Notes to Condensed Consolidated Financial Statements
(Unaudited)
Accordingly, these unaudited condensed consolidated statements do not include all of the information and disclosures required by GAAP or SEC rules and regulations for complete consolidated financial statements. In the opinion of management, these unaudited condensed consolidated financial statements reflect all adjustments (consisting solely of normal recurring nature) considered necessary for a fair presentation of the results for the interim periods presented. The results of operations for any interim period are not necessarily indicative of results for the full year.
These unaudited condensed consolidated financial statements should be read in conjunction with the Company’s filings with the SEC, including its most recent annual report on Form 10-K for the fiscal year ended June 30, 2018 filed on October 19, 2018.
Liquidity and capital resources
For the quarter ended September 30, 2018 we had a net loss totaling approximately $5,007,000 with negative cash flows from operations totaling approximately $8,377,000. Our cash balance at September 30, 2018 was approximately $1,595,000. Since the date of the closing of the FHV Acquisition, our sales were less than anticipated and the resulting cash flows from franchise sales were not sufficient to cover expenditures associated with our daily operations resulting in a substantial decrease in our cash balances and an increase in our outstanding debt. Also, we used cash on hand to retire liabilities associated with the franchise rescissions, for research and development expenditures related to our robotic soft serve vending kiosks and for the purchase of robot inventory. In order to ensure sufficient liquidity for our continuing operations, we will require additional capital financing in the form of either debt or equity (or a combination thereof) financing. During fiscal year 2018 and through the date of this report, the Company raised approximately $17.6 million through the sale of common stock. Furthermore, the Company anticipates generating a significant amount of our required capital resources from deposits on sales of new franchises, royalties from existing and future franchise installs and revenue from corporate-owned kiosks. If additional funds are required, management believes that it will be able to obtain such financing on terms acceptable to the Company, although there can be no assurance that we will be successful.
Our current plans include research and development expenditures for the production of the next generation robot, payments required for the purchase of the Robofusion intellectual property (previous owner of the frozen yogurt robot intellectual property), capital expenditures for the purchase of franchisee and corporate-owned and operated robotic soft serve vending kiosks, as well as the repurchase of machines from franchisees opting to rescind their franchise agreements. Given our current cash position, we may be forced to curtail our plans by delaying or suspending the production and purchase of robotic soft serve vending kiosks until such time that we may able to prepay for the robots.
Principles of consolidation
The condensed consolidated financial statements include the accounts of the Company, and its wholly-owned subsidiaries, Reis & Irvy’s, Inc., FHV LLC (recorded as discontinued operations), 19 Degrees, Inc., Generation Next Vending Robots, The Fresh and Healthy Vending Corporation, and FHV Acquisition, Corp. All significant intercompany accounts and transactions are eliminated.
Use of estimates
The preparation of our Company’s financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of our financial statements and the reported amounts of revenues, costs and expenses during the reporting period. Actual results could differ significantly from those estimates. Significant estimates include our provisions for bad debts, franchisee rescissions and refunds, legal estimates, stock-based compensation, derivative liability and the valuation allowance on deferred income tax assets. It is at least reasonably possible that a change in the estimates will occur in the near term.
Generation NEXT Franchise Brands, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(Unaudited)
Cash and cash equivalents
All investments with an original maturity of three months or less are considered to be cash equivalents. Cash equivalents primarily represent funds invested in money market funds, bank certificates of deposit and U.S. government debt securities whose cost equals fair market value. We had no cash equivalents at September 30. 2018 and June 30, 2018. We may maintain our cash and cash equivalents in amounts that may, at times, exceed federally insured limits. At September 30, 2018, bank balances, per our bank, exceeding federally insured limits totaled approximately $1,212,000. We have not experienced any losses with respect to cash, and we believe our Company is not exposed to any significant credit risk with respect to our cash.
Certain states require the Company to maintain customer deposits in escrow accounts until the Company has substantially performed its obligations. Furthermore, certain franchisees have elected to pay their remaining balance due directly to an escrow account for the beneficiary of the Company’s contract manufacturer and inventory suppliers. At September 30, 2018 and June 30, 2018, the Company had approximately $5,243,000 and $3,710,000, respectively maintained in escrow accounts for these purposes.
Accounts receivable, net
Accounts receivable arise primarily from royalties and are carried at their estimated collectible amounts, net of any estimated allowances for doubtful accounts. We grant unsecured credit to our customers (located throughout North America, the Bahamas and Puerto Rico) deemed credit worthy. Ongoing credit evaluations are performed and potential credit losses estimated by management are charged to operations on a regular basis. At the time any particular account receivable is deemed uncollectible, the balance is charged to the allowance for doubtful accounts. Our allowance for doubtful accounts aggregated approximately $174,000 and $0 at September 30, 2018 and June 30, 2018, respectively.
Inventory
Inventory is carried at the lower of cost or market, with cost determined using the average cost method.
Property and equipment
Property and equipment are carried at cost and depreciated using the straight-line method over their estimated useful lives of the individual assets, generally five to seven years. Leasehold improvements are amortized over the lesser of the term of the related lease or the estimated useful life of the asset. Costs incurred for maintenance and repairs are expensed as incurred and expenditures for major replacements and improvements are capitalized and depreciated over their estimated remaining useful lives.
Intangible assets
Intangible assets consist primarily of patents, trademarks and trade names. Amortization of intangible assets is recorded as amortization expense in the consolidated statements of operations and amortized over the respective useful lives using the straight-line method.
Impairment of long-lived assets
Impairment losses are recognized on long-lived assets used in operations when indicators of impairment are present and the undiscounted cash flows estimated to be generated by those assets are less than the assets’ carrying amount. If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amounts of the assets exceed the estimated fair value of the assets. There were no impairments of long-lived assets for the periods ended September 30, 2018 and June 30, 2018, respectively.
Generation NEXT Franchise Brands, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(Unaudited)
Deferred rent
The Company entered into an operating lease for our corporate offices in San Diego, California that contains provisions for future rent increases, leasehold improvement allowances and rent abatements. We record monthly rent expense equal to the total of the payments due over the lease term, divided by the number of months of the lease term. The difference between the rent expense recorded and the amount paid is credited or charged to deferred rent, which is reflected as a separate line item in the accompanying consolidated balance sheet.
Derivatives and Hedging
In April 2008, the FASB issued a pronouncement that provides guidance on determining what types of instruments or embedded features in an instrument held by a reporting entity can be considered indexed to its own stock for the purpose of evaluating the first criteria of the scope exception in the pronouncement on accounting for derivatives. This pronouncement was effective for financial statements issued for fiscal years beginning after December 15, 2008. The adoption of these requirements can affect the accounting for many convertible instruments with provisions that protect holders from a decline in the stock price. Each reporting period, the Company evaluates whether convertible debt to acquire stock of the Company contains provisions that protect holders from declines in the stock price or otherwise could result in modification of the conversion price under the respective convertible debt agreements. The Company determined that the conversion feature in the convertible notes issued contained such provisions and recorded such instruments as derivative liabilities.
The fair value of derivative instruments is recorded and shown separately under current liabilities. Changes in fair value are recorded in the consolidated statements of operations under other income (expenses).
The accounting treatment of derivative financial instruments requires that the Company record the embedded conversion option and warrants at their fair values as of the inception date of the agreement and at fair value as of each subsequent balance sheet date. Any change in fair value is recorded as a non-operating, non-cash income or expense for each reporting period at each balance sheet date. If the classification changes as a result of events during the period, the contract is reclassified as of the date of the event that caused the reclassification.
The Company evaluates all of 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 instruments are 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. For stock-based derivative financial instruments, the Company uses the Black-Sholes option pricing model to value the derivative instruments at inception and on subsequent valuation dates. 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 twelve months of the balance sheet date.
Revenue, contract liabilities – franchisees advances and deferred revenue, and contract assets – due from franchisees
The Company relies upon ASC 606,
Revenue from Contracts with Customers
, to recognize revenue, contract liabilities-deposits from franchisees and contract assets-due from franchisees.
Reis & Irvy’s, Inc
The primary revenue sources consisted of the following:
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Robotic soft serve vending kiosks
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Franchise fees
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Royalties
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Generation NEXT Franchise Brands, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(Unaudited)
Revenues from robotic soft serve vending kiosks and franchise fees are recognized when the Company has substantially performed or satisfied all material services or conditions relating to the franchise agreement. Substantial performance has occurred when: 1) no remaining obligations are unfulfilled under the franchise agreement; 2) there is no intent to refund any cash received or to forgive any unpaid amounts due from franchisees; 3) all of the initial services in the franchise agreement have been performed; and 4) all other material conditions or obligations have been met. During the quarter ended September 30, 2018 and 2017, 50 and 0 robotic soft serve vending kiosks were installed and operational, respectively, and the Company had no further material conditions or obligations. During the quart ended September 30, 2018 and 2017, the Company recognized revenue of approximately $1,688,000 and $0, respectively for robotic soft serve vending kiosks and approximately $1,500 and $0, respectively in franchise fees.
Upon the execution of a franchise agreement, a deposit from the franchisee is required, and generally consists of 40% - 50% of the sales price of the frozen yogurt and ice cream robots, 50% - 100% of the initial franchise fees, and 40% - 50% of location fees. In accordance with ASC 606, the Company recognizes the contract as a contract liability – customer deposits and deferred revenue when the Company receives consideration or is due consideration. As of September 30, 2018 and June 30, 2018, the Company’s customer advances and deferred revenues were approximately $39,549,000 and $37,222,000, respectively. These amounts are net of certain off-set adjustments of $13,295,000 and $9,921,000, respectively.
The Company recognizes contract assets – due from franchisees when the Company has an unconditional right to consideration. As of September 30, 2018 and June 30, 2018, the Company’s contract assets – due from franchisees was approximately $5,835,000 and $7,251,000, respectively.
Fresh Healthy Vending LLC
Because it was determined the assets of FHV LLC are currently insufficient to satisfy FHV LLC’s obligations to creditors, as of September 28, 2018, FHV LLC has executed an Assignment for the Benefit of Creditors under California law, whereby all of the assets of FHV LLC have been assigned to a third party fiduciary who will expeditiously liquidate such assets and distribute the proceeds thereof to FHV LLC’s creditors pursuant to the priorities established and permitted by law. Consequently, the Company has accounted for FHV LLC as a discontinued operation.
Generation NEXT Franchise Brands, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(Unaudited)
19 Degrees
The Company recognizes revenue from the sale of products from company-owned robotic soft serve vending kiosks when products are purchased. During the quarters ended September 30, 2018 and 2017, the Company recognized approximately $29,000 and $62,000, respectively.
The Company recognizes the value of company-owned machines as inventory when purchased. Subsequent to installation, the purchased cost is recognized in fixed assets and depreciated over its estimated useful life. As of June 30, 2018, there were four company-owned robotic soft serve vending kiosks included in fixed assets.
Generation Next Vending Robots
The Company recognizes revenue from the direct sale of robotic soft serve vending kiosks when the machines are installed and operational. During the quarters ended September 30, 2018 and 2017, there were no revenues from the direct sale of robots.
It is not the Company’s policy to allow for returns, discounts or warranties to our franchisees. Under certain circumstances, including as the result of regulatory action, the Company may become obligated to offer our franchisees amounts in rescission to reacquire their existing franchises, including the robotic soft serve vending kiosks Additionally, if the Company is unable to fulfill its obligations under a franchise agreement the Company may, at its sole discretion, agree to refund or reduce part or all of a franchisees payments or commitments to pay.
As of September 30, 2018 and June 30, 2018, the Company’s provision for Reis & Irvy’s franchisee rescissions and refunds totaled approximately $3,753,000 and $1,924,000, respectively. The balance is based on executed termination agreements and an estimate of future terminations.
Marketing and advertising
Marketing and advertising costs are expensed as incurred. There are no existing arrangements under which the Company provides or receives marketing and advertising services from others for any consideration other than cash. Marketing and advertising expense totaled approximately $798,000 and $747,000 for the quarters ended September 30, 2018 and 2017, respectively.
Freight costs and fees
Outbound freight charged to customers is recorded as revenue. The related outbound freight costs are considered period costs and charged to cost of revenues.
Research and Development Costs
Research and development costs are expensed as incurred. For the quarters ended September 30, 2018 and 2017, the Company recorded approximately $999,000 and $901,000, respectively.
Income taxes
The Company provides for income taxes utilizing the liability method. Under the liability method, current income tax expense or benefit is the amount of income taxes expected to be payable or refundable for the current year. A deferred income tax asset or liability is computed for the expected future impact of differences between the financial reporting and tax bases of assets and liabilities and for the expected future tax benefit to be derived from tax credits. Tax rate changes are reflected in the computation of the income tax provision during the period such changes are enacted.
Generation NEXT Franchise Brands, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(Unaudited)
Deferred tax assets are reduced by a valuation allowance when, in management’s opinion, it is more likely than not that some portion or all of the deferred tax assets will not be realized. The Company considers the scheduled reversal of deferred tax liabilities, projected future taxable income, and tax planning strategies in making this assessment. The Company’s valuation allowance is based on available evidence, including its current year operating loss, evaluation of positive and negative evidence with respect to certain specific deferred tax assets including evaluation sources of future taxable income to support the realization of the deferred tax assets. The Company has established a full valuation allowance on the deferred tax assets as of September 30, 2018 and June 30, 2018, and therefore has not recognized any income tax benefit or expense (other than the state minimum income tax) for the periods presented.
ASC 740, Income Taxes (“ASC 740”), clarifies the accounting for uncertainty in income taxes recognized in the financial statements. ASC 740 provides that a tax benefit from uncertain tax positions may be recognized when it is more-likely-than not that the position will be sustained upon examination, including resolutions of any related appeals or litigation processes, based on the technical merits of the position. Income tax positions must meet a more-likely-than-not recognition threshold to be recognized. ASC 740 also provides guidance on measurement, derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition.
The Company recognizes interest and/or penalties related to income tax matters in income tax expense. There is no accrual for interest or penalties for income taxes on the balance sheets as of September 30, 2018 and June 30, 2018, and the Company has not recognized interest and/or penalties in the consolidated statements of operations for the quarters ended September 30, 2018 and 2017.
Valuation of options and warrants to purchase common stock and share grants
Warrants to purchase common stock are separately valued when issued in connection with notes payable using a binomial quantitative valuation method. The value of such warrants is recognized as a discount from the related notes payable and credited to additional paid-in capital at the time of the issuance of the related notes payable. The value of the discount is applied to the note payable and amortized over the expected term of the note payable using the interest method with the related accretion charged to interest expense.
Share-based compensation to employees is recognized in accordance with ASC 718, using a binomial quantitative valuation method. The resulting compensation expense is recognized in the financial statements on a straight-line basis over the vesting period from the date of grant.
Share-based compensation to non-employees is recognized in accordance with ASC 505, at the estimated fair value until the options or warrants have vested. The resulting compensation expense is recognized on a straight-line basis over the vesting period from the date of grant.
Share grants are measured using a fair value method with the resulting compensation cost recognized in the financial statements. Compensation expense is recognized on a straight-line basis over the service period for the stock awards.
Concentration of credit risk
The Company is subject to credit risk through its accounts receivable consisting primarily of amounts due from franchisees for royalty income, and other products. The financial condition of these franchisees is largely dependent upon the underlying business trends of our brands and market conditions within the vending industry. This concentration of credit risk is mitigated, in part, by the large number of franchisees spread over a large geographical area and the short-term nature of the receivables. Furthermore, this risk is mitigated in large part by the Company’s collection of electronic sales from the robot kiosks.
Concentration of manufacturers
Vending machines and micro markets were supplied by a single manufacturer. Additionally, robotic soft serve vending kiosks are manufactured by one supplier; a change in suppliers could cause a delay in deliveries and possible loss of sales, which could adversely affect the Company’s operating results.
The Company uses a single supplier for its frozen confectionary consumables. Although there are a limited number of product suppliers with the product selection and distribution capabilities required by the franchise network, other manufacturers and distributors could provide similar products on comparable terms.
Vending food products were primarily supplied by one national distributor. Although there are a limited number of product suppliers with the product selection and distribution capabilities required by the franchise network, other distributors could provide similar products on comparable terms. The Company, and its franchisees, also use supplemental suppliers for their product selections, in addition to the national distributor.
See Note 11 for purchase commitments from our manufacturers for inventory.
Generation NEXT Franchise Brands, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(Unaudited)
Fair value of financial instruments
The Company follows guidance for accounting for fair value measurements of financial assets and financial liabilities and for fair value measurements of nonfinancial items that are recognized or disclosed at fair value in the financial statements on a recurring basis. Additionally, the Company adopted guidance for fair value measurement related to nonfinancial items that are recognized and disclosed at fair value in the financial statements on a nonrecurring basis. The guidance 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. The Company determined that the derivative liability was a level 3, as the inputs used to determine the estimated fair value were unobservable.
The Company monitors the market conditions and evaluates the fair value hierarchy levels at least quarterly. For any transfers in and out of the levels of the fair value hierarchy, the Company elects to disclose the fair value measurement at the beginning of the reporting period during which the transfer occurred.
The Company’s financial instruments consisted of cash, cash in escrow, accounts receivable, accounts payable and accrued liabilities, provision for franchisee rescissions and refunds, accrued personnel expenses, due to related party and notes payable. The estimated fair value of these financial instruments approximate the carrying amount due to the short maturity of these instruments. The recognition of the derivative values of convertible debt are based on the weighted-average Black-Scholes option pricing model.
Discontinued Operations
Pursuant to ASC 205-20 Discontinued Operations, in determining whether a group of assets that is disposed (or to be disposed) should be presented as a discontinued operation, we analyze whether the group of assets being disposed represents a component of the Company; that is, whether it had historic operations and cash flows that were clearly distinguished, both operationally and for financial reporting purposes. In addition, we consider whether the disposal represents a strategic shift that has or will have a major effect on our operations and financial results. The results of discontinued operations, as well as any gain or loss on the disposal, if applicable, are aggregated and separately presented in our consolidated statements of operations, net of income taxes. The historical financial position of discontinued operations are aggregated and separately presented in our accompanying condensed consolidated balance sheets.
Reclassifications
Certain amounts in previously issued financial statements have been reclassified to conform to the presentation following the Assignment for the Benefit of Creditors, which includes the reclassification of the combined financial position and results of operations of FHV LLC as discontinued operations (see Note 12) for all periods presented.
Net loss per share
The Company calculates basic earnings per share (“EPS”) by dividing our net loss by the weighted average number of common shares outstanding for the period, without considering common stock equivalents. Diluted EPS is computed by dividing net income or net loss and comprehensive net loss applicable to common shareholders by the weighted average number of common shares outstanding for the period and the weighted average number of dilutive common stock equivalents. Common stock equivalents are only included in the calculation of diluted EPS when their effect is dilutive.
Segment Information
The Company relies upon ASC 280,
Segment Reporting,
to determine and disclose reportable operating segments, and is organized such that each subsidiary represents a different operating purpose. As a result, the Company analyzed each subsidiary to determine reportable operating segments. In its management of operations, the chief operating decision maker, the Chief Executive Office, Nicholas Yates and Chief Financial Officer, Arthur Budman, reviews subsidiary balance sheets and statements of operations prepared on a basis consistent with U.S. GAAP.
For the periods presented, the Company determined that Reis and Irvy’s, Inc., and FHV, LLC (see Note 12 – Discontinued operations) were reportable operating segments; Generation Next Franchise Brands, Inc., 19 Degrees, Inc., Generation Next Vending Robots, The Fresh and Healthy Vending Corporation, FHV Acquisition, Corp. and FHV Acquisition, Corp. were not material segments and therefore have not been reported as such. Reis & Irvy’s, Inc. represents the sale of frozen yogurt and ice cream robots, franchise fees, royalties (12% of gross revenue) location fees, and product rebates. FHV, LLC represents the sale of fresh and healthy vending machines, franchise fees, royalties and product rebates.
Generation NEXT Franchise Brands, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(Unaudited)
Related Party Transactions
The Company has been involved in transactions with related parties. A party is considered to be related to the Company if the party directly or indirectly or through one or more intermediaries, controls, is controlled by, or is under common control with the Company. Related parties also include principal owners of the Company, its management, members of the immediate families of principal owners of the Company and its management, and other parties with which the Company may deal if one party controls or can significantly influence the management or operating policies of the other to an extent that one of the transacting parties might be prevented from fully pursuing its own separate interests. A party which can significantly influence the management or operating policies of the transacting parties or if it has an ownership interest in one of the transacting parties and can significantly influence the other to an extent that one or more of the transacting parties might be prevented from fully pursuing its own separate interests is also a related party.
Recent accounting standards
In July 2015, FASB issued ASU 2015-11, “Inventory (Topic 330) Related to Simplifying the Measurement of Inventory,” which applies to all inventory except that which is measured using last-in, first-out (“LIFO”) or the retail inventory method. Inventory measured using first-in, first-out (“FIFO”) or average cost is within the scope of the new guidance and should be measured at the lower of cost and net realizable value. Net realizable value is the estimated selling price in the ordinary course of business, less reasonably predictable cost of completion, disposal, and transportation. Subsequent measurement is unchanged for inventory measured using LIFO or the retail inventory method. The amendments are effective for public business entities for fiscal years beginning after December 15, 2016, including interim periods within those fiscal years. The new guidance is applied prospectively, and earlier application is permitted as of the beginning of an interim or annual reporting period. The Company adopted ASU 2015-11 effective July 1, 2017, which had no material impact on its consolidated financial statements or financial statement disclosures.
In January 2017, the Financial Accounting Standards Board (the “FASB”) issued new guidance for goodwill impairment which requires only a single-step quantitative test to identify and measure impairment and record an impairment charge based on the excess of a reporting unit’s carrying amount over its fair value. The option to perform a qualitative assessment first for a reporting unit to determine if a quantitative impairment test is necessary does not change under the new guidance. This guidance is effective for the Company beginning in fiscal year 2020 with early adoption permitted. The Company adopted this guidance in fiscal year 2017. The adoption of this guidance will have no impact on the Company’s consolidated financial statements.
In November 2016, the FASB issued ASU No. 2016-18,
Statement of Cash Flows (Topic 230): Restricted Cash
(“ASU 2016-18”). ASU 2016-18 requires that a statement of cash flows explain the change during the period in the total of cash, cash equivalents, and restricted cash. Therefore, amounts generally described as restricted cash should be included with cash and cash equivalents when reconciling the beginning of period and end of period total amounts shown on the statement of cash flows, and transfers between cash and cash equivalents and restricted cash are no longer presented within the statement of cash flows. ASU 2016-18 is effective for annual periods beginning after December 15, 2017, including interim periods within those fiscal years. The Company elected to early adopt ASU 2016-18 for the reporting period ended December 31, 2017 and the standard was applied retrospectively for all periods presented which had no material impact on prior years. As a result of the adoption of ASU 2016-18, the Company no longer presents the change within restricted cash in the consolidated statement of cash flows.
In March 2016, the Financial Accounting Standards Board (the “FASB”) issued new guidance for employee share-based compensation which simplifies several aspects of accounting for share-based payment transactions, including excess tax benefits, forfeiture estimates, statutory tax withholding requirements, and classification in the statements of cash flows. This guidance was effective for the Company in fiscal year 2017. Under the new guidance any future excess tax benefits or deficiencies are recorded to the provision for income taxes in the consolidated statements of operations, instead of additional paid-in capital in the consolidated balance sheets. During the quarters ended September 30, 2018 and 2017, no excess tax benefits were recorded to additional paid-in capital that would have been recorded as a reduction to the provision for income taxes.
In February 2016, the FASB issued ASU No. 2016-02 (“ASU 2016-02”),
Leases (Topic 842)
, which supersedes existing guidance on accounting for leases in
Leases (Topic 840)
and generally requires all leases, including operating leases, to be recognized in the statement of financial position as right-of-use assets and lease liabilities by lessees. The provisions of ASU 2016-02 are to be applied using a modified retrospective approach and are effective for reporting periods beginning after December 15, 2018; early adoption is permitted. In July 2018, the FASB issued ASU 2018-10 “
Codification Improvements of Topic 842, Leases
” and ASU No. 2018-11, “
Leases (Topic 842
):
Targeted Improvements.”
ASU 2018-11 provides companies another transition method in addition to the existing transition method by allowing entities to initially apply the new leases standard at the adoption date and recognize a cumulative-effect adjustment to the opening balance of retained earnings in the period of adoption. The consideration in the contract is allocated to the lease and non-lease components on a relative standalone price basis (for lessees) or in accordance with the allocation guidance in the new revenue standard (for lessors). ASU 2018-11 also provides lessees with a practical expedient, by class of underlying asset, to not separate non-lease components from the associated lease component. If a lessee makes that accounting policy election, it is required to account for the non-lease components together with the associated lease component as a single lease component and to provide certain disclosures. Lessors are not afforded a similar practical expedient. The Company is evaluating the effect ASU 2016-02, 2018-10 and 2018-11 will have on its consolidated financial statements and disclosures and has not yet determined the effect of the standard on its ongoing financial reporting at this time.
Generation NEXT Franchise Brands, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(Unaudited)
In May 2014, the FASB issued ASU No. 2014-09,
Revenue from Contracts with Customers (Topic 606)
(“ASU 2014-09”). ASU 2014-09 requires an entity to recognize the revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods and services. ASU 2014-09 supersedes the revenue requirements in
Revenue Recognition (Topic 605)
and most industry-specific guidance throughout the Industry Topics of the Codification. The New Revenue Standard provides for a single comprehensive principles-based standard for the recognition of revenue across all industries through the application of the following five-step process:
Step 1: Identify the contract(s) with a customer.
Step 2: Identify the performance obligations in the contract.
Step 3: Determine the transaction price.
Step 4: Allocate the transaction price to the performance obligations in the contract.
Step 5: Recognize revenue when (or as) the entity satisfies a performance obligation.
This five-step process will require significant management judgment in addition to changing the way many companies recognize revenue in their financial statements. Additionally, and among other provisions, the New Revenue Standard requires expanded quantitative and qualitative disclosures, including disclosure about the nature, amount, timing and uncertainty of revenue.
In August 2015, the FASB issued ASU 2015-14,
Revenue from Contracts with Customers (Topic 606): Deferral of the Effective Date
(“ASU 2015-14”), which defers the effective date of ASU 2014-09 by one year. Early adoption is permitted but not before the original effective date. The Company’s adoption of ASU 2014-09 will change the timing of the recognition of initial franchise fees. ASU 2014-09 requires these fees to be recognized over the term of the related franchise license for the respective robot, which had a material impact to revenue recognized for initial franchise fees and renewal franchise fees. ASU 2014-09, allows for non-cancellable franchise contract agreements for the Company recognize revenue under the provisions of ASC 606-10-25, Revenue Recognition – Revenue from Contracts with Customers.
In March 2016, FASB issued ASU 2016-09, Compensation - Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting. The amendments in this update change the accounting for certain stock-based compensation transactions, including the income tax consequences and cash flow classification for applicable transactions. The amendments in this update are effective for annual periods beginning after December 31, 2016 and interim periods within those annual periods. The Company is currently evaluating the impact that this amendment will have on its consolidated financial statements.
Generation NEXT Franchise Brands, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(Unaudited)
Effective January 2017, FASB issued ASU No. 2016-15 “Statement of Cash Flows” (Topic 230). This guidance clarifies diversity in practice on where in the Statement of Cash Flows to recognize certain transactions, including the classification of payment of contingent consideration for acquisitions between Financing and Operating activities. We are currently evaluating the impact that this amendment will have on our consolidated financial statements.
On January 5, 2017, the FASB issued ASU No. 2017-01, “Clarifying the Definition of a Business” (Topic ASC 805), guidance to clarify the definition of a business with the objective of adding guidance to assist entities with evaluating whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses. The amendments in this ASU provide a screen to determine when an integrated set of assets and activities (collectively referred to as a “set”) is not a business. The screen requires that when substantially all of the fair value of the gross assets acquired (or disposed of) is concentrated in a single identifiable asset or a group of similar identifiable assets, the set is not a business. This screen reduces the number of transactions that need to be further evaluated. If the screen is not met, the amendments require that to be considered a business, a set must include, at a minimum, an input and a substantive process that together significantly contribute to the ability to create output and remove the evaluation of whether a market participant could replace the missing elements. This ASU is effective for public business entities in annual periods beginning after December 15, 2017, including interim periods therein. We are currently evaluating the impact that this amendment will have on our consolidated financial statements.
In May 2017, the FASB issued ASU No. 2017-09, “Compensation – Stock Compensation” (Topic 718) - Scope of Modification Accounting. This ASU clarifies when to account for a change to the terms or conditions of a share-based payment award as a modification. Under the new guidance, modification accounting is required only if the fair value, the vesting conditions, or the classification of the award (as equity or liability) changes as a result of the change in terms or conditions. This ASU is effective prospectively for the annual period ending December 31, 2018 and interim periods within that annual period. We are currently evaluating the impact that this amendment will have on our consolidated financial statements.
In August 2018, the FASB issued ASU 2018-13, “
Fair Value Measurement (Topic 820): Disclosure Framework-Changes to the Disclosure Requirements for Fair Value Measurement
”, which adds disclosure requirements to Topic 820 for the range and weighted average of significant unobservable inputs used to develop Level 3 fair value measurements. The Company is evaluating the provisions of this ASU and plans to adopt this ASU effective July 1, 2020.
3. Inventory
Inventory consisted of the following:
|
|
September 30,
2018
|
|
|
June 30,
2018
|
|
Inventory on-hand:
|
|
|
|
|
|
|
Raw material
|
|
$
|
10,030,659
|
|
|
$
|
1,800,991
|
|
Work in process
|
|
|
594,762
|
|
|
|
1,003,773
|
|
Finished goods
|
|
|
135,173
|
|
|
|
506,720
|
|
|
|
|
10,760,594
|
|
|
|
3,311,484
|
|
Allowance for obsolete inventory
|
|
|
(400,000
|
)
|
|
|
(300,000
|
)
|
|
|
$
|
10,360,594
|
|
|
$
|
3,011,484
|
|
Generation NEXT Franchise Brands, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(Unaudited)
Prepaid inventory represents payments for raw material that has not been received by the Company.
See Note 10 for purchase commitments from our manufacturers for inventory.
4. Property and equipment
Property and equipment consisted of the following:
|
|
September 30, 2018
(unaudited)
|
|
|
June 30,
2018
(audited)
|
|
|
|
|
|
|
|
|
Furniture and fixtures
|
|
$
|
44,064
|
|
|
$
|
44,065
|
|
Office equipment
|
|
|
32,517
|
|
|
|
32,517
|
|
Tenant improvements
|
|
|
61,414
|
|
|
|
61,414
|
|
Frozen yogurt robots
|
|
|
177,684
|
|
|
|
177,684
|
|
|
|
|
315,679
|
|
|
|
315,680
|
|
Accumulated depreciation
|
|
|
(129,236
|
)
|
|
|
(115,889
|
)
|
|
|
$
|
186,443
|
|
|
$
|
199,791
|
|
For the quarters ended September 30, 2018 and 2017, depreciation expense was $111,000 and $106,000 respectively.
5. Intangible property
Intangible property consisted of the following:
|
|
September 30, 2018
(unaudited)
|
|
|
June 30,
2018
(audited)
|
|
|
|
|
|
|
|
|
Patents
|
|
$
|
2,440,000
|
|
|
$
|
2,440,000
|
|
Computer software
|
|
|
116,176
|
|
|
|
116,176
|
|
|
|
|
2,556,176
|
|
|
|
2,556,176
|
|
Accumulated amortization
|
|
|
(784,102
|
)
|
|
|
(686,052
|
)
|
|
|
$
|
1,772,074
|
|
|
$
|
1,870,124
|
|
For the quarters ended September 30, 2018 and 2017, amortization expense was $98,000 and $96,000 respectively.
Patents
On December 29, 2016, the Company entered into an Asset Purchase Agreement (the “Agreement”) with Robofusion, Inc. (“RFI”), whereby the Company acquired the intellectual property assets of RFI, a developer of robotic-kiosk vending technology, primarily frozen yogurt vending kiosks/cubes, using RFI's trademarked name of Reis & Irvy's (the “Acquisition”). Pursuant to the Agreement, the Company provided RFI, and its designees, a cash payment of $440,000, The Company also issued to RFI a three-year, $2 million note and a five-year common stock purchase warrant for 1,520,000 shares with a strike price of $0.50 per share. Furthermore, certain RFI Officers, Directors and Shareholders will be subject to a five-year, non-compete agreement. Also, the Agreement provides for indemnification and set-off of up to $1 million, under certain circumstances. Through the date of this report, the Company entered into four settlements related to the intellectual property totaling approximately $401,000. Furthermore, the Company made approximately $174,000 in payments. All settlement payments are a reduction of the note payable. (See Note 6).
Generation NEXT Franchise Brands, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(Unaudited)
RFI previously granted the Company an exclusive license to market RFI's frozen yogurt vending kiosks/robots, using RFI's trademarked name of Reis & Irvy's, in the United States and its territories (excluding Puerto Rico) and Canada. The assets acquired pursuant to the Agreement, are substantially all of the assets previously licensed to the Company.
Computer software
Computer software represents capitalized costs of the customer relationship management software utilized by the Company.
6. Notes payable
Senior secured promissory notes
On February 25, 2014, we issued Senior Secured Promissory Notes (the "Initial Notes") to three investors in exchange for cash totaling $501,000. The Initial Notes were set to mature on February 24, 2015 and bear simple interest at a rate of 12% paid monthly over the term of the loan. The Initial Notes also provide that our Company can raise up to $1.5 million in proceeds from the issuance of additional notes (the "Additional Notes") which would have the same seniority and security rights. The Initial Notes are secured by substantially all assets of the Company. On September 23, 2014, the holders of the Company's Initial Notes extended the maturity date from February 24, 2015 to March 15, 2016, and on March 15, 2016, the Notes were further extended to September 30, 2016. The notes have been further extended to December 31, 2018 and $478,000 of the notes, plus accrued interest, were converted to common stock at $.16 per share during fiscal 2018. The remaining outstanding notes, aggregating $23,000, were granted conversion rights at $.16 per share and were converted to common stock during the quarter ended September 30, 2018. The conversion right granted was fixed at the closing trading price of the stock. As a result, the Company determined that the conversion right was not a derivative in accordance with ASC 815,
Derivatives and Hedges,
the host instrument was conventional convertible, and that no beneficial conversion feature was present. The modification of the debt terms was not deemed substantive and therefore, was not accounted for as an extinguishment of debt with the recognition of a gain or loss.
As of September 30, 2018 and June 30, 2018, the outstanding balance was approximately $0 and $23,000, respectively.
As of September 30, 2018 and June 30, 2018, accrued interest was approximately $0 and $6,000, respectively.
Generation NEXT Franchise Brands, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(Unaudited)
Financing and security agreement
On September 23, 2014, the Company entered into a Financing and Security Agreement (the "Financing Agreement") whereby the Company may be able to borrow up to $1.5 million through the issuance of convertible secured debt. The principal terms of the Financing Agreement are as follows:
|
·
|
The Company may borrow up to $1.5 million in tranches of up to $150,000 each.
|
|
|
|
|
·
|
The first tranche of $150,000 was issued at the closing of the transaction and was used to acquire and put into service Company-owned micro markets. An additional amount of $100,000 was issued during the quarter ended December 31, 2014.
|
|
|
|
|
·
|
All subsequent tranches shall be in the amount of up to $150,000, shall be due and funded by the lender within seven days of notice, and shall be contingent upon the Company placing an additional 20 micro markets into service.
|
|
|
|
|
·
|
The notes payable issued under the terms of the Financing Agreement are due in full 24 months from the funding of each tranche. The Company may, at its discretion, extend the due date for each tranche for an additional 12 months.
|
|
|
|
|
·
|
Interest on the borrowings accrues at a rate of 10% per annum, and is payable quarterly. In the event the Company elects to extend the maturity date of a tranche, the interest rate will increase to 12% per annum on that tranche.
|
|
|
|
|
·
|
The lender may at its discretion convert any outstanding principal under any of the tranches into shares of the Company's common stock. The conversion price is 85% of the average closing prices for the 15 trading days prior to the notice of conversion, but in no event at a conversion price lower than $1.28 per share.
|
|
|
|
|
·
|
On the due date, or the extended due date, the Company may at its discretion convert up to one-half of the outstanding principal into shares of common stock. The conversion price is 85% of the average closing prices for the 15 trading days prior to the due date or extended due date, whichever may be applicable.
|
|
|
|
|
·
|
Borrowings are secured by the Company-owned micro markets.
|
At September 30, 2018 and June 30, 2018, there was $250,000 outstanding under the Financing Agreement, of which $150,000 originally matured on September 23, 2016 and $100,000 originally matured on December 15, 2016. On January 20, 2017, the Company extended both tranches until December 31, 2018. As part of the extension, the holder was granted conversion rights at $.16 per share. The conversion right granted was fixed at the closing trading price of the stock. As a result, the Company determined that the conversion right was not a derivative in accordance with ASC 815,
Derivatives and Hedges,
the host instrument was conventional convertible, and that no beneficial conversion feature was present. The modification of the debt terms was not deemed substantive and therefore, was not accounted for as an extinguishment of debt with the recognition of a gain or loss.
Generation NEXT Franchise Brands, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(Unaudited)
The lender of the Financing Agreement has informed the Company that he does not intend to lend additional amounts under the Financing Agreement.
As of September 30, 2018 and June 30, 2018, accrued interest was approximately $88,000 and $81,000, respectively.
For the quarters ended September 30, 2018 and 2017, interest expense was approximately $6,250 and $6,250, respectively.
Convertible promissory note
On June 10, 2015, the Company issued a $600,000 convertible promissory note (the “Promissory Note”) with interest payable at 10% per annum. In connection with the issuance of the Promissory Note, the Company also issued 2,000,000 common stock purchase warrants, with a term of four years, at an exercise price of $.75 per share.
The Promissory Note matures twelve months from issuance, may be extended for an additional three months, and may be converted at any time in whole or in part, at the lesser of:
|
(i)
|
25% discount to the next round of financing prior to conversion in excess of $1 million; or
|
|
|
|
|
(ii)
|
$.30 per share; or,
|
|
|
|
|
(iii)
|
Commencing six months after issuance date, at the investor’s sole discretion, at a 20% discount to the lowest trading price ten business days prior to conversion.
|
Generation NEXT Franchise Brands, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(Unaudited)
In connection with the issuance of the Promissory Note and warrant, the Company has recorded the fair value of the warrant of $78,707 as additional paid-in capital. Furthermore, the Company has recorded a discount on the Promissory Note of $480,100 and a derivative liability of $401,393 due to the lack of explicit limit on the number of shares that may be required to be issued upon future conversion. The discount is amortized as accretion of discount on notes payable over the term of the loan using the effective interest rate method. There was no derivative gain or loss during the three months ended March 31, 2018.
We calculated the value of the discount using a binomial option pricing model employing the following assumptions: volatility of common stock – 76%; risk-free interest rate – 0.28%; forfeiture rate – 0%; value per share of common stock - $0.45; strike price - $0.75; term – 4 years.
The Promissory Note maturity may also be extended for an additional three months. Furthermore, there will be a full ratchet, anti-dilution with respect to the shares of common stock only (no adjustments will be made to the warrants), for any equity or Convertible Debt financing completed or a definitive Term Sheet exercised within twelve months of closing or fifteen months if the Company exercises its one-time extension. The ratchet does not come into effect for any non-convertible debt offering arranged by the Company, its advisors or bankers.
The conversion terms of the Promissory Note were amended pursuant to a first amendment to Promissory Note, dated October 14, 2015. The adjustable pricing mechanism commencing 6 months after the Promissory Note issuance date at a 20% discount to the lowest trading price 10 business days prior to conversion was removed. The negative covenants set forth in the subscription agreement were also amended pursuant to a first amendment to subscription agreement, dated October 14, 2015. The modification of an embedded conversion feature is separately accounted for as a derivative before the modification, after the modification or both. Since the bifurcated conversion option is accounted for at fair value both before and after the modification, any changes in the fair value of the conversion option would be reflected in earnings. Furthermore, the Promissory Note was extended for an additional six months from the original maturity.
On January 20, 2017, the note was extended through June 30, 2017 and the warrant price was reduced to $.30 per share, provided that the warrants must be exercised for cash. Furthermore, the warrant expiration date was amended to June 20, 2018. The modification of the debt terms was not deemed substantive and therefore, was not accounted for as an extinguishment of debt with the recognition of a gain or loss.
The principal balance of $600,000 plus accrued interest was repaid during the first quarter of Fiscal year 2018.
Robofusion note payable
On December 29, 2016, the Company entered into an Asset Purchase Agreement (the “Agreement”) with Robofusion, Inc. (“RFI”), whereby the Company acquired the intellectual property assets of RFI, a developer of robotic-kiosk vending technology, primarily frozen yogurt vending kiosks/robots, using RFI's trademarked name of Reis & Irvy's (the “Acquisition”). Pursuant to the Agreement, the Company provided RFI, and its designees, a cash payment of $440,000. The Company also issued to RFI a three-year, $2 million note.
In connection with the issuance of the note payable, the Company issued a five-year common stock purchase warrant for 1,520,000 shares with a strike price of $0.50 per share (see Note 5). At inception, the estimated fair value of the warrant was approximately $174,000, and was recognized as a debt discount. During the quarters ended September 30, 2018 and 2017, approximately $12,500 and $12,500 was accreted to interest expense in the accompanying statements of operations.
As of September 30, 2018 and June 30, 2018, the outstanding balance was approximately $1,353,000 and $1,441,000, respectively. During the quarter ended September 30, 2018, principal payments were approximately $50,000 and indemnification payments were approximately $39,000. During fiscal 2018, principal payments were approximately $424,000 and indemnification payments were approximately $135,000.
As of September 30, 2018 and June 30, 2018, accrued interest was approximately $24,000 and $15,000, respectively.
For the quarters ended September 30, 2018 and 2017, interest expense was approximately $12,000 and $16,000, respectively.
Bridge notes payable
On February 28, 2017, the Company executed two short-term bridge notes aggregating $345,000. The notes bear interest at 0% per annum and matured on July 28, 2017. In connection with the note issuances, the Company recognized an original issue discount of approximately $45,000 and a debt discount approximately $57,000 related to the issuance of 75,000 shares of the Company’s common stock (Note 7), for a total debt discount of approximately $102,000. The debt discount was amortized over the life of the loan. The bridge notes were repaid during the fiscal year ended June 20, 2018.
Generation NEXT Franchise Brands, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(Unaudited)
|
|
September 30,
2018
|
|
|
June 30,
2018
|
|
|
|
|
|
|
|
|
|
|
Senior Secured Promissory Notes, bearing interest at 12% per annum, payable monthly. The Senior Secured Notes mature on December 31, 2018 and have conversion rights at $.16 per share.
|
|
$
|
-
|
|
|
$
|
23,000
|
|
|
|
|
|
|
|
|
|
|
Convertible secured debt, bearing interest at 10% per annum, payable quarterly. The convertible secured debt matures on December 31, 2018 and has conversion rights at $.16 per share.
|
|
|
250,000
|
|
|
|
250,000
|
|
|
|
|
|
|
|
|
|
|
$2,000,000 Promissory Note, bearing interest at 3.25% per annum. Principal and interest is due quarterly, over a 3 year period, net of discount of $86,997 and $99,426, respectively.
|
|
|
1,265,805
|
|
|
|
1,342,132
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1,515,805
|
|
|
|
1,615,132
|
|
|
|
|
|
|
|
|
|
|
Less current maturities
|
|
|
(1,036,724
|
)
|
|
|
(879,017
|
)
|
|
|
|
|
|
|
|
|
|
|
|
$
|
479,081
|
|
|
$
|
736,115
|
|
|
|
|
|
|
|
|
|
|
Maturities of notes payable, net of discounts, are as follows:
|
|
|
|
|
|
|
|
|
|
September 30, 2019
|
|
$
|
1,036,724
|
|
|
|
|
|
September 30, 2020
|
|
|
479,081
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
1,515,805
|
|
|
|
|
|
7. Stockholders’ deficit
For the quarter ended September 30, 2018, the Company issued or recognized:
·
|
Approximately 832,000 shares of common stock for gross proceeds of approximately $1,248,000
|
·
|
Proceeds of $300,000 were received subsequent to June 30, 2018 for 200,000 shares of common stock that was issued prior to June 30, 2018.
|
·
|
Approximately 179,000 shares of common stock for the conversion of approximately $23,000 of convertible debt and $5,700 of accrued interest.
|
·
|
Approximately $763,000 in stock-based compensation related to options issued inside and outside the 2013 Equity Incentive Plan.
|
·
|
Approximately 432,000 shares of common stock for the cashless exercise of options under the 2013 Equity Incentive Plan. (See Note 8).
|
For the quarter ended September 30, 2017, the Company issued or recognized:
·
|
We issued 4,120,517 shares of common stock during the quarter ended September 30, 2017 for proceeds aggregating $2,017,200.
|
8. Stock-based compensation
2013 Equity Incentive Plan
On August 14, 2013, our Board of Directors approved the adoption of the 2013 Equity Incentive Plan (the “2013 Plan”). The 2013 Plan was approved by a majority of our shareholders (as determined by shareholdings) on September 4, 2013. The 2013 Plan provides for granting of stock-based awards including: incentive stock options, non-statutory stock options, stock bonuses and rights to acquire restricted stock. The total number of shares of common stock that may be issued pursuant to stock awards under the 2013 Plan were initially not exceed in the aggregate 2,600,000 shares of the common stock of our Company. On July 13, 2015, the Company increased the total number of shares that may be issued under the 2013 Plan to 4,000,000. Furthermore, in April 2016, the Company further increased the total number of shares that may be issued under the Plan to 6,000,000.
Generation NEXT Franchise Brands, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(Unaudited)
During the three months ended September 30, 2018, the Company granted stock options under its 2013 Equity Incentive Plan. Stock-based compensation related to these awards is recognized on a straight-line basis over the applicable vesting period (24 months) and is included in selling, general and administrative expenses in the accompanying condensed consolidated statements of operations for the three months ended September 30, 2018 and 2017. Continuous employment is required for the options to vest, and there are no other performance requirements. The options issued were valued using a binomial method assuming the following:
Expected volatility
|
|
232.16%-234.30
|
%
|
Dividend yield
|
|
|
0
|
%
|
Risk-free interest rate
|
|
2.33%-2.44
|
%
|
Expected life in years
|
|
|
3.5
|
|
The expected volatility was estimated based on the volatility of the Company’s stock. The risk-free rate was based on the U.S. Treasury note rate over the expected life of the options. The expected life was determined using the simplified method as we have no historical experience. We recorded stock-based compensation expense of approximately $46,000 and $136,000 during the three months ended September 30, 2018 and 2017, respectively. Remaining stock-based compensation to be recognized is approximately $295,000.
The following table summarizes the stock option activity under the 2013 Plan through September 30, 2018:
|
|
Options
|
|
|
Weighted Average Exercise Price Per Share
|
|
|
Average
Remaining Contractual Term (Years)
|
|
|
Aggregate
Intrinsic Value
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding at June 30, 2018
|
|
|
3,141,876
|
|
|
$
|
0.21
|
|
|
|
5.23
|
|
|
$
|
6,168,665
|
|
Granted
|
|
|
-
|
|
|
$
|
-
|
|
|
|
|
|
|
|
|
|
Exercised
|
|
|
(449,500
|
)
|
|
$
|
0.43
|
|
|
|
|
|
|
|
|
|
Forfeited
|
|
|
-
|
|
|
$
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding at September 30, 2018
|
|
|
2,692,376
|
|
|
$
|
0.38
|
|
|
|
1.92
|
|
|
$
|
674,930
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Vested options
|
|
|
2,310,501
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Remaining options expected to vest
|
|
|
381,875
|
|
|
|
|
|
|
|
|
|
|
|
|
|
At September 30, 2018, the outstanding options had an average remaining expected life of 2.06 years. Furthermore, at September 30, 2018, 2,310,501 options were exercisable at a weighted average exercise price of $0.23.
Generation NEXT Franchise Brands, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(Unaudited)
Non-Qualified Stock Options
On January 20, 2017, the Company granted non-qualified stock options (outside of the 2013 Plan) aggregating 5,000,000 and 500,000, respectively to its Chairman and CEO. The options vest 50% upon the delivery of 400 frozen yogurt robots or achieving cumulative revenue of $15 million and 50% upon the delivery of 800 frozen yogurt robots or achieving cumulative revenue of $30 million.
The estimated fair value of the options was approximately $698,000. Stock-based compensation related to these awards is recognized on a straight-line basis over the expected vesting period (24 months) and is included in selling, general and administrative expenses in the accompanying condensed consolidated statements of operations for the three months ended September 30, 2018 and 2017. The options issued were valued using a binomial method assuming the following:
Expected volatility
|
|
|
134.81
|
%
|
Dividend yield
|
|
|
0
|
%
|
Risk-free interest rate
|
|
|
1.50
|
%
|
Expected life in years
|
|
|
3.5
|
|
During the three months ended September 30, 2018, the Company recognized stock-based compensation expense of approximately $70,000. Remaining stock-based compensation to be recognized is approximately $233,000. No options have vested and the options expected to vest is 4,400,00.
There were no non-qualified stock options granted during the three months ended September 30, 2018.
During February 2018, the Company granted nonqualified stock options (outside of the 2013 Plan) to the following:
|
·
|
The Company granted a potential of 1,175,000 options to employees. The options vest based on objective criteria consisting of sales and overall company goals.
|
|
|
|
|
·
|
Furthermore, we granted a potential of 6,375,000 options to the Chairman, CEO and management employees with an exercise price of $0.87 per share. The options vest 50% upon 1,200 units installed or $45 million in cumulative revenue; and 50% upon 2,000 units installed or $75 million in cumulative revenue.
|
The estimated fair value of the options was approximately $6,464,000. Stock-based compensation related to these awards is recognized on a straight-line basis over the expected vesting period (24 months) and is included in selling, general and administrative expenses in the accompanying condensed consolidated statements of operations. The options issued were valued using a binomial method assuming the following:
Expected volatility
|
|
|
232.16% - 233.60
|
%
|
Dividend yield
|
|
|
0
|
%
|
Risk-free interest rate
|
|
|
2.37% - 2.39
|
%
|
Expected life in years
|
|
|
3.5
|
|
During the three months ended September 30, 2018, the Company recognized stock based compensation expense of approximately $646,000. Remaining stock-based compensation to be recognized is approximately $4,750,000. No options have vested and the remaining options expected to vest is 6,040,000.
Generation NEXT Franchise Brands, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(Unaudited)
9. Leases
On August 1, 2015, the Company moved its corporate and warehouse facilities to a single location aggregating 8,654 feet at 2620 Financial Court, Suite 100, San Diego California 92117. The new lease is for a term of 84 months. The current monthly rental payment, net of utilities for the facility, is $15,995. Future minimum lease payments under the Company’s Facility Lease is as follows:
2018: $47,873; 2019: $196,928; 2020: $202,554; 2021: $208,377; 2022: $214,403: Thereafter: $17,909. Rent expense totaled $54,000 and $43,000 for the three months ended September 30, 2018 and 2017, respectively.
10. Commitments and contingencies
During fiscal year 2018, the Company began a voluntary internal investigation into payments made with respect to the Company’s primary stock sales and whether the payments complied with Section 15 of the Securities Exchange Act of 1934. The Company paid a bonus to certain members of its franchise sales staff and to the Company’s Chairman for any shares of the Company’s stock that potential franchisees purchased. In this regard, the Company paid approximately $332,000 to its franchise sales staff and a matching bonus of approximately $332,000 to its Chairman for the time period July 2017 to April 2018. The Company also paid an outside service provider pursuant to a written contract for franchise reengagement leads. The Company has determined that the outside service provider had some involvement in generating reengagement leads of potential franchisees who also may have had an interest in purchasing stock. These payments are in relation to the $16.4 million (net of offering costs) raised by the Company during the fiscal year ended June 30, 2018. The Company has engaged outside counsel, has ceased and will not make further payments with regard to the Company’s stock sales, will take remedial measures (including oversight and education), and, as deemed appropriate, will take steps to recapture the value of those payments previously made. The Audit Committee has taken charge of and is overseeing the continued internal investigation and remediation efforts. The Company cannot reasonably estimate any potential liability or recovery, if any, related to these payments.
There are warranties on our vending machines extended by the machine manufacturer and its distributors, but required repairs to the machines are the responsibility of the franchisees. To the extent the machines remain under warranty, our franchisees transact directly with the manufacturer or its distributor. As a result, no warranty liability or expense was recognized in 2018 or 2017. The Company provides a one-year parts warranty on its robotic soft serve vending kiosks. Our frozen yogurt robots are supplied by a single manufacturer. Although there are a limited number of manufacturers, we believe that other suppliers could provide similar machines on comparable terms. A change in suppliers, however, could cause a delay in deliveries and a possible loss of sales, which could adversely affect our operating results.
Our frozen yogurt consumables will be supplied by several distributors, based on geographical location. However, there may be only one supplier in each geographic location. A change in suppliers, however, could cause a delay in deliveries and a possible loss of revenue from both current and prospective franchisees, which could adversely affect our operating results.
As of September 30, 2018, the Company had unconditional purchase contracts of approximately $6,115,000 for the purchase of inventory for the frozen yogurt and ice cream robots.
On May 19, 2018, the Company entered into an 18-month consulting contract with a franchisee. Consideration is a total of 300,000 shares of common stock. 50,000 shares of common stock vest every three months during the term of the contract. If the consultant resigns or is terminated, the Company has the option to repurchase the unreleased shares at the lesser of the fair market value of the shares at the time the repurchase option is exercised and the purchase price The Company accounted for the shares in accordance with ASC 505-50,
Equity-Equity Based Payments to Non-Employees
.
On June 6, 2018, the Company entered into an agreement with two investors in connection with the Company’s private placement memorandum. The investors have the right to purchase:
|
·
|
From June 6 through June 30, 2018, 300,000 shares of common stock at $1.00 per share. As of June 30, 2018, the investors purchased 300,000 shares of common stock.
|
|
|
|
|
·
|
From July 1 through September 30, 2018, 1,000,000 shares of common stock at $1.00 per share. As of September 30, 2018, no shares were purchased.
|
|
|
|
|
·
|
From October 1 through December 31, 2018, 1,333,333 shares of common stock at $1.50 per share. As of the date of this report, no shares were purchased.
|
Generation NEXT Franchise Brands, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(Unaudited)
From time to time, we may become involved in litigation and other legal actions, including disagreements with to any pending litigation or franchise agreement rescissions where the amount and range of loss can be estimated. We record our best estimate of a loss when the loss is considered probable. Where a liability is probable and there is a range of estimated loss with no best estimate in the range, we record a charge equal to at least the minimum estimated liability for a loss contingency when both of the following conditions are met: (i) information available prior to issuance of the financial statements indicates that it is probable that an asset had been impaired or a liability had been incurred at the date of the financial statements and (ii) the range of loss can be reasonably estimated. Estimated legal costs expected to be incurred to resolve legal matters are recorded to the consolidated balance sheet and statements of operations.
Additionally, our Company is subject to certain state reviews of our Franchise Disclosure Documents. Such state reviews could lead to our Company being fined or prohibited from entering into franchising agreements with the reviewing state.
Periodically, we are contacted by other state franchise regulatory authorities and in some cases have been required to respond to inquiries, or make changes to our franchise disclosure documents or franchise offer and sale practices. Management believes these communications from state regulators and corresponding changes in our franchise disclosure documents and practices are administrative in nature and do not indicate the presence of a loss or probable potential loss.
11. Related party transactions
Related party debt consisted of the following:
|
|
September 30, 2018
|
|
|
June 30, 2018
|
|
|
|
|
|
|
|
|
Secured Promissory Notes
|
|
$
|
296,779
|
|
|
$
|
296,779
|
|
|
|
|
|
|
|
|
|
|
Convertible Promissory Note
|
|
|
240,007
|
|
|
|
240,007
|
|
|
|
|
|
|
|
|
|
|
|
|
|
536,786
|
|
|
|
536,786
|
|
|
|
|
|
|
|
|
|
|
Less current maturities
|
|
|
(536,786
|
)
|
|
|
(536,786
|
)
|
|
|
|
|
|
|
|
|
|
|
|
$
|
-
|
|
|
$
|
-
|
|
Notes Payable to Socially Responsible Brands
On October 27, 2015, the Company obtained secured loans in the aggregate amount of $500,000 from Socially Responsible Brands, Inc. The Company’s Chairman, Nicholas Yates, is a 20% owner of Socially Responsible Brands, Inc.
The Company issued two Secured Promissory Notes and a related Security Agreement, each dated October 27, 2015 (the “Notes” and “Security Agreement”). Certain current lien holders of the Company also executed and delivered a Subordination Agreement in connection with the issuance of the Notes and Security Agreement (the “Subordination Agreement”, and together with the Notes and Security Agreement, the “Transaction Documents”).
The Notes are each in the principal amount of $250,000, and have terms of eighteen months and one year, respectively. The first Note was secured by the Company’s fifty (50) corporate-owned micro-markets and the Note principal and interest is repaid according to a schedule based on sale of such micro-markets. The second Note is secured by the Company's franchise royalties and principal and interest is repaid on a schedule based on receipt of combo machine sales, with guaranteed payments of at least $75,000 per quarter during the term of the Note. During the quarter ended September 30, 2018, the Company paid $0 of principal and interest, respectively, under the Notes.
Generation NEXT Franchise Brands, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(Unaudited)
On January 20, 2017, Socially Responsible Brands agreed to extend the maturity date on their notes until December 31, 2017. In connection with the loan extension, the holder may convert their Notes into shares of the Company’s stock at $.16 per share. Furthermore, on September 18, 2017, the Notes were amended whereby the interest rate was modified to a rate of 20% per annum effective October 1, 2016. Additionally, the Notes were further extended until December 31, 2018.
Notes Payable to Nick Yates
On January 13, 2015, the Company's Chairman, Nicholas Yates, agreed to loan the Company up to $200,000 (the "Loan"), each incremental borrowing under the Loan to be evidenced by a promissory note. Mr. Yates further agreed to loan the Company up to $550,000. Amounts borrowed under the Loan bear interest at 10% per annum and are due on December 31, 2016. The Loan also provides for conversion to common stock, at the option of the holder, at a price equal to the Company’s next round of funding. In connection with the beneficial conversion option, the Company recorded $300,000 as a discount on the Loan and charged $0 and $0, to operations during the quarters ended September 30, 2018 and 2017, respectively. As of September 30, 2018 and June 30, 2018, $240,000 and $240,000, respectively were outstanding under the Loan.
On January 20, 2017, Mr. Yates agreed to extend his loans until December 31, 2017. In exchange for extending the loans, Mr. Yates was granted an option to convert the loan to common stock at $.16 per share. Furthermore, Loans were extended until December 31, 2018.
On October 9, 2018, the Company repaid the outstanding balance of approximately $240,000 of convertible notes payable to the Company's Chairman, Nicholas Yates, and related accrued interest of approximately $14,000, for a total of approximately $254,000.
On January 20, 2017, the Company executed a loan agreement with Nine Dragons Investments (“Nine Dragons”) for borrowings in an amount not to exceed $300,000. Nine Dragons is an entity affiliated with our Chairman Nick Yates. In connection with the loan agreement, the Company borrowed proceeds aggregating $209,931. The loans bear interest at 10% per annum, are due on December 31, 2017 and are secured by certain assets of the Company, including its intellectual property. Furthermore, the loans are convertible at the option of the holder at $.16 per share. During the year ended June 30, 2017, $209,931 of the Nine Dragons loans were redeemed for cash.
Other Transactions
During fiscal 2018, the Company paid a bonus to the Chairman for shares of the Company’s stock that potential franchisees purchased. In this regard, the Company paid approximately $332,000 to its Chairman for the time-period July 2017 to April 2018. The Company will take steps to recapture the value of these payments previously made to its Chairman.
In July 2017, the Company issued 150,000 shares of common stock in connection with settlement of a former franchisee. Terms of the agreement state that Nick Yates will receive 50% of the proceeds in excess of $200,000.
The spouse of the Company’s Chairman was employed by the Company during 2017 and through May 31, 2018. The Company charged approximately $0 and $10,000 to operations for her compensation during the three months ended September 30, 2018 and 2017, respectively.
As of September 30, 2018 and June 30, 2018, prepaid expenses and other current assets in the accompanying balance sheet included approximately $21,000 and $28,000, respectively, of short-term advances to an officer of the Company.
The Company determined that there may be a material weakness related to the identification of transactions that could be deemed violations of Section 13(k) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), and Section 402 of the Sarbanes-Oxley Act of 2002.
12. Discontinued operations
Because it was determined the assets of FHV LLC are currently insufficient to satisfy FHV LLC’s obligations to creditors, as of September 28, 2018, FHV LLC has executed an Assignment for the Benefit of Creditors under California law, whereby all of the assets of FHV LLC have been assigned to a third party fiduciary who will expeditiously liquidate such assets and distribute the proceeds thereof to FHV LLC’s creditors pursuant to the priorities established and permitted by law.
Discontinued operations as of September 30, 2018 and June 30, 2018 and for the three months ended September 30, 2018 and 2017 consist of the operations from the FHV LLC subsidiary.
Gain (Loss) from Discontinued Operations
|
|
|
|
|
|
|
|
|
|
For the three months ended
September 30,
|
|
|
|
2018
|
|
|
2017
|
|
Revenues:
|
|
|
|
|
|
|
Vending machine sales, net
|
|
|
-
|
|
|
$
|
59,082
|
|
Franchise fees
|
|
|
-
|
|
|
|
6,145
|
|
Agency sales, net
|
|
|
-
|
|
|
|
16,040
|
|
Royalties
|
|
|
8,041
|
|
|
|
72,981
|
|
Other
|
|
|
2,050
|
|
|
|
2,500
|
|
|
|
|
|
|
|
|
|
|
Total revenue, net
|
|
|
10,091
|
|
|
|
156,748
|
|
|
|
|
|
|
|
|
|
|
Cost of revenues
|
|
|
5,237
|
|
|
|
49,558
|
|
|
|
|
|
|
|
|
|
|
Gross margin
|
|
|
4,854
|
|
|
|
107,190
|
|
|
|
|
|
|
|
|
|
|
Operating expenses:
|
|
|
|
|
|
|
|
|
Personnel
|
|
|
-
|
|
|
|
252,764
|
|
Marketing
|
|
|
-
|
|
|
|
43,276
|
|
Professional fees
|
|
|
26,451
|
|
|
|
46,496
|
|
Insurance
|
|
|
-
|
|
|
|
12,827
|
|
Rent
|
|
|
6,199
|
|
|
|
12,317
|
|
Depreciation and amortization
|
|
|
-
|
|
|
|
432
|
|
Stock compensation
|
|
|
-
|
|
|
|
11,714
|
|
Provision for legal settlement
|
|
|
-
|
|
|
|
90,660
|
|
Other
|
|
|
6
|
|
|
|
36,339
|
|
|
|
|
|
|
|
|
|
|
Total operating expenses
|
|
|
32,656
|
|
|
|
506,825
|
|
|
|
|
|
|
|
|
|
|
Income (loss) from operations
|
|
|
(27,802
|
)
|
|
|
(399,635
|
)
|
|
|
|
|
|
|
|
|
|
Other expenses:
|
|
|
|
|
|
|
|
|
Interest expense
|
|
|
-
|
|
|
|
(80,715
|
)
|
Derivative liability income (expense)
|
|
|
-
|
|
|
|
(220,003
|
)
|
|
|
|
|
|
|
|
|
|
Loss before provision for income taxes
|
|
|
(27,802
|
)
|
|
|
(700,353
|
)
|
|
|
|
|
|
|
|
|
|
Provision for income taxes
|
|
|
-
|
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
Loss from operations
|
|
|
(27,802
|
)
|
|
|
(700,353
|
)
|
|
|
|
|
|
|
|
|
|
Gain from disposition of operations
|
|
|
169,304
|
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
Net gain (loss)
|
|
$
|
141,502
|
|
|
$
|
(700,353
|
)
|
See accompanying notes to the unaudited condensed consolidated financial statements.
The following tables lists the assets of discontinued operations and liabilities of discontinued operations as of September 30, 2018 and June 30, 2018 and the discontinued operations for FHV LLC for the three months ended September 30, 2018 and 2017.
Assets and Liabilities of Discontinued Operations
|
|
|
|
|
|
|
June 30,
|
|
|
|
2018
|
|
|
|
|
|
Current assets:
|
|
|
|
Cash
|
|
$
|
26,417
|
|
Restricted cash
|
|
|
1,500
|
|
Accounts receivable, net of allowance for doubtful accounts of $174,011
|
|
|
18,451
|
|
Inventory on-hand, net of allowance for obsolete inventory of $100,000
|
|
|
246,296
|
|
|
|
|
|
|
Current assets held for disposition
|
|
$
|
292,664
|
|
|
|
|
|
|
Current liabilities:
|
|
|
|
|
Accounts payable and accrued liabilities
|
|
$
|
280,159
|
|
Contract liabilities - customer advances and deferred revenues
|
|
|
515,517
|
|
Provision for franchisee rescissions and refunds
|
|
|
496,000
|
|
|
|
|
|
|
Total current liabilities
|
|
$
|
1,291,676
|
|
13. Subsequent events
On October 9, 2018, the Company repaid the outstanding balance of approximately $240,000 of convertible notes payable to the Company's Chairman, Nicholas Yates, and related accrued interest of approximately $14,000, for a total of approximately $254,000.
On various dates subsequent to September 30, 2018 and through the date of this report, the Company entered into termination agreements with franchisees for refunds aggregating approximately $69,000. The Company considered the guidance in ASC 855,
Subsequent Events
, and determined that no accrual was required as of September 30, 2018.