The accompanying notes are an integral part of the consolidated financial statements.
The accompanying notes are an integral part of the consolidated financial statements.
The accompanying notes are an integral part of the consolidated financial statements.
Notes to Consolidated Financial Statements
December 31, 2018 and 2017
Effective August 17, 2017 (the “Effective
Date”), Grom Social Enterprises, Inc. (the “Company”, “Grom” “we”, “us” or
“our”) a Florida corporation f/k/a Illumination America, Inc. (“Illumination”), consummated the acquisition
of Grom Holdings, Inc. (“Grom Holdings”). Pursuant to the terms of the Share Exchange Agreement (“Share
Exchange”) that was entered into on May 15, 2017, the Company amended its Articles of Incorporation to increase its authorized
capital to 200,000,000 shares of common stock, as well as to change its name to “Grom Social Enterprises, Inc.” On
the Effective Date, the Company issued an aggregate of 110,853,883 shares of its common stock to the Grom Holdings shareholders,
pro rata to their respective ownership percentage. Each share of Grom Holdings was exchanged for 4.17 shares of Illumination common
stock. As a result, the stockholders of Grom Holdings are now stockholders of the Company and own approximately 92% of the Company’s
issued and outstanding shares of common stock.
As a result of the acquisition of Grom
Holdings, Inc. the Company now operates its business through five wholly-owned subsidiaries, including:
|
·
|
Grom Social, Inc. (“Grom Social”) was incorporated in the State of Florida on March 5, 2012 and operates our social media network designed for children.
|
|
·
|
TD Holdings Limited (“TD Holdings”), which was acquired in July 2016, was incorporated in Hong Kong on September 15, 2005. Its operations are conducted through its subsidiary companies, Top Draw Animation Hong Kong Limited (“TDAHK”) and Top Draw Animation, Inc (“Top Draw” or “TDA”). The group’s principal activities are the production of animated films based in Manila, the Philippines.
|
|
·
|
Grom Educational Services, Inc. (“GES”), was incorporated in the State of Florida on January 17, 2017, and operates our NetSpective Webfiltering services to schools and libraries.
|
|
·
|
Grom Nutritional Services, Inc. (“GNS”) was incorporated in the State of Florida on April 19, 2017. We intend to market and distribute four flavors of a nutritional supplement to children through GNS. GNS did not record any revenue in 2018.
|
|
·
|
Illumination America Lighting, Inc. (“IAL”), was incorporated in the State of Florida on August 21, 2017. IAL operates our LED lighting business that was our principal business prior to the Share Exchange. IAL did not record any revenue in 2018.
|
Retroactive Application of the Share
Exchange Ratio
All references to Common Share totals or
values in this Form 10-K, unless otherwise stated, have been adjusted, retroactively, to reflect the Share Exchange ratio of 4.17
as of August 17, 2017.
2.
|
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
|
Going Concern
The accompanying consolidated financial
statements have been prepared assuming the Company will continue as a going concern, which contemplates realization of assets and
the satisfaction of liabilities in the normal course of business for the twelve-month period following the date of these financial
statements. On a consolidated basis, the Company has incurred significant operating losses since inception.
Because the Company does not expect that
existing operational cash flow will be sufficient to fund presently anticipated operations, this raises substantial doubt about
the Company’s ability to continue as a going concern. Therefore, the Company will need to raise additional funds and is currently
exploring alternative sources of financing. Historically, the Company has raised capital through private placements, convertible
debentures and officer loans as an interim measure to finance working capital needs and may continue to raise additional capital
through the sale of common stock or other securities and obtaining some short-term loans. The Company will be required to continue
to so until its consolidated operations become profitable. Also, the Company has, in the past, paid for consulting services with
its common stock to maximize working capital, and intends to continue this practice where feasible.
Basis of Presentation
The Company deemed the transfer of net
assets pursuant to the Share Exchange Agreement to be a reverse acquisition in accordance with FASB ASC 805-40,
"Reverse
Acquisitions"
. The legal acquirer is Illumination America, Inc. and the legal acquiree is Grom Holdings, Inc. However,
the transaction was accounted for as a recapitalization effected by a share exchange, wherein Grom Holdings is considered the acquirer
for accounting and financial reporting purposes. The assets and liabilities of the acquired entity have been brought forward at
their book value and no goodwill has been recognized.
The consolidated financial statements
of the Company have been prepared in accordance with US GAAP and are expressed in United States dollars. For the years ended December
31, 2018 and 2017, the consolidated financial statements include the accounts of the Company; and its wholly-owned subsidiaries
Grom Social, TD Holdings, GES, GNS, and Illumination America Lighting. TD Holdings was acquired on July 1, 2016; and GES was formed
in January 2017 to operate the NetSpective WebFiltering assets and business which was acquired on January 1, 2017.
GNS which was formed in April 2017, had
not recorded any activity through the date of this Annual Report.
All intercompany accounts and transactions
are eliminated in consolidation.
Use of Estimates
The preparation of consolidated financial
statements in conformity with US GAAP requires management to make estimates and assumptions that affect the reported amounts of
liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts
of revenues and expenses during the reporting period. The most significant estimates relate to revenue recognition, valuation of
accounts receivable and inventories, purchase price allocation of acquired businesses, impairment of long-lived assets and goodwill,
valuation of financial instruments, income taxes, and contingencies. The Company bases its estimates on historical experience,
known or expected trends and various other assumptions that are believed to be reasonable given the quality of information available
as of the date of these financial statements. The results of these assumptions provide the basis for making estimates about the
carrying amounts of assets and liabilities that are not readily apparent from other sources. Actual results could differ from these
estimates.
Revenue Recognition
In May 2014, the FASB issued Accounting
Standards Update No. 2014-09,
Revenue from Contracts with Customers (Topic 606)
("ASU 2014-09"). ASU
2014-09 outlines a single comprehensive model for entities to use in accounting for revenue arising from contracts with customers
and supersedes most current revenue recognition guidance, including industry-specific guidance. The guidance provided in ASC Topic
606 ("ASC 606") requires entities to use a five-step model to recognize revenue by allocating the consideration from
contracts to performance obligations on a relative standalone selling price basis. Revenue is recognized when a customer obtains
control of promised goods or services in an amount that reflects the consideration that the entity expects to receive in exchange
for those goods or services. The standard also requires new disclosures regarding the nature, amount, timing, and uncertainty
of revenue and cash flows arising from contracts with customers. ASC 606 also includes Subtopic 340-40,
Other Assets and
Deferred Costs - Contracts with Customers
, which requires the deferral of incremental costs of obtaining a contract with a
customer. This new guidance was initially effective for annual reporting periods (including interim reporting periods within those
periods) beginning after December 15, 2016 and early adoption was not permitted. However, in July 2015, the FASB voted to defer
the effective date of this ASU by one year for reporting periods beginning after December 15, 2017, with early adoption permitted
as of the original effective date. As a result, the effective date for the Company is January 1, 2018.
Entities have the option of using
either a full retrospective or a modified approach to adopt the guidance. The Company adopted this ASU in accordance with the
modified retrospective method, effective January 1, 2018 for all contracts not completed as of January 1, 2018. Results for reporting
periods beginning after January 1, 2018 are presented under ASC 606 while prior period amounts continue to be reported in accordance
with legacy GAAP.
Under the applicable revenue recognition
guidance for fiscal years 2017 and prior, these transactions were recognized when the amounts were billed to the customer.
As a result of the Company’s transition
to ASC 606, the Company recorded a net change in beginning retained earnings of 263,741 on January 1, 2018 due to the cumulative
effect of adopting ASC 606. For year ended December 31, 2018, the Company recorded a total of $7,801,157 of animation revenue
from contracts with customers which include $ 528,822 in additional revenue as a result of the adoption of ASC 606.
Under ASC 606 our animation revenues are
generated primarily from contracts with customers for preproduction and production services related to the development of animated
movies and television series. TDA preproduction activities include producing storyboards, location design, model and props design,
background color and color styling. For production, TDA focuses on library creation, digital asset management, background layout
scene assembly, posing, animation and after effects. We provide our services under fixed-price contracts. Under fixed-price contracts,
we agree to perform the specified work for a pre-determined price. To the extent our actual costs vary from the estimates upon
which the price was negotiated, we will generate more or less profit or could incur a loss.
We account for a contract after it has
been approved by all parties to the arrangement, the rights of the parties are identified, payment terms are identified, the contract
has commercial substance and collectability of consideration is probable.
We evaluate the services promised in each
contract at inception to determine whether the contract should be accounted for as having one or more performance obligations.
The services in our contracts are distinct from one another as the referring parties typically can direct all, limited, or single
portions of the various preproduction and production activities required to create and design and entire episode to us and we
therefore have a history of developing stand alone selling prices for all of these distinct components. Accordingly, our contracts
are typically accounted for as containing multiple performance obligations.
We determine the transaction price for
each contract based on the consideration we expect to receive for the distinct services being provided under the contract.
We recognize revenue as performance obligations
are satisfied and the customer obtains control of the services. In determining when performance obligations are satisfied, we consider
factors such as contract terms, payment terms and whether there is an alternative future use of the product or service. Substantially
all of our revenue is recognized over time as we perform under the contract due to the contractual terms present in each contract
which irrevocably transfer control of the work product to the customer as the services are performed.
For performance obligations recognized
over time, revenue is recognized based on the extent of progress towards completion of the performance obligation, generally using
the percentage-of-completion cost-to-cost measure of progress for our contracts because it best depicts the transfer of control
to the customer as we incur costs on our contracts. Under the percentage-of-completion cost-to-cost measure of progress, the extent
of progress towards completion is measured based on the ratio of costs incurred to date to the total estimated costs to complete
the performance obligation.
Webfiltering revenue
Revenue from subscription sales for webfiltering
at NetSpective is recognized on a pro-rata basis over the subscription period. Typically, a subscriber purchases computer hardware
and a service license for a period of use between one year to five years for software and support. The subscriber is billed in
full at the time of the sale. The Company immediately recognizes any revenue attributable to the computer hardware as it is non-refundable
and control of the hardware has passed to the customer. The advanced billing for software and service is initially recorded as
deferred revenue and subsequently recognized as revenue over time evenly throughout the subscription period. Adoption of
ASC 606 had no impact on NetSpective’s revenues.
Substantially all of the revenue at TDA
and Netspective comes from the North American in the form of animation and webfiltering services, respectively. Historically and
going forward, TDA’s business is concentrated on five to eight key clients, that vary from year to year based upon discrete
projects which become available based on the popularity of a particular TV series, or the expected acceptance of new animated
series. TDA receives advance payments for a significant portion of the work it performs. Netspective, as consistent with industry
practice receives full payment in advance of providing webfiltering services over a period of one to five years. Revenue recognition
under ASC 606 and historically was unrelated to the timing of milestone or advance payments. Netspective’s business is focused
on forty to fifty US-based school districts located in the US. Both TDA and Netspective earn revenue via services transferred
over time to the client. Approximately 1/10 of Netspective’s business is recognized at a point time due to the non-refundable
sale of computer hardware associated with web filtering services.
Contract Assets and Liabilities
Revenues from NetSpective contracts are
all billed in advance and therefore represent contract liabilities until fully recognized on a ratable basis over the contract
life. Animation revenue contracts vary with movie contracts typically allowing for progress billings over the contract term while
other episodic development activities are typically billable upon delivery of the performance obligation for an episode. These
episodic activities typically create unbilled contract assets between episode delivery dates while movies can create contract assets
or liabilities based on the progress of activities versus the arranged billing schedule. Approximately $468,277 of NetSpective
revenue and $428,481 of animation revenue recognized during 2018 was included in the respective opening contract liability balance.
Remaining revenue expected to be recognized on contracts with customers are as follows as of December 31, 2018:
The following table depicts the composition
of our contract assets and liabilities as of December 31, 2018 and 2017:
|
|
December 31,
2018
|
|
|
December 31,
2017
|
|
|
|
|
|
|
|
|
Animation contract assets
|
|
$
|
1,040,309
|
|
|
$
|
280,458
|
|
NetSpective contract assets
|
|
|
74,743
|
|
|
|
157,593
|
|
Other contract assets
|
|
|
8,441
|
|
|
|
7,337
|
|
Total contract assets
|
|
$
|
1,123,493
|
|
|
$
|
445,388
|
|
|
|
|
|
|
|
|
|
|
Animation contract liabilities
|
|
$
|
380,749
|
|
|
$
|
428,481
|
|
NetSpective contract liabilities
|
|
|
727,979
|
|
|
|
756,143
|
|
Other contract liabilities
|
|
|
11,500
|
|
|
|
–
|
|
Total contract liabilities
|
|
$
|
1,120,228
|
|
|
$
|
1,184,624
|
|
Fair Value Measurements
The Financial Accounting Standards Board
(“FASB”) Accounting Standards Codification (“ASC”) 820 “Fair Value Measurements and Disclosures”
(“ASC 820”) 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. 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. The standard 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
- Inputs other than
quoted prices included within Level 1 that are either directly or indirectly observable.
Level 3
- Unobservable inputs
that are supported by little or no market activity, therefore requiring an entity to develop its own assumptions about the assumptions
that market participants would use in pricing.
Fair value estimates discussed herein are
based upon certain market assumptions and pertinent information available to management as of December 31, 2018 and December 31,
2017. The Company uses the market approach to measure fair value for its Level 1 financial assets and liabilities. The market approach
uses prices and other relevant information generated by market transactions involving identical or comparable assets or liabilities.
The respective carrying value of certain balance sheet financial instruments approximates its fair value. These financial instruments
include cash, trade receivables, related party payables, accounts payable, accrued liabilities and short-term borrowings. Fair
values were estimated to approximate carrying values for these financial instruments since they are short term in nature, and they
are receivable or payable on demand.
The estimated fair value of assets and
liabilities acquired in business combinations and reporting units and long-lived assets used in the related asset impairment tests
utilize inputs classified as Level 3 in the fair value hierarchy.
The Company determines the fair value of
contingent consideration based on a probability-weighted discounted cash flow analysis. The fair value remeasurement is based on
significant inputs not observable in the market and thus represents a Level 3 measurement as defined in the fair value hierarchy.
In each period, the Company reassesses its current estimates of performance relative to the stated targets and adjusts the liability
to fair value. Any such adjustments are included as a component of Other Income (Expense) in the Consolidated Statements of Operations
and Comprehensive Loss.
The following table summarizes the change
in the Company’s financial assets and liabilities measured at fair value as of December 31, 2018 and December 31, 2017.
|
|
Level 1
|
|
|
Level 2
|
|
|
Level 3
|
|
Earnout liability
|
|
$
|
–
|
|
|
$
|
–
|
|
|
$
|
429,000
|
|
The following table summarizes the change
in the Company’s financial assets and liabilities measured at fair value as of December 31, 2018 and December 31, 2017.
Fair value, December 31, 2016
|
|
|
1,931,707
|
|
Fair value of contingent consideration issued during the period
|
|
|
362,500
|
|
Change in fair value
|
|
|
(1,865,207
|
)
|
Fair value, December 31, 2017
|
|
$
|
429,000
|
|
Change in fair value
|
|
|
–
|
|
Fair value, December 31, 2018
|
|
$
|
429,000
|
|
Derivative Financial Instruments
The Company does not use derivative instruments
to hedge exposures to cash flow, market or foreign currency risk. Terms of convertible and other promissory notes are reviewed
to determine whether they contain embedded derivative instruments that are required to be accounted for separately from the host
contract and recorded on the balance sheet at fair value. The fair value of derivative liabilities is required to be revalued at
each reporting date, with corresponding changes in fair value recorded in current period operating results.
Beneficial Conversion Features
In accordance with FASB ASC 470-20, “Debt
with Conversion and Other Options” the Company records a beneficial conversion feature (“BCF”) related to the
issuance of convertible debt or preferred stock instruments that have conversion features at fixed rates that are in-the-money
when issued. The BCF for the convertible instruments is recognized and measured by allocating a portion of the proceeds equal to
the intrinsic value of that feature to additional paid-in capital. The intrinsic value is generally calculated at the commitment
date as the difference between the conversion price and the fair value of the common stock or other securities into which the security
is convertible, multiplied by the number of shares into which the security is convertible. If certain other securities are issued
with the convertible security, the proceeds are allocated among the different components. The portion of the proceeds allocated
to the convertible security is divided by the contractual number of the conversion shares to determine the effective conversion
price, which is used to measure the BCF. The effective conversion price is used to compute the intrinsic value. The value of the
BCF is limited to the basis that is initially allocated to the convertible security.
Stock Purchase Warrants
The Company accounts for warrants issued
to purchase shares of its common stock as equity in accordance with FASB ASC 480,
Accounting for Derivative Financial Instruments
Indexed to, and Potentially Settled in, a Company’s Own Stock, Distinguishing Liabilities from Equity.
Cash and cash equivalents
The Company considers all highly liquid
investments with a maturity of three months or less at the date of purchase to be cash equivalents. Cash and cash equivalents consist
of cash on deposit with banks and money market funds, the fair value of which approximates cost. The Company maintains its cash
balances with a high-credit-quality financial institution. At times, such cash may be more than the Federal Deposit Insurance Corporation-insured
limit of $250,000. The Company has not experienced any losses in such accounts, and management believes the Company is not exposed
to any significant credit risk on its cash and cash equivalents.
Accounts receivable
Accounts receivable are customer obligations
due under normal trade terms which are recorded at net realizable value. The Company establishes an allowance for doubtful accounts
based on management’s assessment of the collectability of trade receivables. A considerable amount of judgment is required
in assessing the amount of the allowance. The Company makes judgments about the creditworthiness of each customer based on ongoing
credit evaluations and monitors current economic trends that might impact the level of credit losses in the future. If the financial
condition of the customers were to deteriorate, resulting in their inability to make payments, a specific allowance will be required.
Recovery of bad debt amounts previously
written off is recorded as a reduction of bad debt expense in the period the payment is collected. If the Company’s actual
collection experience changes, revisions to its allowance may be required. After all attempts to collect a receivable have failed,
the receivable is written off against the allowance.
Inventory
Inventory consists of animation supplies used for the sole
purpose of completing animation projects at Top Draw.
Property and equipment
Property and equipment are stated at cost
or fair value if acquired as part of a business combination. Depreciation is computed by the straight-line method and is charged
to operations over the estimated useful lives of the assets. Maintenance and repairs are charged to expense as incurred. The carrying
amount and accumulated depreciation of assets sold or retired are removed from the accounts in the year of disposal and any resulting
gain or loss is included in results of operations. The estimated useful lives of property and equipment are as follows:
Computers, software, and office equipment
|
1 – 5 years
|
Machinery and equipment
|
3 – 5 years
|
Vehicles
|
5 years
|
Furniture and fixtures
|
5 – 10 years
|
Leasehold improvements
|
Lesser of the lease term or estimated useful life
|
Construction in process is not depreciated
until the construction is completed and the asset is placed into service.
Goodwill and Intangible Assets
Goodwill represents the future economic
benefit arising from other assets acquired that could not be individually identified and separately recognized. The goodwill arising
from the Company’s acquisitions is attributable to the value of the potential expanded market opportunity with new customers.
Intangible assets have either an identifiable or indefinite useful life. Intangible assets with identifiable useful lives are amortized
on a straight-line basis over their economic or legal life, whichever is shorter. The Company’s amortizable intangible assets
consist of customer relationships and non-compete agreements. Their useful lives range from 1.5 to 10 years. The Company’s
indefinite-lived intangible assets consist of trade names.
Goodwill and indefinite-lived assets are
not amortized but are subject to annual impairment testing unless circumstances dictate more frequent assessments. The Company
performs an annual impairment assessment for goodwill during the fourth quarter of each year and more frequently whenever events
or changes in circumstances indicate that the fair value of the asset may be less than the carrying amount. Goodwill impairment
testing is a two-step process performed at the reporting unit level. Step one compares the fair value of the reporting unit to
its carrying amount. The fair value of the reporting unit is determined by considering both the income approach and market approaches.
The fair values calculated under the income approach and market approaches are weighted based on circumstances surrounding the
reporting unit. Under the income approach, the Company determines fair value based on estimated future cash flows of the reporting
unit, which are discounted to the present value using discount factors that consider the timing and risk of cash flows. For the
discount rate, the Company relies on the capital asset pricing model approach, which includes an assessment of the risk-free interest
rate, the rate of return from publicly traded stocks, the Company’s risk relative to the overall market, the Company’s
size and industry and other Company-specific risks. Other significant assumptions used in the income approach include the terminal
value, growth rates, future capital expenditures and changes in future working capital requirements. The market approaches use
key multiples from guideline businesses that are comparable and are traded on a public market. If the fair value of the reporting
unit is greater than its carrying amount, there is no impairment. If the reporting unit’s carrying amount exceeds its fair
value, then the second step must be completed to measure the amount of impairment, if any. Step two calculates the implied fair
value of goodwill by deducting the fair value of all tangible and intangible net assets of the reporting unit from the fair value
of the reporting unit as calculated in step one. In this step, the fair value of the reporting unit is allocated to all of the
reporting unit’s assets and liabilities in a hypothetical purchase price allocation as if the reporting unit had been acquired
on that date. If the carrying amount of goodwill exceeds the implied fair value of goodwill, an impairment loss is recognized in
an amount equal to the excess.
Determining the fair value of a reporting
unit is judgmental in nature and requires the use of significant estimates and assumptions, including revenue growth rates, strategic
plans, and future market conditions, among others. There can be no assurance that the Company’s estimates and assumptions
made for purposes of the goodwill impairment testing will prove to be accurate predictions of the future. Changes in assumptions
and estimates could cause the Company to perform an impairment test prior to scheduled annual impairment tests.
The Company performed its annual fair value
assessment at December 31, 2018, on its subsidiaries with material goodwill and intangible asset amounts on their respective balance
sheets and determined that no impairment exists.
Long-Lived Assets
The Company evaluates the recoverability
of its long-lived assets whenever events or changes in circumstances have indicated that an asset may not be recoverable. The long-lived
asset is grouped with other assets at the lowest level for which identifiable cash flows are largely independent of the cash flows
of other groups of assets and liabilities. If the sum of the projected undiscounted cash flows is less than the carrying value
of the assets, the assets are written down to the estimated fair value.
The Company evaluated the recoverability
of its long-lived assets on December 31, 2018 and at December 31, 2017, respectively on its subsidiaries with material amounts
on their respective balance sheets and determined that no impairment exists.
Income taxes
The Company accounts for income taxes under
FASB ASC 740,
“Accounting for Income Taxes”
. Under FASB ASC 740, deferred tax assets and liabilities are
recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing
assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates
expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. Under
FASB ASC 740, the effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period
that includes the enactment date. FASB ASC 740-10-05,
“Accounting for Uncertainty in Income Taxes”
prescribes
a recognition threshold and a measurement attribute for the financial statement recognition and measurement of tax positions taken
or expected to be taken in a tax return. For those benefits to be recognized, a tax position must be more-likely-than-not to be
sustained upon examination by taxing authorities.
The amount recognized is measured as the
largest amount of benefit that is greater than 50 percent likely of being realized upon ultimate settlement. The Company assesses
the validity of its conclusions regarding uncertain tax positions on a quarterly basis to determine if facts or circumstances have
arisen that might cause it to change its judgment regarding the likelihood of a tax position’s sustainability under audit.
Foreign Currency Translation
The functional and reporting currency of
TD Holdings and TDAHK is the Hong Kong Dollar. The functional and reporting currency of Top Draw is the Philippine Peso. Management
has adopted ASC 830 “Foreign Currency Matters” for transactions that occur in foreign currencies. Monetary assets denominated
in foreign currencies are translated using the exchange rate prevailing at the balance sheet date. Average monthly rates are used
to translate revenues and expenses.
Transactions denominated in currencies
other than the functional currency are translated into the functional currency at the exchange rates prevailing at the dates of
the transaction. Exchange gains or losses arising from foreign currency transactions are included in the determination of net income
for the respective periods.
Assets and liabilities of the Company’s
operations are translated into the reporting currency, United States dollars, at the exchange rate in effect at the balance sheet
dates. Revenue and expenses are translated at average rates in effect during the reporting periods. Equity transactions are recorded
at the historical rate when the transaction occurred. The resulting translation adjustment is reflected as accumulated other comprehensive
income, a separate component of stockholders' equity in the statement of stockholders' equity.
Differences may arise in the amount of
bad debt expense, depreciation expense and amortization expense reported in the Company's operating results as compared to the
corresponding change in the allowance for doubtful accounts, accumulated depreciation, and accumulated amortization, respectively,
due to foreign currency translation. These translation adjustments are reflected in accumulated other comprehensive income, a separate
component of the Company's stockholders' equity.
Comprehensive Gain or Loss
ASC 220 “Comprehensive Income,”
establishes standards for the reporting and display of comprehensive income and its components in the financial statements. As
of December 31, 2018, and December 31, 2017, the Company determined that it had items that represented components of comprehensive
income (loss) and, therefore, has included a statement of comprehensive income (loss) in the financial statements.
Advertising expenses
Advertising costs are expensed as incurred
and included in selling and marketing expenses.
Shipping and handling costs
Shipping and handling costs related to
the acquisition of goods from vendors are included in the cost of sales.
Basic and Diluted Net Income (Loss)
Per Share
The Company computes net income (loss)
per share in accordance with ASC 260,
“Earnings per Share”
. ASC 260 requires presentation of both basic
and diluted earnings per share (“EPS”) on the face of the income statement. Basic EPS is computed by dividing net
income (loss) available to common stockholders (numerator) by the weighted average number of shares outstanding (denominator)
during the period. Diluted EPS gives effect to all dilutive potential common shares outstanding during the period using the treasury
stock method and convertible preferred stock using the if-converted method. These potential dilutive shares include 6,630,103
shares from convertible notes, 14,814,815 shares related to the conversion rights of the TDH Sellers Note, 31,043,000 vested stock
options and 781,910 stock purchase warrants. In computing diluted EPS, the average stock price for the period is used in determining
the number of shares assumed to be purchased from the exercise of stock options or warrants. Diluted EPS excludes all dilutive
potential shares if their effect is anti-dilutive.
Recent accounting pronouncements
The Company has implemented all new accounting
pronouncements that are in effect and that may impact its financial statements and does not believe that there are any other new
pronouncements that have been issued that might have a material impact on its financial position or results of operations except
as noted below:
In February 2016, the FASB issued ASU No.
2016-02,
Leases (Topic 842)
, which establishes a new lease accounting model for lessees. The updated guidance requires
an entity to recognize assets and liabilities arising from financing and operating leases, along with additional qualitative and
quantitative disclosures. The amended guidance is effective for fiscal years, and interim periods within those years, beginning
after December 15, 2018, with early adoption permitted. In March 2019, the FASB issued ASU 2019-01,
Codification Improvements
,
which clarifies certain aspects of the new lease standard. The FASB issued ASU 2018-10,
Codification Improvements to Topic 842,
Leases
in July 2018. Also, in 2018, the FASB issued ASU 2018-11, Leases
(Topic 842) Targeted Improvements,
which
provides an optional transition method whereby the new lease standard is applied at the adoption date and recognized as an adjustment
to retained earnings. The amendments have the same effective date and transition requirements as the new lease standard.
ASC 842 will be effective for us beginning
on January 1, 2019. As of January 1, 2019, we will record right-of-use assets and lease liabilities of approximately $365,000.
3.
|
ACCOUNTS RECEIVABLE, NET
|
The following table sets forth the components
of the Company’s accounts receivable at December 31, 2018 and December 31, 2017:
|
|
December 31,
2018
|
|
|
December 31,
2017
|
|
|
|
|
|
|
|
|
Billed accounts receivable
|
|
$
|
419,802
|
|
|
$
|
445,338
|
|
Unbilled accounts receivable
|
|
|
703,691
|
|
|
|
–
|
|
Total accounts receivable, net
|
|
$
|
1,123,493
|
|
|
$
|
445,338
|
|
As of December 31, 2018, and December 31,
2017, the Company evaluated its outstanding trade receivables and determined that no allowance for bad debts was required so as
a result no bad debt expense was recorded during the years ended December 31, 2018 and December 31, 2017.
During the year ended December 31, 2018,
the Company had three customers that accounted for 50.1% of revenues and one customer that accounted for 9.2% of accounts receivable.
During the year ended December 31, 2017,
the Company had four customers that accounted for approximately 71.6% of consolidated revenues and three customers that accounted
for 77.3% of consolidated accounts receivable.
4.
|
PREPAID EXPENSES AND OTHER CURRENT ASSETS
|
The following table sets forth the components
of the Company’s prepaid expenses and other current assets at December 31, 2018 and December 31, 2017:
|
|
December 31,
2018
|
|
|
December 31,
2017
|
|
|
|
|
|
|
|
|
Collaborative development agreement
|
|
$
|
95,766
|
|
|
$
|
191,531
|
|
Prepaid rent
|
|
|
31,773
|
|
|
|
55,211
|
|
Vendor advances
|
|
|
7,867
|
|
|
|
43,219
|
|
Prepaid service agreements
|
|
|
174,920
|
|
|
|
578,732
|
|
Employee advance and other payroll related items
|
|
|
16,208
|
|
|
|
15,734
|
|
Other prepaid expenses and current assets
|
|
|
123,306
|
|
|
|
150,952
|
|
Total
|
|
$
|
449,840
|
|
|
$
|
1,035,379
|
|
Prepaid expenses and other assets represent
prepayments made in the normal course and in which the economic benefit is expected to be realized within twelve months.
5.
|
PROPERTY AND EQUIPMENT
|
The following table sets forth the components of the Company’s
property and equipment at December 31, 2018 and December 31, 2017:
|
|
December 31, 2018
|
|
|
December 31, 2017
|
|
|
|
Cost
|
|
|
Accumulated Depreciation
|
|
|
Net Book Value
|
|
|
Cost
|
|
|
Accumulated Depreciation
|
|
|
Net Book Value
|
|
Capital assets subject to depreciation:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Computers, software and office equipment
|
|
$
|
1,937,987
|
|
|
$
|
(1,508,104
|
)
|
|
|
429,883
|
|
|
$
|
1,792,499
|
|
|
$
|
(1,319,388
|
)
|
|
$
|
473,111
|
|
Machinery and equipment
|
|
|
167,731
|
|
|
|
(99,900
|
)
|
|
|
67,831
|
|
|
|
95,356
|
|
|
|
(88,342
|
)
|
|
|
7,014
|
|
Vehicles
|
|
|
153,927
|
|
|
|
(120,728
|
)
|
|
|
33,199
|
|
|
|
159,431
|
|
|
|
(110,098
|
)
|
|
|
49,333
|
|
Furniture and fixtures
|
|
|
381,248
|
|
|
|
(284,410
|
)
|
|
|
96,838
|
|
|
|
305,855
|
|
|
|
(273,768
|
)
|
|
|
32,087
|
|
Leasehold improvements
|
|
|
1,031,687
|
|
|
|
(623,125
|
)
|
|
|
408,562
|
|
|
|
654,309
|
|
|
|
(585,808
|
)
|
|
|
68,501
|
|
Total fixed assets
|
|
|
3,672,580
|
|
|
|
(2,636,267
|
)
|
|
|
1,036,313
|
|
|
$
|
3,007,450
|
|
|
$
|
(2,377,404
|
)
|
|
$
|
630,046
|
|
Capital assets not subject to depreciation:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Construction in progress
|
|
|
–
|
|
|
|
–
|
|
|
|
–
|
|
|
|
219,847
|
|
|
|
–
|
|
|
|
219,847
|
|
Total fixed assets
|
|
$
|
3,672,580
|
|
|
$
|
(2,636,267
|
)
|
|
$
|
1,036,313
|
|
|
$
|
3,227,297
|
|
|
$
|
(2,377,404
|
)
|
|
$
|
849,893
|
|
For the years ended December 31, 2018 and the year ended December
31, 2017, the Company recorded depreciation expense of $395,556 and $277,407 respectively.
Acquisition of NetSpective Webfiltering
On January 1, 2017, Grom Holdings acquired
the assets of NetSpective Webfilter, a division of TeleMate.net Software (“TeleMate”). Under the terms of the agreement,
Grom Holdings paid $1.0 million in consideration in the form of a $1.0 million redeemable, convertible promissory note. The note
bears interest at 0.68% per annum. All note principal and accrued interest is payable January 1, 2020. The note is convertible
at the election of TeleMate into the Company’s common stock at a conversion rate of $0.78 per share. Furthermore, if not
previously converted by TeleMate, the note may be converted by the Company into shares of the Company’s common stock at a
rate of $0.48 per share commencing on November 1, 2019.
TeleMate had the opportunity for contingent,
earn-out payments of up to $362,500 if certain net cash flow thresholds are achieved during the one-year post-closing period. The
earn-out payments, if made, shall be payable entirely in common stock.
Consideration Paid:
|
|
|
|
Cash and cash equivalents
|
|
$
|
–
|
|
Common stock, 41,700 shares paid with letter of intent
|
|
|
32,500
|
|
Senior, secured promissory notes
|
|
|
1,000,000
|
|
Financial liabilities assumed
|
|
|
521,735
|
|
Contingent purchase consideration
|
|
|
362,500
|
|
Fair value of total consideration
|
|
$
|
1,916,735
|
|
Recognized amount of identifiable assets acquired, and liabilities assumed:
|
|
|
|
Financial assets:
|
|
|
|
Intangible asset
|
|
|
|
Brand name
|
|
$
|
69,348
|
|
Software
|
|
|
1,134,435
|
|
Customer relationships
|
|
|
74,004
|
|
Financial liabilities:
|
|
|
|
|
Deferred revenues
|
|
|
(521,735
|
)
|
Write-down of purchase consideration
|
|
|
463,978
|
|
Goodwill
|
|
|
696,705
|
|
|
|
$
|
1,916,735
|
|
Additionally, since the valuation report
reflected that the earnout threshold would not be reached, and the earnout was achieved, the Company recorded an additional expense
of $362,500 related to the acquisition of Netspective.
In determining the fair value of the convertible
promissory note issued, the Company considered, among other factors, the market yields on debt securities for similar time horizons
and level of perceived risk of the investment. Based on the conversion factors and interest rate contained in the note, the Company
believes the note represents fair value.
We used a lattice model to estimate the
fair value of the contingent consideration. We forecast future up and down movements based on the 9.7% historical volatility of
“Net Cash Flow” which includes the years 2014-2016. The weighted average probability of each scenario was calculated
and since it did not reach the earnout threshold, we did not record any contingent consideration provision.
The fair value of the internally developed
software was estimated using a replacement cost approach similar to the Constructive Cost Model (“COCOMO”) II.
The model is an algorithmic software cost estimation tool that estimates the cost, effort, and schedule of a hypothetical software
project. We estimated costs based on total lines of code in the program and labor cost rates for the required personnel, in addition
to a profit component. Although this is a replacement cost model, we believe it represents fair value from a market participant
perspective. The key assumptions used include average labor rates, total estimated labor hours, and an income tax rate of 40%.
In determining the purchase price allocation,
the Company considered, among other factors, how a market participant would likely use the acquired assets. The estimated fair
value of intangible assets was based on the income approach for customer relationships and tradename and a replacement cost method
for the software programs. The income approach requires a projection of the cash flow that the asset is expected to generate in
the future. The projected cash flow is discounted to its present value using a rate of return, or discount rate, which accounts
for the time value of money and the degree of risk inherent in the asset. The expected future cash flow that is projected should
include all of the economic benefits attributable to the asset, including the tax savings associated with the amortization of the
intangible asset value over the tax life of the asset. The income approach may take the form of a “relief-from-royalty”
methodology, a cost savings methodology, a “with and without” methodology, or excess earnings methodology, depending
on the specific asset under consideration. The replacement cost model uses estimated current costs at the Measurement Date, plus
a profit component.
The “relief-from-royalty” method
was used to value the trade names acquired from TeleMate. The “relief-from-royalty” method estimates the cost savings
that accrue to the owner of an intangible asset that would otherwise be required to pay royalties or license fees on revenues earned
through the use of the asset. The royalty rate used is based on an analysis of empirical, market-derived royalty rates for guideline
intangible assets. Typically, revenue is projected over the expected remaining useful life of the intangible asset. The key assumptions
in the prospective cash flows include a 15% compound annual sales growth rate over the five years period subsequent to the acquisition.
The royalty rate is then applied to estimate the royalty savings. The key assumptions used in valuing the existing trade names
acquired were as follows: royalty rate of 1.0%, discount rate of 17.1%, and a tax rate of 40.0%. The trade names are expected to
be used indefinitely and the value includes a terminal value, based on a long-term sustainable growth rate of 2.0%, of the after-tax
royalty savings determined using a form of the Gordon Growth model.
The fair value of customer relationships
was valued using an income method. Net Operating Profit After Tax (“NOPAT”) per customer is a function of the gross
profit margin of the Company, applicable contributory assets (i.e., working capital, fixed capital, workforce, brand, IPR&D)
charges, and the discount rate reflecting the riskiness of the asset undervaluation. NOPAT per customer was used to estimate the
value of customer relationships. The key assumptions used include a revenue attrition rate of 10%, an income tax rate of 40%, and
a discount rate of 17.1%.
7.
|
GOODWILL AND INTANGIBLE ASSETS
|
The following table sets forth the changes
in the carrying amount of the Company’s goodwill at December 31, 2018 and December 31, 2017:
|
|
|
|
|
|
|
|
Balance, December 31, 2016
|
|
$
|
8,104,056
|
|
Acquisition of Netspective Webfiltering
|
|
|
696,705
|
|
Balance, December 31, 2017
|
|
|
8,800,761
|
|
Acquisition of Bonnie Boat assets
|
|
|
52,500
|
|
Balance, December 31, 2018
|
|
$
|
8,853,261
|
|
The following table sets forth the components
of the Company’s intangible assets at December 31, 2018 and December 31, 2017:
|
|
|
December
31, 2018
|
|
|
|
December
31, 2017
|
|
|
|
|
Amortization
Period (Years)
|
|
|
|
Gross
Carrying Amount
|
|
|
|
Accumulated
Amortization
|
|
|
|
Net
Book Value
|
|
|
|
Gross
Carrying Amount
|
|
|
|
Accumulated
Amortization
|
|
|
|
Net
Book Value
|
|
Intangible assets subject
to amortization:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Customer relationships
|
|
|
10.00
|
|
|
$
|
1,600,286
|
|
|
$
|
(396,371
|
)
|
|
$
|
1,203,915
|
|
|
$
|
1,600,286
|
|
|
$
|
(236,343
|
)
|
|
$
|
1,363,943
|
|
Mobile software applications
|
|
|
2.00
|
|
|
|
282,500
|
|
|
|
(282,500
|
)
|
|
|
–
|
|
|
|
282,500
|
|
|
|
(240,729
|
)
|
|
|
41,771
|
|
NetSpective webfiltering software
|
|
|
5.00
|
|
|
|
1,134,435
|
|
|
|
(453,774
|
)
|
|
|
680,661
|
|
|
|
1,134,435
|
|
|
|
(226,887
|
)
|
|
|
907,548
|
|
Noncompete agreements
|
|
|
2.00
|
|
|
|
846,638
|
|
|
|
(846,638
|
)
|
|
|
–
|
|
|
|
846,638
|
|
|
|
(846,638
|
)
|
|
|
–
|
|
Subtotal
|
|
|
–
|
|
|
|
3,863,859
|
|
|
|
(1,979,283
|
)
|
|
|
1,884,576
|
|
|
|
3,863,859
|
|
|
|
(1,550,597)
|
|
|
|
2,313,262
|
|
Intangible assets not subject
to amortization:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Trade names
|
|
|
–
|
|
|
|
4,455,595
|
|
|
|
–
|
|
|
|
4,455,595
|
|
|
|
4,455,595
|
|
|
|
–
|
|
|
|
4,455,595
|
|
Total intangible assets
|
|
|
–
|
|
|
$
|
8,319,454
|
|
|
$
|
(1,979,283
|
)
|
|
$
|
6,340,171
|
|
|
$
|
8,319,454
|
|
|
$
|
(1,550,597
|
)
|
|
$
|
6,768,857
|
|
The Company recorded amortization expense
for intangible assets subject to amortization of $428,686 for the year ended December 31, 2018 and $1,092,592 during the year ended
December 31, 2017.
The following table provides information
regarding estimated amortization expense for intangible assets subject to amortization for each of the following years ending December
31:
|
2019
|
|
|
$
|
386,916
|
|
|
2020
|
|
|
|
386,916
|
|
|
2021
|
|
|
|
386,916
|
|
|
2022
|
|
|
|
160,029
|
|
|
2023
|
|
|
|
160,029
|
|
|
Thereafter
|
|
|
|
403,772
|
|
|
|
|
|
$
|
1,884,578
|
|
Other assets are comprised solely of guarantee
deposits at TDA which are refundable upon termination of contract or delivery of subject matter of the contract. These are initially
recorded at cost which is the fair value at the time of the transaction and are subsequently measured at amortized cost.
9.
|
ACCOUNTS PAYABLE AND ACCRUED LIABILITIES
|
Trade payables are recognized initially
at the transaction price and subsequently measured at the undiscounted amount of cash or other consideration expected to be paid.
Accrued expenses are recognized based on the expected amount required to settle the obligation or liability.
The following table sets forth the components
of the Company’s accrued liabilities at December 31, 2018 and December 31, 2017.
|
|
December 31,
2018
|
|
|
December 31,
2017
|
|
|
|
|
|
|
|
|
Earnout consideration payable in connection with Netspective acquisition
|
|
$
|
362,500
|
|
|
$
|
362,500
|
|
Executive and employee compensation
|
|
|
792,402
|
|
|
|
838,689
|
|
Interest on convertible debentures and promissory notes
|
|
|
210,221
|
|
|
|
356,599
|
|
Other accrued expenses and liabilities
|
|
|
67,914
|
|
|
|
34,938
|
|
Total accrued liabilities
|
|
$
|
1,433,037
|
|
|
$
|
1,592,726
|
|
Accrued expenses for both periods include
approximately $138,000 for an estimated compromise settlement relating to tax deductions against supplier invoices in the Philippines
at TDA. The Company in accordance with ASC 740-10 has determined that the recording of this amount is required because it is more
likely than not that the tax will be assessed.
10.
|
RELATED PARTY PAYABLES AND ACTIVITY
|
The Company has engaged the Chief
Executive Officer, Darren Mark’s family to assist in the development of the Grom Social website and to create original content
for the site. Since these individuals have been responsible for creating in excess of 500 episodes of original content. Mr. Marks
wife Sarah; his sons Zach the founder of Grom, Luke, Jack, Dawson, and his daughters Caroline and Victoria all work for the Company
either as employees or contractors. The amount they were paid for the year ended December 31, 2018 are as follows: Sarah $33,600,
Zach $90,000, Luke $33,800, Jack $5,400, Victoria $6,750 and Caroline $11,250. The total annual compensation payable to these
six individuals for the periods ended December 31, 2018, and December 31, 2017, was $180,800 and $165,800, respectively, which
the Company believes is below market rate for the value of the services performed. This expenditure for services provided by the
Marks family is expected to continue for the foreseeable future. Members of the Marks family are actively involved on a daily
basis in creating all of the current content for the website which includes numerous videos on social responsibility, anti-bullying,
digital citizenship, unique blogs, and special events.
Liabilities Due to Executive and Other Officers
Messrs. Darren Marks and Melvin Leiner,
both officers of the Company, have made numerous loans to Grom to help fund operations. These loans are non-interest bearing and
callable on demand. No such loans were made to the Company during the years ended December 31, 2018, and December 31, 2017. Neither
Mr. Marks nor Mr. Leiner have any intention of calling these loans at present. The loan balances are classified as short-term obligations
under Related Party Payables on the Company’s balance sheet.
During 2017 and 2018 Mr. Marks and Mr. Leiner on several occasions
agreed to convert a portion of their loans into equity. These transactions are summarized as follows:
Name
|
|
Date
|
|
|
Amount of Loan Principal Converted to Equity
|
|
|
Share Price
Used for conversion
|
|
|
Trading price of Grom stock on the date of conversion
|
|
|
Shares issued
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Darren Marks
|
|
|
12/29/2017
|
|
|
|
333,333
|
|
|
$
|
0.50
|
|
|
|
0.30
|
|
|
|
666,666
|
|
|
|
|
10/15/2018
|
|
|
|
333,333
|
|
|
$
|
0.31
|
|
|
|
0.19
|
|
|
|
1,075,268
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Melvin Leiner
|
|
|
12/29/2017
|
|
|
|
166,667
|
|
|
$
|
0.50
|
|
|
|
0.30
|
|
|
|
333,334
|
|
|
|
|
10/15/2018
|
|
|
|
166,667
|
|
|
$
|
0.31
|
|
|
|
0.19
|
|
|
|
537,635
|
|
The outstanding amount due to Mr.
Marks and Mr. Leiner’s LLC’s were $469,506 and $1,215,442; and $451,944 and $861,198 as of December 31, 2018 and December
31, 2017, respectively. Additionally, we owed $50,000 to Dr. Rutherford our director who extended a short-term loan to the Company,
and $210,145 to Wayne and Stella Dearing who have extended loans to Top Draw animation to assist with its liquidity.
As of December 31, 2018, and December
31, 2017, the balances in related party payables were $1,181,645 and $2,076,640, respectively.
11.
|
OTHER NONCURRENT LIABILITIES
|
Other noncurrent liabilities are comprised
solely of retirement benefit costs. The Philippine Republic Act (RA) No. 7641, mandates all private employers to provide retirement
benefits to employees who upon reaching the age of sixty years or more, but not beyond sixty-five years, have served at least
five years in the said establishment. The amount of retirement benefit was defined as “at least one-half month salary for
every year of service, a fraction of at least six months being considered as one whole year”.
The balance of the accrued retirement benefit
cost as of December 31, 2018 and December 31, 2017 amounted to $224,797 and $237,496, respectively.
Convertible Debentures
The following tables set forth the components
of the Company’s, convertible debentures as of December 31, 2018 and December 31, 2017:
|
|
December 31,
2018
|
|
|
December 31,
2017
|
|
Redeemable unsecured convertible note -TeleMate
|
|
$
|
1,000,000
|
|
|
|
1,000,000
|
|
Principal value of secured convertible notes
|
|
|
2,822,708
|
|
|
|
676,223
|
|
Loan discounts
|
|
|
(735,871
|
)
|
|
|
(137,950
|
)
|
Less: Current portion
|
|
|
(676,223
|
)
|
|
|
(75,000
|
)
|
Total convertible notes, net
|
|
$
|
2,410,614
|
|
|
$
|
1,463,273
|
|
Redeemable unsecured convertible
note -TeleMate
On January 1, 2017, the Company issued
a three-year 0.68% redeemable convertible note for $1,000,000 to TeleMate. net in connection with the acquisition of the NetSpective
Webfiltering assets from them. All note principal and accrued interest is payable January 1, 2020. The note is convertible at the
election of the noteholders into the Company’s’ common stock at a conversion rate of $0.78 per share. Furthermore,
if not previously converted by the noteholders, the note may be converted by the Company into shares of the Company’s common
stock at a rate of $0.48 per share commencing on November 1, 2019.
Under the terms of the asset purchase agreement
in which TeleMate had the obligation to collect certain monies on behalf of the Company, TeleMate failed to remit $146,882 it had
collected on the Company’s behalf from NetSpective customers. As a result of TeleMate’s non-payment, and to avoid litigation,
on January 12, 2018, we entered into a First Modification to the Purchase and Sale Agreement (the “Modification”).
Under the terms of the Modification, the
TeleMate agreed to the following terms:
|
·
|
To pay the Company $10,000 per month against their outstanding balance of $146,822. To date, they have paid the Company $30,000 and are current on their monthly payment obligations.
|
|
·
|
They cannot exercise the conversion feature of their $1.0 million promissory note, nor will any of the $362,500 Earnout shares (464,744) until all payments are made in full.
|
|
·
|
The December 31, 2019 maturity date of the $1,000,000 convertible note is extended indefinitely until all payments are made in full.
|
|
·
|
All interest payments ($6,800 annually) due from the Company to TeleMate were suspended indefinitely until all payments are made in full.
|
Under the terms of the First Modification,
TeleMate agreed to pay us $10,000 per month against their outstanding balance due to us of $146,822. The TeleMate Note may not
be converted or any earnout shares issued by us until the outstanding balance is paid in full, and all interest payments due under
the TeleMate Note have been suspended until all payments owing the Company has been made. If and when TeleMate is permitted to
convert the TeleMate Note, the number of shares converted thereunder will be subject to a one-year leakout agreement.
Telemate has paid in full by April 2019.
If TeleMate does not convert the TeleMate Note to equity by October 1, 2019, the Company has the right to force conversion at a
conversion price of $0.48 per share.
Newbridge Offering
On November 30, 2018, the Company closed
a private offering in which it sold 12% secured convertible promissory notes in an aggregate principal amount of $552,000 and issued
an aggregate of 730,974 shares of its common stock to nine accredited investors pursuant to a private placement memorandum and
subscription agreement. The Notes which are due and payable two years from issuance are secured by certain assets of the Company
and rank senior to all other indebtedness of the Company except for the $4,000,000 promissory notes (the “TD Notes”)
issued to TD Holdings in connection with the Share Sale Agreement, dated June 30, 2016, as amended. Messrs. Marks and Leiner also
pledged an aggregate of 10,000,000 shares pursuant to a pledge and security agreement to secure the timely payment of the Notes.
The Notes are convertible, in whole or in part, by the note holder at a conversion rate of $0.40 if the Company’s common
stock trades or is quoted at more than $0.40 per share for 10 consecutive days. The conversion price is subject to adjustment resulting
from certain corporate actions including the subdivision or combination of stock, payment of dividends, reorganization, reclassification,
consolidations, merger or sale of the Company.
Interest on the Note is payable
monthly in 21 equal installments commencing four months after the issuance of the Notes. Upon the occurrence of an
“event of default” as described in the Notes, the interest rate will increase to 15% and the Notes shall become
immediately due and payable. The Company may prepay the Notes in full at any time by paying accrued interest and 110% of the
outstanding principal balance. Newbridge Securities Corporation acted as exclusive placement agent for the offering and
received (i) $55,200, (ii) 113,586 shares of common stock (the “Placement Agent Shares”); and (iii) $11,040,
representing a non-accountable expense allowance, for its services.
Secured Convertible Notes 2018
During the year ended December 31, 2018, the Company privately
placed a series of secured, convertible, original issue discount (OID) notes with accredited investors for gross proceeds of $1,238,485.
The Notes were issued with OID discounts of 20.0%, or $247,697. The debentures carried an interest rate of 10% per annum, payable
semiannually in cash, for a two-year term with a fixed conversion price of $0.50 if converted within one year of issuance and $0.78
per share thereafter.
During the year ended December 31, 2017,
the Company privately placed a series of secured, convertible, original issue discount (OID) notes with accredited investors for
gross proceeds of $601,223. The Notes were issued with OID discounts of 10.0%, or $60,122. The debentures carried an interest rate
of 10% per annum, payable semiannually in cash, for a two-year term with a fixed conversion price of $0.78.
In connection with the issuance of these
convertible debentures, the Company issued to its noteholders an aggregate of 150,305 shares of common stock as an inducement to
lend. These shares were valued at $78,321 with share prices ranging between $0.38 and $0.54 per share. The Company recorded the
value of these shares as a loan discount to be amortized as interest expense over the term of the related convertible debentures.
The related amortization expense was $4,543 for the year ended December 31, 2017.
Additionally, at the end of 2017, there
were two convertible notes outstanding amounting to $75,000 that had been issued in 2016 with a fixed conversion price of $1.19.
Senior Secured Promissory Notes
The following tables set forth the components
of the Company’s senior, secured promissory notes at December 31, 2018 and December 31, 2017:
|
|
December 31,
2018
|
|
|
December 31,
2017
|
|
Principal value of promissory notes
|
|
$
|
4,000,000
|
|
|
$
|
4,000,000
|
|
Loan discounts
|
|
|
(171,182
|
)
|
|
|
(86,339
|
)
|
Total promissory notes, net
|
|
$
|
3,828,818
|
|
|
$
|
3,953,661
|
|
On June 20, 2016, the Company issued
a secured promissory note to the TDA Sellers in connection with the share sale agreement. The note totaled $4.0 million, bears
interest at 5.0% per annum and is due on the earlier of (i) April 1, 2020 or (ii) the date on which the Company successfully completes
a qualified initial public offering as defined in the agreement. The note is collateralized by all of the assets of TD Holdings.
First Amendment of TDA Sellers Note
On January 3, 2018, we entered into an
amendment to the acquisition agreement with the TDA Sellers (the “Amendment”):
|
·
|
The TDA Sellers agreed to extend the maturity date of the $4.0 secured promissory note one year until July 1, 2019 (see 2016 description below);
|
|
·
|
The interest rate on the Note during the one-year extension period from July 2, 2018 to July 1, 2019 was changed to 10%. The interest rate on the Note remained at 5%, payable annually in arrears, until June 30, 2018;
|
|
·
|
During the one-year extension period, the interest will be paid quarterly in arrears, instead of annually in arrears. The first such quarterly interest payment of $100,000 is due on September 30, 2018; and
|
|
·
|
Under the terms of the terms acquisition agreement, the Sellers had an opportunity to earn up to $5.0 million in contingent Earnout Payments (as described above). The original Earn out measurement period ended on December 31, 2018. As part of the consideration for the Sellers agreeing to enter the Amendment, we agreed to extend the Earnout Period, one year, to December 31, 2019.
|
Also, as additional consideration,
we issued an additional 800,000 restricted shares of our common stock to the TDA Sellers which were expensed in 2018.
Second Amendment of TDA Sellers
Note
On January 15, 2019, we entered into a
second amendment to the TDH Acquisition Agreement (the “Second Amendment”). Under the terms of the Second Amendment:
|
·
|
the maturity date of the Note was extended
from July 1, 2019 to April 2, 2020.
|
|
|
|
|
·
|
the TDA Sellers shall have the right to
convert the Note at a conversion price of $0.27 per share, either in whole or in part at any time prior to the maturity, subject
to the terms and conditions set forth in the Amendment
|
|
|
|
|
·
|
in the event the Note is not repaid prior
to July 2, 2019: (i) no management fee shall be paid by TDA to the Company as provided in the Share Sale Agreement. Management
fees paid by TDA to the Company to date are approximately $100,000 per month. Non-payment of the management fees to the Company
by TDA due to the non-payment of the Note would have a material adverse impact on the Company.
|
|
|
|
|
·
|
The earnout was modified for 50% cash and 50% stock, to 75% cash and 25% stock.
|
|
|
|
|
·
|
The Sellers received 800,000 shares of the Company’s restricted common stock.
|
Maturities of the Company’s borrowings
for each of the next five years are as follows:
2019
|
|
|
$
|
1,676,223
|
|
2020
|
|
|
$
|
7,146,285
|
|
2021
|
|
|
$
|
–
|
|
The following table sets forth the components
of income tax expense (benefit) for the years ended December 31, 2018 and 2017:
|
|
December 31,
2018
|
|
|
December 31,
2017
|
|
|
|
|
|
|
|
|
Current:
|
|
|
|
|
|
|
|
|
Federal
|
|
$
|
–
|
|
|
$
|
–
|
|
State and local
|
|
|
–
|
|
|
|
–
|
|
Foreign
|
|
|
74,356
|
|
|
|
70,457
|
|
Total current
|
|
|
74,356
|
|
|
|
70,457
|
|
Deferred:
|
|
|
|
|
|
|
|
|
Federal
|
|
|
–
|
|
|
|
–
|
|
State and local
|
|
|
–
|
|
|
|
–
|
|
Foreign
|
|
|
(59,412
|
)
|
|
|
(36,851
|
)
|
Total deferred
|
|
|
(59,412
|
)
|
|
|
(36,851
|
)
|
Total
|
|
$
|
14,944
|
|
|
$
|
33,696
|
|
The following table sets forth a reconciliation of income tax
expense (benefit) at the federal statutory rate to recorded income tax expense (benefit) for the years ended December 31, 2018
and 2017:
|
|
December 31,
2018
|
|
|
December 31,
2017
|
|
|
|
|
|
|
|
|
Tax benefit at the statutory federal rate
|
|
|
–%
|
|
|
|
–%
|
|
Increase (decrease) in rate(s) resulting from:
|
|
|
|
|
|
|
|
|
Foreign operations, net
|
|
|
(0.3
|
)
|
|
|
(0.6
|
)
|
Change in deferred taxes
|
|
|
21.3
|
|
|
|
(26.6
|
)
|
Change in valuation allowance
|
|
|
(21.3
|
)
|
|
|
26.6
|
|
Total
|
|
|
(0.3
|
)%
|
|
|
(0.6
|
)%
|
The following tables set forth the components of income taxes
payable as of December 31, 2018 and 2017:
|
|
December 31,
2018
|
|
|
December 31,
2017
|
|
Federal
|
|
$
|
–
|
|
|
$
|
–
|
|
State and local
|
|
|
–
|
|
|
|
–
|
|
Foreign
|
|
|
41,907
|
|
|
|
46,963
|
|
Total
|
|
$
|
41,907
|
|
|
$
|
46,963
|
|
(a) The reduction of the valuation allowance
was due to the change in U.S. corporate tax rates from 34% to 21% starting in 2018.
The following tables set forth the components of deferred income
taxes as of December 31, 2018 and 2017:
|
|
December 31,
2018
|
|
|
December 31,
2017
|
|
|
|
|
|
|
|
|
Non-current deferred tax assets:
|
|
|
|
|
|
|
|
|
Retirement benefits
|
|
$
|
67,439
|
|
|
$
|
71,249
|
|
Write down of investment(s)
|
|
|
62,421
|
|
|
|
65,958
|
|
Deferred revenue net
|
|
|
96,090
|
|
|
|
43,193
|
|
Other
|
|
|
23,833
|
|
|
|
20,890
|
|
Net operating loss carryforwards
|
|
|
4,150,813
|
|
|
|
5,143,029
|
|
Less: valuation allowance
|
|
|
(4,150,813
|
)
|
|
|
(5,143,029
|
)
|
Total non-current deferred tax asset
|
|
|
249,783
|
|
|
|
201,290
|
|
Total deferred tax asset
|
|
$
|
249,783
|
|
|
$
|
201,290
|
|
The deferred tax asset relates solely to
the Company’s foreign operations at TDH. The company believes these assets are realizable in future periods due to the consistent
historic profitability of TDH.
On
December 22, 2017, the United States enacted the Tax Cuts and Jobs Act (“TCJA”), which instituted fundamental changes
to the taxation of multinational corporations, including a reduction the U.S. corporate income tax rate to 21% beginning
in 2018.
The
TCJA also requires a one-time transition tax on the mandatory deemed repatriation of the cumulative earnings of certain of the
Company’s foreign subsidiaries as of December 31, 2017. To determine the amount of this transition tax, the Company
must determine the amount of earnings generated since inception by the relevant foreign subsidiaries, as well as the amount of
non-U.S. income taxes paid on such earnings, in addition to potentially other factors. The Company believes that no such tax will
be due since TDH has paid taxes locally and that the cumulative undistributed earnings of TDH are not material.
As of December 31, 2018, the Company had
federal, state and foreign net operating loss carryforwards of approximately $19,765,774 that are available to offset future liabilities
for income taxes. The Company has generally established a valuation allowance against these carryforwards based on an assessment
that it is more likely than not that these benefits will not be realized in future years. The federal and state net operating loss
carryforwards expire at various dates through 2036.
The Company remains subject to examination
in federal, state and foreign jurisdictions in which the Company conducts its operations and files tax returns. These tax years
range from 2013 through 2017. The Company believes that the results of current or any prospective audits will not have a material
effect on its financial position or results of operations as adequate reserves have been provided to cover any potential exposures
related to these ongoing audits.
The Company has made its assessment of
the level of tax authority for each tax position (including the potential application of interest and penalties) based on the technical
merits and determined that no unrecognized tax benefits associated with the tax positions exist.
Preferred Stock
The Company is authorized to issue 25,000,000
shares of Preferred Stock at a par value of $0.001. No shares of Preferred Stock were issued and outstanding as of December 31,
2018 or December 31, 2017.
Common stock
The Company is authorized to issue 200,000,000
shares of common stock at a par value of $0.001 and had 138,553,655 and 124,273,548 shares of common stock issued and outstanding
as of December 31, 2018 and December 31, 2017, respectively.
Common Stock Issued in Private Placements
During the year ended December 31, 2018,
the Company issued 3,854,869 shares and realized proceeds of $608,718.
During the year ended December 31, 2017,
the Company did not issue any shares of stock in private placements.
Common Stock Issued in Connection
with the Exercise of Warrants
During the year ended December 31,
2018, the Company issued 256,455 shares of common stock for proceeds of 61,500 under a series of stock warrant exercises with a
share price of approximately $0.24 per share.
During the year ended December 31,
2017, the Company issued 6,530,220 shares of common stock for proceeds of $1,566,000 under a series of stock warrant exercises
with a share price of approximately $0.24 per share.
Common Stock Issued in Exchange for
Consulting, Professional and Other Services
During the year ended December 31, 2018
the Company issued 1,200,321 shares of common stock with a fair market value of $458,918 to employees in lieu of cash payment.
Additionally, the Company issued 2,385,505 shares of common stock with a fair value of $825,170 to consultants and other professionals
in lieu of cash payments.
During the year ended December 31, 2017,
the Company issued 1,156,931 shares of common stock with a fair market value of $835,225 to employees, officers and directors
in lieu of cash payment. Additionally, the Company issued 3,264,965 shares of common stock with a fair value of $1,892,735 to consultants
and other professionals in lieu of cash payments.
Each share issuance made in exchange for
services was valued based upon the private placement offering price of the Company’s common stock in place on its respective
date of award.
Common Stock Issued In lieu of Cash
for Loans Payable and Other Accrued Obligations
During the year ended December 31, 2018,
the Company issued 3,995,304 shares of common stock with a fair market value of $1,321,376 to satisfy loans payable and other accrued
obligations.
During the year ended December 31, 2017,
the Company issued 1,045,870 shares of common stock with a fair market value of $533,000 to satisfy loans payable and other
accrued obligations.
Common Stock Issued in Connection
with the Amendment of Terms of a Promissory Note
During the year ended December 31, 2018,
the Company issued 805,000 shares of common stock valued at $482,250 to amend the terms of a promissory note.
Common Stock Issued in Connection
with the Issuance of Convertible Debentures
During the year ended December 31, 2018
the Company issued 1,432,653 shares of common stock valued at $523,601 in connection with the issuance of convertible notes.
Common Stock Issued in the Acquisition
of a Business
During the year ended December 31, 2018
the Company issued 150,000 shares of common stock valued at $52,500 in connection with the acquisition of a business.
Conversion of Convertible Debentures
and Accrued Interest into Common stock
During the
year ended December 31, 2018, the Company issued 200,000 shares of common stock valued at $30,000 in connection with the
conversion of convertible debentures and accrued interest into common stock.
Common Stock
Issued in Connection with Secured convertible OID notes
In 2017, we issued
$601,223 of secured convertible OID Notes at an interest rate of 10%. In connection with the issuance of these Notes and as an
inducement to enter into these Notes we issued 150,305 shares valued at $78,321.
Stock Purchase Warrants
The stock purchase warrants have been accounted
for as equity in accordance with FASB ASC 480, Accounting for Derivative Financial Instruments Indexed to, and potentially settled
in, a company’s own stock, distinguishing liabilities from equity.
The following table reflects all outstanding
and exercisable warrants at December 31, 2018 and December 31, 2017. All stock warrants are exercisable for a period of approximately
five years from the date of issuance.
|
|
Number of Warrants Outstanding
|
|
|
Weighted Avg. Exercise Price
|
|
|
Weighted Avg. Contractual Life (Yrs.)
|
|
|
|
|
|
|
|
|
|
|
|
Balance January 1, 2017
|
|
|
7,608,154
|
|
|
$
|
0.26
|
|
|
|
0.75
|
|
Warrants issued
|
|
|
567,166
|
|
|
$
|
1.50
|
|
|
|
2.25
|
|
Less: Warrants exercised
|
|
|
(7,107,765
|
)
|
|
$
|
0.24
|
|
|
|
|
|
Warrants forfeited
|
|
|
(29,190
|
)
|
|
$
|
0.24
|
|
|
|
|
|
December 31, 2017
|
|
|
1,038,365
|
|
|
$
|
1.36
|
|
|
|
2.38
|
|
Warrants issued
|
|
|
–
|
|
|
|
–
|
|
|
|
|
|
Warrants exercised
|
|
|
(256,455
|
)
|
|
|
–
|
|
|
|
|
|
Balance 31, 2018
|
|
|
781,910
|
|
|
$
|
1.36
|
|
|
|
1.38
|
|
Stock Options
The following table represents all outstanding
and exercisable stock options as of December 31, 2018.
|
|
Options
Issued
|
|
|
Options
Forfeited
|
|
|
Options
Outstanding
|
|
|
Vested
Options
|
|
|
Strike Price
|
|
|
Weighted Average Remaining Life (Yrs.)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
7,735,350
|
|
|
|
–
|
|
|
|
7,735,350
|
|
|
|
7,735,350
|
|
|
$
|
0.24
|
|
|
4.27
|
|
|
|
9,695,250
|
|
|
|
417,000
|
|
|
|
9,278,250
|
|
|
|
9,278,250
|
|
|
$
|
0.36
|
|
|
0.44
|
|
|
|
13,135,500
|
|
|
|
3,544,500
|
|
|
|
9,591,000
|
|
|
|
9,591,000
|
|
|
$
|
0.72
|
|
|
1.25
|
|
|
|
5,481,000
|
|
|
|
1,042,500
|
|
|
|
4,438,500
|
|
|
|
4,011,019
|
|
|
$
|
0.78
|
|
|
2.20
|
Total
|
|
|
36,047,100
|
|
|
|
5,004,000
|
|
|
|
31,043,100
|
|
|
|
30,615,619
|
|
|
$
|
0.50
|
|
|
1.90
|
The Company did not issue any stock
options in 2018. The remaining stock-based compensation to be recorded on the above issuance was zero as of December 31, 2018.
During the years ended December 31, 2018
and 2017, the Company recorded $2,300 and $1,823,408 in stock-based compensation expense related to these stock options.
15.
|
COMMITMENTS AND CONTINGENCIES
|
In the United States, the Company leases
approximately 1,550 square feet of office space in Boca Raton, Florida at the rate of $3,958 per month pursuant to a three-year
lease which expired in October 2018. In October 2018, the Company entered into a new three-year lease at the same location and
added an additional 513 sq. feet in space at a total rate of $4,223 per month. The Florida office houses the Company’s corporate
headquarters and administrative staff.
The Company animation subsidiary TDH leases
portions of 3 floors comprising in the aggregate approximately 28,800 square feet in the West Tower of the Philippine Stock Exchange
Centre in Pasig City, Manila. The space is used for administration and production purposes and the Company pays approximately $22,533
per month in the aggregate for such space (which increases by approximately 5% per year. These leases expire in December 2022.
The
Company opened a new 1,400 square foot office in Norcross, Georgia on January 1, 2018 to house its NetSpective Webfilter division.
The monthly rent pursuant to a five-year lease which expires in December 2023, is $2,055 per month which increases by approximately
3% annually.
The future minimum payment
obligations as of December 31, 2018, for operating leases are as follows:
2019
|
|
|
$
|
97,859
|
|
2020
|
|
|
$
|
98,599
|
|
2021
|
|
|
$
|
90,892
|
|
2022
|
|
|
$
|
49,402
|
|
2023
|
|
|
$
|
27,619
|
|
On February 22, 2019, the Company designated
2,000,000 shares of its Preferred Stock as 10% Series A Convertible preferred stock, par value $0.001 per share (“Series
A”). On each of February 27, 2019 and March 11, 2019, the Company received $400,000, or a total of $800,000, in proceeds
from the sale of 400,000 shares of Series A to each accredited investor in a private offering pursuant to Section 4(a)(2) and/or
Rule 506(b) of Regulation D, as promulgated under the Securities Act, As an inducement to purchase the Series A Stock, each investor
also received 2,000,000 restricted shares of the Company’s common stock.
On April 2, 2019 we received an addition
$125,000 in proceeds from the sale of 125,000 shares of Series A to one of the same accredited investors made the February 22
nd
purchase. In connection with this purchase the investor received 625,000 restricted shares of the Company’s common stock.
The Series A Stock is convertible, at
any time, into five shares of common stock of the Company.