Netcapital Inc. - Quarter Report: 2014 July (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

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

For the quarterly period ended: July 31, 2014

OR

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

Commission file number: 000-55036

Indicate by check whether the registrant (1) filed all reports required to be filed by Section 13 or 15(d) of the Securities and 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 ý 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 ¨ No ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.

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

As of September 22, 2014, the Company had 500,000,000 shares of its common stock, par value $0.001 per share, issued and outstanding.

TABLE OF CONTENTS

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PART I – FINANCIAL INFORMATION

Item 1. Financial Statements.

Valuesetters Inc.

Condensed Balance Sheets (Unaudited)

See notes to the condensed financial statements.

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Valuesetters Inc.

Condensed Statements of Operations

(Unaudited)

See notes to the condensed financial statements.

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Valuesetters Inc.

Condensed Statements of Cash Flows

(Unaudited)

See notes to the condensed financial statements.

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Valuesetters Inc.

Notes To Condensed Financial Statements (Unaudited)

Note 1– Basis of Presentation

The accompanying unaudited condensed financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and in accordance with the rules and regulations of the U.S. Securities and Exchange Commission (“SEC”) for quarterly reports on Form 10-Q. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the three-month period ended July 31, 2014, are not necessarily indicative of the results that may be expected for the year ended April 30, 2015. For further information, refer to the audited financial statements and footnotes thereto in our Annual Report on Form 10-K for the year ended April 30, 2014.

Note 2 – Going Concern Matters and Realization of Assets

The accompanying financial statements have been prepared on a going concern basis, which contemplates the realization of assets and the satisfaction of liabilities in the ordinary course of business. However, the Company has sustained recurring losses from its continuing operations and as of July 31, 2014, had negative working capital of $431,199 and a stockholders’ deficit of $553,144. In addition, the Company is unable to meet its obligations as they become due and sustain its operations. The Company believes that its existing cash resources are not sufficient to fund its continuing operating losses, capital expenditures, lease and debt payments and working capital requirements.

The Company may not be able to raise sufficient additional debt, equity or other cash on acceptable terms, if at all. Failure to generate sufficient revenues, achieve certain other business plan objectives or raise additional funds could have a material adverse effect on the Company’s results of operations, cash flows and financial position, including its ability to continue as a going concern, and may require it to significantly reduce, reorganize, discontinue or shut down its operations.

In view of the matters described above, recoverability of a major portion of the recorded asset amounts shown in the accompanying balance sheet is dependent upon continued operations of the Company which, in turn, is dependent upon the Company’s ability to meet its financing requirements on a continuing basis, and to succeed in its future operations. The financial statements do not include any adjustments relating to the recoverability and classification of recorded asset amounts or amounts and classification of liabilities that might be necessary should the Company be unable to continue in its existence.

Management’s plans include:

There can be no assurance that the Company will be able to achieve its business plan objectives or be able to achieve or maintain cash-flow-positive operating results. If the Company is unable to generate adequate funds from operations or raise sufficient additional funds, the Company may not be able to repay its existing debt, continue to operate its business network, respond to competitive pressures or fund its operations. As a result, the Company may be required to significantly reduce, reorganize, discontinue or shut down its operations. The financial statements do not include any adjustments that might result from this uncertainty.

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Note 3 – Income (Loss) Per Common Share

Income (Loss) per common share data was computed as follows:

As of July 31, 2014, the weighted average diluted common shares outstanding exceeds the number of authorized common shares of the Company. This excess has no effect on diluted net income per common share for the three months ended July 31, 2013. See Note 9 for the derivative liabilities recorded as a result of the shortfall in authorized shares.

Note 4 – Principal Financing Arrangements

As of July 31, 2014 and April 30, 2014, the Company owed its principal lender (“Lender”) $98,179 and $93,219, respectively, under a loan and security agreement (“Loan”) dated April 28, 2011, that was amended on July 26, 2014 to change the maturity date to June 30, 2017. The maximum amount of the Loan is $250,000. The Lender is also the majority shareholder of the Company, owning 271,673,207 shares of common stock, or 54% of the 500,000,000 shares issued and outstanding.

In connection with the financing, the Company has agreed to certain restrictive covenants, including, among others, that the Company may not convey, sell lease, transfer or otherwise dispose of any part of its business or property, except as permitted in the agreement, dissolve, liquidate or merge with any other party unless, in the case of a merger, the Company is the surviving entity, incur any indebtedness except as defined in the agreement, create or allow an lien on any of its assets or collateral that has been pledge to the Lender, make any loans to any person, except for prepaid items or deposits incurred in the ordinary course of business, or make any material capital expenditures

To secure the payment of all obligations to the lender, the Company granted to the lender a continuing security interest and first lien on all of the assets of the Company.

As of July 31, 2014 and April 30, 2014, the Company’s related-party unsecured notes payable totaled $348,914 and $350,116, respectively. The majority of this debt is owed to a former board member, who is a 10% shareholder, for a $314,000 note payable dated April 30, 2011. In July 2014, this note was renegotiated to a 3% term loan due on June 30, 2017. The same person has personally guaranteed a bank line of credit under which the Company owes $47,817 and $48,469 and as of July 31, 2014 and April 30, 2014, respectively. The Company pays approximately $220 a month in principal payments on the outstanding balance, plus the monthly interest expense, which is calculated at a rate of 5.5% per annum.

Other notes payable totaled $17,377 and $16,000 at July 31, 2014 and April 30, 2014, respectively.

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Note 5 – Investments

During the first quarter of fiscal 2015, the Company acquired a 5% interest in two early-stage companies, Zelgor Inc. and NetCapital Systems LLC, as payment for consulting and advisory services provided to the companies. The investment is recorded at the value of the services provided by the Company.

Note 6 – Income Taxes

At July 31, 2014, the Company had net operating loss carryforwards for federal income tax purposes of approximately $1,060,000 that expire in the years 2015 through 2030. The Company has provided an allowance for the full value of the related deferred tax asset since it is more likely than not that none of such benefit will be realized. Utilization of the net operating losses may be subject to annual limitations provided by Section 382 of the Internal Revenue Code and similar state provisions.

Due to the availability of the tax loss carryforward for the three-month period ended July 31, 2014 and the loss for the three-month period ended July 31, 2013, the Company has recorded no income tax expense in either of these three-month periods.

Note 7 – Related Party Transactions

The Company’s majority shareholder is also its principal lender. As of July 31, 2014 and April 30, 2014, the Company owed its majority shareholder, under a secured lending agreement, $98,179 and $93,219, respectively. The maximum amount of the loan is $250,000, and the loan matures on June 30, 2017. The majority shareholder of the Company owns 271,673,207 shares of common stock, or 54% of the 500,000,000 shares issued and outstanding.

A former director of the Company and founder of Valuesetters, Inc., which merged with the Company in December 2003, has personally guaranteed bank debt of $47,817 and $48,469, as of July 31, 2014 and April 30, 2014 and credit card debt of $21,579 and $22,947 as of July 31, 2014 and April 30, 2014, respectively. In addition to the personal guarantees, the Company owes him $421,774 and $419,895 as of July 31, 2013 and April 30, 2013, respectively, for loans, interest payable and unpaid expenses.

The Company owes a second director $31,680 as of July 31, 2014 and April 30, 2014.

The Company owes a third director $15,000 as of July 31, 2014 and April 30, 2014.

The Company owes its Chief Executive Officer and Chairman of the board of directors $848 and $2,050 as of July 31, 2014 and April 30, 2014, respectively.

Note 8 – Stockholders’ Deficit

The Company is authorized to issue 500,000,000 shares of its common stock, par value $0.001. 500,000,000 shares were outstanding as of July 31, 2014 and April 30, 2014, and no shares were issued during the three-month period ended July 31, 2014 or during the fiscal year ended April 30, 2014.

On May 7, 2014, the Company granted 5-year stock options that fully vest over a three year period to three consultants. Each consultant was granted an option to purchase up to 6 million shares of the Company’s common stock at a price of $0.03 per share.

On July 5, 2014, the Company agreed to issue 6,000,000 shares of restricted common stock in exchange for investor awareness services for the period of July 10, 2014 to December 31, 2014. The shares are issuable after the Company increases its authorized shares.

On July 24, 2014, the Company signed a three-year consulting agreement in exchange for 6,000,000 shares of common stock to be issued after the Company increases its authorized shares.

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Note 9 – Derivative Liabilities

The Company evaluated its stock options and stock-based payment agreements pursuant to ASC 815 and due to there being no authorized shares of common stock available to issue to satisfy the terms of the agreements, the Company determined the agreements were derivative liabilities. The Company valued the stock option derivatives using the Black-Scholes valuation model, and the stock-based payment agreements using the actual trading prices of the Company’s common stock.  

On May 7, 2014, the Company estimated the fair value of the stock option derivatives using the Black-Scholes valuation method with assumptions including: (1) term of 5 years; (2) a computed volatility rate of 213% (3) a discount rate of 1.65% and (4) zero dividends.  

At July 31, 2014, the Company estimated the fair value of the derivatives using the Black-Scholes valuation method with assumptions including: (1) term of 4.75 years; (2) a computed volatility rate of 211% (3) a discount rate of 1.65% and (4) zero dividends.  

On May 7, 2014, the Company accepted a stock subscription agreement for the purchase of 500,000 shares of common stock at $0.02 per share. The agreement was recorded as a $10,000 derivative liability on May 7, 2014 and was valued at July 31, 2014 at the closing price of the Company’s common stock, $0.0121 per share.

On July 5, 2014, the Company signed an investor awareness agreement that required the issuance of 6,000,000 shares of common stock. The agreement was recorded as a derivative liability on July 5, 2014 at a price of $0.0149 and was valued at July 31, 2014 at the closing price of the Company’s common stock, $0.0121 per share.

On July 24, 2014, the Company signed a consulting agreement that required the issuance of 6,000,000 shares of common stock. The agreement was recorded as a derivative liability on July 24, 2014 at a price of $0.0101 and was valued at July 31, 2014 at the closing price of the Company’s common stock, $0.0121 per share.

All of the aforementioned derivatives were recorded on the day the agreements were effective and were revalued at July 31, 2014. Any changes in the value of the derivative liabilities were recorded as a gain or loss in the income statement for the three months ended July 31, 2014.

The net gain recorded for the change in value of the derivatives for the three month-period ended July 31, 2014 was $329,043. There were no derivatives in the three month-period ended July 31, 2013.

Note 10 – Fair Value

The Fair Value Measurements Topic of the FASB Accounting Standards Codification establishes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and the lowest priority to measurements involving significant unobservable inputs (Level 3 measurements). The three levels of the fair value hierarchy are as follows:

• Level 1: inputs are quoted prices (unadjusted) in active markets for identical assets or liabilities that the company has the ability to access at the measurement date.

• Level 2: inputs are inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly.

• Level 3: inputs are unobservable inputs for the asset or liability.

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Under the Fair Value Measurements Topic of the FASB Accounting Standards Codification, we base fair value on the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. It is our policy to maximize the use of observable inputs and minimize the use of unobservable inputs when developing fair value measurements, in accordance with the fair value hierarchy. Fair value measurements for assets and liabilities where there exists limited or no observable market data and, therefore, are based primarily upon management’s own estimates, are often calculated based on current pricing policy, the economic and competitive environment, the characteristics of the asset or liability and other such factors. Therefore, the results cannot be determined with precision and may not be realized in an actual sale or immediate settlement of the asset or liability. Additionally, there may be inherent weaknesses in any calculation technique, and changes in the underlying assumptions used, including discount rates and estimates of future cash flows that could significantly affect the results of current or future value.

Derivative Liability

The table below presents the amounts of liabilities measured at fair value on a recurring basis as of July 31, 2014 and April 30, 2014.

The fair value of the derivatives that are traded in less active over-the counter markets are generally measured using pricing models with market observable inputs such as interest rates and equity index levels. These measurements are classified as Level 2 within the fair value of hierarchy.

Note 11 – Stock-Based Compensation Plans

The Company entered consulting agreements to issue common stock and options to purchase common stock, and recorded the applicable non-cash expense in accordance with the authoritative guidance of the Financial Accounting Standards Board. For the three-month periods ended July 31, 2014 and July 31, 2013, the Company recorded $175,703 and $0, respectively, in stock-based compensation expense. As of July 31, 2014, there was $505,476 of prepaid stock-based compensation expense, $271,176 of which is current and $234,300 of which is non-current.

Note 12 – Subsequent Events

The Company purchased a consulting firm on September 11, 2014 for a purchase price of $200,000. The Company issued a three-year note at 2% interest per annum, which can be converted into a maximum of 20,000,000 shares of common stock of the Company.

On August 8, 2014, the Company signed a six-month consulting agreement in exchange for 2,000,000 shares of common stock to be issued after the Company increases its authorized shares.

In accordance with ASC 855-10, the Company has analyzed its operations subsequent to July 31, 2014 to the date these financial statements were issued, and has determined that it does not have any material subsequent events to disclose in these financial statements beyond the events described above.

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

This quarterly report on Form 10-Q and other reports filed by the Company from time to time with the U.S. Securities and Exchange Commission (collectively, the “Filings”) contain or may contain forward-looking statements and information that are based upon beliefs of, and information currently available to, the Company’s management as well as estimates and assumptions made by Company’s management. Readers are cautioned not to place undue reliance on these forward-looking statements, which are only predictions and speak only as of the date hereof. When used in the Filings, the words “anticipate,” “believe,” “estimate,” “expect,” “future,” “intend,” “plan,” or the negative of these terms and similar expressions as they relate to the Company or the Company’s management identify forward-looking statements. Such statements reflect the current view of the Company with respect to future events and are subject to risks, uncertainties, assumptions, and other factors. Should one or more of these risks or uncertainties materialize, or should the underlying assumptions prove incorrect, actual results may differ significantly from those anticipated, believed, estimated, expected, intended, or planned.

Although the Company believes that the expectations reflected in the forward-looking statements are reasonable, the Company cannot guarantee future results, levels of activity, performance, or achievements. Except as required by applicable law, including the securities laws of the United States, the Company does not intend to update any of the forward-looking statements to conform these statements to actual results.

Our financial statements are prepared in accordance with accounting principles generally accepted in the United States (“GAAP”). These accounting principles require us to make certain estimates, judgments and assumptions. We believe that the estimates, judgments and assumptions upon which we rely are reasonable based upon information available to us at the time that these estimates, judgments and assumptions are made. These estimates, judgments and assumptions can affect the reported amounts of assets and liabilities as of the date of the financial statements as well as the reported amounts of revenues and expenses during the periods presented. Our financial statements would be affected to the extent there are material differences between these estimates and actual results. In many cases, the accounting treatment of a particular transaction is specifically dictated by GAAP and does not require management’s judgment in its application. There are also areas in which management’s judgment in selecting any available alternative would not produce a materially different result. The following discussion should be read in conjunction with our financial statements and notes thereto appearing elsewhere in this report.

Overview

We are an Internet-based company that seeks free subscribers and revenue-generating subscribers for digital product that we offer to game players and app users. We operate on an automated basis with the belief that Internet operations, customer sign-ups, sales and game playing should occur without requiring a Company employee to participate in the transaction, so that it is possible for the Company to quickly expand in the event the number of subscribers begins to rapidly grow on a viral basis. Our back-office software operates 24 hours a day and can quickly collect money from and deliver games to subscribers. Similarly, we sell a mobile calling application that can be downloaded to an Android phone or tablet on an automated basis, 24 hours a day, from anywhere in the world. Our focus is on the digital delivery of games, apps, movies and music.

We intend to employ personnel in such areas as sales, technical support and finance once we have increased our revenues or received an injection of capital that is sufficient to support such personnel. In addition to our online chess subscriptions, we recently began selling a mobile VoIP app on the Google Play app store. Google recently provided us with vendor credit of $50,000 and assistance in analyzing where and to whom we should target our advertising. Beginning in late September of 2014, Google plans to work with us to advertise our app and generate app revenues.

Beginning in the first quarter of fiscal 2015, we began consulting for small companies and taking an equity stake in the companies in exchange for our services. To help further develop this effort, we purchased a management consulting firm in September 2014.

Our limited operating history and the uncertain nature of our future operations and the markets we address or intend to address make prediction of our future results of operations difficult. Our operations may never generate significant revenues, and we may never achieve profitable operations.   

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Results of Operations

For the Three Months Ended July 31, 2014 Compared to the Three Months Ended July 31, 2013

Our revenues for the first quarter of fiscal 2015 increased by $14,530, or 677%, to $16,676 as compared to $2,146 reported for the first quarter of fiscal 2014. The increase in revenues is attributable to revenues of $15,000 for consulting services we performed for two companies that paid us with a 5% ownership stake in their company.

Selling, general and administrative expenses increased by $180,897, to $186,114 for the first quarter of fiscal 2015 from $5,217 reported in the prior year fiscal period. The increase is primarily attributable to stock-based compensation expense of $175,703 and a $4,000 increase in consulting fees from $3,000 in the first quarter of fiscal 2014 to $7,000 in the first quarter of fiscal 2015.

Interest expense increased by $797 to $5,279 for the quarter ended July 31, 2014, as compared to $4,482 for the prior fiscal quarter. Increased borrowings in the first quarter of fiscal 2015 accounted for the increase in interest expense.

Liquidity and Capital Resources

At July 31, 2014, we had cash and cash equivalents of $374 and negative working capital of $442,252 as compared to cash and cash equivalents of $1,623 and negative working capital of $284,226 at April 30, 2014.

Net cash used in operating activities aggregated $6,895 and $7,614 in the first quarters of fiscal 2015 and 2014, respectively. The principal components of the use of cash from operating activities in the first quarter of fiscal 2015 were the net income of $143,014 plus non-cash compensation of $175,703, which were offset by a change in the fair market value of derivative liabilities of $329,043. The principal use of cash from operating activities in the first quarter of fiscal 2014 was the net loss of $8,202

There was no investing activity in the first quarter of fiscal 2015 or in fiscal 2014.

Net cash provided by financing activities aggregated $5,646 and $5,797 in the first quarters of fiscal 2015 and 2014, respectively. The principal sources of cash from financing activities were proceeds from our secured related party lender, who is our majority stockholder, plus the proceeds of a $5,500 demand note in the fiscal 2015 quarter.

In the first quarters of fiscal 2015 and 2014, there were no expenditures for capital assets. We do not anticipate any capital expenditures in fiscal 2015.

The accompanying financial statements have been prepared in conformity with generally accepted accounting principles, which contemplate continuation of our company as a going concern. However, we have sustained net losses from operations during the last several years, and we have very limited liquidity. Management anticipates that we will be dependent, for the near future, on additional capital to fund our operating expenses and anticipated growth and the report of our independent registered public accounting firm expresses doubt about our ability to continue as a going concern. Our operating losses have been funded through borrowings under a line of credit from our majority shareholder.

Although we are not yet profitable and we are not generating cash from operations, we believe we have short-term financing available from our majority shareholder to fund our monthly cash-flow deficit. While we continually look for other financing sources, in the current economic environment, the procurement of outside funding is extremely difficult and there can be no assurance that such financing will be available, or, if available, that such financing will be at a price that will be acceptable to us. Failure to generate sufficient revenues or raise additional capital will have an adverse impact on our ability to achieve our longer-term business objectives, and will adversely affect our ability to continue operating as a going concern.

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Item 3. Quantitative and Qualitative Disclosures about Market Risk.

We are a smaller reporting company as defined by Rule 12b-2 of the Securities Exchange Act of 1934, as amended, and are not required to provide information under this item.

Item 4. Controls and Procedures.

(a) Disclosure Controls and Procedures.

The Company’s management, with the participation of the Company’s principal executive officer (“PEO”) / principal financial officer (“PFO”), evaluated the effectiveness of the Company’s disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) promulgated under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) as of the end of the period covered by this report. Based on this evaluation, the PEO / PFO concluded that, as of the end of such period, the Company’s disclosure controls and procedures were not effective to ensure that information that is required to be disclosed by the Company in the reports it files or submits under the Exchange Act is (i) recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms and (ii) accumulated and communicated to the Company’s management, including the PEO / PFO, as appropriate, to allow timely decisions regarding required disclosure. The material weaknesses in our disclosure controls and procedures consisted of:

(b) Changes in Internal Control Over Financial Reporting

There have not been any changes in our internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during our most recently completed fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

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PART II – OTHER INFORMATION

Item 1. Legal Proceedings.

We are currently not involved in any litigation that we believe could have a material adverse effect on our financial condition or results of operations. There is no action, suit, proceeding, inquiry or investigation before or by any court, public board, government agency, self-regulatory organization or body pending or, to the knowledge of the executive officers of our company or any of our subsidiaries, threatened against or affecting our company, our common stock, any of our subsidiaries or of our companies or our subsidiaries’ officers or directors in their capacities as such, in which an adverse decision could have a material adverse effect.

Item 1A. Risk Factors.

We are a smaller reporting company as defined by Rule 12b-2 of the Securities Exchange Act of 1934, as amended, and are not required to provide information under this item.

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

None.

Item 3. Defaults Upon Senior Securities.

None.

Item 4. Mine Safety Disclosers

Not applicable.

Item 5. Other Information.

None.

Item 6. Exhibits.

31 Rule 13a-14(a) Certification

32 Rule 13a-14(b) Certification

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned hereunto duly authorized.

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