Generation Alpha, Inc. - Quarter Report: 2021 March (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-Q

(Mark One)

FOR THE QUARTERLY PERIOD ENDED: MARCH 31, 2021

For the transition period from __________ to __________

Commission File Number: 000-53635

GENERATION ALPHA, INC.

(Exact name of registrant as specified in its charter)

1689-A Arrow Route

Upland, California 91786

(Address of principal executive offices) (Zip code)

(888) 998-8881

(Registrant’s telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act:

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 every Interactive Data File required to be submitted 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.

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]

The number of shares of registrant’s common stock outstanding as of May 11, 2021  was 60,029,830.

GENERATION ALPHA, INC.

INDEX

PART I - FINANCIAL INFORMATION

Item 1. Condensed Consolidated Financial Statements.

GENERATION ALPHA, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(Unaudited)

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

GENERATION ALPHA, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

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 March 31, 2021

Three months ended March 31, 2020

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

GENERATIONAL ALPHA, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

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 MONTHS ENDED MARCH 31, 2021 AND 2020

(Unaudited)

NOTE 1 – ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

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 a vertically integrated technology innovator, developer, manufacturer, and distributor focused on bringing products and solutions to commercial and retail cannabis growers in both the medical and adult use recreational space in legal markets across the U.S. The Company’s lighting and nutrient customers include retail stores, distributors and commercial growers in the United States and abroad.

COVID-19 Considerations

During the three months ended March 31, 2021, 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. 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.

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.

Going Concern

The accompanying 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 consolidated financial statements, during the three months ended March 31, 2021, the Company incurred a net loss of $1,863,000 and had a shareholders’ deficit of $10,376,000 as of March 31, 2021. In addition, $2,915,000 of notes payable to related parties, $590,000 of accrued interest to related parties, and $820,000 of contract obligations are past due. 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.

At March 31, 2021, the Company had cash on hand in the amount of $345,000. Management estimates that the current funds on hand will be sufficient to continue operations through December 31, 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 our operations, in the case of debt financing or cause substantial dilution for our stockholders, in case or equity financing.

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.

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.

Revenue Recognition

The Company recognizes revenue in accordance with Financial Accounting Standards Board (“FASB”) Accounting Standard Codification (“ASC”) 606, Revenue from Contracts with Customers (“ASC 606”). 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. As of March 31, 2021 and December 31, 2020, the Company determined that no reserves for returned product were necessary.

In the following table, revenue is disaggregated by major product line for three months ended March 31, 2021:

In the following table, revenue is disaggregated by major product line for three months ended March 31, 2020:

Accounts Receivable

Accounts receivable are recorded net of an allowance for expected losses. The Company evaluates the collectability of its trade accounts receivable based on a number of factors. In circumstances where the Company becomes aware of a specific customer’s inability to meet its financial obligations to the Company, a specific reserve for bad debts is estimated and recorded, which reduces the recognized receivable to the estimated amount the Company believes will ultimately be collected. In addition to specific customer identification of potential bad debts, bad debt charges are recorded based on the Company’s historical losses and an overall assessment of past due trade accounts receivable outstanding.

The allowance for doubtful accounts and returns is established through a provision reducing the carrying value of receivables. At March 31, 2021 and December 31, 2020, the allowance for doubtful accounts was $10,000 and $12,000, respectively.

Inventories

Inventories are stated at the lower of cost or net realizable value. Cost is computed on a first-in, first-out basis. The Company’s inventories consist almost entirely of finished goods as of March 31, 2021 and December 31, 2020.

The Company provides 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 net realizable value based on upon assumptions about future demand and charged to the provision for inventory write down, 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. At March 31, 2021 and December 31, 2020, the reserve for excess and obsolete inventory was $45,000 and $30,000, respectively.

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.

Research and Development

Research and development costs are expensed in the period incurred. The costs primarily consist of personnel and supplies.

Shipping and Handling Costs

The Company’s shipping and handling costs relating to inbound freight are reported as cost of goods sold in the consolidated Statements of Operations, while shipping and handling costs relating to outbound freight are reported as selling, general and administrative expenses in the consolidated Statements of Operations. The Company classifies amounts billed to customers for shipping fees as revenues.

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:

The carrying amounts of financial instruments such as cash, accounts receivable, inventories, and accounts payable and accrued liabilities, 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 $3,598,000 and $2,161,000 at March 31, 2021 and December 31, 2020, respectively, was valued using Level 2 inputs.

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 three months ended March 31, 2021, options to acquire 10,262,627 shares of common stock, warrants to acquire 32,283,140 shares of common stock, and 70,033,903 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 three months ended March 31, 2020, options to acquire 4,433,300 shares of common stock, warrants to acquire 21,283,140 shares of common stock, and 267,089,041 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.

Concentration Risks

Cash includes cash on hand and cash in banks and are reported as “Cash” in the consolidated balance sheets. At March 31, 2021 and December 31, 2020, cash includes cash on hand of $255,000 and $289,000, respectively, and cash in banks of $90,000 and $83,000, 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 operates in markets that are highly competitive and rapidly changing. Significant technological changes, shifting customer needs, the emergence of competitive products or services with new capabilities, and other factors could negatively impact the Company’s operating results. State and federal government laws could have a material adverse impact on the Company’s future revenues and results of operations.

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 three months ended March 31, 2021 and 2020, its ballasts, lamps, and reflectors, which comprised the clear majority of the Company’s purchases during those periods, were each only purchased from one separate vendor.

The Company performs a regular review of customer activity and associated credit risks and does not require collateral or other arrangements. One customer accounted for 12% of the Company’s revenue for the three months ended March 31, 2021, and one customer accounted for 30% of the Company’s revenue for the three months ended March 31, 2020. Shipments to customers outside the United States comprised less than 5% of our sales for the three months ended March 31, 2021 and 2020, respectively.

As of March 31, 2021, three customers accounted for 33%, 24%, and 12% of the Company’s trade accounts receivable balance, and as of December 31, 2020, three customers accounted for 37%, 23%, and 15% of the Company’s trade accounts receivable balance.

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.

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).” ASU 2020-06 reduces the number of accounting models for convertible debt instruments by eliminating the cash conversion and beneficial conversion models. As a result, a convertible debt instrument will be accounted for as a single liability measured at its amortized cost as long as no other features require bifurcation and recognition as derivatives. By removing those separation models, the effective interest rate of convertible debt instruments will be closer to the coupon interest rate. Further, the diluted net income per share calculation for convertible instruments will require the Company to use the if-converted method. For contracts in an entity’s own equity, the type of contracts primarily affected by this update are freestanding and embedded features that are accounted for as derivatives under the current guidance due to a failure to meet the settlement conditions of the derivative scope exception. This update simplifies the related settlement assessment by removing the requirements to (i) consider whether the contract would be settled in registered shares, (ii) consider whether collateral is required to be posted, and (iii) assess shareholder rights. ASU 2020-06 will be effective January 1, 2024, for the Company and the provisions of this update can be adopted using either the modified retrospective method or a fully retrospective method. Early adoption is permitted, but no earlier than January 1, 2021, including interim periods within that year. Effective January 1, 2021, the Company early adopted ASU 2020-06 and that adoption did not have an impact on our financial statements and the related disclosures.

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 2 - PROPERTY AND EQUIPMENT

Property and equipment consist of the following at March 31, 2021 and December 31, 2020:

Depreciation expense for the three months ended March 31, 2021 and 2020 was $3,000 and $2,000, respectively.

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 of $1,139,000 accordingly. The Company has a continuing obligation under the Management Agreement of $816,000 (net of discount of $34,000) as of December 31, 2020. As of March 31, 2021, the remaining Management Agreement obligation was $820,000 (net of discount of $30,000) and is reflected as a current liability in the accompanying consolidated balance sheet. As of March 31, 2021, 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 March 31, 2021 and December 31, 2020:

At December 31, 2020, accrued interest on the notes payable to related parties was $187,000. During the three months ended March 31, 2021, the Company added $17,000 of additional accrued interest, and made interest payments of $7,000, leaving an accrued interest on the notes payable to related parties balance of $197,000 at March 31, 2021.

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 ROU asset and lease liability is measured at the present value of future lease payments as of the lease commencement date. The Company accounts for the lease and non-lease components of its leases as a single lease component. Rent expense is recognized on a straight-line basis over the lease term.

In 2019, we occupied a 17,640 square foot facility located at 853 Sandhill Avenue, Carson, California under a five-year lease with an independent party ending on June 30, 2023, pursuant to which we paid $15,000 per month in rental charges. On December 31, 2019, we abandoned our Carson, California lease. The Company remains obligated under its Carson, California lease, until such time the landlord releases us from our lease agreement. During the three-months ended March 31, 2020, management determined it no longer had access to the Carson, California facility, and recorded an impairment charge for the remaining ROU asset balance of $82,000. 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 three months ended March 31, 2021. The remaining balance of the lease obligation was $556,000 at both March 31, 2021 and December 31, 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 under a three-year lease with an independent party ending on January 31, 2023, pursuant to which the Company pays $2,800 per month in rental charges. The operating lease ROU asset balance related to the Upland, California operating lease was $63,000 as of December 31, 2020. During the three months ended March 31, 2021, the Company reflected amortization of the ROU assets of $7,000 related to its Upland, California operating lease, resulting in an ROU asset balance of $56,000 as of March 31, 2021.

On January 11, 2021, the Company opened a regional sales and distribution office at Windolph Plaza Center, 1020 NW 6^th Street, Bay G, Deerfield Beach in Broward County, Florida. The Florida lease is for a 4,304 square foot facility under a five-year and two-month lease with an independent party ending on March 31, 2026, pursuant to which it pays an average $3,691 per month in rental charges. On January 11, 2021, the Company recognized an operating lease ROU asset and lease liability of $173,000, related to the Florida operating lease. During the three months ended March 31, 2021, the Company reflected amortization of the ROU assets of $4,000 related to its Florida operating lease, resulting in an ROU asset balance of $169,000 as of March 31, 2021.

As of December 31, 2020, liabilities recorded under operating leases were $622,000. During the three months ended March 31, 2021, the Company added $173,000 in lease liabilities related to its Florida operating lease, and made lease payments of $4,000 towards its operating lease liability. As of March 31, 2021, liabilities under operating leases amounted to $791,000, of which $380,000 were reflected as current due.

The lease agreements above have a weighted average remaining lease term of 2.85 years as of March 31, 2021, and the weighted average discount rate for operating leases is 10%. Rent expense during the three months ended March 31, 2021 and 2020 was $18,000 and $6,000, respectively.

Maturities of the Company’s lease liabilities are as follows:

NOTE 6 – LEGAL OBLIGATION PAYABLE

Effective June 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. No payments have been made, leaving $448,000 owed at March 31, 2021 and December 31, 2020.

NOTE 7 – LOANS PAYABLE

Notes payable consists of the following at March 31, 2021 and December 31, 2020:

NOTE 8 – CONVERTIBLE SECURED NOTE PAYABLE TO RELATED PARTY

Secured notes payable to related party consists of the following as of March 31, 2021 and December 31, 2020:

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.

In 2019, the Company entered into an amendment agreements with YA II, PN, which amended the secured promissory note in the principal face amount of $1.5 million issued on May 10, 2018. The Company calculated the fair market value of the secured note payable before and after the modifications and recorded the difference of $962,000 as a debt extinguishment cost in 2019.

As part of the issuance of the Notes, 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. 7,500,000 warrants granted as part of the Note issuances were also modified to ultimately change the exercise price from $0.50 per share (1,000,000 warrants), $0.75 per share (2,250,000 warrants), $1.00 per share (2,250,000 warrants) and $1.25 per share (2,000,000 warrants) to $0.05 per share for all four warrants. Furthermore, the amendments removed the Company’s right of redemption and right to compel exercise on certain Warrants. The Company calculated the fair market value of the warrants before and after the modifications above and recorded the difference of $194,000 as a financing cost in 2019.

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 $109,000 at the date of issuance. The Company also granted YA II PN 5-year warrants with a fair value of $66,000, 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 $177,000, 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 $27,000 was recorded as a financing cost.

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 September 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 $322,000 at the date of issuance. The Company also granted YA II PN 5-year warrants with a fair value of $68,000, 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 $389,000, 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 $39,000 was recorded as a financing cost.

The remaining unamortized balance of the valuation discount was $220,000 at December 31, 2020. During the three months ended March 31, 2021, amortization of valuation discount was $183,000 and was recorded as an interest cost, leaving a $37,000 remaining unamortized balance of the valuation discount at March 31, 2021.

At December 31, 2020, accrued interest on the convertible secured notes payable to related parties of $344,000 was included in accrued interest to related parties on the consolidated balance sheet. During the three months ended March 31, 2021, the Company added $49,000 of additional accrued interest, leaving an accrued interest to related parties balance of $393,000 at March 31, 2021.

As of March 31, 2021, 70,033,933 shares of common stock were potentially issuable under the conversion terms of the convertible secured notes.

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 March 31, 2021 and December 31, 2020, the derivative liabilities were valued using a Black-Scholes Merton pricing model with the following assumptions:

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 following table sets forth a summary of the changes in the estimated fair value of our embedded derivative during the three months ended March 31, 2021 and 2020:

NOTE 10 – SHAREHOLDERS’ EQUITY

Common Shares Issued to Directors

The Company appointed certain directors and issued shares as part of their director compensation agreements. During the three months ended March 31, 2021, the Company issued an aggregate of 472,000 shares of common stock, with a fair value of $20,000 at date of grant. During the three months ended March 31, 2020, the Company issued an aggregate of 2,166,667 shares of common stock, with a fair value of $23,000 at date of grant. The issued shares were recognized as compensation cost.

Common Shares Issued on Conversion of Convertible Note Payable

During the three months ended March 31, 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.

Summary of Stock Options

A summary of stock options for the three months ended March 31, 2021, is as follows:

On January 1, 2021, the Company entered into a new five-year employment agreement with Tiffany Davis as the Company’s Chief Executive Officer. Ms. Davis is entitled to receive stock options of $12,500 of shares per quarter at the then closing market price on the last trading day at the end of each calendar quarter, which expire five years from the date of issuance. Accordingly, during the three months ended March 31, 2021, Davis was granted a total of 260,417 stock options, with the fair value determined to be $12,000, and was recorded to stock-based compensation expense during the three months ended March 31, 2021. The fair value of options on the date of grant was estimated using the Black-Scholes option pricing model with the following weighted average assumptions: stock price of $0.048, risk-free interest rate of 0.35%, expected volatility of 248%, and an expected life of 3.0 years.

Information relating to outstanding options at March 31, 2021, summarized by exercise price, is as follows:

As of December 31, 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 March 31, 2021 was 2.34 years. Both the outstanding and exercisable stock options had an intrinsic value of $302,000 at March 31, 2021.

Summary of Warrants

A summary of warrants for the year ended March 31, 2021, is as follows:

Information relating to outstanding warrants at March 31, 2021, summarized by exercise price, is as follows:

During the three months ended March 31, 2021, the Company issued five-year warrants with a fair value of $191,000 to purchase 4,000,000 shares of common stock at an exercise price of $0.001 as part of a settlement agreement regarding a trade vendor payable (see Note 11). The fair value of warrants on the date of grant was estimated using the Black-Scholes option pricing model with the following weighted average assumptions: stock price of $0.048, risk-free interest rate of 0.35%, expected volatility of 248%, and an expected life of 3.0 years.

The weighted-average remaining contractual life of warrants outstanding and exercisable at December 31, 2020 was 3.39 years. Both the outstanding and exercisable warrants had an intrinsic value of $378,000 at March 31, 2021.

NOTE 11 – COMMITMENTS AND CONTINGENCIES

On March 30, 2021, the Company entered into a Settlement Agreement and Release (“Agreement”) with Sichenzia Ross Ference LLP (“SRF”), for services that were performed for the Company. The Company owed SRF $160,000, of which the Company agreed to pay SRF the sum total $75,000. The $75,000 is payable in fifteen monthly installments, commencing on March 31, 2021, and with the last installment payment due no later than May 31, 2022. As an alternative to the Settlement Payment, the Company shall have the option to pay to SRF:

a. An initial installment payment of $5,000 on or before March 31, 2021, $5,000 on or before April 30, 2021, and a lump sum payment of $40,000 on or before June 7, 2021, for a total payments of $50,000; or

b. An initial installment payment of $5,000 on or before March 31, 2021, $5,000 on or before April 30, 2021, $5,000 on or before May 31, 2021, $5,000 on or before June 30, 2021, $5,000 on or before July 30, 2021 and a lump sum payment of $50,000 on or before August 6, 2021 for a total payments of $75,000.

As further consideration of the full and final settlement of these matters, the Company issued to SRF, a cashless five-year warrant to purchase 4,000,000 shares of common stock of the Company at an exercise price per share equal to $0.001 per share and a fair value of $191,000 on the date granted.

The total settlement amount was $266,000, made up the $75,000 reduced payable to SFR, plus the fair value of the warrants of $191,000, which was more than the original trade vendor balance owed of $160,000. The difference of $106,000 was recorded as a loss on settlement of trade vendor payable on the accompanying condensed consolidated statements of operations for the three months ended March 31, 2021.

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 months ended March 31, 2021 and 2020, $25,000 was recorded as research and development expense under the agreement on the Condensed Consolidated Statements of Operations related to the minimum annual fee. For the three months ended March 31, 2021 and 2020, no royalty was recorded as cost of goods sold on the Consolidated Statements of Operations. A total of $364,000 and $339,000 was owed under the amended agreement at March 31, 2021 and December 30, 2020, respectively.

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.

Results of Operations

Results of Operations for the three months ended March 31, 2021 compared to the three months ended March 31, 2020.

Revenue and Cost of Goods Sold

Revenue for the three months ended March 31, 2021 and 2020 was $454,000 and $307,000, respectively, an increase of $147,000, or 48%. Revenue for the three months ended March 31, 2021 and 2020 was $454,000 and $307,000, respectively, an increase of $147,000, or 48%. The increase is due to two factors 1) the company’s initiative to focus direct sales and marketing efforts on its nutrient business and 2) the increase in new markets that are granting new cultivation licenses which resulted in new companies obtaining licenses to legally grow cannabis, which has ultimately resulted in new order for our lights and our nutrient product.

Cost of sales for the three months ended March 31, 2021 and 2020 was $227,000 and $195,000, respectively. Gross profit for the three months ended March 31, 2021 and 2020 was $227,000 and $112,000, respectively. As a percentage of revenue, gross profit was 50% and 36% for the three months ended March 31, 2021 and 2020, respectively. The increase in our gross profit was due to our increase in revenue.

Selling, General and Administration Expenses

SG&A expenses for the three months ended March 31, 2021 and 2020 were $266,000 and $361,000, respectively, a decrease of $95,000, or 26%. We implemented several cost reduction initiatives leading to decreased wages and benefits of $21,000 and decreased rent expense of $70,000. The remaining decrease of $4,000 was across our numerous remaining expense accounts.

Research and Development (R&D) Expenses

R&D expenses for the three months ended March 31, 2021 and 2020 were comparable at $26,000 and $25,000, respectively.

Impairment of Right of Use Asset

Impairment of right of use asset for the three months ended March 31, 2020 was $82,000. In March 2020, we determined that our right of use asset was impaired and recorded an impairment charge accordingly. No similar activity occurred during the current year period.

Other Income and Expenses

Other income for the three months ended March 31, 2021 was $1,798,000, as compared to other expense of $1,282,000 for the three months ended March 31, 2020. The change in balance was due to the loss on settlement of a trade vendor payable of $106,000, offset by a gain on the settlement of debt of $2,000, both of which did not exist during the prior year period. Additionally, we realized the change in the fair value of derivative liability of $495,000, and the change in interest expense of $68,000, as compared to the prior year period.

Net Loss

Net loss for the three months ended March 31, 2021 and 2020 was $1,863,000 and $1,638,000, respectively. The increase in net loss was due to the increase in gross profit, the decrease in operating expenses, and the change in other income and expenses as discussed above.

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 three months ended March 31, 2021, we generated cash from operating activities of $14,000 as compared to cash used in operating activities of $13,000 in the prior year period. During the three months ended March 31, 2021, cash was primarily used to fund our operating loss of $65,000, a change in the fair value of derivative liabilities of $1,437,000, amortization on convertible notes payable of $183,000, a change in inventory of $19,000, a $59,000 increase in interest due to related parties, $32,000 of stock-based related compensation, a $58,000 increase in accounts receivable, and a $106,000 loss on settlement of trade accounts payable.

Cash Flows Used in Investing Activities

During the three months ended March 31, 2021 and 2020, we used $32,000 and $0 in cash from investing activities to purchase property and equipment.

Cash Flows Provided by (Used in) Financing Activities

During the three months ended March 31, 2021, we used cash in financing activities of $9,000, compared to cash provided by financing activities of $102,000 for the three months ended March 31, 2020. During the three months ended March 31, 2021, we made $9,000 of payments on our notes payable. During the three months ended March 31, 2020, we received proceeds of $125,000, net of fees of $25,000, from a secured convertible note payable, offset by $23,000 of payments on our notes payable to related parties.

The accompanying 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 consolidated financial statements, during the three months ended March 31, 2021, the Company incurred a net loss of $1,863,000 and had a shareholders’ deficit of $10,376,000 as of March 31, 2021. In addition, $2,915,000 of notes payable to related parties, $590,000 of accrued interest to related parties, and $820,000 of contract obligations are past due. 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.

Historically, we have financed our operations primarily through private sales of common stock, 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. If our sales goals do not materialize as planned, we believe that we can reduce our operating costs and achieve positive cash flow from operations. 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 March 31, 2021 and 2020.

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 March 31, 2021 and December 31, 2020.

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 notes are currently past due.

A total of $40,000 was due on the loans at each of March 31, 2021 and December 20, 2020.

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 February 9, 2019. The 2018 Note was amended effective February 9, 2019 for which the maturity date was extended to August 9, 2019 and could be converted into our common stock at a conversion price of $0.50 a share. On October 29, 2019, the 2018 Note was further amended to include an extended maturity date of 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.

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. We received net proceeds of $237,500, net of closing costs of $37,500. 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.

On February 13, 2020, we issued a secured convertible debenture (the “2020 Note”) 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 2020 Note is secured by all our and our subsidiaries assets. 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.

On September 23, 2020, we issued a secured convertible debenture (the “September 2020 Note”) in the amount of $150,000. The September 2020 Note bears interest at a rate of 10% per annum (15% on default) and has a maturity date of August 10, 2021. The September 2020 Note is secured by all our and our subsidiaries assets. The 2020 September Note provides a conversion right, in which any portion of the principal amount of the 2020 September 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.

Term Loan

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. A total of $205,000 was due on the loan as of December 31, 2020.

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. A total of $150,000 was due on the loan as of December 31, 2020.

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 have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results or operations, liquidity, capital expenditures or capital resources that is material to investors.

Item 3. Quantitative and Qualitative Disclosures about Market Risk.

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

Item 4. Controls and Procedures.

Management’s evaluation of disclosure controls and procedures.

Our Chief Executive Officer and Chief Financial Officer evaluated the effectiveness of our disclosure controls and procedures pursuant to Rule 13a-15 under the Exchange Act as of March 31, 2021. Based on this evaluation, our principal executive officer and our principal financial officer concluded that as of March 31, 2021, 2021, our disclosure controls and procedures were not effective to provide reasonable assurance that information required to be disclosed by us in reports we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and is accumulated and communicated to our management, including our principal executive officer and our principal financial officer, as appropriate, to allow timely decisions regarding required disclosures. The conclusion that our disclosure controls and procedures were not effective was due to the presence of material weaknesses in internal control over financial reporting, as that term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act. In light of the material weaknesses identified by management, we performed additional analyses and procedures in order to conclude that our financial statements for the year ended December 31, 2020, are fairly presented, in all material respects, in accordance with U.S. generally accepted accounting principles.

Management’s report on internal control over financial reporting.

Our management is responsible for establishing and maintaining adequate internal control over financial reporting as such term as defined in Exchange Act Rule 13a-15(f). Internal control over financial reporting is a process designed under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with accounting principles generally accepted in the United States of America.

As of March 31, 2021, our management assessed the effectiveness of our internal control over financial reporting using the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission in Internal Control-Integrated Framework (2013 Framework). Based on this assessment, our management concluded that, as of March 31, 2021, our internal control over financial reporting was not effective as of March 31, 2021 and identified the material weaknesses described below.

Description of Material Weaknesses and Management’s Remediation Initiatives

The following material weaknesses in our internal control over financial reporting were identified by management as of March 31, 2021:

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 period ended March 31, 2021, 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.

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.

This annual report does not include an attestation report of our independent registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by our independent registered public accounting firm pursuant to the rules of the SEC that permit us to provide only management’s report in this annual report.

Changes in internal control over financial reporting.

There were no changes in our internal control over financial reporting that occurred during the quarter ended March 31, 2021 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II

Item 1. Legal Proceedings.

Information regarding reportable legal proceedings is contained in Part I, Item 3, “Legal Proceedings,” in our Annual Report on Form 10-K for the year ended December 31, 2020. There have been no material changes to the legal proceedings previously disclosed in the Annual Report on Form 10-K, which are incorporated by reference herein.

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.

On March 30, 2021, the Company issued a vendor a cashless five year warrant to purchase four million (4,000,000) shares of common stock of the Company at an exercise price per share equal to $0.001 per share as part of a settlement agreement.

During the three months ended March 31, 2021, the Company issued its Chief Executive Officer a total of 260,417 stock options at an exercise price of $0.048 per share.

During the three months ended March 31, 2021, the Company issued an aggregate of 472,000 shares of common stock pursuant to the compensation agreements with its directors.

Item 3. Defaults Upon Senior Securities.

None.

Item 4. Mine Safety Disclosures

Not applicable.

Item 5. Other Information.

None.

Item 6. Exhibits.

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.