UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

Form 10-Q

 

(Mark One)

 

[X]

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

 

FOR THE QUARTERLY PERIOD ENDED: SEPTEMBER 30, 2020

 

[  ]

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

 

For the transition period from __________ to __________

 

Commission File Number: 000-53635

 

GENERATION ALPHA, INC.

(Exact name of registrant as specified in its charter)

 

Nevada		20-8609439
(State or other jurisdiction of		(I.R.S. Employer
incorporation or organization)		Identification No.)

 

1689-A Arrow Route

Upland, California 91786

(Address of principal executive offices) (Zip code)

 

(888) 998-8881

(Registrant’s telephone number, including area code)

 

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

 

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

 

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

 

Large accelerated filer	[  ]	Accelerated filer	[  ]
Non-accelerated filer	[X]	Smaller reporting company	[X]
		Emerging growth company	[  ]

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13 (a) of the Exchange Act. [  ]

 

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

 

Securities registered pursuant to Section 12(b) of the Act: None.

 

The number of shares of registrant’s common stock outstanding as of October 29, 2020 was 58,105,153.

 

 

 

GENERATION ALPHA, INC.

 

INDEX

 

PART I.	FINANCIAL INFORMATION
	ITEM 1.	Financial Statements
		Condensed Consolidated Balance Sheets as of September 30, 2020 (unaudited) and December 31, 2019	1
		Condensed Consolidated Statements of Operations for the three and nine months ended September 30, 2020 and 2019 (unaudited)	2
		Condensed Consolidated Statements of Shareholders’ Deficit for the three and nine months ended September 30, 2020 and 2019 (unaudited)	3
		Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 2020 and 2019 (unaudited)	5
		Notes to Condensed Consolidated Financial Statements (unaudited)	6-17
	ITEM 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	18-24
	ITEM 3.	Quantitative and Qualitative Disclosures about Market Risk	24
	ITEM 4.	Controls and Procedures	25
PART II.	OTHER INFORMATION		26
	ITEM 1.	Legal Proceedings	26
	ITEM 1A.	Risk Factors	26
	ITEM 2.	Unregistered Sales of Equity Securities and Use of Proceeds	26
	ITEM 3.	Defaults Upon Senior Securities	26
	ITEM 4.	Mine Safety Disclosures	26
	ITEM 5.	Other Information	26
	ITEM 6.	Exhibits	26
	SIGNATURES		28

 

 

PART I - FINANCIAL INFORMATION

 

Item 1. Condensed Consolidated Financial Statements.

 

GENERATION ALPHA INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

 

		September 30, 2020				December 31, 2019
			(Unaudited)
ASSETS
Current Assets
Cash		$	549,000			$	104,000
Accounts receivable, net of allowance for doubtful accounts and returns of $12,000 and $112,000, respectively			65,000				-
Inventories, net of allowance of $79,000 and $126,000, respectively			143,000				390,000
Prepaid expenses and other current assets			32,000				24,000
Total Current Assets			789,000				518,000
Property and equipment, net			17,000				22,000
Right of use asset, net			415,000				427,000
Other assets			11,000				10,000
Total Assets		$	1,232,000			$	977,000
LIABILITIES AND SHAREHOLDERS’ DEFICIT
Current Liabilities
Accounts payable and accrued expenses		$	1,585,000			$	1,562,000
Legal obligations payable – past due			613,000				2,550,000
Leases payable, current portion			259,000				133,000
Contract obligations acquired from related parties – past due			811,000				799,000
Notes payable to related parties – past due			790,000				790,000
Convertible notes payable to related party, net of discount of $435,000 and $178,000, respectively			1,840,000				1,597,000
Accrued interest to related parties			471,000				351,000
Loans payable, current portion			24,000				64,000
Total Current Liabilities			6,393,000				7,846,000
Leases payable, net of current portion			370,000				423,000
Loans payable, net of current portion			355,000				-
Derivative liabilities			3,106,000				1,332,000
Total Liabilities			10,224,000				9,601,000
Commitments and Contingencies
Shareholders’ Deficit
Preferred stock, no par value, 20,000,000 shares authorized; no shares issued and outstanding at September 30, 2020 and December 31, 2019			-				-
Common stock, $0.001 par value, 100,000,000 shares authorized; 58,105,153 and 46,820,564 shares issued and outstanding at September 30, 2020 and December 31, 2019, respectively			58,000				47,000
Additional paid-in capital			32,011,000				31,739,000
Accumulated deficit			(41,061,000	)			(40,410,000	)
Total Shareholders’ Deficit			(8,992,000	)			(8,624,000	)
TOTAL LIABILITIES AND SHAREHOLDERS’ DEFICIT		$	1,232,000			$	977,000

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

 

GENERATION ALPHA, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(UNAUDITED)

 

		Three months ended September 30,								Nine months ended September 30,
		2020				2019				2020				2019
Sales		$	397,000			$	475,000			$	980,000			$	1,895,000
Cost of goods sold			248,000				158,000				577,000				922,000
Gross profit			149,000				317,000				403,000				973,000
Operating expenses
Selling, general and administrative expenses			218,000				829,000				839,000				3,096,000
Research and development			25,000				37,000				75,000				191,000
Legal judgment			-				-				448,000				-
Impairment of right of use asset			-				-				82,000				-
Loss on abandonment of leasehold improvements			-				-				-				218,000
Impairment of intangible assets acquired from related party			-				-				-				1,139,000
Amortization of license agreement			-				-				-				163,000
Total operating expenses			243,000				866,000				1,444,000				4,807,000
Loss from operations			(94,000	)			(549,000	)			(1,041,000	)			(3,834,000	)
Other income (expenses)
Gain on settlement of legal judgments			2,417,000				-				2,417,000
Financing costs (1)			(83,000	)			-				(98,000	)			(129,000	)
Change in fair value of derivative liability			260,000				644,000				(1,265,000	)			2,172,000
Interest expense (2)			(93,000	)			(103,000	)			(664,000	)			(453,000	)
Total other income			2,501,000				540,000				390,000				1,590,000
Net income (loss)		$	2,407,000			$	(9,000	)		$	(651,000	)		$	(2,244,000	)
BASIC INCOME (LOSS) PER SHARE		$	0.05			$	(0.00	)		$	(0.01	)		$	(0.05	)
DILUTED INCOME (LOSS) PER SHARE		$	0.01			$	(0.00	)		$	(0.01	)		$	(0.05	)
WEIGHTED - AVERAGE COMMON SHARES OUTSTANDING
- BASIC			51,794,338				46,320,564				53,418,875				46,465,868
- DILUTED			300,652,628				46,320,564				53,418,875				46,465,868
(1) Included in financing costs are these amounts from a related party		$	83,000			$	-			$	98,000			$	129,000
(2) Included in interest expense are these amounts from related parties		$	88,000			$	69,000			$	532,000			$	404,000

 

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

 

GENERATION ALPHA INC.

CONDENSED CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ DEFICIT

(UNAUDITED)

 

Three months ended September 30, 2020

 

										Additional
		Common Stock								Paid-in				Accumulated
		Shares				Amount				Capital				Deficit				Total
Balance, June 30, 2020 (Unaudited)			51,738,920			$	52,000			$	31,861,000			$	(43,468,000	)		$	(11,555,000	)
Fair value of common stock issued to directors			2,032,900				2,000				18,000								20,000
Fair value of common stock issued in settlement of legal judgments			4,333,333				4,000				56,000								60,000
Warrants issued as debt discount											53,000								53,000
Fair value of vested stock options											23,000								23,000
Net income															2,407,000				2,407,000
Balance, September 30, 2020 (Unaudited)			58,105,153			$	58,000			$	32,011,000			$	(41,061,000	)		$	(8,992,000	)

 

Nine months ended September 30, 2020

 

										Additional
		Common Stock								Paid-in				Accumulated
		Shares				Amount				Capital				Deficit				Total
Balance, December 31, 2019			46,820,564			$	47,000			$	31,739,000			$	(40,410,000	)		$	(8,624,000	)
Common shares issued on conversion of accrued interest on note payable			2,287,066				2,000				27,000								29,000
Fair value of common stock issued to directors			4,664,190				5,000				67,000								72,000
Fair value of common stock issued in settlement of legal judgments			4,333,333				4,000				56,000								60,000
Fair value of warrants issue as debt discount											53,000								53,000
Fair value of vested stock options											69,000								69,000
Net loss															(651,000	)			(651,000	)
Balance, September 30, 2020 (Unaudited)			58,105,153			$	58,000			$	32,011,000			$	(41,061,000	)		$	(8,992,000	)

 

 

Three months ended September 30, 2019

 

										Additional
		Common Stock								Paid-in				Accumulated
		Shares				Amount				Capital				Deficit				Total
Balance, June 30, 2019 (Unaudited)			46,320,564			$	46,000			$	29,301,000			$	(34,752,000	)		$	(5,405,000	)
Fair value of vested stock options											6,000								6,000
Net loss															(8,000	)			(8,000	)
Balance, September 30, 2019 (Unaudited)			46,320,564			$	46,000			$	29,307,000			$	(34,760,000	)		$	(5,407,000	)

 

Nine months ended September 30, 2019

 

										Additional
		Common Stock								Paid-in				Accumulated
		Shares				Amount				Capital				Deficit				Total
Balance, December 31, 2018			45,794,564			$	46,000			$	29,042,000			$	(32,516,000	)		$	(3,428,000	)
Fair value of common stock issued for services			426,000				-				178,000								178,000
Fair value of common stock issued to directors			100,000				-				63,000								63,000
Fair value of vested stock options											24,000								24,000
Net loss															(2,244,000	)			(2,244,000	)
Balance, September 30, 2019 (Unaudited)			46,320,564			$	46,000			$	29,307,000			$	(34,760,000	)		$	(5,407,000	)

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

 

 

GENERATIONAL ALPHA, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(UNAUDITED)

 

		Nine Month Ended September 30,
		2020				2019
Cash Flows from Operating Activities
Net loss		$	(651,000	)		$	(2,244,000	)
Adjustments to reconcile net loss to net cash used in operating activities
Provision for allowance for doubtful accounts and sales returns			(100,000	)			(33,000	)
Provision for inventory reserves			(46,000	)			(673,000	)
Depreciation and amortization			5,000				189,000
Amortization of right of use asset			19,000				87,000
Impairment of right of use asset			82,000				-
Imputed interest contract obligation			12,000				13,000
Amortization on convertible notes payable			242,000				247,000
Loss on abandonment of leasehold improvements			-				218,000
Impairment of intangible asset			-				1,139,000
Fair value of vested stock options			69,000				24,000
Fair value of common stock issued for services			-				178,000
Fair value of common stock issued to directors			72,000				63,000
Financing costs			98,000				129,000
Gain on settlement of legal judgments			(2,417,000	)			-
Change in the fair value of derivative liability			1,265,000				(2,172,000	)
Changes in Assets and Liabilities
(Increase) Decrease in:
Accounts receivable			35,000				(9,000	)
Legal settlements payable			540,000				-
Inventories			293,000				716,000
Prepaid expenses and other			(8,000	)			224,000
Other assets			(1,000	)			53,000
(Decrease) Increase in:
Accounts payable and accrued expenses			23,000				1,043,000
Lease payable			(16,000	)			(61,000	)
Accrued interest to related parties			149,000				12,000
Net cash used in operating activities			(335,000	)			(857,000	)
Cash Flows from Investing Activities
Purchase of property and equipment			-				(218,000	)
Net cash used in investing activities			-				(218,000	)
Cash Flows from Financing Activities
Proceeds from convertible notes payable related party, net of fees			465,000				-
Proceeds from loans payable			355,000				150,000
Proceeds from note payable related party			-				150,000
Payments on loans payable			(40,000	)			(46,000	)
Net cash provided by financing activities			780,000				254,000
Net increase (decrease) in cash			445,000				(821,000	)
Cash beginning of period			104,000				887,000
Cash end of period		$	549,000			$	66,000
Interest paid		$	42,000			$	50,000
Taxes paid		$	-			$	-
Non-Cash Financing Activities
Recording of right to use asset and lease liability		$	89,000			$	659,000
Conversion of accrued interest to related parties for common stock		$	29,000			$	-
Fair value of derivative liability created upon issuance of convertible notes		$	510,000			$	-
Fair value of common stock issue on settlement of legal judgments		$	60,000			$	-

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

 

GENERATION ALPHA INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2020 AND 2019

(UNAUDITED)

 

NOTE 1 – BASIS OF PRESENTATION

 

History and Organization

 

Generation Alpha, Inc. (the “Company”) was originally incorporated under the laws of the State of Nevada on March 2, 2007 as Cinjet, Inc. (“Cinjet”). Effective September 1, 2015, Cinjet changed its corporate name to Solis Tek Inc. (“Solis Tek”). Effective September 25, 2018, Solis Tek changed its corporate name to Generation Alpha, Inc. Effective September 25, 2018, Generation Alpha, Inc. (f/k/a Solis Tek Inc.) (the “Company”) entered into an agreement and plan of merger (the “Merger Agreement”), whereby a wholly-owned subsidiary of the Company (the “Merger Sub”) was merged into the Company (the “Merger”). Upon consummation of the Merger, the separate existence of Merger Sub ceased. On June 23, 2015, the Company entered into an Agreement of Merger and Plan of Reorganization (the “Agreement”) with Solis Tek Inc., a California corporation (“STI”), and CJA Acquisition Corp., a California corporation and a wholly owned subsidiary of the Company (“Merger Sub”), providing for the merger of Merger Sub with and into STI (the “Merger”), with STI surviving the Merger as a wholly-owned subsidiary of the Company. The Merger was accounted for as a recapitalization of the Company with STI being deemed the accounting acquirer.

 

Overview of Business

 

The Company is focused on the research, design, development, and manufacturing of advanced, energy efficient indoor horticulture lighting, plant nutrient products, and ancillary equipment.

 

COVID-19 Considerations

 

In the period ended September 30, 2020, the COVID-19 pandemic did not have a material net impact on our operating results. In the future, the pandemic may cause reduced demand for our products if, for example, the pandemic results in a recessionary economic environment which negatively effects the consumers who purchase our products.

 

Our ability to operate without significant negative operational impact from the COVID-19 pandemic will in part depend on our ability to protect our employees and our supply chain. The Company has endeavored to follow the recommended actions of government and health authorities to protect our employees. Since the onset of the COVID-19 pandemic, we maintained the consistency of our operations. However, the uncertainty resulting from the pandemic could result in an unforeseen disruption to our workforce and supply chain (for example an inability of a key supplier or transportation supplier to source and transport materials) that could negatively impact our operations.

 

Through September 30, 2020, the COVID-19 pandemic has not negatively impacted the Company’s liquidity position as of such date. Through September 30, 2020, the Company continues to generate cash flows to meet its short-term liquidity needs, and it expects to maintain access to the capital markets. The Company has not observed any material impairments of its assets or a significant change in the fair value of its assets due to the COVID-19 pandemic.

 

Going Concern

 

The accompanying condensed consolidated financial statements have been prepared on a going concern basis, which contemplates the realization of assets and the settlement of liabilities and commitments in the normal course of business. As reflected in the accompanying condensed consolidated financial statements, during the nine months ended September 30, 2020, the Company incurred a net loss of $651,000 and used cash in operations of $335,000, and had a shareholders’ deficit of $8,992,000 at September 30, 2020. These factors raise substantial doubt about the Company’s ability to continue as a going concern within one year after the date of the financial statements being issued. The ability of the Company to continue as a going concern is dependent upon the Company’s ability to raise additional funds and implement its business plan. The financial statements do not include any adjustments that might be necessary if the Company is unable to continue as a going concern. In addition, the Company’s independent registered public accounting firm, in its report on the Company’s December 31, 2019 financial statements, has raised substantial doubt about the Company’s ability to continue as a going concern.

 

 

At September 30, 2020, the Company had cash on hand in the amount of $549,000. Management estimates that the current funds on hand will be sufficient to continue operations through March 2021. The continuation of the Company as a going concern is dependent upon its ability to obtain necessary debt or equity financing to continue operations until it begins generating positive cash flow. No assurance can be given that any future financing will be available or, if available, that it will be on terms that are satisfactory to the Company. Even if the Company is able to obtain additional financing, it may contain undue restrictions on its operations, in the case of debt financing or cause substantial dilution for the Company’s shareholders, in case of equity financing.

 

NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

 

Basis of Consolidation

 

The consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries: STI; Solis Tek East, Corporation (“STE”), an entity incorporated under the laws of the State of New Jersey, Zelda Horticulture, Inc. (“Zelda”), an entity incorporated under the laws of the State of California, and YLK Partners NV, LLC (“YLK”), Generation Alpha Brands, Inc., Trilogy Dispensaries, Inc., Extracting Point, LLC (“Extracting Point”), and GrowPro Solutions, Inc., all entities formed under the laws of Nevada. Intercompany transactions and balances have been eliminated in consolidation.

 

Loss per Share Calculations

 

Basic earnings per share are computed by dividing net income (loss) available to common shareholders by the weighted-average number of common shares available. Diluted earnings per share is computed by dividing the net income applicable to common stock holders by the weighted average number of common shares outstanding plus the number of additional common shares that would have been outstanding if all dilutive potential common shares had been issued using the treasury stock method. Potential common shares are excluded from the computation when their effect is antidilutive. The dilutive effect of potentially dilutive securities is reflected in diluted net income per share if the exercise prices were lower than the average fair market value of common shares during the reporting period.

 

For the nine months ended September 30, 2020, options to acquire 8,079,133 shares of common stock, warrants to acquire 28,283,140 shares of common stock, and 239,274,957 shares to be issued upon conversion of our convertible notes have been excluded from the calculation of weighted average common shares, as their effect would have been anti-dilutive. For the nine months ended September 30, 2019, options to acquire 8,149,391 shares of common stock, warrants to acquire 12,783,140 shares of common stock, and 3,000,000 shares to be issued upon conversion of our convertible note have been excluded from the calculation of weighted average common shares, as their effect would have been anti-dilutive.

 

Use of Estimates

 

The preparation of the consolidated financial statements in conformity with accounting principles generally accepted in the U.S. requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the financial statement date, and reported amounts of revenue and expenses during the reporting period. Significant estimates are used in valuing our allowances for doubtful accounts, reserves for inventory obsolescence, valuing derivative liabilities, valuing equity instruments issued for services, and valuation allowance for deferred tax assets, among others. Actual results could differ from these estimates.

 

Segment Reporting

 

The Company operates in one segment for the manufacture and distribution of its products. In accordance with the “Segment Reporting” Topic of the ASC, the Company’s chief operating decision maker has been identified as the Chief Executive Officer and President, who reviews operating results to make decisions about allocating resources and assessing performance for the entire Company. Existing guidance, which is based on a management approach to segment reporting, establishes requirements to report selected segment information quarterly and to report annually entity-wide disclosures about products and services, major customers, and the countries in which the entity holds material assets and reports revenue. All material operating units qualify for aggregation under “Segment Reporting” due to their similar customer base and similarities in: economic characteristics; nature of products and services; and procurement, manufacturing and distribution processes. Since the Company operates in one segment, all financial information required by “Segment Reporting” can be found in the accompanying consolidated financial statements.

 

 

Revenue Recognition

 

The Company recognizes revenue in accordance with Accounting Standard Update (“ASU”) No. 2014-09. This standard provides authoritative guidance clarifying the principles for recognizing revenue and developing a common revenue standard for U.S. generally accepted accounting principles. The core principle of the guidance is that an entity should recognize revenue to depict the transfer of promised goods and services to customers in an amount that reflects the consideration to which the entity expects to be entitled in the exchange for those goods or services.

 

Under this guidance, revenue is recognized when control of promised goods or services is transferred to the Company’s customers, in an amount that reflects the consideration the Company expects to be entitled to in exchange for those goods or services. The Company reviews its sales transactions to identify contractual rights, performance obligations, and transaction prices, including the allocation of prices to separate performance obligations, if applicable. Revenue and cost of sales are recognized once products are delivered to the customer’s control and performance obligations are satisfied.

 

All products sold by the Company are distinct individual products and consist of advanced energy efficient indoor horticulture lighting, plant nutrient products, and ancillary equipment. The products are offered for sale as finished goods only, and there are no performance obligations required post-shipment for customers to derive the expected value from them. Contracts with customers contain no incentives or discounts that could cause revenue to be allocated or adjusted over time.

 

The Company does not offer a general right of return on any of its sales and considers all sales as final. The Company generally provides a three-year warranty on its ballasts. However, the Company does not maintain a warranty reserve as the Company is able to chargeback its vendors for all warranty claims.

 

In the following table, revenue is disaggregated by major product line for the three months ended September 30, 2020:

 

Sales Channels		Lighting				Plant Nutrients and Fertilizers				Total
Hydroponic resellers/retail		$	173,000			$	214,000			$	387,000
Direct to consumer/online			10,000				-				10,000
Total		$	183,000			$	214,000			$	397,000

 

In the following table, revenue is disaggregated by major product line for the three months ended September 30, 2019:

 

Sales Channels		Lighting				Plant Nutrients and Fertilizers				Total
Hydroponic resellers/retail		$	349,000			$	126,000			$	475,000
Direct to consumer/online			-				-				-
Total		$	349,000			$	126,000			$	475,000

 

 

In the following table, revenue is disaggregated by major product line for the nine months ended September 30, 2020:

 

Sales Channels		Lighting				Plant Nutrients and Fertilizers				Total
Hydroponic resellers/retail		$	357,000			$	602,000			$	959,000
Direct to consumer/online			21,000				-				21,000
Total		$	378,000			$	602,000			$	980,000

 

In the following table, revenue is disaggregated by major product line for the nine months ended September 30, 2019:

 

Sales Channels		Lighting				Plant Nutrients and Fertilizers				Total
Hydroponic resellers/retail		$	1,490,000			$	405,000			$	1,895,000
Direct to consumer/online			-				-				-
Total		$	1,490,000			$	405,000			$	1,895,000

 

Concentration Risks

 

Cash includes cash on hand and cash in banks and are reported as “Cash” in the consolidated statements of financial position. At September 30, 2020 and December 31, 2019, cash includes cash on hand of $323,000 and $12,000, respectively, and cash in banks of $226,000 and $92,000, respectively. The balance of cash on hand is not insured by the Federal Deposit Insurance Corporation. The balance of cash in banks is insured by the Federal Deposit Insurance Corporation for up to $250,000.

 

The Company’s products require specific components that currently are available from a limited number of sources. The Company purchases some of its key products and components from single vendors. During the nine months ended September 30, 2020 and 2019, its ballasts, lamps and reflectors, which comprised the clear majority of the Company’s purchases during those periods, were each only purchased from one and three separate vendors, respectively.

 

The Company performs a regular review of customer activity and associated credit risks and does not require collateral or other arrangements. Two customers accounted for 13% and 12% of the Company’s revenue for the three months ended September 30, 2020, and two customers accounted for 18% and 12% of the Company’s revenue for the three months ended September 30, 2019. One customer accounted for 11% of the Company’s revenue for the nine months ended September 30, 2020, and no customer accounted for more than 10% of the Company’s revenue for the nine months ended September 30, 2019. There were no other customers that accounted for more than 10% of the Company’s revenue. Shipments to customers outside the United States comprised less than 5% of our sales for the three and nine months ended September 30, 2020 and 2019.

 

As of September 30, 2020, two customers accounted for 32% and 13% of the Company’s trade accounts receivable balance, and as of December 31, 2019, two customers accounted for 24% and 10% of the Company’s trade accounts receivable balance.

 

Fair Value Measurements

 

The Company determines the fair value of its assets and liabilities based on the exchange price in U.S. dollars that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. Valuation techniques used to measure fair value maximize the use of observable inputs and minimize the use of unobservable inputs. The Company uses a fair value hierarchy with three levels of inputs, of which the first two are considered observable and the last unobservable, to measure fair value:

 

●

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

 

 

	●	Level 2 — Inputs, other than Level 1, that are observable, either directly or indirectly, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.
	●	Level 3 — Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.

 

The carrying amounts of financial instruments such as cash, accounts receivable, inventories, accounts payable and accrued liabilities, and legal settlements payable, approximate the related fair values due to the short-term maturities of these instruments. The carrying values of notes payable approximate their fair values due to the fact that the interest rates on these obligations are based on prevailing market interest rates.

 

The fair value of the derivative liabilities of $3,106,000 and $1,332,000 at September 30, 2020 and December 31, 2019, respectively, was valued using Level 2 inputs.

 

Derivative Financial Instruments

 

The Company evaluates its financial instruments to determine if such instruments are derivatives or contain features that qualify as embedded derivatives. For derivative financial instruments that are accounted for as liabilities, the derivative instrument is initially recorded at its fair value and is then re-valued at each reporting date, with changes in the fair value reported in the consolidated statements of operations. The classification of derivative instruments, including whether such instruments should be recorded as liabilities or as equity, is evaluated at the end of each reporting period. Derivative instrument liabilities are classified in the balance sheet as current or non-current based on whether or not net-cash settlement of the derivative instrument could be required within 12 months of the balance sheet date.

 

Recently Issued Accounting Pronouncements

 

In June 2016, the Financial Accounting Standards Board (“FASB”) issued ASU 2016-13, Measurement of Credit Losses on Financial Instruments. ASU 2016-13 requires entities to use a forward-looking approach based on current expected credit losses (“CECL”) to estimate credit losses on certain types of financial instruments, including trade receivables. This may result in the earlier recognition of allowances for losses. ASU 2016-13 is effective for the Company beginning January 1, 2023, and early adoption is permitted. The Company does not believe the potential impact of the new guidance and related codification improvements will be material to its financial position, results of operations and cash flows.

 

In August 2020, the FASB issued ASU No. 2020-06 (“ASU 2020-06”) “Debt—Debt with Conversion and Other Options (Subtopic 470-20) and Derivatives and Hedging—Contracts in Entity’s Own Equity (Subtopic 815-40): Accounting for Convertible Instruments and Contracts in an Entity’s Own Equity.” ASU 2020-06 will simplify the accounting for convertible instruments by reducing the number of accounting models for convertible debt instruments and convertible preferred stock. Limiting the accounting models will result in fewer embedded conversion features being separately recognized from the host contract as compared with current GAAP. Convertible instruments that continue to be subject to separation models are (1) those with embedded conversion features that are not clearly and closely related to the host contract, that meet the definition of a derivative, and that do not qualify for a scope exception from derivative accounting and (2) convertible debt instruments issued with substantial premiums for which the premiums are recorded as paid-in capital. ASU 2020-06 also amends the guidance for the derivatives scope exception for contracts in an entity’s own equity to reduce form-over-substance-based accounting conclusions. ASU 2020-06 will be effective for the Company beginning January 1, 2024. Early adoption is permitted, but no earlier than January 1, 2021, including interim periods within that year. Management is currently evaluating the effect of the adoption of ASU 2020-06 on the consolidated financial statements, but currently does not believe ASU 2020-06 will have a significant impact on the Company’s accounting for its convertible debt instruments. The effect will largely depend on the composition and terms of the financial instruments at the time of adoption.

 

Other recent accounting pronouncements issued by the FASB, its Emerging Issues Task Force, the American Institute of Certified Public Accountants, and the Securities and Exchange Commission did not or are not believed by management to have a material impact on the Company’s present or future financial statements.

 

 

NOTE 3 – CONTRACT OBLIGATION ACQUIRED FROM RELATED PARTIES

 

In May 2018, the Company entered into an acquisition agreement with the members, which in the aggregate, owned 100% of the membership interests in YLK, a related party. The major asset of YLK is a Cultivation Management Services Agreement (the “Management Agreement”) with an Arizona licensee that was entered into on January 5, 2018. During the year ended December 31, 2019, the Company determined the acquired assets were fully impaired, and recorded an impairment charge accordingly. The Company has a continuing obligation under the Management Agreement of $799,000 (net of discount of $51,000) as of December 31, 2019. As of September 30, 2020, the remaining Management Agreement obligation was $811,000 (net of discount of $39,000) and is reflected as a current liability in the accompanying condensed consolidated balance sheet. As of September 30, 2020, the Company is past due on its installment payments obligations under the Management Agreement.

 

NOTE 4 – NOTES PAYABLE TO RELATED PARTIES – PAST DUE

 

Notes payable to related parties consists of the following at September 30, 2020 and December 31, 2019:

 

		September 30, 2020				December 31, 2019
Notes payable to former officers/shareholders – past due (a)		$	600,000			$	600,000
Notes payable to related party – past due (b)			150,000				150,000
Notes payable to related parties – past due (c)			40,000				40,000
Total		$	790,000			$	790,000

 

	a.	On May 9, 2016, the Company entered into note payable agreements with Alan Lien and Alvin Hao, each a former officer and director, to borrow $300,000 under each individual note. Pursuant to the terms of each of these agreements, the Company borrowed $300,000 from each of Alan Lien and Alvin Hao. The notes accrue interest at a rate of 8% per annum, are unsecured and were due on or before May 31, 2018. The loans are currently past due. A total of $600,000 was due on the combined notes as of September 30, 2020 and December 31, 2019.
	b.	On May 8, 2019, the Company entered into a note agreement with the sister of Alvin Hao, a former officer and director, to borrow $150,000. The loan accrues interest at 8% per annum (12% on default), is unsecured and was due on November 8, 2019. The note is currently past due. A total of $150,000 was due on the loan as of September 30, 2020 and December 31, 2019.
	c.	The Company entered into note agreements with the parents of Alan Lien, a former officer and director. The loans accrue interest at 10% per annum, are unsecured and were due on or before December 31, 2016. The loans are currently past due. A total of $40,000 was due on the loans as of September 30, 2020 and December 31, 2019.

 

At December 31, 2019, accrued interest on the notes payable to related parties balance was $149,000 and included in accrued interest to related parties on the condensed consolidated balance sheet. During the nine months ended September 30, 2020, the Company added $53,000 of additional accrued interest, and made interest payments of $25,000, leaving an accrued interest on the notes payable to related parties balance of $177,000 at September 30, 2020.

 

NOTE 5 – LEASE PAYABLE

 

The Company leases its executive offices and warehouse space. The Company analyzes all leases at inception to determine if a right of use (“ROU”) asset and lease liability should be recognized. Leases with an initial term of 12 months or less are not included on the condensed consolidated balance sheets. The lease liability is measured at the present value of future lease payments as of the lease commencement date.

 

 

On March 6, 2018, the Company entered into a lease for its principal executive offices and warehouse located in Carson, California. The Company occupies a 17,640 square foot facility pursuant to a five-year lease ending on September 30, 2023, with an unaffiliated party, pursuant to which it pays $15,000 per month in rental charges. As required by ASC 842, the Company recorded an ROU asset and lease liability of $659,000 at January 1, 2019 for the net present value of future lease obligations related to the Carson property. As of December 31, 2019, the balance of the ROU asset amounted to $527,000 and the lease liability amounted to $556,000.

 

In January 2020, the Company vacated its office and warehouse in Carson and is currently trying to sublease the said property. The Company remains obligated under its Carson, California lease, until such time the landlord releases the Company from the lease agreement. As of December 31, 2019, the Company recorded an impairment charge related to the ROU asset amounting to $100,000, which reflected management’s best estimate of the cost to sublease the premises. As of the date of this report, the Company has not been released from the lease agreement, and no lease payments were made during the nine months ended September 30, 2020. During the nine months ended September 30, 2020, management revised its estimate and recorded an additional impairment charge to the ROU asset amounting to $82,000, which was charged to operating expenses in the consolidated statements of operations for the nine months ended September 30, 2020.

 

On January 1, 2020, the Company relocated its principal executive offices and warehouse to 1689-A Arrow Rt., Upland, California, 91786. The Upland, California lease is for a 2,974 square foot facility pursuant to a three-year lease with an independent party ending on January 31, 2023, pursuant to which it pays $2,800 per month in rental charges. On January 1, 2020, the Company recognized an operating lease ROU asset and lease liability of $89,000, related to the Upland, California operating lease. During the nine months ended September 30, 2020, the Company reflected amortization of the ROU assets of $19,000 related to its Upland, California operating lease, and recorded an impairment charge of $82,000 related to the abandoned Carson, California lease, resulting in an ROU asset balance of $415,000 as of September 30, 2020.

 

As of December 31, 2019, liabilities recorded under operating leases were $556,000. During the nine months ended September 30, 2020, the Company added $89,000 in lease liabilities related to its Upland, California operating lease, and made lease payments of $16,000 towards its operating lease liability. As of September 30, 2020, liabilities under operating leases amounted to $629,000, of which $259,000 were reflected as current due.

 

As of September 30, 2020, the weighted average remaining lease terms for operating lease are 2.96 years, and the weighted average discount rate for operating leases is 10%. Rent expense during the three and nine months ended September 30, 2020 and 2019 was $8,000 and $26,000, and $62,000 and $340,000, respectively.

 

NOTE 6 – LEGAL OBLIGATIONS PAYABLE – PAST DUE

 

As of December 31, 2019, the Company was obligated to pay $2,550,000, including accrued interest at rates ranging from 12% to 18% per annum, related to legal judgments. During the nine months ended September 30, 2020, $7,000 of additional settlement-related expenses and $224,000 of accrued interest were added, resulting in a legal obligations payable of $2,781,000, which, in September 2020, the Company negotiated the settlement of for total consideration of $411,000, and recorded a gain on the settlement of legal obligations of $2,370,000. $246,000 of the settlement was paid in September 2020, including $186,000 in cash, and the issuance of 4,333,333 shares of the Company’s common stock valued at $60,000. The balance of $165,000 was paid in cash in October 2020.

 

On September 25, 2018, Matthew Geschke (the “Plaintiff”) filed a breach of contract case against the Company in the San Diego Superior Court of San Diego, California. The Plaintiff claimed damages for breach of an employment contract when the Company terminated the Plaintiff’s employment agreement on February 22, 2018. On June 26, 2020, the Plaintiff was awarded a default judgment against the Company in the amount of $448,000.

 

 

NOTE 7 – LOANS PAYABLE

 

Notes payable consists of the following at September 30, 2020 and December 31, 2019:

 

		September 30, 2020				December 31, 2019
Notes payable to Celtic Bank – past due (a)		$	24,000			$	64,000
SBA Paycheck Protection Program loan (b)			205,000				-
SBA Economic Injury Disaster Loan (c)			150,000				-
Total loans payable		$	379,000			$	64,000
Loans payable, current portion			(24,000	)			(64,000	)
Loans payable, net of current portion			355,000				-

 

	a)	On May 21, 2019, the Company entered into a loan agreement with Celtic Bank in the principal amount of $150,000 with interest at 40.44% per annum and due on May 21, 2020. The loan was guaranteed by Alvin Hao, a former officer of the Company. A total of $64,000 was owed on the loan as of December 31, 2019. During the nine months ended September 30, 2020, the Company made principal payments of $40,000, leaving a total of $24,000 owed on the loan as of September 30, 2020. The loan is currently past due.
	b)	On May 7, 2020, the Company was granted a loan (the “PPP loan”) from Wells Fargo Bank in the aggregate amount of $205,000, pursuant to the Paycheck Protection Program (the “PPP”) under the CARES Act.
		The PPP loan agreement is dated May 8, 2020, matures on May 7, 2022, bears interest at a rate of 1% per annum, with the first six months of interest deferred, and is unsecured and guaranteed by the U.S. Small Business Administration (“SBA”). The loan term may be extended to May 7, 2025, if mutually agreed to by the Company and lender. The Company applied ASC 470, Debt, to account for the PPP loan. The PPP loan may be prepaid at any time prior to maturity with no prepayment penalties. Funds from the PPP loan may only be used for qualifying expenses as described in the CARES Act, including qualifying payroll costs, qualifying group health care benefits, qualifying rent and debt obligations, and qualifying utilities. The Company intends to use the entire loan amount for qualifying expenses. Under the terms of the PPP, certain amounts of the loan may be forgiven if they are used for qualifying expenses. The Company intends to apply for forgiveness of the PPP loan with respect to these qualifying expenses, however, it cannot assure that such forgiveness of any portion of the PPP loan will occur. As for the potential loan forgiveness, once the PPP loan is, in part or wholly, forgiven and a legal release is received, the liability would be reduced by the amount forgiven and a gain on extinguishment would be recorded. The terms of the PPP loan provide for customary events of default including, among other things, payment defaults, breach of representations and warranties, and insolvency events. The Company was in compliance with the terms of the PPP loan as of September 30, 2020.
	c)	On June 7, 2020, the Company obtained an Economic Injury Disaster Loan from the SBA in the amount of $150,000. Interest on the loan is at the rate of 3.75% per year, and all loan payments are deferred for twelve months, at which time the balance is payable in monthly installments of $731 over a 30-year term. The loan is secured by all the Company’s assets.

 

NOTE 8 – CONVERTIBLE SECURED NOTES PAYABLE TO RELATED PARTY

 

Secured notes payable to related party consists of the following as of September 30, 2020 and December 31, 2019:

 

		September 30, 2020				December 31, 2019
YA II PN, Ltd.		$	2,275,000			$	1,775,000
Less debt discount			(435,000	)			(178,000	)
Secured note payable, net		$	1,840,000			$	1,597,000

 

On May 10, 2018 and October 29, 2019, the Company issued convertible secured debentures (“Notes”) to YA II PN Ltd. (“YA II PN”) in the principal amounts of $1,500,000 and $275,000, respectively, with interest rates of 8% and 10%, respectively, which matured in June 2020 and April 2020, respectively. The notes are currently past due. The Company is in discussion with YA II PN to extend the maturity date of the Notes. The Notes provide a conversion right, in which the principal amount of the Note, together with any accrued but unpaid interest, could be converted into the Company’s common stock at a conversion price at 75% of the lowest volume weighted average price (VWAP) of the Company’s Common Stock during the 10 trading days immediately preceding the conversion date. As part of the issuance, the Company also granted YA II PN 5-year warrants, which were modified, to purchase a total of 13,000,000 shares of the Company at an exercise price of $0.05 per share, with expiration dates ranging from May 2024 to December 2024.

 

 

On February 13, 2020, the Company issued a note (the “2020 Note”) to YAII PN in the amount of $150,000. The 2020 Note bears interest at a rate of 10% per annum (15% on default) and has a maturity date of August 10, 2021. The Company received net proceeds of $125,000, net of closing costs of $25,000. The 2020 Note is secured by all the assets of the Company and its subsidiaries. The 2020 Note provides a conversion right, in which any portion of the principal amount of the 2020 Note, together with any accrued but unpaid interest, may be converted into the Company’s common stock at a conversion price equal to 75% of the lowest VWAP of the Company’s common stock during the ten (10) trading days immediately preceding the date of conversion, subject to adjustment. As such, the Company determined that the conversion feature created a derivative with a fair value of $140,000 at the date of issuance. The Company also granted YA II PN 5-year warrants to purchase a total of 3,000,000 shares of the Company at an exercise price of $0.05 per common share. The aggregate amount of the closing costs, and the fair value of the derivative liability, was $165,000, of which $150,000 was recorded as a valuation discount on the 2020 Note to be amortized over the life of the 2020 Note, and $15,000 was recorded as a financing cost during the nine months ended September 30, 2020.

 

On September 23, 2020, the Company issued a note (the “September 2020 Note”) to YAII PN in the amount of $350,000. The September 2020 Note bears interest at a rate of 10% per annum (15% on default) and has a maturity date of March 23, 2021. The Company received net proceeds of $340,000, net of closing costs of $10,000. The September 2020 Note is secured by all the assets of the Company and its subsidiaries. The September 2020 Note provides a conversion right, in which any portion of the principal amount of the 2020 Note, together with any accrued but unpaid interest, may be converted into the Company’s common stock at a conversion price equal to 75% of the lowest VWAP of the Company’s common stock during the ten (10) trading days immediately preceding the date of conversion, subject to adjustment. As such, the Company determined that the conversion feature created a derivative with a fair value of $370,000 at the date of issuance. The Company also granted YA II PN 5-year warrants to purchase a total of 7,000,000 shares of the Company at an exercise price of $0.05 per common share. The aggregate amount of the closing costs, and the fair value of the warrants and derivative liability, was $433,000, of which $350,000 was recorded as a valuation discount on the September 2020 Note to be amortized over the life of the September 2020 Note, and $83,000 was recorded as a financing cost during the nine months ended September 30, 2020.

 

The unamortized balance of the valuation discounts was $178,000 at December 31, 2019. During the nine months ended September 30, 2020, valuation discounts of $500,000 were added as discussed above, and amortization of valuation discount of $243,000 was recorded as an interest cost, leaving a $435,000 remaining unamortized balance of the valuation discount at September 30, 2020.

 

At December 31, 2019, accrued interest on the convertible secured notes payable to related parties of $202,000 was included in accrued interest to related parties on the condensed consolidated balance sheet. During the nine months ended September 30, 2020, interest of $29,000 was converted into common stock (see Note 10), and the Company added $121,000 of additional accrued interest, leaving an accrued interest to related parties balance of $294,000 at September 30, 2020.

 

NOTE 9 – DERIVATIVE LIABILITY

 

The FASB has issued authoritative guidance whereby instruments which do not have fixed settlement provisions are deemed to be derivative instruments. The conversion prices and the exercise prices of the warrants described in Note 8 were not a fixed amount because they were either subject to an adjustment based on the occurrence of future offerings or events or they were variable. Since the number of shares is not explicitly limited, the Company is unable to conclude that enough authorized and unissued shares are available to settle the conversion option. In accordance with the FASB authoritative guidance, the conversion features have been characterized as derivative liabilities to be re-measured at the end of every reporting period with the change in value reported in the statement of operations.

 

 

As of September 30, 2020, and December 31, 2019, the derivative liabilities were valued using a Black-Scholes Merton pricing model with the following assumptions:

 

		September 30, 2020				Issued During 2020				December 31, 2019
Exercise Price		$	0.012			$	0.009 - 0.025			$	0.050
Stock Price		$	0.009			$	0.011 - 0.024			$	0.010
Risk-free interest rate			0.110	%			0.011 - 1.46	%			1.55 – 1.60	%
Expected volatility			320	%			232-319	%			201-203	%
Expected life (in years)			1.0				1.0 – 1.5				0.3-0.5
Expected dividend yield			0	%			0	%			0	%
Fair Value: Conversion Feature		$	3,106,000			$	509,000			$	1,332,000

 

The risk-free interest rate was based on rates established by the Federal Reserve Bank. The Company uses the historical volatility of its common stock to estimate the future volatility for its common stock. The expected life of the conversion feature of the notes was based on the remaining term of the notes. The expected dividend yield was based on the fact that the Company has not customarily paid dividends in the past and does not expect to pay dividends in the future.

 

The balance of the derivative liability at December 31, 2019 was $1,332,000. During the nine months ended September 30, 2020, the Company recognized derivative liabilities of $509,000 upon issuance of a secured convertible notes (see Note 8), and recognized $1,265,000 as other expense, which represented the change in the fair value of the derivative from the respective prior period.

 

NOTE 10 – SHAREHOLDERS’ EQUITY

 

Common Shares Issued on Conversion of Convertible Note Payable

 

During the nine months ended September 30, 2020, the Company was notified by YA II PN (see Note 8) in writing of their election to convert $29,000 of interest accrued into 2,287,066 shares of the Company’s common at $0.0127 per share.

 

Common Shares Issued to Directors

 

The Company appointed certain directors and issued shares as part of their director compensation agreements. During the nine months ended September 30, 2020, the Company issued an aggregate of 4,664,190 shares of common stock, with a fair value of $72,000 at date of grant, which was recognized as compensation cost.

 

Common Shares Issued for Legal Judgments

 

During the nine months ended September 30, 2020, the Company issued an aggregate of 4,333,333 shares of common stock, with a fair value of $60,000 at the date of grant, as settlement of certain legal judgments (see Note 6).

 

Summary of Stock Options

 

A summary of stock options for the nine months ended September 30, 2020, is as follows:

 

						Weighted
		Number				Average
		of				Exercise
		Options				Price
Balance outstanding, December 31, 2019			1,948,300				0.35
Options granted			6,145,833				0.01
Options exercised			-				-
Options expired or forfeited			(15,000	)			(0.69	)
Balance outstanding, September 30, 2020			8,079,133			$	0.09
Balance exercisable, September 30, 2020			8,079,133			$	0.09

 

 

On October 31, 2019, the Board of Directors of the Company reappointed Ms. Tiffany Davis as Chief Executive Officer, Chief Financial Officer and as a director, effective immediately. In connection with the appointment of Ms. Davis, Ms. Davis is entitled to receive stock options equivalent to $25,000 of common shares per quarter at the then closing market price on the last trading day at the end of each calendar quarter. Accordingly, Ms. Davis was granted 2,500,000 stock options at the closing market price of $0.01 on March 31, 2020, 1,562,500 stock options at the closing market price of $0.016 on June 30, 2020, and 2,083,333 stock options at the closing market price of $0.012 on September 30, 2020. The fair value of the 6,145,833 stock options granted was determined to be $69,000, of which $23,000 and $69,000 was recorded to stock-based compensation expense during the three and nine months ended September 30, 2020, respectively.

 

Information relating to outstanding options at September 30, 2020, summarized by exercise price, is as follows:

 

				Outstanding												Exercisable
												Weighted								Weighted
Exercise												Average								Average
Price Per Share				Shares				Life (Years)				Exercise Price				Shares				Exercise Price
$	0.01 – 0.03				6,979,133				4.58			$	0.014				6,979,133			$	0.014
$	0.46				100,000				3.19			$	0.460				100,000			$	0.460
$	0.60				1,000,000				2.36			$	0.600				1,000,000			$	0.600
					8,079,133				2.70			$	0.092				8,079,133			$	0.092

 

As of September 30, 2020, the Company has no outstanding unvested options with future compensation costs. In addition, there will be future compensation related to the options to be awarded to Ms. Davis under her employment agreement discussed above. The weighted-average remaining contractual life of options outstanding and exercisable at September 30, 2020 was 2.70 years. Both the outstanding and exercisable stock options had an intrinsic value of $5,000 at September 30, 2020.

 

Summary of Warrants

 

A summary of warrants for the nine months ended September 30, 2020, is as follows:

 

						Weighted
		Number				Average
		of				Exercise
		Warrants				Price
Balance outstanding, December 31, 2019			18,283,140				0.06
Warrants granted			10,000,000				0.05
Warrants exercised			-				-
Warrants expired or forfeited			-				-
Balance outstanding, September 30, 2020			28,283,140			$	0.05
Balance exercisable, September 30, 2020			28,283,140			$	0.05

 

 

Information relating to outstanding warrants at September 30, 2020, summarized by exercise price, is as follows:

 

				Outstanding												Exercisable
												Weighted								Weighted
Exercise												Average								Average
Price Per Share				Shares				Life (Years)				Exercise Price				Shares				Exercise Price
$	0.01				5,000,000				2.61			$	0.01				5,000,000			$	0.01
$	0.05				23,000,000				4.24			$	0.05				23,000,000			$	0.05
$	1.10				283,140				2.05			$	1.10				283,140			$	1.10
					28,283,140				3.93			$	0.05				28,283,140			$	0.05

 

During the nine months ended September 30, 2020, the Company issued five-year warrants to purchase 10,000,000 shares of common stock at an exercise price of $0.05 as part of a secured convertible promissory note (see Note 8).

 

The weighted-average remaining contractual life of warrants outstanding and exercisable at September 30, 2020 was 3.93 years. Both the outstanding and exercisable warrants had an intrinsic value of $10,000 at September 30, 2020.

 

NOTE 11 – COMMITMENTS AND CONTINGENCIES

 

Technology License Agreement

 

The Company entered into a technology license agreement with a third-party vendor for consulting services. Under the agreement, the Company will pay the vendor a minimum consulting amount of $100,000 per year, plus a royalty of 7% of all net sales of the vendor’s products above $1,429,000 per calendar year. For the three and nine months ended September 30, 2020 $25,000 and $75,000, respectively, and for each of the three and nine months ended September 30, 2019, $25,000 and $75,000, respectively, was recorded as research and development expense under the agreement on the condensed consolidated statements of operations related to the minimum annual fee. For each of nine months ended September 30, 2020 and 2019, no royalty was recorded as cost of goods sold on the Condensed Consolidated Statements of Operations. A total of $314,000 and $239,000 was owed under the amended agreement at September 30, 2020 and December 31, 2019, respectively, and is included in accounts payable and accrued liabilities on the accompanying condensed consolidated balance sheets.

 

Litigation

 

On September 25, 2018, Matthew Geschke (the “Plaintiff”) filed a breach of contract case against the Company in the San Diego Superior Court of San Diego, California. The Plaintiff claimed damages of $335,000 for breach of an employment contract when the Company terminated the Plaintiff’s employment agreement on February 22, 2018. On June 26, 2020, the Plaintiff was awarded a default judgment against the Company in the amount of $448,000 (see Note 6).

 

 

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

 

This Management’s Discussion and Analysis of Financial Condition and Results of Operations includes a number of forward-looking statements that reflect Management’s current views with respect to future events and financial performance. You can identify these statements by forward-looking words such as “may,” “will,” “expect,” “anticipate,” “believe,” “estimate” and “continue,” or similar words. Those statements include statements regarding the intent, belief or current expectations of us and members of our management team as well as the assumptions on which such statements are based. Prospective investors are cautioned that any such forward-looking statements are not guarantees of future performance and involve risk and uncertainties, and that actual results may differ materially from those contemplated by such forward-looking statements.

 

Readers are urged to carefully review and consider the various disclosures made by us in this report and in our other reports filed with the Securities and Exchange Commission. Important factors currently known to Management could cause actual results to differ materially from those in forward-looking statements. We undertake no obligation to update or revise forward-looking statements to reflect changed assumptions, the occurrence of unanticipated events or changes in the future operating results over time. We believe that our assumptions are based upon reasonable data derived from and known about our business and operations. No assurances are made that actual results of operations or the results of our future activities will not differ materially from our assumptions. Factors that could cause differences include, but are not limited to, expected market demand for our products, fluctuations in pricing for materials, and competition.

 

Business Overview

 

We are focused on the research, design, development and manufacturing of advanced, energy efficient indoor horticulture lighting, plant nutrient products, and ancillary equipment. Our vision is to apply the latest advances in high efficiency lighting and controls technology as well as effective manufacturing techniques to deliver highly differentiated lighting and nutrient products with clear benefits at competitive prices to the greenhouse and indoor horticulture markets.

 

Our subsidiary, Solis Tek, Inc., a California corporation, was formed in June of 2010. Its operations consist of designing, developing and sourcing of a line of Solis Tek Digital Ballasts intended for use in high intensity lighting systems used for horticulture. An electrical ballast is a device intended to limit the amount of current in an electric circuit. A familiar and widely used example is the inductive ballast used in fluorescent lamps, which limits the current through the tube, which would otherwise rise to destructive levels due to the tube’s negative resistance characteristic. Since the commencement of operations, our product line has evolved from digital ballasts to a line of lighting products including a line of specialty ballasts ranging from 400 watts to 1,000 watts with various features, our lamp products, a line of reflectors, high intensity lighting accessories and a new line of LED lighting technologies.

 

Previously, we attempted to expand our operations in cannabis cultivation and processing management services. In 2018, we acquired YLK Partners AZ, LLC, or YLK Partners, an Arizona-based company to provide turn-key services for the management, administration, and operation of a medical marijuana cultivation and processing facility. YLK had a cultivation management services agreement with an Arizona licensee. In 2019, we purchased real property in Phoenix, Arizona for $3,500,000, which property held the approval and authorization for a Conditional Use Permit, which allows the property to be used for the operation of a cultivation and infusion facility, allowing for the cultivation, harvesting, preparation, packaging and storing of medical cannabis, as well as extraction, refinement, infusion, production, preparation, packaging, and storage of manufactured and derivative oils, waxes, concentrates, edible and non-edible products that contain cannabis. Later in 2019, we conveyed the property to our lender in full settlement of the outstanding amounts we borrowed to acquire the property. For various reasons, we decided to abandon the expanded business lines and to re-focus on our core business of lights and nutrients.

 

 

Known Trends and Uncertainties

 

In March 2020, the World Health Organization declared the outbreak of COVID-19 a global pandemic. The responses by federal, state and local governments to restrict public gatherings and travel rapidly grew to include stay-at-home orders, school closures and mandatory restrictions on non-essential businesses and services that has adversely affected workforces, economies, and financial markets resulting in a significant economic downturn. In particular, on March 19, 2020, California Governor Gavin Newsom issued an executive order requiring all California residents to stay home, making it the first state to impose that strict mandate on all residents to counteract a looming surge of new infections. The Company’s executive offices are located in Upland, California. While we currently believe we are an “essential” business, we have been following the recommendations of local health authorities to minimize exposure risk for our employees, including temporary closures of our offices and having employees work remotely to the extent possible. The order, which has subsequently been modified to provide for a gradual re-opening of businesses and travel, is to remain in place until further notice. While California is currently in early stage 2 (out of 4 stages) of re-opening, there is no known timeframe as to when California may move to stage 3, and there remains a risk that California may regress.

 

While this disruption is currently expected to be temporary, there is considerable uncertainty around the duration. We are actively monitoring the COVID-19 situation and its impact in the markets we serve. We are taking all precautionary measures as directed by health authorities and local and national governments. Due to continuing uncertainties regarding the ultimate scope and trajectory of COVID-19’s spread and evolution, it is impossible to predict the total impact that the pandemic will have on our business. If public and private entities continue to implement restrictive measures, the material adverse effect on our business, results of operations, financial condition and cash flows could persist.

 

On May 7, 2020, we were granted a loan (the “PPP loan”) from Wells Fargo Bank in the aggregate amount of $205,000, pursuant to the Paycheck Protection Program (the “PPP”) under the CARES Act. The PPP loan agreement is dated May 8, 2020, matures on May 7, 2022, bears interest at a rate of 1% per annum, with the first six months of interest deferred, and is unsecured and guaranteed by the U.S. Small Business Administration. The loan term may be extended to May 7, 2025, if mutually agreed to by us and lender. We applied ASC 470, Debt, to account for the PPP loan. The PPP loan may be prepaid at any time prior to maturity with no prepayment penalties. Funds from the PPP loan may only be used for qualifying expenses as described in the CARES Act, including qualifying payroll costs, qualifying group health care benefits, qualifying rent and debt obligations, and qualifying utilities. We intend to use the entire loan amount for qualifying expenses. Under the terms of the PPP, certain amounts of the loan may be forgiven if they are used for qualifying expenses. We intend to apply for forgiveness of the PPP loan with respect to these qualifying expenses, however, we cannot assure that such forgiveness of any portion of the PPP loan will occur. As for the potential loan forgiveness, once the PPP loan is, in part or wholly, forgiven and a legal release is received, the liability would be reduced by the amount forgiven and a gain on extinguishment would be recorded. The terms of the PPP loan provide for customary events of default including, among other things, payment defaults, breach of representations and warranties, and insolvency events. We were in compliance with the terms of the PPP loan as of September 30, 2020.

 

On June 7, 2020, we obtained an Economic Injury Disaster Loan from the United States Small Business Administration in the amount of $150,000. Interest on the loan is at the rate of 3.75% per year, and all loan payments are deferred for twelve months, at which time the balance is payable in monthly installments of $731 over a 30-year term. The loan is secured by all of our assets.

 

We continue to review and consider any available potential benefit under the CARES Act for which we qualify. We cannot predict the manner in which such benefits or any of the other benefits described herein will be allocated or administered and we cannot assure you that we will be able to access such benefits in a timely manner or at all. If the U.S. government or any other governmental authority agrees to provide such aid under the CARES Act or any other crisis relief assistance it may impose certain requirements on the recipients of the aid, including restrictions on executive officer compensation, dividends, prepayment of debt, limitations on debt and other similar restrictions that will apply for a period of time after the aid is repaid or redeemed in full.

 

 

Results of Operations

 

Results of operations for the three months ended September 30, 2020 compared to the three months ended September 30, 2019.

 

Revenue and Cost of Goods Sold

 

Revenue for the three months ended September 30, 2020 and 2019 was $397,000 and $475,000, respectively, a decrease of $78,000, or 16%. The decrease was due to two significant factors during three months ended September 30, 2020, as compared to the prior year period. Those factors were: 1) a failed expansion of operations into cannabis cultivation and processing management services, which diverted resources and management attention; and 2) stagnation of the cannabis industry in terms of new markets and granting of new cultivation licenses, which resulted in few new companies obtaining licenses to legally grow cannabis, which ultimately resulted in a lack of orders for our lights.

 

Cost of sales for the three months ended September 30, 2020 and 2019 was $248,000 and $158,000, respectively. Gross profit for the three months ended September 30, 2020 and 2019, was $149,000 and $317,000, respectively. As a percentage of revenue, gross profit for the three months ended September 30, 2020 was 38%, compared to 67% for the three months ended September 30, 2019. The decrease in gross profit and our gross margin percentage was primarily due to our decrease in reserves for inventory obsolescence and change in product mix sold.

 

Selling, General and Administrative Expenses

 

Selling, general and administrative (“SG&A”) expenses for the three months ended September 30, 2020 and 2019 were $218,000 and $829,000, respectively, a decrease of $611,000, or 74%. Our SG&A expenses decreased primarily due to reductions in the number of employees, benefits, and professional fees.

 

Research and Development Expenses

 

Research and development (“R&D”) expenses for the three months ended September 30, 2020 and 2019 was $25,000 and $37,000, respectively, a decrease of $12,000, or 32%. The decrease in R&D expenses was primarily due to decreased royalty expense.

 

Other Income and Expenses

 

Other income for the three months ended September 30, 2020 was $2,501,000, as compared to other income of $540,000 for the three months ended September 30, 2019 The increase was due to the gain on settlement of legal judgments of $2,417,000, offset by financing costs of $83,000, neither of which occurred in the prior year period, offset by the difference in the change in fair value of derivative liability of $384,000, and a decrease in interest expense of $10,000.

 

Net Income (Loss)

 

Our net income for the three months ended September 30, 2020 was $2,407,000, as compared to a net loss $9,000 for the three months ended September 30, 2019. The increase in net income was due primarily to the gain on settlement of legal judgments, and the decrease in loss from operations.

 

Results of operations for the nine months ended September 30, 2020 compared to the nine months ended September 30, 2019.

 

Revenue and Cost of Goods Sold

 

Revenue for the nine months ended September 30, 2020 and 2019 was $980,000 and $1,895,000, respectively, a decrease of $915,000, or 48%. The decrease was due to two significant factors during the nine months ended September 30, 2020, as compared to the prior year period. Those factors were: 1) a failed expansion of operations into cannabis cultivation and processing management services, which diverted resources and management attention; and 2) stagnation of the cannabis industry in terms of new markets and granting of new cultivation licenses, which resulted in few new companies obtaining licenses to legally grow cannabis, which ultimately resulted in a lack of orders for our lights.

 

 

Cost of sales for the nine months ended September 30, 2020 and 2019, was $577,000 and $922,000, respectively. Gross profit for the nine months ended September 30, 2020 and 2019, was $403,000 and $973,000, respectively. As a percentage of revenue, gross profit for the nine months ended September 30, 2020 was 41%, compared to 51% for the nine months ended September 30, 2019. The decrease in gross profit and our gross margin percentage was primarily due to our decrease in reserves for inventory obsolescence and change in product mix sold.

 

Selling, General and Administrative Expenses

 

SG&A expenses for the nine months ended September 30, 2020 and 2019 were $839,000 and $3,096,000, respectively, a decrease of $2,257,000, or 73%. Our SG&A expenses decreased primarily due to reductions in the number of employees, benefits, and professional fees.

 

Research and Development Expenses

 

R&D expenses for the nine months ended September 30, 2020 and 2019 were $75,000 and $191,000, respectively, a decrease of $116,000, or 61%. The decrease in R&D expenses was primarily due to decreased royalty expense.

 

Legal Judgment

 

On September 25, 2018, Matthew Geschke (the “Plaintiff”) filed a breach of contract case against us in the San Diego Superior Court of San Diego, California. The Plaintiff claimed damages for breach of an employment contract when we terminated the Plaintiff’s employment agreement on February 22, 2018. On June 26, 2020, the Plaintiff was awarded a default judgment against us in the amount of $448,000.

 

Impairment of Right of Use (ROU”) Asset

 

Impairment of ROU asset for the nine months ended September 30, 2020 was $82,000. In March 2020, we determined that our ROU asset was impaired and recorded an impairment charge accordingly. (See Note 5 to the accompanying condensed consolidated financial statements). No similar activity occurred during the prior year period.

 

Loss on Abandonment of Leasehold Improvements

 

Loss on abandonment of leasehold improvement for the nine months ended September 30, 2019 was $218,000. In February 2019, we terminated our Arizona facility lease, thereby abandoning $218,000 of leasehold improvements during the nine months ended September 30, 2019. No similar activity occurred during the current year period.

 

Impairment of Intangible Assets

 

Impairment of intangible assets for the nine months ended September 30, 2019 was $1,139,000. In June 2019, we determined that our intangible assets were impaired and recorded an impairment charge accordingly. No similar activity occurred during the current year period.

 

Other Income and Expenses

 

Other income for the nine months ended September 30, 2020 was $390,000, as compared to other income of $1,590,000 for the nine months ended September 30, 2019. The decrease was due to the gain on settlement of legal judgments of $2,417,000 during the nine months ended September 30, 2020, which did not occur in the prior year period, offset by difference in the change in fair value of derivative liability of $3,437,000, increased interest expense of $211,000 due to our increased debt levels, and the decrease in financing costs of $31,000.

 

 

Net Loss

 

Our net loss for the nine months ended September 30, 2020 and 2019 was $651,000 and $2,244,000, respectively. The decrease in net loss was due primarily to the change in other income and expenses, and the decrease in loss from operations.

 

Liquidity and Capital Resources

 

Cash and Liquidity

 

Liquidity is the ability of a company to generate funds to support its current and future operations, satisfy its obligations, and otherwise operate on an ongoing basis. Significant factors in the management of liquidity are funds generated by operations, levels of accounts receivable and accounts payable and capital expenditures.

 

Cash Flows Used in Operating Activities

 

During the nine months ended September 30, 2020 and 2019, we used cash in operating activities of $335,000 and $857,000, respectively. During the nine months ended September 30, 2020, cash was primarily used to fund our net loss of $651,000, partially offset by non-cash related items such as the settlement of legal judgments, impairment of ROU asset, financing costs, and the change in the fair value of derivative liabilities. Non-cash items during the nine months ended September 30, 2020 in aggregate were $645,000. The remaining changes were due to a $203,000 decrease in inventory accounts payable and accrued expenses, and a $122,000 change in our remaining working capital accounts.

 

Cash Flows Used in Investing Activities

 

During the nine months ended September 30, 2020 and 2019, we used $0 and $218,000, respectively, in cash from investing activities to purchase property and equipment.

 

Cash Flows Provided by Financing Activities

 

During the nine months ended September 30, 2020 and 2019, we generated cash from financing activities of $780,000 and $254,000, respectively. During the nine months ended September 30, 2020, we received proceeds of $465,000, net of fees of $35,000, from a secured convertible notes payable and $355,000 from loans payable, offset by $40,000 of payments on our notes payable to related parties. During the nine months ended September 30, 2019, we received $150,000 from the issuance of a note payable to related party and $150,000 from a loan, and we made payments on our loans payable totaling $46,000.

 

The accompanying condensed consolidated financial statements have been prepared on a going concern basis, which contemplates the realization of assets and the settlement of liabilities and commitments in the normal course of business. As reflected in the accompanying condensed consolidated financial statements, during the nine months ended September 30, 2020, we incurred a net loss of $651,000 and used cash in operations of $335,000 and had a shareholders’ deficit of $8,992,000 at September 30, 2020. These factors raise substantial doubt about our ability to continue as a going concern within one year after the date of the financial statements being issued. Our ability to continue as a going concern is dependent upon our ability to raise additional funds and implement our business plan. The financial statements do not include any adjustments that might be necessary if we are unable to continue as a going concern. In addition, our independent registered public accounting firm, in its report on our December 31, 2019 financial statements, has raised substantial doubt about our ability to continue as a going concern.

 

At September 30, 2020, we had cash on hand in the amount of $549,000. Management estimates that the current funds on hand will be sufficient to continue operations through March 2021. Our continuation as a going concern is dependent upon our ability to obtain necessary debt or equity financing to continue operations until we begin generating positive cash flow. No assurance can be given that any future financing will be available or, if available, that it will be on terms that are satisfactory to us. Even if we are able to obtain additional financing, it may contain undue restrictions on our operations, in the case of debt financing or cause substantial dilution for our shareholders, in case of equity financing.

 

 

Historically, we have financed our operations primarily through private sales of equity and convertible debt, a line of credit, loans from a third party financial institutions, related parties, and operations. We anticipate that our primary capital source will be from the issuance of notes payable or the proceeds from the sale of our common stock. However, we may not generate sufficient revenues from product sales in the future to achieve profitable operations. If we are not able to achieve profitable operations at some point in the future, we may have insufficient working capital to maintain our operations as we presently intend to conduct them or to fund our expansion, marketing, and product development plans. There can be no assurance that we will be able to obtain such financing on acceptable terms, or at all.

 

Notes Payable to Related Parties

 

On May 9, 2016, we entered into note payable agreements with Alan Lien and Alvin Hao, former officers and directors, to borrow $300,000 under each individual note. Pursuant to the terms of each of these agreements, we borrowed $300,000 from each of Alan Lien and Alvin Hao. The notes accrue interest at a rate of 8% per annum, are unsecured and were due on or before May 31, 2018. The notes are currently past due. A total of $600,000 was due on the combined notes at September 30, 2020 and December 31, 2019.

 

On May 8, 2019, we entered into a note agreement with the sister of Alvin Hao, a former officer and director, to borrow $150,000. The loan accrues interest at 8% per annum, are unsecured and due on November 8, 2019. The note is currently past due. A total of $150,000 was due on the note at September 30, 2020 and December 31, 2019.

 

We entered into note agreements with the parents of Alan Lien, a former officer and director. The loans accrue interest at 10% per annum, are unsecured and were due on or before December 31, 2016. The loans are currently past due. A total of $40,000 was due on the loans at each of September 30, 2020 and December 31, 2019.

 

Secured Convertible Notes Payable

 

On May 10, 2018, we issued a secured debenture (the “2018 Note”) to YA II PN in the principal amount of $1,500,000 with interest at 8% per annum (18% on default) and due on June 30, 2020, and provide a conversion right, in which the principal amount of the 2018 Note, together with any accrued but unpaid interest, could be converted into our common stock at a conversion price at 75% of the lowest volume weighted average price (VWAP) of our common stock during the 10 trading days immediately preceding the conversion date. A total of $1,758,000, including accrued interest, was due on the 2018 Note as of September 30, 2020. The 2018 Note is past due.

 

On October 29, 2019, we issued a convertible secured debenture (the “2019 Note”) to YA II PN in the principal amount of $275,000 with interest at 10% per annum (15% on default) and due on April 29, 2020. The 2019 Note provides a conversion right, in which the principal amount of the Note, together with any accrued but unpaid interest, could be converted into our common stock at a conversion price at 75% of the lowest volume weighted average price (VWAP) of our common stock during the 10 trading days immediately preceding the conversion date. A total of $300,000, including accrued interest, was due on the 2019 Note as of September 30, 2020. The 2019 Note is past due.

 

On February 13, 2020, we issued a secured convertible debenture (the “2020 Note”) in the principal amount of $150,000 with interest at 10% per annum (15% on default) and due on August 10, 2021. The 2020 Note provides a conversion right, in which any portion of the principal amount of the 2020 Note, together with any accrued but unpaid interest, may be converted into our common stock at a conversion price equal to 75% of the lowest VWAP of our common stock during the ten (10) trading days immediately preceding the date of conversion, subject to adjustment. A total of $160,000, including accrued interest, was due on the 2020 Note as of September 30, 2020.

 

On September 23, 2020, we issued a secured convertible debenture (the “September 2020 Note”) in the principal amount of $350,000 with interest at 10% per annum (15% on default) and due on March 23, 2021. The September 2020 Note provides a conversion right, in which any portion of the principal amount of the September 2020 Note, together with any accrued but unpaid interest, may be converted into our common stock at a conversion price equal to 75% of the lowest VWAP of our common stock during the ten (10) trading days immediately preceding the date of conversion, subject to adjustment. A total of $351,000, including accrued interest, was due on the September 2020 Note as of September 30, 2020.

 

 

Term Loans

 

On May 21, 2019, we entered into a loan agreement with Celtic Bank in the principal amount of $150,000 (the “Celtic Loan”) with interest at 40.44% per annum and due on May 21, 2020. The loan was guaranteed by Alvin Hao, one of our former officers. We have made principal payment of $126,000, leaving a total of $24,000 due on the term loan as of September 30, 2020. The Celtic Loan is past due.

 

On May 8, 2020, we obtained a Paycheck Protection Program loan in the amount of $205,000 pursuant to the Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”). Interest on the loan is at the rate of 1% per year, and all loan payments are deferred for six months, at which time the balance is payable in 18 monthly installments if not forgiven in accordance with the CARES Act and the terms of the promissory note we executed in connection with the loan.

 

On June 7, 2020, we obtained an Economic Injury Disaster Loan from the United States Small Business Administration in the amount of $150,000. Interest on the loan is at the rate of 3.75% per year, and all loan payments are deferred for twelve months, at which time the balance is payable in monthly installments of $731 over a 30 year term. The loan is secured by all of our assets.

 

Critical Accounting Policies

 

The Securities and Exchange Commission (“SEC”) defines “critical accounting policies” as those that require application of management’s most difficult, subjective or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain and may change in subsequent periods. Not all of the accounting policies require management to make difficult, subjective or complex judgments or estimates. However, the following policies could be deemed to be critical within the SEC definition.

 

Allowance for Doubtful Accounts

 

The allowance for doubtful accounts is based on our assessment of the collectability of customer accounts. We regularly review the allowance by considering factors such as historical experience, the age of the accounts receivable balances, credit quality, economic conditions that may affect a customer’s ability to pay and expected default frequency rates. Trade receivables are written off at the point when they are considered uncollectible.

 

Inventories

 

We provide inventory reserves based on excess and obsolete inventories determined primarily by future demand forecasts. The write down amount is measured as the difference between the cost of the inventory and market based upon assumptions about future demand and charged to the provision for inventory, which is a component of cost of sales. At the point of the loss recognition, a new, lower cost basis for that inventory is established, and subsequent changes in facts and circumstances do not result in the restoration or increase in that newly established cost basis.

 

Recent Accounting Pronouncements

 

See Note 2 of the condensed consolidated financial statements for management’s discussion of recent accounting pronouncements.

 

Off-Balance Sheet Arrangements

 

We do not have any off balance sheet arrangements that are reasonably likely to have a current or future effect on our financial condition, revenues, and results of operations, liquidity or capital expenditures.

 

Item 3. Quantitative and Qualitative Disclosures about Market Risk.

 

Not required under Regulation S-K for “smaller reporting companies.”

 

 

Item 4. Controls and Procedures.

 

Evaluation of disclosure controls and procedures.

 

Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of our disclosure controls and procedures pursuant to Rule 13a-15 under the Securities Exchange Act of 1934 as of the end of the period covered by this Quarterly Report on Form 10-Q. In designing and evaluating the disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives. In addition, the design of disclosure controls and procedures must reflect the fact that there are resource constraints and that management is required to apply its judgment in evaluating the benefits of possible controls and procedures relative to their costs.

 

Based on management’s evaluation, we concluded that, as of the date of this report, our remediation efforts continue related to each of the material weaknesses that we have identified in our internal control over financial reporting, and additional time and resources will be required in order to fully address these material weaknesses. We have not been able to complete all actions necessary and test the remediated controls in a manner that would enable us to conclude that such controls are effective. We are committed to implementing the necessary controls to remediate the material weaknesses described below as our resources permit. These material weaknesses will not be considered remediated until (1) the new processes are designed, appropriately controlled and implemented for a sufficient period of time and (2) we have sufficient evidence that the new processes and related controls are operating effectively. The following material weaknesses in our internal control over financial reporting were identified by management as of September 30, 2020:

 

Ineffective Control Environment. The Company did not maintain an effective control environment, which is the foundation necessary for effective internal control over financial reporting. Specifically, the Company (i) did not maintain a functioning independent audit committee; (ii) did not have its Board of Directors review and approve significant transactions; (iii) had an insufficient number of personnel appropriately qualified to perform control design, execution and monitoring activities; (iv) had an insufficient number of personnel with an appropriate level of U.S. GAAP knowledge and experience and ongoing training in the application of U.S. GAAP and SEC disclosure requirements commensurate with the Company’s financial reporting requirements; (v) had inadequate segregation of duties consistent with control objectives; and (vi) lack of written documentation of the Company’s key internal control policies and procedures over financial reporting. The Company is required under Section 404 of the Sarbanes-Oxley Act to have written documentation of key internal controls over financial reporting. The Company did not formally document policies and controls to enable management and other personnel to understand and carry out their internal control responsibilities including the lack of closing checklists, budget-to-actual analyses, balance sheet variation analysis, and pro-forma financial statements. Additionally, the Company did not have an adequate process in place to complete its testing and assessment of the design and operating effectiveness of internal control over financial reporting in a timely manner;

 

Ineffective controls over financial statement close and reporting process. The Company did not maintain effective controls over its financial statement close and reporting process. Specifically, the Company: (i) had insufficient preparation and review procedures for disclosures accompanying the Company’s financial statements; and (ii) did not provide reasonable assurance that accounts were complete and accurate and agreed to detailed support and that reconciliations of accounts were properly performed, reviewed and approved; and

 

Insufficient segregation of duties in our finance and accounting functions due to limited personnel. We do not have sufficient segregation of duties within accounting functions. During the quarter ended September 30, 2020, we had limited personnel that performed nearly all aspects of our financial reporting process, including, but not limited to, access to the underlying accounting records and systems, the ability to post and record journal entries and responsibility for the preparation of the financial statements. Due to the fact that these duties were often performed by the same person, this creates a lack of review over the financial reporting process that would likely result in a failure to detect errors in spreadsheets, calculations, or assumptions used to compile the financial statements and related disclosures as filed with the SEC. These control deficiencies could result in a material misstatement to our interim or annual financial statements that would not be prevented or detected.

 

Changes in internal control over financial reporting.

 

There were no changes in our internal control over financial reporting that occurred during the quarter ended September 30, 2020 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

 

PART II

 

Item 1. Legal Proceedings.

 

For information that updates the disclosures set forth under Part I, Item 3, “Legal Proceedings” in our 2019 Annual Report, refer to Note 6, Legal Settlements Payable – Past Due, and Note 12, Subsequent Events, to the Condensed Consolidated Financial Statements contained in Part I, Item 1 of this report, which are incorporated herein by reference.

 

Item 1A. Risk Factors.

 

Not required under Regulation S-K for “smaller reporting companies.”

 

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

 

During the quarter ended September 30, 2020, we issued an aggregate of 2,032,900 shares of our common stock to directors as fees for serving on our board of directors. The shares had an aggregate value of $20,000.

 

In September 2020, we issued 4,333,333 shares of our common stock in connection with the settlement of outstanding legal judgments. The shares had a value of $60,000.

 

Item 3. Defaults Upon Senior Securities.

 

For information regarding senior securities that are currently in default, please refer to Note 8, Convertible Secured Note Payable to Related Party, to the Condensed Consolidated Financial Statements contained in Part I, Item 1 of this report, which is incorporated herein by reference.

 

Item 4. Mine Safety Disclosures

 

Not applicable.

 

Item 5. Other Information.

 

None.

 

Item 6. Exhibits.

 

Exhibit Number		Description of Exhibit
3.1		Amended and Restated Articles of Incorporation of the Company, dated August 31, 2015. Incorporated by reference to the Current Report on Form 8-K filed on September 2, 2015 as Exhibit 3.2 thereto.
3.2		Bylaws. Incorporated by reference to Exhibit 3.2 of the Company’s Registration Statement on Form SB-2 filed with the Securities and Exchange Commission on June 28, 2007.
3.3		Agreement of Merger between the Company, Cinjet, Inc., and CJA Acquisition Corp., dated June 23, 2015. Incorporated by reference to Exhibit 3.4 of the Company’s Registration Statement on Form S-1 filed with the Securities and Exchange Commission on December 20, 2017.
3.4		Certificate of Designation of Series A Preferred Stock, dated October 20, 2017. Agreement of Merger between the Company, Cinjet, Inc., and CJA Acquisition Corp., dated June 23, 2015. Incorporated by reference to Exhibit 3.4 of the Company’s Registration Statement on Form S-1 filed with the Securities and Exchange Commission on August 3, 2018.

 

 

3.5		Articles of Merger between Solis Tek Inc. and Generation Alpha, Inc., effective September 25, 2018. Incorporated by reference to Exhibit 3.01 of the Current Report on Form 8-K filed with the Securities and Exchange Commission on September 26, 2018.
3.6		Agreement and Plan of Merger, by and between Solis Tek Inc. and Generation Alpha, Inc., effective September 25, 2018. Incorporated by reference to Exhibit 3.01 of the Current Report on Form 8-K filed with the Securities and Exchange Commission on September 26, 2018.
10.1		Form of Securities Purchase Agreement, dated September 23, 2020.  Incorporated by reference to Exhibit 10.1 of the Current Report on Form 8-K filed with the Securities and Exchange Commission on October 6, 2020.
10.2		Form of Secured Convertible Debenture, dated September 23, 2020.  Incorporated by reference to Exhibit 10.2 of the Current Report on Form 8-K filed with the Securities and Exchange Commission on October 6, 2020.
10.3		Form of Registration Rights Agreement, dated September 23, 2020.  Incorporated by reference to Exhibit 10.3 of the Current Report on Form 8-K filed with the Securities and Exchange Commission on October 6, 2020.
10.4		Form of Warrant, dated September 23, 2020. Incorporated by reference to Exhibit 10.4 of the Current Report on Form 8-K filed with the Securities and Exchange Commission on October 6, 2020.
31.1*		Certification of Chief Executive Officer pursuant to Exchange Act Rules 13a-14(a) and 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2*		Certification of Chief Financial Officer pursuant to Exchange Act Rules 13a-14(a) and 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1**		Certifications of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
101*		The following materials from Generation Alpha, Inc.’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2020, formatted in XBRL (Extensible Business Reporting Language): (i) the Condensed Consolidated Balance Sheets, (ii) the Condensed Consolidated Statements of Operations, (iii) the Condensed Consolidated Statements of Shareholders’ Deficit, (iv) the Condensed Consolidated Statements of Cash Flows, and (vi) Notes to Unaudited Condensed Consolidated Financial Statements.

 

* Filed herewith

** Furnished herewith

 

 

SIGNATURES

 

In accordance with the requirements of the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

	GENERATION ALPHA, INC.
Date: November 6, 2020	By:	/s/ Tiffany Davis
		Tiffany Davis
		Chief Executive Officer (Principal Executive Officer, Principal Financial Officer and Principal Accounting Officer)