Notes to Unaudited Consolidated Financial Statements

For the Three and Nine Months Ended September 30, 2018

(Unaudited)

Note 1 – Organization and Basis of Presentation

The unaudited financial statements were prepared by Alpine 4 Technologies Ltd. (the "Company"), pursuant to the rules and regulations of the Securities Exchange Commission ("SEC"). The information furnished herein reflects all adjustments (consisting of normal recurring accruals and adjustments) which are, in the opinion of management, necessary to fairly present the operating results for the respective periods. Certain information and footnote disclosures normally present in annual financial statements prepared in accordance with accounting principles generally accepted in the United States of America ("U.S. GAAP") were omitted pursuant to such rules and regulations. These financial statements should be read in conjunction with the audited financial statements and footnotes included in the Company's Annual Report on Form 10-K filed with the SEC on April 17, 2018. The results for the three and nine months ended September 30, 2018, are not necessarily indicative of the results to be expected for the year ending December 31, 2018.

Description of Business

The Company was incorporated under the laws of the State of Delaware on April 22, 2014.  The Company was formed to serve as a vehicle to affect an asset acquisition, merger, exchange of capital stock, or other business combination with a domestic or foreign business.  The Company is a technology holding company owning four companies (ALTIA, LLC; Quality Circuit Assembly, Inc. ("QCA"); Venture West Energy Services ("VWES") (formerly Horizon Well Testing, LLC); and American Precision Fabricators, Inc., an Arkansas corporation ("APF").   On April 5, 2018, the Company acquired 100% of the outstanding shares of APF (see Note 9).

Note 2 - Summary of Significant Accounting Policies

Principles of consolidation

The consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries as of September 30, 2018, and December 31, 2017.  Significant intercompany balances and transactions have been eliminated.

Basis of presentation

The accompanying financial statements present the balance sheets, statements of operations, stockholders' deficit and cash flows of the Company. The financial statements have been prepared in accordance with U.S. GAAP.

Use of estimates

The preparation of financial statements in conformity with U.S. GAAP requires the Company to make estimates and judgments that affect the reported amounts of assets and liabilities, revenues and expenses, and related disclosures of contingent assets and liabilities.  These estimates and judgments are based on historical information, information that is currently available to the Company and on various other assumptions that the Company believes to be reasonable under the circumstances.  Actual results could differ from those estimates.

Reclassification

Certain prior year amounts have been reclassified to conform to the current period presentation.  These reclassifications had no impact on net earnings and financial position.

Advertising

Advertising costs are expensed when incurred.  All advertising takes place at the time of expense.  We have no long-term contracts for advertising.  Advertising expense for all periods presented were not significant.

Cash

Cash and cash equivalents consist of cash and short-term investments with original maturities of less than 90 days.   As of September 30, 2018, and December 31, 2017, the Company had no cash equivalents.

The following table provides a reconciliation of cash and restricted cash reported within the accompanying consolidated balance sheets that sum to the total of the same such amounts shown in the consolidated statements of cash flows.

 

Major Customers

The Company had two customers that made up 20% and 11%, respectively, of accounts receivable as of September 30, 2018.  The Company had two customers that made up 41% and 13%, respectively, of accounts receivable as of December 31, 2017.

For the three months ended September 30, 2018, the Company had two customers that made up 24% and 10%, respectively, of total revenues.  For the nine months ended September 30, 2018, the Company had one customer that made up 23% of total revenues.  For the three months ended September 30, 2017, the Company had one customer that made up approximately 38% of total revenues.  For the nine months ended September 30, 2017, the Company had one customer that made up approximately 35% of total revenues.

Accounts Receivable

The Company maintains reserves for potential credit losses on accounts receivable. Management reviews the composition of accounts receivable and analyzes historical bad debts, customer concentrations, customer credit worthiness, current economic trends and changes in customer payment patterns to evaluate the adequacy of these reserves. Reserves are recorded primarily on a specific identification basis.  As of September 30, 2018 (unaudited), and December 31, 2017, allowance for bad debt was $18,710 and $18,710, respectively.

 

Maintenance and repair costs are charged against income as incurred.  Significant improvements or betterments are capitalized and depreciated over the estimated life of the asset.

During the nine months ended September 30, 2018 (unaudited), the Company sold automobiles and trucks with a book value of $674,671 for $260467 of proceeds, resulting in a loss on disposal of $414,204 which is reflected in the Company's operating expenses for the nine months ended September 30, 2018.

Property and equipment consisted of the following as of September 30, 2018 (unaudited), and December 31, 2017:

Purchased Intangibles and Other Long-Lived Assets

The Company amortizes intangible assets with finite lives over their estimated useful lives, which range between five and fifteen years as follows:

Intangible assets consisted of the following as of September 30, 2018 (unaudited), and December 31, 2017:

Other long-term assets consisted of the following as of September 30, 2018 (unaudited), and December 31, 2017:

Restricted cash consists of deposit account collateralizing letters of credit in favor of the counterparty in our lease financing obligation.  Changes in restricted cash are reflected as financing activities because the cash is being used in conjunction with financing activities.

Impairment of Long-Lived Assets

The Company accounts for long-lived assets in accordance with the provisions of Financial Accounting Standards Board ("FASB") Accounting Standards Codification ("ASC") Topic 360, "Accounting for the Impairment of Long-Lived Assets."  This statement requires that long-lived assets and certain identifiable intangibles be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable.  An impairment loss would be recognized when the estimated future cash flows from the use of the asset are less than the carrying amount of that asset.  During all periods presented, there have been no impairment losses.

Goodwill

 

In financial reporting, goodwill is not amortized, but is tested for impairment annually or whenever events or changes in circumstances indicate that the carrying amount may not be recoverable.  Events that result in an impairment review include significant changes in the business climate, declines in our operating results, or an expectation that the carrying amount may not be recoverable.  We assess potential impairment by considering present economic conditions as well as future expectations.  All assessments of goodwill impairment are conducted at the individual reporting unit level.  As of September 30, 2018, and December 31, 2017, the reporting units with goodwill were QCA, VWES and APF .

 

Fair Value Measurement

The Company's financial instruments consist of cash and cash equivalents, accounts receivable, accounts payable, accrued expenses, convertible notes, notes and line of credit.  The carrying amount of these financial instruments approximates fair value due either to length of maturity or interest rates that approximate prevailing market rates unless otherwise disclosed in these financial statements.  For additional information, please see Note 11 – Derivative Liabilities and Fair Value Measurements.

Revenue Recognition

On January 1, 2018, the Company adopted ASC Topic 606, "Revenue from Contracts with Customers" using the modified retrospective method applied to those contracts which were not completed as of January 1, 2018.  Results for reporting periods beginning after January 1, 2018 are presented under ASC Topic 606, while prior period amounts are not adjusted and continue to be reported in accordance with the historic accounting under ASC Topic 605.

The Company recorded a net increase to its opening accumulated deficit of $178,202 as of January 1, 2018 due to the cumulative impact of adopting ASC Topic 606, with the impact related to recognition of revenue and costs relating to the sales of the 6 ^th Sense Auto service.  Under the new revenue standard, sales of the Company's 6 ^th Sense Auto service, which includes a hardware and a monthly subscription component, are required to be treated as a single performance obligation and recognized over time.  As a result, the deferred revenue increased by $279,736 and capitalized contract costs increased by $101,534.  The impact to the consolidated statement of operations for the quarter ended September 30, 2018 was a net increase of $103,249 to revenue and a net increase of $31,630 to cost of revenue an increase of as a result of applying ASC Topic 606.  The impact to the consolidated statement of operations for the nine months ended September 30, 2018 was a net increase of $119,137 to revenue and a net increase of $37,300 to cost of revenue an increase of as a result of applying ASC Topic 606.  The impact to the consolidated statement of operations for the three and nine months ended September 30, 2017 was a net decrease of $103,708 to revenue and a net decrease of $32,385 to cost of revenue.

Revenues under ASC Topic 606 are recognized when the promised goods or services are transferred to customers, in an amount that reflects the consideration to which the Company expects to be entitled to in exchange for those goods or services.  The following is a summary of the revenue recognition policy for each of the Company's subsidiaries.

ALTIA

Revenues recorded by ALTIA relate primarily to the Company's 6 ^th Sense Auto service.  The Company accounts for its revenue by deferring the total contract amount and recognizing the amounts over the monthly subscription period, ranging from 12 to 36 months.  

QCA

QCA is a contract manufacturer and recognizes revenue when the products have been built and control has been transferred to the customer.  If a deposit for product or service is received prior to completion, the payment is recorded to deferred revenue until such point the product or services meets our revenue recognition policy.  Management assesses the materiality and likelihood of warranty work and returns, and records reserves as needed.  For all periods presented, management determined that the warranty and returns would be immaterial.

VWES

VWES performs water transfer services and well testing for the oil and gas industry.  Revenue is recognized over time as services under the contracts are completed. 

APF

APF is a contract manufacturer and recognizes revenue when the products have been built and control has been transferred to the customer.  If a deposit for product or service is received prior to completion, the payment is recorded to deferred revenue until such point the product or services meets our revenue recognition policy.  Management assesses the materiality and likelihood of warranty work and returns, and records reserves as needed.  For all periods presented, management determined that the warranty and returns would be immaterial.

Earnings (loss) per share

Basic earnings (loss) per common share is computed by dividing net income (loss) available to common shareholders by the weighted-average number of shares of common stock outstanding during the period. Diluted earnings per common share is computed by dividing income available to common shareholders by the weighted-average number of shares of common stock outstanding during the period increased to include the number of additional shares of common stock that would have been outstanding if potentially dilutive securities had been issued. The only potentially dilutive securities outstanding during the periods presented were the convertible debentures, but they are anti-dilutive due to the net loss incurred. 

 

Stock-based compensation

Income taxes

The Company records income taxes under the asset and liability method, whereby deferred tax assets and liabilities are recognized based on the future tax consequences attributable to temporary differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases, and attributable to operating loss and tax credit carry forwards. Accounting standards regarding income taxes requires a reduction of the carrying amounts of deferred tax assets by a valuation allowance, if based on the available evidence, it is more likely than not that such assets will not be realized. Accordingly, the need to establish valuation allowances for deferred tax assets is assessed at each reporting period based on a more-likely-than-not realization threshold. This assessment considers, among other matters, the nature, frequency and severity of current and cumulative losses, forecasts of future profitability, the duration of statutory carry forward periods, the Company's experience with operating loss and tax credit carry forwards not expiring unused, and tax planning alternatives.

The Company recorded valuation allowances on the net deferred tax assets.  Management will reassess the realization of deferred tax assets based on the accounting standards for income taxes each reporting period. To the extent that the financial results of operations improve, and it becomes more likely than not that the deferred tax assets are realizable, the Company will be able to reduce the valuation allowance.

Significant judgment is required in evaluating the Company's tax positions and determining its provision for income taxes. During the ordinary course of business, there are many transactions and calculations for which the ultimate tax determination is uncertain. Accounting standards regarding uncertainty in income taxes provides a two-step approach to recognizing and measuring uncertain tax positions. The first step is to evaluate the tax position for recognition by determining if the weight of available evidence indicates it is more likely than not that the position will be sustained on audit, including resolution of related appeals or litigation processes, if any. The second step is to measure the tax benefit as the largest amount which is more than 50% likely, based solely on the technical merits, of being sustained on examinations. The Company considers many factors when evaluating and estimating its tax positions and tax benefits, which may require periodic adjustments, and which may not accurately anticipate actual outcomes.

Embedded Conversion Features

The Company evaluates embedded conversion features within convertible debt under ASC 815 "Derivatives and Hedging" to determine whether the embedded conversion feature(s) should be bifurcated from the host instrument and accounted for as a derivative at fair value with changes in fair value recorded in earnings.  If the conversion feature does not require derivative treatment under ASC 815, the instrument is evaluated under ASC 470-20 "Debt with Conversion and Other Options" for consideration of any beneficial conversion features.

Related Party Disclosure

FASB ASC 850, "Related Party Disclosures," requires companies to include in their financial statements disclosures of material related party transactions. The Company discloses all material related party transactions. Related parties are defined to include any principal owner, director or executive officer of the Company and any immediate family members of a principal owner, director or executive officer.

Recent Accounting Pronouncements

In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842) . The guidance in ASU No. 2016-02 supersedes the lease recognition requirements in ASC Topic 840, Leases (FAS 13) . ASU 2016-02 requires an entity to recognize assets and liabilities arising from a lease for both financing and operating leases, along with additional qualitative and quantitative disclosures. ASU 2016-02 is effective for fiscal years beginning after December 15, 2018, with early adoption permitted. The Company is currently evaluating the effect this standard will have on its financial statements.

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

 

Note 3 – Going Concern

The accompanying financial statements have been prepared on a going concern basis. The working capital of the Company is currently negative and causes doubt of the ability for the Company to continue. The Company requires capital for its operational and marketing activities.  The Company's ability to raise additional capital through the future issuances of common stock is unknown. The obtainment of additional financing, the successful development of the Company's plan of operations, and its ultimate transition to the attainment of profitable operations are necessary for the Company to continue operations. The ability to successfully resolve these factors raise substantial doubt about the Company's ability to continue as a going concern. The financial statements of the Company do not include any adjustments that may result from the outcome of these aforementioned uncertainties.

In order to mitigate the risk related with the going concern uncertainty, the Company has a three-fold plan to resolve these risks.  First, the acquisitions of QCA, VWES, and APF have allowed for an increased level of cash flow to the Company.  Second, the Company is considering other potential acquisition targets that, like QCA, should increase income and cash flow to the Company.  Third, the Company plans to issue additional shares of common stock for cash and services during the next 12 months and has engaged professional service firms to provide advisory services in connection with that capital raise.

 

 

In 2016, the Company sold a building and used the money to purchase QCA.  Because this is a financing transaction, the sale is recorded under "financing lease obligation" on the accompanying consolidated balance sheet and amortized over the 15-year term of the lease.  The term of the lease has been extended through September 30, 2032 at a monthly rate of approximately $69,000.  These payments are reflected in the table above.

On April 5, 2018, the Company acquired APF (see Note 9).  In order to fund a portion of the acquisition price, the Company simultaneously entered into a sale leaseback transaction with a third-party lender whereby the building acquired from APF was sold for $1,900,000, and leased back to the company for a period of 15 years at a monthly rate of $15,833, subject to an annual increase of 2% throughout the term of the lease.  The Company had no gain or loss resulting from the sale of the property, and the resulting lease qualifies as a capital lease.  As a result, the Company has capitalized the cost of the building and the resulting capital lease obligation liability of $1,900,000.  The resulting capital lease obligation liability of $1,769,770 as of September 30, 2018 is reflected in financing lease obligation in the accompanying consolidated balance sheets.  The payments related to this lease are reflected in the table above.

A letter of credit of $1,000,000 is to be provided to the landlord in the above QCA financing lease obligation, of which $207,311 had been satisfied as of September 30, 2018.

Operating Leases

The Company has two non-cancellable operating leases as of September 30, 2018 for its locations in San Jose, California and Oklahoma City, Oklahoma.  Approximate monthly rent obligations for these locations amount to $21,500 and $5,000 respectively.  The Company also has an office it leases in Phoenix, Arizona on a month-to-month basis.  VWES also rents certain equipment on a temporary basis to perform its services.

The five-year minimum rent payments for each location are as follows:

Rent expense for the three months ended September 30, 2018 and 2017 amounted to $362,327 and $88,500, respectively.  Rent expense for the nine months ended September 30, 2018 and 2017 amounted to $1,183,229 and $270,300, respectively.

Note 5 – Notes Payable

During the year ended December 31, 2017, VWES secured a line of credit with a third-party lender, Crestmark.  The line of credit is collateralized by VWES's outstanding accounts receivable, up to 85% with maximum draws of $2,000,000 and a variable interest rate.  The Company also secured a five-year fixed rate (10.14%) term loan with Crestmark Equipment Finance for $1,872,392 which is collateralized by VWES's equipment.  Both are guaranteed by the Company.

In May 2018, APF also secured a line of credit with Crestmark, providing for borrowings up to $1,000,000 at a variable interest rate, collateralized by APF's outstanding accounts receivable. 

As of December 31, 2017, the Company had an outstanding term loan with a 30% interest rate of $10,000 which was repaid during the nine months ended September 30, 2018.  During the nine months ended September 30, 2018, the Company borrowed an aggregate total of $149,000 in additional short-term notes payable bearing interest at 15% per annum with maturity dates of three months from the date of issuance.

On February 22, 2018, the Company issued a $3,000,000 note payable under the Amended and Restated Secured Promissory Note with the seller of VWES (see Note 9).  The note is secured by the assets of VWES and bears interest at 7% per annum and is due in semi-annual payments of $150,000 commencing on June 1, 2018, through June 1, 2020.

 

On April 5, 2018, the Company issued two secured promissory notes in the aggregate principal amount of $1,950,000 ("Secured APF Notes") as part of the consideration for the purchase of APF (see Note 9).  The Secured APF Notes are secured by the equipment, customer accounts and intellectual property of the Company, and all of the products and proceeds from any of the assets of APF.  The Secured APF Notes bear interest at 4.25% per annum and have aggregate monthly payments of $19,975 for the first 23 months, with a balloon payment due in April 2020 for the remaining principal and interest outstanding.

		September 30, 2018  (Unaudited)				December 31, 2017
Lines of credit, current portion		$	3,249,443			$	2,012,116
Equipment loans, current portion			1,451,076				1,871,501
Term notes, current portion			525,991				10,000
Total current			5,226,510				3,893,617
Long-term portion			5,001,457				-
Total notes payable		$	10,227,967			$	3,893,617

		12 Months Ended
		September 30:
2019		$	5,226,510
2020			604,329
2021			4,183,422
2022			178,607
2023			35,099
Total		$	10,227,967

 

 

 

The discounts on convertible notes payable arise from stock issued with notes payable, beneficial conversion features, as well as conversion features of certain convertible notes being treated as derivative liabilities (see Note 11).  The discounts are being amortized over the terms of the convertible notes payable.  Amortization of debt discounts during the three months ended September 30, 2018 and 2017 amounted to $303,433 and $11,468, respectively.  Amortization of debt discounts during the nine months ended September 30, 2018 and 2017 amounted to $606270 and $22,500, respectively, and is recorded as interest expense in the accompanying consolidated statements of operations.  The unamortized discount balance for these notes was $745,915 as of September 30, 2018, which is expected to be amortized over the next 12 months.

Future scheduled maturities of outstanding convertible notes payable are as follows:

Note 8 – Stockholders' Equity

Preferred Stock

The Company is authorized to issue 10,000,000 shares of $.0001 par value preferred stock. As of September 30, 2018 and December 31, 2017, no shares of preferred stock were outstanding.

Common Stock

Pursuant to the Second Amended and Restated Certificate of Incorporation, the Company is authorized to issue two classes of common stock: Class A common stock, which has one vote per share, and Class B common stock, which has ten votes per share. Any holder of Class B common stock may convert his or her shares at any time into shares of Class A common stock on a share-for-share basis. Otherwise the rights of the two classes of common stock will be identical.

The Company had the following transactions in its common stock during the nine months ended September 30, 2018:

 

 

Redeemable Common Stock

 

During 2017, the Company issued 379,403 shares of its Class A common stock in connection with the purchase of VWES.  Of these shares, 260,000 shares were redeemable at $4.25 per share at three different redemption periods:  130,000 shares at 12 months, 65,000 shares at 18 months and 65,000 shares at 24 months from the closing date of the purchase of VWES.  Additionally, 119,403 shares were redeemable at $3.35 per share at 12 months from the closing date of the purchase of VWES.  These shares were valued at the redemption value of $1,439,725.  The redemption right on these shares was cancelled in connection with the Amended Agreement entered on February 22, 2018 (see Note 9).

Due to the nature of the issuance of stock for the VWES acquisition, it was historically recorded outside of permanent equity.  Subsequent to February 22, 2018 after the cancellation of the redemption rights, the stock was reclassified to equity in the accompanying consolidated balance sheet.

Stock Options

The Company has issued stock options to purchase shares of the Company's Class A common stock issued pursuant to the Company's 2016 Stock Option and Stock Award Plan (the "Plan").  The Company uses the Black-Scholes option pricing model to estimate the fair value of stock-based awards on the date of grant and on each modification date.

The following summarizes the stock option activity for the nine months ended September 30, 2018:

The following table summarizes information about options outstanding and exercisable as of September 30, 2018:

During the three months ended September 30, 2018 and 2017, stock option expense amounted to $18,914 and $36,617, respectively.  During the nine months ended September 30, 2018 and 2017, stock option expense amounted to $52,309 and $69,290, respectively.  Unrecognized stock option expense as of September 30, 2018 amounted to $205,134, which will be recognized over a period extending through May 2022. 

Warrants

On January 1, 2017, the Company granted 75,000 warrants to the seller of VWES.  The warrants have a 3 year contractual life, an exercise price of $4.25 per share and are vested immediately.  The warrants were accounted for as part of the purchase price of the acquisition of VWES.  On February 22, 2018, in connection with the Amended Agreement (see Note 9), the warrants were cancelled and replaced with 75,000 new warrants with an exercise price of $1 per share that were vested immediately and have a contractual life of 3 years.

On April 9, 2018, the Company granted 153,340 warrants in connection with the issuance of a convertible note payable.  The warrants have a 3 year contractual life, an exercise price of $1 per share and are vested immediately.

During the nine months ended September 30, 2017, the Company granted an aggregate total of 2,001 warrants to individuals.  These warrants all have a 3 year contractual life, an exercise price of $2.00 per share and are vested immediately.

Note 9 – Business Combinations

Venture West Energy Services

Pro forma information is not provided because the results after December 31, 2016 are post-acquisition.

On February 22, 2018, the Company entered into an Amended Agreement with the seller of VWES.  Per the terms of the Amended Agreement, the two notes payable initially issued to the seller of VWES on January 1, 2017, for $1,500,000 and $300,000 were cancelled, along with the redemption rights associated with 379,403 shares the Company's Class A common stock and 75,000 warrants, and replaced with a new Amended and Restated Secured Promissory Note for $3,000,000 (see Note 5).  The new note is due in semi-annual payments of $150,000 commencing on June 1, 2018, through June 1, 2020 and bears interest at 7% per annum.  If the note is paid was full on or before June 1, 2018, the balance due would be discounted by $500,000.  If the note is paid in full after June 1, 2018, and on or before December 1, 2018, the balance due will be discounted by $450,000.  If the note is paid in full after December 1, 2018, and on or before June 1, 2019, the balance due will be discounted by $350,000.  If the note is paid in full after June 1, 2019, and on or before December 1, 2019, the balance due will be discounted by $250,000.  If the note is paid in full after December 1, 2019, and on or before June 1, 2020, the balance due will be discounted by $200,000.

In connection with the Amended Agreement, the Company also issued an additional 100,000 shares of Class A common stock to the seller of VWES valued at $15,000, and granted new warrants effective February 22, 2018 to purchase 75,000 shares of common stock with an exercise price of $1.00 per share valued at $9,142 using the Black-Sholes model.  The warrants are immediately vested and have a contractual life of 3 years.  The Company also agreed to return the land and building acquired in the acquisition of VWES to the seller.  The land and building had an aggregate book value as of February 22, 2018 of $173,396, which approximated its fair value.

The Company compared the value of the extinguished debt, returned land and building and cancelled stock and warrants to the value of the new Amended and Restated Secured Promissory Note and new instruments issued as of February 22, 2018.  The difference of $136,300 was reflected as a gain on extinguishment of debt during the accompanying consolidated statements of operations for the nine months ended September 30, 2018.

The following is a summary of the non-cash items given as consideration to the seller of VEWS in connection with the Amended and Restated Secured Promissory Note, which is reflected in the supplemental disclosure of non-cash financing activities in the accompanying consolidated statement of cash flows for the nine months ended September 30, 2018.

American Precision Fabricators ("APF")

On April 5, 2018, the Company announced that it had entered into a Securities Purchase Agreement (the "SPA") with APF, an Arkansas corporation, and Andy Galbach ("Galbach") and Clarence Carl Davis, Jr. ("Davis"), the owners of APF (the "Sellers").  Pursuant to the SPA, the Company acquired 100% of the outstanding shares in APF.

The total purchase price of APF from the SPA amounted to $4,500,000, which consisted of aggregate cash consideration paid to the Sellers of $2,100,000, an aggregate of $1,950,000 of secured promissory notes due to the Sellers (see Note 5), and an aggregate of $450,000 of convertible promissory notes due to the Sellers (see Note 7).  At the closing date, the Company and the Sellers agreed to a reduction of the purchase price of $123,250, resulting from a net working capital adjustment which was deducted from the cash consideration due to the Sellers.  As a result, the total purchase price of APF was $4,376,750.

A summary of the purchase price allocation at fair value is below.  The business combination accounting is not yet complete and the amounts assigned to assets acquired and liabilities assumed are provisional.  Therefore, this may result in future adjustments to the provisional amounts as new information is obtained about facts and circumstances that existed at the acquisition date.

In connection with the SPA, and as consideration for the Company to enter into the SPA, APF and Galbach entered into a Consulting Services Agreement (the "Consulting Agreement"), pursuant to which Galbach agreed for a period of 90 days following the closing date to provide strategic management services to APF, meet with APF's new management, and provide his knowledge in customer relations, trade and service implementation, and other business disciplines. Additionally, APF agreed to reimburse Galbach for his expenses incurred by Galbach in connection with providing the services under the Consulting Agreement.

Simultaneous with the purchase of APF, a building, owned by APF prior to the acquisition, was sold in a sale-leaseback transaction agreement, whereby the building was leased from the buyer for 15 years.  The proceeds from the sale-leaseback of $1,900,000 were used to fund the cash consideration to the sellers.  The building and the lease is being treated as a capital lease (see Note 4).

The following are the unaudited pro forma results of operations for the three and nine months ended September 30, 2018 and 2017, as if APF had been acquired on January 1, 2017.  The pro forma results include estimates and assumptions which management believes are reasonable.  However, pro forma results do include any anticipated cost savings or other effects of the planned integration of these entities, and are not necessarily indicative of the results that would have occurred if the business combination had been in effect on the dates indicated.

Note 11 – Derivative Liabilities and Fair Value Measurements

Derivative liabilities

The Company has issued convertible notes payable that were evaluated under the guidance in FASB ASC 815-40, Derivatives and Hedging, and were determined to have characteristics of derivative liabilities.  As a result of the characteristics of these notes, the conversion options relating to previously issued convertible debt and outstanding Class A common stock warrants were also required to be accounted for as derivative liabilities under ASC 815.   Under this guidance, this derivative liability is marked-to-market at each reporting period with the non-cash gain or loss recorded in the period as a gain or loss on derivatives. 

During the nine months ended September 30, 2018, the Company had new convertible notes which became convertible that resulted in an additional $2,305,872 initial derivative fair value, which was recorded as a derivative liability and a discount to the note payable, of which $1,042,902 was immediately recorded as a derivative expense due to the value of the derivative liability exceeding the book value of the note payable.  In addition, the Company paid off existing convertible notes which resulted in a reduction of the derivative liability and a loss on the change in value of derivatives of $766,718.

As of December 31, 2017, the fair value of the derivative liability amounted to $271,588.  As of September 30, 2018, the fair value of the derivative liability amounted to $550,033.  The change in value of the derivative liabilities for the three and nine months ended September 30, 2018 in the accompanying consolidated statements of operations amounted to a gain of $246,025 and $239,610, respectively.

The valuation of our embedded derivatives is determined by using the Black-Scholes Option Pricing Model.  As such, our derivative liabilities have been classified as Level 3.

The Company estimated the fair value of the derivative liabilities using the Black-Scholes Option Pricing Model and the following key assumptions during the nine months ended September 30, 2018.

Fair value measurements

FASB ASC 820, Fair Value Measurements and Disclosures, defines fair value as the exchange price 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.  FASB ASC 820 also establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value.  FASB ASC 820 describes three levels of inputs that may be used to measure fair value:

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

Level 2 – Observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.

Level 3 – Unobservable inputs that are supported by little or no market activity and that are financial instruments whose values are determined using pricing models, discounted cash flow methodologies, or similar techniques, as well as instruments for which the determination of fair value requires significant judgment or estimation.

If the inputs used to measure the financial assets and liabilities fall within more than one level described above, the categorization is based on the lowest level of input that is significant to the fair value measurement of the instrument.

The following table provides a summary of the fair value of our derivative liabilities as of September 30, 2018 (unaudited), and December 31, 2017: