidance, modification accounting is required only if the fair value, the vesting conditions, or the classification of the award (as equity or liability) changes as a result of the change in terms or conditions. The guidance is effective prospectively for all companies for annual periods beginning on or after December 15, 2017. Early adoption is permitted. The adoption of ASU 2017-09 did not have any impact on the Company's condensed consolidated financial statements and related disclosures.

In January 2017, FASB issued ASU 2017-01, “Business Combinations (Topic 805) Clarifying the Definition of a Business”.  The amendments in this Update is to clarify the definition of a business with the objective of adding guidance to assist entities with evaluating whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses. The definition of a business affects many areas of accounting including acquisitions, disposals, goodwill, and consolidation.  The guidance is effective for annual periods beginning after December 15, 2017, including interim periods within those periods. The Company adopted this ASU on June 1, 2018.  The adoption of ASU 2017-01 did not have any impact on the Company's condensed consolidated financial statements and related disclosures.

In August 2016, the FASB issued ASU 2016-15, “Statement of Cash Flows (Topic 230) Classification of Certain Cash Receipts and Cash Payments”. The new guidance is intended to reduce diversity in practice in how certain transactions are classified in the statement of cash flows. ASU 2016-15 is effective for the Company beginning in the first quarter of fiscal 2019. Early adoption is permitted, provided that all of the amendments are adopted in the same period. The guidance requires application using a retrospective transition method. The adoption of ASU 2016-15 did not have any impact on the Company's condensed consolidated financial statements and related disclosures.

All newly issued but not yet effective accounting pronouncements have been deemed to be not applicable or immaterial to the Company.

NOTE 3 – REVENUES

On June 1, 2018, the Company adopted ASC Topic 606, “Revenue from Contracts with Customers”, using the modified retrospective method, and accordingly the new guidance was applied retrospectively to contracts that were not completed as of June 1, 2018 (the date of initial application). As a result, the Company has recorded a cumulative effect adjustment to increase accumulated deficit by $561,028 as of June 1, 2018 as well as the following cumulative effect adjustments:

The adoption of ASC Topic 606 did not have a material impact on net cash used in operating activities for the three months ended August 31, 2018.

The increase in accumulated deficit, and increase to warranty reserve of $190,213, primarily resulted from a change in the manner of accounting for revenue recognition over time. Previously, the Company used the milestone method of accounting for contracts. Upon adoption of ASC Topic 606, Solar system contracts are generally accounted for using the cost to cost percentage of completion method, resulting in a more constant recognition of revenue and margin over the term of the contract.

The following table presents how the adoption of ASC Topic 606 affected certain line items in the condensed consolidated balance sheet:

Update to Major Accounting Policies

Upon adoption of ASC Topic 606, the Company revised its accounting policy on revenue recognition from the policy provided in the Notes to Consolidated Financial Statements included in the Form 10-K for the year ended May 31, 2018. The revised accounting policy on revenue recognition is provided below.

Performance Obligations

A performance obligation is a promise in a contract to transfer a distinct good or service to the customer and is the unit of account in ASC Topic 606. The Company’s contract’s transaction price is allocated to each distinct performance obligation and recognized as revenue when, or as, the performance obligation is satisfied. The majority of the Company’s contracts have a single performance obligation as the promise to transfer the individual goods or services is not separately identifiable from other promises in the contracts and is, therefore, not distinct.

Payment is generally due within 30 to 45 days of invoicing based on progress billings.  There is no financing or variable component.  The Company does not act as an agent in its contracts.

Solar Installation and Construction Contracts

The Company recognizes solar panel system design, construction and installation contract revenue over time, as performance obligations are satisfied, due to the continuous transfer of control to the customer. The Company has determined that individual contracts at a single location are generally accounted for as a single performance obligation and are not segmented between types of services provided on these contracts.  The Company recognizes revenue using the cost to cost percentage of completion method, based primarily on contract cost incurred to date compared to total estimated contract cost.  The percentage-of-completion method (an input method) is the most faithful depiction of the Company’s performance because it directly measures the value of the services transferred to the customer, and the consideration that is required to be paid by the customer based on the contract.

Changes to total estimated contract cost or losses, if any, are recognized in the period in which they are determined as assessed at the contract level. Pre-contract costs are expensed as incurred unless they are expected to be recovered from the client. Customer payments on solar system contracts are typically billed upon the successful completion of milestone written into the contract and are due within 30 to 45 days of billing, depending on the contract.

Contract assets represent revenue recognized in excess of amounts billed and include unbilled receivables (typically for cost reimbursable contracts). Contract liabilities represent amounts billed to clients in excess of revenue recognized to date.  The Company has recorded a loss reserve on contract assets as of August 31, 2018 of $125,674.

Variable Consideration

The nature of the Company’s contracts gives rise to several types of variable consideration, including claims and unpriced change orders. The Company recognizes revenue for variable consideration when it is probable that a significant reversal in the amount of cumulative revenue recognized will not occur. The Company estimates the amount of revenue to be recognized on variable consideration using the expected value (i.e., the sum of a probability-weighted amount) or the most likely amount method, whichever is expected to better predict the amount. Factors considered in determining whether revenue associated with claims (including change orders in dispute and unapproved change orders in regard to both scope and price) should be recognized include the following: (a) the contract or other evidence provides a legal basis for the claim, (b) additional costs were caused by circumstances that were unforeseen at the contract date and not the result of deficiencies in the Company’s performance, (c) claim-related costs are identifiable and considered reasonable in view of the work performed, and (d) evidence supporting the claim is objective and verifiable. If the requirements for recognizing revenue for claims or unapproved change orders are met, revenue is recorded only when the costs associated with the claims or unapproved change orders have been incurred. Back charges to suppliers or subcontractors are recognized as a reduction of cost when it is determined that recovery of such cost is probable, and the amounts can be reliably estimated. Disputed back charges are recognized when the same requirements described above for claims accounting have been satisfied.

The Company generally provides limited warranties for work performed under its solar system contracts. The warranty periods typically extend for a limited duration following substantial completion of the Company’s work on a project. The Company does not charge customers or sell warranties separately, as such Warranties are not considered a separate performance obligation of the Company. The vast majority of warranties are guaranteed by subcontractors. As of August 31, 2018, the Company has recognized a warranty reserve of approximately $210,594.

Practical Expedients

The Company does not adjust the contract price for the effects of a significant financing component if the Company expects, at contract inception, that the period between when the Company transfers a service to a customer and when the customer pays for that service will be one year or less.

The Company has made an accounting policy election to exclude from the measurement of the transaction price all taxes assessed by governmental authorities that are collected by the Company from its customers (use taxes, value added taxes, some excise taxes).

Contract modifications

There were no contract modifications during the three months ended August 31, 2018.  Contract modifications are not routine in the performance of the Company’s contracts.

Remaining Unsatisfied Performance Obligations

The Company’s remaining unsatisfied performance obligations as of August 31, 2018 represent a measure of the total dollar value of work to be performed on contracts awarded and in progress. The Company had $2,768,406 in remaining unsatisfied performance obligations as of August 31, 2018.

The Company expects to satisfy its remaining unsatisfied performance obligations as of August 31, 2018 over the following year. Although the remaining unsatisfied performance obligations reflects business that is considered to be firm, cancellations, deferrals or scope adjustments may occur. The remaining unsatisfied performance obligations is adjusted to reflect any known project cancellations, revisions to project scope and cost, foreign currency exchange fluctuations and project deferrals, as appropriate.

NOTE 4 - ACQUISITIONS 

Merger Agreement with Iota Networks, LLC

On July 30, 2018, the Company entered into an Agreement and Plan of Merger and Reorganization (the “Merger Agreement”) with Iota Networks, LLC, an Arizona limited liability company, and a direct wholly owned subsidiary of the Company (the “Merger Sub”), M2M Spectrum Networks, LLC, an Arizona limited liability company (“M2M”), and Spectrum Networks Group, LLC, an Arizona limited liability company and the majority member of M2M (“Spectrum”).  Pursuant to the terms of the Merger Agreement, as of September 1, 2018, Merger Sub will merge with and into M2M (the “Merger”), a dedicated Internet of Things (IoT) network access and IoT solutions company, with M2M continuing as the surviving entity and a wholly owned subsidiary of the Company.  See Note 15 - Subsequent Events.

Proforma Information (unaudited)

The following unaudited pro forma information presents the consolidated results of the Company’s operations and the results of the Merger as if it had been consummated on June 1, 2018. Such unaudited pro forma information is based on historical unaudited financial information with respect to the Merger and does not include operational for other charges which might have been affected by the Company.  The unaudited pro forma information for the three months ended August 31, 2018 and 2017 presented below is for illustrative purposes only and is not necessarily indicative of the results which would have been achieved or results which may be achieved in the future.  There were no material nonrecurring pro forma adjustments:

NOTE 5 - INTANGIBLE ASSETS AND GOODWILL

During the three months ended, August 31, 2018, the Company did not complete any acquisitions.

The following table provides a roll forward of goodwill:

During the year ended May 31, 2018, the Company determined that the value of the intangible assets was impaired and recorded an impairment loss of $1,259,587.

The following provides a breakdown of identifiable intangible assets as of:

The weighted average useful life remaining of identifiable intangible assets remaining is 3.7 years.

Amortization of identifiable intangible assets for the three months ended August 31, 2018 and 2017 was $59,606, and $138,330, respectively.

As of August 31, 2018, the estimated annual amortization expense for each of the next four fiscal years is approximately $230,000 per year through 2022.

NOTE 6 - ACCRUED EXPENSES

As of August 31 and May 31, 2018, accrued expenses consist of the following amounts:

NOTE 7 – WARRANTY RESERVE

The Company generally provides limited warranties for work performed under its solar system contracts. The warranty periods typically extend for a limited duration following substantial completion of the Company’s work on a project. The Company does not charge customers or sell warranties separately, as such warranties are not considered a separate performance obligation of the Company. The vast majority of warranties are guaranteed by subcontractors. As of August 31, 2018, the Company has recognized a warranty reserve of $210,594.   Warranty expense was $20,381 and $0 for the three months ended August 31, 2018 and 2017, respectively.   The warranty reserve in the table noted below was included with contract liabilities as of May 31, 2018 on the accompanying balance sheet.

The following table provides a roll forward of the Company’s warranty reserve:

NOTE 8 – CONVERTIBLE DEBENTURES AND NOTES PAYABLE

As of August 31 and May 31, 2018, convertible debentures, net of debt discount, consist of the following amounts:

As of August 31 and May 31, 2018, notes payable consist of the following amounts:

AIP Financing

On May 1, 2017, the Company issued 10% Secured Convertible Promissory Notes (the “10% Secured Convertible Notes”) in the aggregate principal amount of $2,500,000 to a group of noteholders (“AIP”)

In connection with the AIP Financing, the Company and the Holders entered into a Registration Rights Agreement under which the Company required, in no event later than 75 calendar days after the closing of the AIP Financing, to file a registration statement with the SEC covering the resale of the shares of the Company’s common stock issuable on conversion of the 10% Secured Convertible Notes and exercise of the AIP Warrants and to use reasonable best efforts to have the registration declared effective as soon as practicable, but in no event later than 120 days after the closing of the AIP Financing. The Company will be subject to certain monetary penalties, as set forth in the Registration Rights Agreement, if the registration statement is not filed, does not become effective on a timely basis, or does not remain available for the resale (subject to certain allowable grace periods) of the Registrable Securities, as such term is defined in the Registration Rights Agreement. On August 29, 2017, the Company entered into an Agreement and Waiver (the “Waiver”) with AIP and issued an aggregate of 150,001 shares to AIP as a monetary penalty for not filing a registration statement on Form S-1 by July 15, 2017 as set forth in the Registration Rights Agreement dated May 1, 2017. Additionally, under the Waiver, the Company agreed to reduce the conversion price of the 2,500,000 warrants issued to AIP in connection with the AIP Financing from $0.80 to $0.60 per share. This modification in connection with the amendment of this beneficial conversion feature resulted in a charge to other expense of $594,583 for the three months ended August 31, 2017.

In relation to this transaction, the Company recorded a debt discount related to the warrants issued, a debt discount related to the beneficial conversion feature, an OID and deferred finance costs. Total straight-line amortization for these transactions amounted to $0 and $1,052,539 for the three months ended August 31, 2018 and 2017, respectively.

On April 30, 2018, the Company entered into a Waiver and Extension Agreement extending the maturity date of the 10% Secured Convertible Notes and the filing date of a registration on Form S-1 to July 1, 2018 in exchange for 3,000,000 shares of the Company’s common stock with a value of $963,900 and is included in accrued expenses and interest expense as of and for the year ended May 31, 2018. These shares were issued during the three months ended August 31, 2018.

These Secured Notes were repaid in full during the three months ended August 31, 2018.

9% Convertible Notes

On April 21, 2017, the Company closed a private placement (the “2017 Convertible Notes Private Placement”) of $899,999 principal amount of its 9% Convertible Promissory Notes (the “9% Convertible Notes”) and common stock purchase warrants (the “2017 Notes Offering Warrants”) issued to two institutional investors (the “Note Investors”). The 9% Convertible Notes and the 2017 Notes Offering Warrants were issued pursuant to Note Purchase Agreements (the “Note Purchase Agreements”), dated April 21, 2017, to each of the Note Investors, in substantially the same form.

The 9% Convertible Notes mature on October 21, 2017 unless earlier converted pursuant to the terms of the Note Purchase Agreements. The 9% Convertible Notes bear interest at 9% per annum. The outstanding principal and interest under the 9% Convertible Notes, solely upon an Event of Default (as defined in the 9% Convertible Notes) that is not cured within five business days, are convertible at the option of each of the Note Investors into shares of the Company’s common stock at an exercise price equal to 60% of the lowest traded price of the common stock on the OTC Pink Marketplace during the 30 trading days prior to the conversion date (the “Market Price”).

As a part of the 2017 Convertible Notes Private Placement, the Company issued 2017 Notes Offering Warrants to the Note Investors providing them with the right to purchase, in the aggregate, up to 1,279,998 shares of the Company’s common stock at an initial exercise price equal to the lesser of (i) $0.60 and (ii) 75% of the offering price of the Company’s common stock in the Company’s next publicly registered offering, subject to adjustment for certain events such as stock splits and stock dividends. Subject to certain limitations, the 2017 Notes Offering Warrants are exercisable on any date after the date of issuance for a term of five years. On May 16, 2017, one of the Note Investors exercised their 831,168 warrants in a cashless exercise for 447,552 shares of the Company’s common stock at $0.60 per share.

In relation to this transaction, the Company recorded a debt discount related to the warrants issued, a debt discount related to the beneficial conversion feature, an OID and deferred finance costs. Total straight-line amortization for these transactions amounted to $0 and $512,786 for the three months ended August 31, 2018 and 2017, respectively. The loan balance of $859,999, net of debt discount of $0, is classified as convertible debentures, net of debt discount, as of August 31, 2018 and May 31, 2018.

On February 22, 2018, the Company entered into Amendment #2 with each of the Note Investors further extending the maturity dates of the Notes through May 22, 2018 if the Company issues 100,000 shares to each of the Note Investors on or before March 22, 2018 and April 22, 2018. The Company issued these shares and entered into Amendment #3 on May 22, 2018 with both parties, further extending the notes through August 22, 2018 for consideration of 200,000 shares to each party on May 22, 2018, June 22, 2018 and July 22, 2018.

These notes were exchanged for two convertible notes totaling $700,000 on June 28, 2018. The new notes are due December 31, 2018, bear interest at 9%, and are convertible at $1.00 per share, or upon default at a 40% discount of the lowest trading price of the Company’s common stock over the prior 30 trading days from the date of conversion. The terms of the Exchange Agreements included cash payment in the aggregate of $900,000, 1,200,000 shares of the Company’s common stock, and warrants to purchase 900,000 of the Company’s common stock. Total debt discount as a result of the exchange was $740,032.  The total balance of the two convertible notes was $700,000 as of August 31, 2018.

Fiscal Year 2018 (Year Ended May 31, 2018)

On January 23, 2018, the Company issued a convertible note payable for $237,600, due October 18, 2018, with an annual interest rate of 8%, convertible at any time at a price of $0.60 per share. In connection with the convertible note payable, the Company issued 30,000 shares of its common stock and 300,000 warrants to purchase the Company’s common stock with an exercise price of $0.60 per shares and a three-year term. The note includes OID of $20,000, deferred financing costs of $17,600, and a discount for the warrants, restricted stock and beneficial conversion feature of $165,026, resulting in a total debt discount of $202,626. Total proceeds from this note was $200,000. The total amortization of the debt discount was $105,849 for the three months ended August 31, 2018. This note was converted in full for 396,000 shares of the Company’s stock during the three months ended August 31, 2018.

On February 2, 2018, the Company issued a convertible note payable for $150,000, due February 2, 2019, with an annual interest rate of 10%. The note is non-convertible for 180 days from the date of issuance, after which the note is convertible at a conversion price equal to 60% of the lowest trading price during the 20 trading days prior to conversion. The note includes OID of $3,000, resulting in net proceeds of $147,000. The beneficial conversion feature resulted in a debt discount of $120,142. The total amortization of the total debt discount was $84,681 for the three months ended August 31, 2018. This note was repaid in full in August 2018.

On March 9, 2018, the Company entered into a note for $115,000, including $15,000 OID with an institutional investor. The note bears interest at 9%, has a maturity date of 6 months from the date of each tranche, and is convertible in the event of a default into shares of the Company’s common stock at a price of equal to the lowest trading price over the 30 trading days prior to conversion. The Company received an initial tranche of $10,000 on March 15, 2018, which includes on OID of $1,500 and beneficial conversion feature resulting in a debt discount of $4,275. In connection with this initial tranche, the Company also issued 29,464 warrants with a five-year term and an exercise price equal to the closing price of the Company’s common stock on the trading day immediately prior to the funding date of the respective tranche under the note ($0.578 per share), resulting in a debt discount of $11,500. The total amortization of the total debt discount of $11,500 was $6,313 for the three months ended August 31, 2018. The outstanding principal balance of $11,500 was repaid in July 2018.

On March 9, 2018, the Company entered into a note for $120,000, including $15,000 OID and $5,000 of loan costs with an institutional investor. The note bears interest at 9%, has a maturity date of 6 months from the date of each tranche, and is convertible in the event of a default into shares of the Company’s common stock at a price of equal to the lowest trading price over the 30 trading days prior to conversion. The Company received an initial tranche of $10,000 on March 15, 2018, which includes on OID of $1,500, deferred financing costs of $500, and beneficial conversion feature resulting in a debt discount of $4,293. In connection with this initial tranche, the Company also issued 29,464 warrants with a five-year term and an exercise price equal to the closing price of the Company’s common stock on the trading day immediately prior to the funding date of the respective tranche under the note ($0.60 per shares), resulting in a debt discount of $12,000. The total amortization of the debt discount was $6,587 for the three months ended August 31, 2018. The outstanding principal balance of $12,000 was repaid in July 2018.

Effective May 31, 2018, the Company, Mr. Hassell and SRE Holdings, LLC, an entity owned and controlled by Mr. Hassell entered into a Settlement Agreement and Release (the “Agreement”). Under the terms of the Agreement, (i) the Company and SRE agreed to cancel the $2,000,000 Senior Secured Promissory Note issued by the Company in exchange for Five Thousand (5,000) shares of common stock and (ii) SRE agreed to allow the Company to redeem 100% of the Series A Preferred Stock from SRE for consideration in the amount of One Hundred Dollars ($100.00). In addition, Mr. Hassell and the Company mutually agree to amend Mr. Hassell’s employment agreement to reflect that, going forward, the Company shall pay to Mr. Hassell $120,000 per year and that all unvested common stock and stock options shall cease to vest as of the date of the Agreement.

Transactions for the Three Months Ended August 31, 2018

In August 2018, the Company repaid a note payable dated January 15, 2016 to a third party for $60,000.

On June 19, 2018, the Company entered into a convertible note payable for $150,000 with interest at 10%, due June 19,2019, convertible in 180 days at an exercise price equal to a 40% discount of lowest trading price of the Company’s common stock over the 20 trading days prior to conversion.

Note Purchase and Sale Transaction  – Related Party

On June 28, 2018, the Company entered into Note Purchase Agreements (the “Purchase Agreements”) with certain “accredited investors” (See Note 15 - Subsequent Events) (collectively, the “Holders”), pursuant to which the Holders will purchase 10% Secured Convertible Promissory Notes of the Company (the “Convertible Notes”) in the aggregate principal amount of up to $5,000,000 (the “Note Purchase and Sale Transaction”).  The Company used the net proceeds from the sale of the Convertible Notes to repay certain of the Company’s existing indebtedness and for working capital and general corporate purposes.  The Convertible Notes will have an aggregate principal balance of up to $5,000,000, and a stated maturity date of December 31, 2018.  The principal on the Convertible Notes bears interest at a rate of 10% per annum, which is also payable on maturity.  Upon the occurrence of an event of default, the interest rate will increase by an additional 10% per annum. Amounts due under the Convertible Notes may be converted into shares (“Conversion Shares”) of the Company’s common stock, $0.0001 par value per share, at any time at the option of the Holders, or automatically upon the occurrence of certain events, at a conversion price of $1.00 per share (the “Conversion Price”).  Upon the occurrence of an event of default under the terms of the Convertible Notes, and the passage of 15 business days following the Holders giving notice of such event of default to the Company, the entire unpaid principal balance of the Convertible Note, together with any accrued and unpaid interest thereon, will become due and payable, without presentment, demand, or protest of any kind.  The Conversion Price and number of shares issuable upon conversion of the Convertible Notes is subject to adjustment from time to time for subdivision or consolidation of shares, or upon the issuance by the Company of additional shares of common stock, or common stock equivalents, at a price lower than the Conversion Price while the Convertible Notes are outstanding, or other standard dilutive events. The Company has agreed to provide the Holders with registration rights covering the Conversion Shares.  In connection with the issuance of the Convertible Notes, the Company entered into a Pledge Agreement with the Holders, pursuant to which the Company granted the Holders, a security interest in 100% of the shares of the Company’s subsidiaries. All of the Convertible Notes issued under the Purchase Agreements rank pari passu with all other Convertible Notes issued in connection with the Note Purchase and Sale Transaction.

The Company used approximately $3,400,000 of the net proceeds from the Note Purchase and Sale Transaction to repay outstanding indebtedness and other obligations owing from the Company to certain existing noteholders (the “Existing Noteholders”) under convertible notes the Company issued to such Existing Noteholders (the “Existing Notes”) pursuant to Note Purchase Agreements between the Company and the Existing Noteholders, as amended, extended, restated, modified or supplemented. The Company also exchanged the remaining $1,113,437 due under certain of the Existing Notes for (a) an aggregate of 1,200,000 shares of the Company’s common stock, (b) additional warrants to purchase an aggregate of 900,000 shares of the Company’s common stock, at an exercise price of $0.38 per share, and (iii) replacement convertible promissory notes in the aggregate principal amount of $700,000, convertible into shares of the Company’s common stock at a price of $1.00 per share.  In addition, the Company entered into a commitment letter with one of the Existing Noteholders, pursuant to which, in consideration for the Company’s issuance to such Existing Noteholder of 1,500,000 restricted shares of the Company’s common stock, the Existing Noteholder agreed to provide the Company with up to $2,500,000 of additional funding, subject to mutual acceptance of such funding, before December 31, 2018.

Upon execution of the Merger Agreement (See Note 15  - Subsequent Events), an aggregate of $5,038,712 of principal and accrued interest due in connection with the Note Purchase Agreement was converted into 5,038,712 shares of the Company’s common stock on July 31, 2018, at a conversion price of $1.00 per share.

Total interest expense for all notes was $2,925,195 and $610,577 for three months ended August 31, 2018 and 2017, respectively.

NOTE 9 - STOCKHOLDERS’ EQUITY

Preferred Stock

On April 28, 2017, the Company’s Board of Directors adopted resolutions authorizing an amendment (the “Amendment”) to the Company’s amended certificate of incorporation to authorize the Board of Directors, without further vote or action by the stockholders, to create out of the unissued shares of the Company’s preferred stock, par value $0.001 per share (“Preferred Stock”), series of Preferred Stock and, with respect to each such series, to fix the number of shares, designations, preferences, voting powers, qualifications, and special or relative rights or privileges as the Board of Directors shall determine, which may include, among others, dividend rights, voting rights, liquidation preferences, conversion rights and preemptive rights (the “Board Authorization”). The certificate of incorporation authorizes the issuance of 5,000,000 shares of Preferred Stock, none of which are issued or outstanding as of August 31, 2018 or May 31, 2018.

Upon effectiveness of the Amendment, the Board of Directors will have the authority to issue shares of Preferred Stock from time to time on terms it may determine, to divide shares of preferred stock into one or more series and to fix the designations, preferences, privileges, and restrictions of preferred stock, including dividend rights, conversion rights, voting rights, terms of redemption, liquidation preference, and the number of shares constituting any series or the designation of any series to the fullest extent permitted by the General Corporation Law of Delaware. The issuance of Preferred Stock could have the effect of decreasing the trading price of the common stock, restricting dividends on the capital stock, diluting the voting power of the common stock, impairing the liquidation rights of the capital stock, or delaying or preventing a change in control of the Company.

Dividends

Cash dividends accrue on each share of Series A Stock, at the rate of 4% per annum of the Stated Value and are payable quarterly in arrears in cash on the first day of March, June, September and December each year, commencing June 1, 2017. Dividends accrue whether or not they are declared and whether or not the Company has funds legally available to make the cash payment. As of August 31, 2018, the Company had no undeclared dividends in arrears.

Equity Transactions During the Period

The following transactions affected the Company’s Stockholders’ Equity:

Transactions for the Three Months Ended August 31, 2017

On June 1, 2017, the Company entered into a consulting agreement for services which included the issuance of 160,000 shares of the Company’s common stock at a value of $112,000.

On August 11, 2017, the Company entered into a consulting agreement for services which included the issuance of 200,000 shares of the Company’s common stock at a value of $124,000.

On August 29, 2017, the Company entered into an Agreement and Waiver (the “Waiver”) with AIP and issued an aggregate of 150,001 shares to AIP as a monetary penalty for not filing a registration statement on Form S-1 by July 15, 2017 as set forth in the Registration Rights Agreement dated May 1, 2017 (see Note 8). Additionally, under the Waiver, the Company agreed to reduce the conversion price of the 2,500,000 warrants issued to AIP in connection with the AIP Financing from $0.80 to $0.60 per share. This modification in connection with the amendment of this beneficial conversion feature resulted in a charge to other expense of $594,583 for the three months ended August 31, 2017.

Transactions for the Three Months Ended August 31, 2018

The following transactions affected the Company’s Stockholders’ Equity for Three Months Ended August 31, 2018:

In June 2018, the Company issued a total of 850,000 shares of common stock to two noteholders with an aggregate value of $276,250 for extension of the maturity dates of the notes.

In June 2018, the Company issued a total of 2,999,999 shares of common stock to four noteholders with an aggregate value of $963,900 for extending of the requirement date for filing a Form S-1 under the terms of the notes.

In June 2018, the Company issued 400,000 shares of common stock with a value of $152,000 to a consultant for services.

In June 2018, the Company issued a total of 1,500,000 shares of common stock with a value of $555,000 to two noteholders in connection with an agreement for additional funding of a maximum of $2.5 million.

In June 2018, the Company issued 250,000 shares of common stock with a value of $92,500 to a noteholder for payment of monitoring fees and legal expenses.

In July 2018, the Company issued 424,200 shares of common stock with a value of $156,954 and 318,150 warrants to a noteholder for the repayment of $424,200 of debt and interest.

In July 2018, the Company issued 775,800 shares of common stock with a value of $294,804 and 581,850 warrants to a noteholder for the repayment of $775,800 of debt and interest.

In July 2018, a related party converted $5,038,712 of convertible notes and accrued interest into 5,038,712 shares of the Company’s common stock at a price of $1.00 per share.

In August 2018, the Company issued 500,000 shares of common stock with a value of $299,750 to a consultant for services.

In August 2018, the Company issued an aggregate of 900,000 shares of common stock with an aggregate value of $927,000 to employees for services.

In August 2018, the Company issued 100,000 shares of common stock with a value of $103,000 to a consultant for services.

In August 2018, the Company issued an aggregate of 396,000 shares of common stock to a noteholder for conversion of $237,600 of debt.

In August 2018, the Company issued 192,453 shares of common stock to a warrant holder for the cashless exercise of warrants.

NOTE 10 – STOCK-BASED COMPENSATION

The Company accounted for its stock-based compensation in accordance with the fair value recognition provisions of FASB ASC Topic 718, “Compensation – Stock Compensation.”

2017 Equity Incentive Plan

The Board of Directors approved the Company’s 2017 Equity Incentive Plan (the “2017 Plan”) on April 27, 2017 and the stockholders of the Company holding a majority in interest of the outstanding voting capital stock of the Company approved and adopted the 2017 Plan on April 28, 2017.  The maximum number of shares of the Company’s common stock that may be issued under the Company’s 2017 Plan, is 10,000,000 shares.

Options

There were no options issued during the three months ended August 31, 2018.

Compensation based stock option activity for qualified and unqualified stock options are summarized as follows:

The following table summarizes information about options to purchase shares of the Company’s common stock outstanding and exercisable at August 31, 2018:

The compensation expense attributed to the issuance of the options will be recognized as they vested/earned. These stock options are exercisable for three to ten years from the grant date.

The employee stock option plan stock options are exercisable for ten years from the grant date and vest over various terms from the grant date to three years.

The aggregate intrinsic value totaled $0 and was based on the Company’s closing stock price of $0.39 as of August 31, 2018, which would have been received by the option holders had all option holders exercised their options as of that date.

Total compensation expense related to the options was $0 and $244,060 for the three months ended August 31, 2018 and 2017, respectively. As of August 31, 2018, there was future compensation cost of $0 related to non-vested stock options.

Warrants

The issuance of warrants to purchase shares of the Company's common stock including those attributed to debt issuances are summarized as follows:

The following table summarizes information about warrants outstanding and exercisable at August 31, 2018:

The expense attributed to the issuances of the warrants was recognized as they vested/earned. These warrants are exercisable for three to five years from the grant date. All are currently exercisable.

Issuances of warrants to purchase shares of the Company's common stock were as follows:

a.     On June 28, 2018, the Company issued an aggregate of 900,000 warrants with a five-year term and an exercise price of $0.60 per share in connection with Exchange Agreements with two noteholders (see Note 8).

b.      In August 2018, a warrant holder for executed a cashless exercise of 300,000 warrants for 192,453 shares of the Company’s common stock.      

NOTE 11 – COMMITMENTS AND CONTINGENCIES

Leases

Effective October 1, 2014 as amended on January 15, 2015, the Company entered a lease for its office space at a total monthly rental of $1,874. The lease expired on January 15, 2016. The Company renewed this lease until January 15, 2017 at a monthly rental of $2,034. In January 2017, the Company renewed this lease until January 15, 2018, with an option to renew for one additional year upon its expiration. The lease was not renewed and expired.

The Company’s SES subsidiary leases offices in Jericho, New York. The facility is approximately 1,850 square feet, occupied pursuant to a lease that commenced on August 1, 2015 and expires September 30, 2018. The average annual rent over the term of the lease is approximately $57,300. This amount does not include taxes for the premises. This lease was not renewed and expired on September 30, 2018.

In May 2016, SES entered into a new facilities lease with a third party for an office space in South Carolina with a lease term of 64 months for its corporate office.  The first two months were abated and then the monthly base rent is $5,176 per month for 10 months.  The base rent has gradual increases until $6,000 per month in months 61-64.  Monthly rent payment also includes common area maintenance charges, taxes, parking and other charges.  The Company also paid a security deposit of $7,166 which is recorded as a prepaid expense on the accompanying balance sheet.

Rent expense for all locations including occupancy costs for the three months ended August 31, 2018 and 2017 was $14,616 and $27,166, respectively.

Future minimum rental commitments of non-cancelable operating leases (including the Jericho lease) are as follows:

Legal Claims

From time to time, the Company may become involved in legal proceedings arising in the ordinary course of business. The Company is not presently a party to any legal proceedings that it currently believes, if determined adversely to the Company, would individually or taken together have a material adverse effect on the Company’s business, operating results, financial condition or cash flows.

The Company is currently the defendant of a lawsuit from a subcontractor seeking damages in excess of $255,000. The Company has responded to the lawsuit and is prepared to vigorously contest the matter believing a favorable resolution will be reached.

On September 8, 2017, Joseph Gunnar & Co., LLC (the “Plaintiff”) filed a complaint with the Supreme Court of the State of New York, County of New York against the Company alleging failure and refusal to make payments totaling $262,500 owed to the Plaintiff under certain written agreements between the Plaintiff and the Company.  On August 15, 2018, the Plaintiff and the Company reached a settlement whereby the Company agreed to pay the Plaintiff $150,000 for the release of all claims.  The Company paid such settlement amount on August 16, 2018.

NOTE 12 - CONCENTRATIONS OF CREDIT RISK

Cash

The Company maintains principally all cash balances in two financial institutions which, at times, may exceed the amount insured by the Federal Deposit Insurance Corporation. The exposure to the Company is solely dependent upon daily bank balances and the respective strength of the financial institutions. The Company has not incurred any losses on these accounts.

Net Sales

Two customers accounted for 98% of net sales for the three months ended August 31, 2018, as set forth below:

One customer accounted for 93% of net sales for the three months ended August 31, 2017, as set forth below:

Accounts Receivable

Two customers accounted for 74% of the accounts receivable as of August 31, 2018, as set forth below:

One customer accounted for 96% of the accounts receivable as of August 31, 2017, as set forth below:

NOTE 13 - RELATED PARTY TRANSACTIONS

See Note 15 - Subsequent Events regarding compensatory arrangements with certain officers.

NOTE 14 - BUSINESS SEGMENT INFORMATION

As of August 31, 2018, the Company had two operating segments, Arkados and SES.

The Company’s reportable segments are distinguished by types of service, customers and methods used to provide their services. The operating results of these business segments are regularly reviewed by the Company’s chief operating decision maker.

The accounting policies of each of the segments are the same as those described in the Summary of Significant Accounting Policies in Note 2. The Company evaluates performance based primarily on income (loss) from operations.

The Company’s revenues for the three months ended August 31, 2018 and 2017 were solely derived from SES revenues from solar energy projects within North America.

Operating results for the business segments of the Company were as follows:

NOTE 15 – SUBSEQUENT EVENTS

On September 18, 2018, the Company entered into a $440,000 convertible note with an accredited investor. The note bears interest at 8%, is due March 31, 2019, includes an OID of $40,000, and is convertible into shares of the Company’s common stock at any time at a price of $0.60 per share. The terms of the note include the issuance a warrant to purchase 600,000 shares of the Company’s stock with a 3-year term and exercise price of $0.60 per shares, and the issuance of 100,000 shares of the Company’s common stock which the Company issued on October 9, 2018.

On October 3, 2018, the Company issued 129,300 shares of common stock with a fair value of $0.89 per share to a noteholder in exchange for a waiver of default related to a note payable.

On October 16, 2018, the Company issued 70,700 shares of common stock to a noteholder in exchange for an Amendment to the note dated June 29, 2018 allowing for an extension of repayment terms.

Merger Agreement with Iota Networks, LLC

On July 30, 2018, the Company entered into an Agreement and Plan of Merger and Reorganization (the “Merger Agreement”) with Iota Networks, LLC, an Arizona limited liability company, and a direct wholly owned subsidiary of the Company (the “Merger Sub”), M2M Spectrum Networks, LLC, an Arizona limited liability company (“M2M”), and Spectrum Networks Group, LLC, an Arizona limited liability company and the majority member of M2M (“Spectrum”).  Pursuant to the terms of the Merger Agreement, Merger Sub will merge with and into M2M (the “Merger”), a dedicated Internet of Things (IoT) network access and IoT solutions company, with M2M continuing as the surviving entity and a wholly owned subsidiary of the Company.

On September 5, 2018, the parties to the Merger Agreement entered into an amendment to the Merger Agreement (the “Amendment”), pursuant to which the terms of the Merger Agreement were amended to reflect that:

Additionally, in July 2018, M2M converted $5,038,712 of convertible debt and accrued interest into 5,038,712 shares of the Company’s common stock.

Except as specifically amended by the Amendment, all of the other terms of the Merger Agreement remain in full force and effect. Pursuant to the Merger Agreement, as amended, at the effective time of the Merger:

The Warrants are exercisable for a period of five years from the date the original warrants to purchase common equity units of M2M Spectrum Networks were issued to the holders. The Warrants provide for the purchase of shares of the Company's common stock an exercise price of $0.3753 per share. The Warrants are exercisable for cash only. The number of shares of common stock to be deliverable upon exercise of the Warrants is subject to adjustment for subdivision or consolidation of shares and other standard dilutive events.

The Merger Agreement, as amended, contained customary representations and warranties and pre- and post-closing covenants of each party and customary closing conditions. Breaches of the representations and warranties will be subject to indemnification provisions.

Immediately following the Merger, the Company had 196,570,322 shares of common stock issued and outstanding. The pre-Merger stockholders of the Company retained an aggregate of 43,429,034 shares of common stock of the Company, representing approximately 19.6% ownership of the post-Merger Company. Therefore, upon consummation of the Merger, there was a change in control of the Company, with the former owners of M2M Spectrum Networks effectively acquiring control of the Company. The Merger will be treated as a recapitalization and reverse acquisition of the Company for financial accounting purposes. M2M Spectrum Networks is considered the acquirer for accounting purposes, and the Company’s historical financial statements before the Merger will be replaced with the historical financial statements of M2M Spectrum Networks before the Merger in future filings with the SEC.

The parties intend for the Merger to qualify as a tax-free exchange under Section 351 of the Internal Revenue Code of 1986, as amended.

The Company is currently evaluating the purchase price allocation for the Merger which it expects to be completed during the three months ended November 30, 2018.

Appointment of Certain Officers

On September 5, 2018, at the effective time of the Merger, Terrence DeFranco resigned from his position as Chief Executive Officer of the Company and, in connection with such resignation, relinquished his role as “Principal Executive Officer” of the Company for SEC reporting purposes. Mr. DeFranco remained in the roles of President, Chief Financial Officer, Secretary and Treasurer of the Company and, as such, continued in the roles of “Principal Financial Officer” and “Principal Accounting Officer” of the Company for SEC reporting purposes.

On September 5, 2018, in accordance with Article III, Section 3.2 of the Company’s Amended and Restated Bylaws, the Company increased the number of directors constituting its Board from one (1) to two (2). Upon consummation of the Merger, Barclay Knapp was appointed as member of the Board, to fill the vacancy created by the increase in the authorized number of directors.

In addition, at the effective time of the Merger, and upon effectiveness of Mr. DeFranco’s resignation as Chief Executive Officer, Barclay Knapp was appointed as Chief Executive Officer of the Company, to serve in such office at the pleasure of the Board, and until his successor has been appointed by the Board. In connection with his appointment as Chief Executive Officer of the Company, Barclay Knapp was designated as the Company’s “Principal Executive Officer” for SEC reporting purposes.

Compensatory Arrangements of Certain Officers

Employment Agreement with Barclay Knapp

On September 5, 2018, simultaneously with the consummation of the Merger, the Company entered into a two-year Employment Agreement with Barclay Knapp (the “Knapp Employment Agreement”), pursuant to which he will serve as the Company’s Chief Executive Officer. The term will automatically renew for periods of one year unless either party gives written notice to the other party that the agreement shall not be further extended at least 90 days prior to the end of the term, as it may have been extended.

Pursuant to the Knapp Employment Agreement, Mr. Knapp will earn an initial base annual salary of $450,000, which may be increased in accordance with the Company’s normal compensation and performance review policies for senior executives generally. He is entitled to receive semi-annual bonuses in a yearly aggregate amount of up to 100% of his base annual salary, at the Board’s discretion, based on the attainment of certain individual and corporate performance goals and targets and the business condition of the Company. Mr. Knapp will also receive stock options, under the Company’s 2017 Equity Incentive Plan, to purchase a number of shares of the Company’s common stock determined by the Board, with an exercise price equal to the fair market value of the Company’s common stock on the grant date. The stock options will vest in a series of 16 successive equal quarterly installments, provided that Mr. Knapp is employed by the Company on each such vesting date. Mr. Knapp will also be eligible to participate in any long-term equity incentive programs established by the Company for its senior level executives generally, and benefits under any benefit plan or arrangement that may be in effect from time to time and made available to similarly situated executives of the Company.

Employment Agreement with Terrence DeFranco

On September 5, 2018, simultaneously with the consummation of the Merger, the Company entered into a two-year Employment Agreement (the “DeFranco Employment Agreement”) with Terrence DeFranco, pursuant to which he will serve as the Company’s President and Chief Financial Officer. The term will automatically renew for periods of one year unless either party gives written notice to the other party that the agreement shall not be further extended at least 90 days prior to the end of the term, as it may have been extended.

Pursuant to the DeFranco Employment Agreement, Mr. DeFranco will earn an initial base annual salary of $375,000, which may be increased in accordance with the Company’s normal compensation and performance review policies for senior executives generally. He is entitled to receive semi-annual bonuses in a yearly aggregate amount of up to 100% of his base annual salary, at the discretion of the Board, based on the attainment of certain individual and corporate performance goals and targets and the business condition of the Company. Mr. DeFranco will also receive stock options, under the Company’s 2017 Equity Incentive Plan, to purchase 4,000,000 shares of the Company’s common stock, with an exercise price equal to the fair market value of the Company’s common stock on the grant date. The stock options will vest in a series of 16 successive equal quarterly installments, provided that Mr. DeFranco is employed by the Company on each such vesting date. Mr. DeFranco will also be eligible to participate in any long-term equity incentive programs established by the Company for its senior level executives generally, and benefits under any benefit plan or arrangement that may be in effect from time to time and made available to similarly situated executives of the Company.

Convertible Note Transaction

As of September 20, 2018, the Company entered into a Securities Purchase Agreement (the “Purchase Agreement”) with an “accredited investor” (the “Buyer”), pursuant to which, for a purchase price of $400,000, the Buyer purchased (a) a Convertible Promissory Note in the principal amount of $440,000 (the “Note”), (b) warrants (the “Warrants”) to purchase 600,000 shares of the Company’s common stock, and (c) 100,000 restricted shares of the Company’s common stock (the “Shares”) (the “Purchase and Sale Transaction”).  The Company will use the net proceeds from the Purchase and Sale Transaction for working capital and general corporate purposes.

The Convertible Note has a principal balance of $440,000 (taking into consideration a $40,000 original issue discount received by the Buyer), and a stated maturity date of March 31, 2019.  Upon issuance of the Convertible Note, a one-time interest charge of 8% was applied to the principal amount of the Convertible Note, which is also payable on maturity.  Upon the occurrence of an event of default, which is not cured within 7 business days, the principal balance of the Convertible Note shall immediately increase to 140% of the outstanding balance immediately prior to the occurrence of the event of default.  In addition, upon the occurrence of an event of default, the entire unpaid principal balance of the Convertible Note, together with any accrued and unpaid interest thereon, will become due and payable, without presentment, demand, or protest of any kind.  Amounts due under the Convertible Note may be converted into shares (“Conversion Shares”) of the Company’s ocmmon tsock at any time, at the option of the holder, at a conversion price of $0.60 per share.  The Company has agreed to at all times reserve and keep available out of its authorized common stock a number of shares equal to at least two times the full number of Conversion Shares.  The Company may redeem the Convertible Note, upon 10 business days’ notice to the holder, by paying the holder: (i) if the redemption is within the first 90 days after the issuance of the Convertible Note, an amount equal to 100% of the outstanding balance of the Convertible Note, plus any accrued and unpaid interest, or (ii) if the redemption is on or after the 91st day after issuance of the Convertible Note, an amount equal to 120% of the outstanding balance of the Convertible Note, plus any accrued and unpaid interest.  If, while the Convertible Note is outstanding, the Company, or any of its subsidiaries, issues any security with any term more favorable to the holder of such security, or with a term in favor of the holder of such security that was not similarly provided to the Buyer, then the Company will notify the holder of the Convertible Note of such additional or more favorable term and such term, at holder’s option, shall become a part of the Convertible Note.  The Company has granted the holder piggyback registration rights with respect to the Conversion Shares.

The Warrants are exercisable for a period of three years from the date of issuance, at an exercise price of $0.60 per share.  The Warrants are exercisable for cash, or on a cashless basis.  The number of shares of common stock to be deliverable upon exercise of the Warrants is subject to adjustment for subdivision or consolidation of shares and other standard dilutive events.