The accompanying notes are an integral part of these consolidated financial statements.
The accompanying notes are an integral part of these consolidated financial statements.
The accompanying notes are an integral part of these consolidated financial statements.
The accompanying notes are an integral part of these consolidated financial statements.
Notes to Consolidated Financial Statements
December 31, 2017 and 2016
NOTE 1 - ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
a.
Organization
The consolidated financial statements presented are those of Medizone International, Inc. (“Medizone”), Medizone Canada, Inc., a wholly owned subsidiary, and the Canadian Foundation for Global Health (“CFGH”) (“Affiliate”), a not-for-profit foundation based in Ottawa, Canada, considered to be a variable interest entity (“VIE”) as described below. Collectively, they are referred to herein as the “Company.”
In late 2008, the Company assisted in the formation of CFGH, a not-for-profit foundation. The Company helped establish CFGH for two primary purposes: (1) to establish an independent not-for-profit foundation intended to have a continuing working relationship with the Company for research purposes positioned to attract the finest scientific, medical and academic professionals possible to work on projects deemed to be of social benefit; and (2) to provide a means for the Company to use a tiered pricing structure for services and products in emerging economies and extend the reach of its technology to as many in need as possible.
US generally accepted accounting principles (“US GAAP”) require a VIE to be consolidated by a company if that company absorbs a majority of the VIE’s expected losses and/or receives a majority of the VIE’s expected residual returns as a result of holding variable interests (ownership, contractual, or other financial interests) in the VIE. In addition, a legal entity is considered to be a VIE, if it does not have sufficient equity at risk to finance its own activities without relying on financial support from other parties. If the legal entity is a VIE, then the reporting entity determined to be the primary beneficiary of the VIE must consolidate the financial results of the VIE with it. Accordingly, the financial position and results of operations of CFGH are consolidated with Medizone as of and for the years ended December 31, 2017 and 2016. The noncontrolling interest portion of net assets and net loss not attributable, directly or indirectly, to Medizone International, Inc. is considered immaterial.
b.
Business Activities
The Company is a global provider of disinfection systems. The Company invented the AsepticSure
®
system to provide a superior means of disinfecting non-porous surfaces in a variety of settings including hospitals, other healthcare facilities, and non- hospital/healthcare facilities. The AsepticSure
®
system utilizes hydrogen peroxide vapor and ozone in a patented process.
c.
Basic and Diluted Net Loss Per Common Share
The computations of basic and diluted net loss per common share are based on the weighted average number of common shares outstanding during the years as follows:
|
|
For the Years Ended
December 31,
|
|
|
|
2017
|
|
|
2016
|
|
|
|
|
|
|
|
|
Numerator (net loss)
|
|
$
|
(2,013,799
|
)
|
|
$
|
(2,673,836
|
)
|
|
|
|
|
|
|
|
|
|
Denominator (weighted average number of common shares outstanding – basic and diluted)
|
|
|
400,207,813
|
|
|
|
375,118,494
|
|
|
|
|
|
|
|
|
|
|
Basic and diluted net loss per common share
|
|
$
|
(0.01
|
)
|
|
$
|
(0.01
|
)
|
As of December 31, 2017, common stock equivalents, consisting of 18,087,500 options, warrants to purchase 1,750,000 shares of common stock, and warrants to purchase up to $1,000,000 of common stock with the number of shares determined based on a 20-day average stock price prior to the date of exercise, have not been included in the calculation, as their effect is antidilutive for the year ended December 31, 2017. As of December 31, 2016, common stock equivalents, consisting of 20,715,000 options and warrants to purchase up to $1,000,000 of common stock with the number of shares to be determined based on similar terms as in 2017, have not been included in the calculation, as the effect is antidilutive for the year ended December 31, 2016.
MEDIZONE INTERNATIONAL, INC., SUBSIDIARY AND AFFILIATE
Notes to Consolidated Financial Statements
December 31, 2017 and 2016
NOTE 1 - ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
d.
Property and Equipment
Property and equipment are recorded at cost. Any major additions and improvements are capitalized. The cost and related accumulated depreciation of equipment retired or sold are removed from the accounts and any differences between the undepreciated amount and the proceeds from the sale are recorded as gain or loss on sale of property and equipment. Depreciation is computed using the straight-line method over periods of three years for computers and software, and five years for office equipment and furniture.
e.
Provision for Income Taxes
The Company estimates income taxes in each of the jurisdictions in which it operates. This process involves estimating the Company’s actual current income tax expense together with assessing temporary differences resulting from differing treatment of items for income tax and financial reporting purposes. These temporary differences result in deferred income tax assets and liabilities, the net amount of which is included in the Company’s consolidated balance sheets. When appropriate, the Company records a valuation allowance to reduce its deferred income tax assets to the amount that the Company believes is more likely than not to be realized. Key assumptions used in estimating a valuation allowance include potential future taxable income, projected income tax rates, expiration dates of net operating loss (“NOL”) and tax credit carry forwards, and ongoing prudent and feasible tax planning strategies.
As of December 31, 2017, the Company had NOL carryforwards of approximately $14,087,000 that may be offset against future taxable income, if any, and expire through 2035. If substantial changes in the Company’s ownership should occur, there would also be an annual limitation of the amount of the NOL carryforwards available for use. No tax benefit has been reported in the consolidated financial statements as, in the opinion of management, it is more likely than not that all of the deferred income tax assets will not be realized and the NOL carryforwards will expire unused. Deferred income tax assets and liabilities are adjusted for the effects of changes in tax laws and rates on the date of enactment. If the Company were to determine that it would be able to realize its deferred income tax assets in the future in excess of the net recorded amount, an adjustment to reduce the valuation allowance would increase net income or decrease net loss in the period such determination was made.
Interest and penalties associated with any underpayment of income taxes would be classified as income tax provision in the statements of comprehensive loss. The Company has elected to present revenues net of any tax collected.
Deferred income tax assets as of December 31, 2017 and 2016 comprised the following:
|
|
2017
|
|
|
2016
|
|
|
|
|
|
|
|
|
Net operating loss carryforwards
|
|
$
|
3,514,700
|
|
|
$
|
4,959,900
|
|
Related party accruals
|
|
|
980,100
|
|
|
|
1,564,700
|
|
Valuation allowance
|
|
|
(4,494,800
|
)
|
|
|
(6,524,600
|
)
|
|
|
$
|
-
|
|
|
$
|
-
|
|
The income tax benefit differs from the amount determined by applying the U.S. federal income tax rate to pretax loss for the years ended December 31, 2017 and 2016 due to the following:
|
|
2017
|
|
|
2016
|
|
|
|
|
|
|
|
|
Income tax benefit based on U.S. statutory rate of 34%
|
|
$
|
(684,700
|
)
|
|
$
|
(909,100
|
)
|
Effect of change in deferred tax rates (39.834% to 24.95%)
|
|
|
2,681,404
|
|
|
|
-
|
|
Other
|
|
|
33,096
|
|
|
|
(40,800
|
)
|
Change in valuation allowance
|
|
|
(2,029,800
|
)
|
|
|
949,900
|
|
|
|
$
|
-
|
|
|
$
|
-
|
|
The Company had no uncertain income tax positions as of December 31, 2017, and 2016. The Company files income tax returns in the U.S. federal, California and Michigan jurisdictions. With few exceptions, the Company is no longer subject to US federal, state and local tax examinations for years before 2014.
MEDIZONE INTERNATIONAL, INC., SUBSIDIARY AND AFFILIATE
Notes to Consolidated Financial Statements
December 31, 2017 and 2016
NOTE 1 - ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
e.
Provision for Income Taxes (continued)
On December 22, 2017, the Tax Cuts and Jobs Act (the Tax Act) was enacted. The Tax Act makes broad and complex changes to the US tax code that will affect our fiscal year ending December 31 2018, including, but not limited to (1) reducing the US federal corporate tax rate from 35 percent to 21 percent; (2) generally eliminating U.S. federal income taxes on dividends from foreign subsidiaries; (3) requiring a current inclusion in US federal taxable income of certain earnings of controlled foreign corporations; (4) creating a new limitation on deductible interest expense; (5) revising the rules that limit the deductibility of compensation to certain highly compensated executives, and (6) changing rules related to uses and limitations of net operating loss carryforwards created in tax years beginning after December 31, 2017.
The SEC staff issued SAB 118, which provides guidance on accounting for the tax effects of the Tax Act. SAB 118 provides a measurement period that should not extend beyond one year from the Tax Act enactment date for companies to complete the accounting under ASC 740. In accordance with SAB 118, a company must reflect the income tax effects of those aspects of the Act for which the accounting under ASC 740 is complete. To the extent that a company’s accounting for certain income tax effects of the Tax Act is incomplete but it is able to determine a reasonable estimate, it must record a provisional estimate in the financial statements. If a company cannot determine a provisional estimate to be included in the financial statements, it should continue to apply ASC 740 on the basis of the provisions of the tax laws that were in effect immediately before the enactment of the Tax Act.
The Company is continuing to gather information and to analyze aspects of the Tax Act, which could potentially affect the estimated impact on the deferred tax balances.
As a result of changes made by the Tax Act, Section 162(m) will limit the deduction of compensation, including performance-based compensation, in excess of $1 million paid to anyone who, for tax years beginning after January 1, 2018, serves as the Chief Executive Officer or Chief Financial Officer, or who is among the three most highly compensated executive officers for any fiscal year. The only exception to this rule is for compensation that is paid pursuant to a binding written contract in effect on November 2, 2017 that would have otherwise been deductible under the prior Section 162(m) rules. Accordingly, any compensation paid in the future pursuant to new compensation arrangements entered into after November 2, 2017, even if performance-based, will count towards the $1 million fiscal year deduction limit if paid to a covered executive. The Company estimates that there will not be a material impact during the current quarter or fiscal year, as the law is effective for tax years beginning after January 1, 2018. The Company has evaluated its binding contracts entered into prior to November 2, 2017 and believes there will be no material impact on the Company’s balance sheet. The Company is still analyzing certain aspects of the Act and refining calculations, which could potentially affect the impact of the Company’s deferred tax asset and this provision.
f.
Principles of Consolidation
The consolidated financial statements include the accounts of Medizone and the accounts of Medizone Canada, Inc., a wholly-owned subsidiary incorporated in Canada, and CFGH, a VIE. All material intercompany accounts and transactions have been eliminated.
g.
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 assets and liabilities and disclosure of the contingent assets and liabilities as of the dates of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from those estimates.
h.
Advertising
The Company expenses the costs of advertising as incurred. The Company did not incur any advertising expense for the years ended December 31, 2017 and 2016.
MEDIZONE INTERNATIONAL, INC., SUBSIDIARY AND AFFILIATE
Notes to Consolidated Financial Statements
December 31, 2017 and 2016
NOTE 1 - ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
i.
Stock Options
The Company records compensation expense in connection with the granting of stock options and their vesting periods based on their fair values. The Company estimates the fair values of stock option awards issued to employees, consultants and others by using the Black-Scholes option-pricing model. For stock options with a service condition, the expense is measured at the grant date and expensed over the vesting period. For stock options with a performance condition, the expense is measured when it is probable that the performance condition will be met, subsequently re-measured at each reporting date, and trued up upon the final completion of the performance condition.
j.
Common Stock Warrant Liability
The Company accounts for certain common stock warrants as liabilities. The fair value of the common stock warrant liability is determined at each reporting period-end, with the changes in fair value recognized as gain (loss) on change in fair value of warrant liability. The fair value of the warrants to purchase common stock is estimated using the Black-Scholes valuation model. The significant assumptions used in estimating the fair value of warrant liabilities include the exercise price, volatility of the stock underlying the warrant, risk-free interest rate, estimated fair value of the stock underlying the warrant and the estimated life of the warrant.
k.
Trademark and Patents
Trademark and patents are recorded at cost. Amortization is computed using the straight-line method over a period of seven years. The Company evaluates the recoverability of intangibles and reviews the amortization period on a continual basis. Several factors are used to evaluate intangibles, including management’s plans for future operations, recent operating results, and projected, undiscounted net cash flows.
l.
Revenue Recognition Policy
The Company recognizes revenue when it ships its products, title and risk of loss passes to customers, payment from the customer is reasonably assured and the price is fixed or determinable. The Company records customer deposits received in advance of shipping products as a liability.
m.
Inventory
The Company’s inventory consists of its AsepticSure
®
system and is valued on a specific identification basis. The Company generally purchases its inventory as a finished product from unrelated manufacturing companies. The Company determined that there was no obsolete or excess inventory as of December 31, 2017, and 2016.
n.
Fair Value of Financial Instruments
The Company’s financial instruments consist of cash, accounts payable, accrued expenses, notes payable and warrant liability. The carrying amounts of cash, accounts payable, and accrued expenses approximate their fair values because of the short-term nature of these instruments. The carrying amounts of the notes payable approximate fair values as the individual borrowings bear interest at rates that approximate market interest rates for similar debt instruments. The fair value of the warrant liability represents its estimated fair value using the Black-Scholes option pricing model.
MEDIZONE INTERNATIONAL, INC., SUBSIDIARY AND AFFILIATE
Notes to Consolidated Financial Statements
December 31, 2017 and 2016
NOTE 1 - ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
n.
Fair Value of Financial Instruments (continued)
The Company measures certain financial liabilities (warrant liability) at fair value on a recurring basis. The Company follows 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 and liabilities (Level 1) and the lowest priority to measurements involving significant unobservable inputs (Level 3). The three levels of the fair value hierarchy are as follows:
·
|
Level 1 measurements 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 measurements are inputs other than quoted prices included in Level 1 that are observable either directly or indirectly.
|
·
|
Level 3 measurements are unobservable inputs.
|
o.
Recent Accounting Pronouncements
In May 2014, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2014-09,
Revenue from Contracts with Customers,
which supersedes nearly all existing revenue recognition guidance under US GAAP. The core principle of ASU No. 2014-09 is to recognize revenues when promised goods or services are transferred to customers in an amount that reflects the consideration to which an entity expects to be entitled for those goods or services. ASU No. 2014-09 defines a five-step process to achieve this core principle and, in doing so, more judgment and estimates may be required within the revenue recognition process than are required under existing US GAAP. ASU No. 2014-09 is effective for annual reporting periods beginning after December 15, 2017, and interim periods therein. Early adoption is permitted only as of annual reporting periods beginning after December 15, 2016, including interim reporting periods therein. The implementation of this guidance is not expected to have a material impact on the Company’s consolidated financial position, results of operations and liquidity.
In November 2015, the FASB issued ASU 2015-17,
Income Taxes (Topic 740)
, simplifying the presentation of deferred income taxes on the balance sheet by requiring companies to classify all deferred taxes as either a non-current asset or a non-current liability. ASU No. 2015-17 is effective for annual reporting periods beginning after December 15, 2016, and interim periods within annual periods ending after December 15, 2016. The implementation of this guidance had no impact on the Company’s consolidated financial statement presentation.
In February 2016, the FASB released ASU No. 2016-02,
Leases (Topic 842)
, to bring transparency to lessee balance sheets. ASU No. 2016-02 will require organizations that lease assets (lessees) to recognize assets and liabilities on the balance sheet for the rights and obligations created by all leases with terms of more than 12 months. ASU No. 2016-02 will apply to both types of leases; capital (or finance) leases and operating leases. Previously, US GAAP has required only capital leases to be recognized on lessee balance sheets. ASU No. 2016-02 is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018. Early application is permitted. The Company is assessing the impact of ASU No. 2016-02 will have on its future consolidated financial position, results of operations and liquidity.
In March 2016, the FASB issued ASU No. 2016-09,
Compensation - Stock Compensation: Improvements to Employee Share-Based Payment Accounting
. ASU No. 2016-09 is intended to simplify several areas of accounting for share-based compensation arrangements, including the income tax impact, classification in the statement of cash flows, and forfeitures. ASU No. 2016-09 is effective for fiscal years, and interim periods within those years beginning after December 15, 2016. The implementation of this guidance did not have a material impact on the Company’s consolidated financial statement presentation.
In October 2016, the FASB issued ASU No. 2016-17,
Interests held Through Related Parties That are Under Common Control
. ASU No. 2016-17 clarifies the consolidation process for the primary beneficiary of a VIE should that related party have indirect interests under common control with the reporting entity. ASU No. 2016-17 is effective for years ending after December 31, 2016. The implementation of this guidance did not have a material impact on the Company’s consolidated financial statement presentation.
MEDIZONE INTERNATIONAL, INC., SUBSIDIARY AND AFFILIATE
Notes to Consolidated Financial Statements
December 31, 2017 and 2016
NOTE 1 - ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
o.
Recent Accounting Pronouncements (continued)
In January 2017, the FASB issued ASU No. 2017-04,
Intangibles-Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment
. ASU No. 2017-04 eliminates the requirement to calculate the implied fair value of goodwill to measure a goodwill charge. The guidance is effective for annual and interim periods of public entities beginning after December 15, 2019, with early adoption permitted for interim periods after January 1, 2017. The Company is currently assessing the potential impact ASU No. 2017-04 will have on its consolidated results of operations, financial position and cash flows.
In May 2017, the FASB issued ASU No. 2017-09,
Compensation – Stock Compensation (Topic 718)
. ASU No. 2017-09 provides clarity and reduces the diversity of practice and complexity in determining when additional expense should be recorded resulting from a modification to stock-based grants and awards. ASU No. 2017-09 is effective for annual periods beginning after December 15, 2017. Early adoption is permitted for interim periods. The Company is currently assessing the potential impact ASU No. 2017-09 will have on its consolidation results of operations, financial position and cash flows.
p.
Concentration of Credit Risk
The Company maintains its cash in bank deposit accounts which cash, at times, exceeds federally insured limits. As of December 31, 2017, the Company did not have cash balances that exceeded US federally insured limits. To date, the Company has not experienced a material loss or lack of access to its cash; however, no assurance can be provided that access to the Company’s cash will not be impacted by adverse conditions in the financial markets.
NOTE 2 – INVENTORY
In December 2016, the Company terminated a Distribution and License Agreement with a distributor due to a lack of market development by the distributor. In connection with the termination, the Company negotiated the return of five disinfection units on or before January 17, 2017 paying the distributor $25,000 per unit. The units were upgraded with the Company’s current technology to support the ongoing expansion of the Company’s commercial strategy.
NOTE 3 - TRADEMARK AND PATENTS
Trademark and patents consist of the following as of December 31, 2017 and 2016:
|
|
2017
|
|
|
2016
|
|
Patent costs
|
|
$
|
433,865
|
|
|
$
|
415,251
|
|
Trademark
|
|
|
770
|
|
|
|
770
|
|
|
|
|
434,635
|
|
|
|
416,021
|
|
Accumulated amortization
|
|
|
(317,019
|
)
|
|
|
(264,577
|
)
|
Trademark and patents, net
|
|
$
|
117,616
|
|
|
$
|
151,444
|
|
Amortization expense for the years ended December 31, 2017 and 2016, was $52,442 and $55,896, respectively. The future amortization as of December 31, 2017, is as follows: 2018-$41,409; 2019-$27,745; 2020-$20,203; 2021-$12,956; 2022-$8,412 and thereafter-$6,891.
NOTE 4 - ACCOUNTS PAYABLE – RELATED PARTIES
As of December 31, 2017, and 2016, the Company owed $40,415 and $0 to directors and officers for various administrative and travel related expenses. In July 2016, the Company converted $228,109 of accounts payable – related parties into notes payable – related parties (see Note 8).
MEDIZONE INTERNATIONAL, INC., SUBSIDIARY AND AFFILIATE
Notes to Consolidated Financial Statements
December 31, 2017 and 2016
NOTE 5 - ACCRUED EXPENSES
Accrued expenses consist of the following as of December 31, 2017 and 2016:
|
|
2017
|
|
|
2016
|
|
Accrued interest
|
|
$
|
577,978
|
|
|
$
|
549,909
|
|
Other accruals
|
|
|
52,921
|
|
|
|
42,712
|
|
Total
|
|
$
|
630,899
|
|
|
$
|
592,621
|
|
Accrued interest pertains to notes payable (see Note 7). Other accruals consist of legal and advisory fees, estimated taxes and product warranties.
NOTE 6 - ACCRUED EXPENSES – RELATED PARTIES
Accrued expenses – related parties consist of the following as of December 31, 2017 and 2016:
|
|
2017
|
|
|
2016
|
|
Accrued payroll and consulting – related parties
|
|
$
|
648,167
|
|
|
$
|
422,334
|
|
Accrued payroll taxes – related parties
|
|
|
131,877
|
|
|
|
116,553
|
|
Total
|
|
$
|
780,044
|
|
|
$
|
538,887
|
|
In July 2016, the Company converted $1,389,772 of accrued expenses – related parties into notes payable – related parties. These parties are officers and executives of the Company (see Note 8).
Accrued payroll and consulting fees increased during 2017, as the Company’s Interim CEO, current CEO, and Executive Vice President, Administration and Operations have deferred their salaries until such time as a significant financing has occurred.
NOTE 7 - NOTES PAYABLE
Notes payable consist of the following as of December 31, 2017 and 2016:
|
|
2017
|
|
|
2016
|
|
Unsecured notes payable to former directors and a family member of a former director, due at various dates in 1995, 1996 and 1997, interest at 8%. The Company has the right to repay the loans with restricted stock at $0.10 per share if alternative financings do not occur. These notes payable are in default.
|
|
$
|
182,676
|
|
|
$
|
182,676
|
|
Unsecured notes payable to a third party in the amount of $50,000, due on September 8, 2018, interest at 12%. Accrued interest due semi-annually, January 5 and July 5 of each year. The note holder has the right to convert 20% of the then outstanding principal into common shares at $0.10 per share.
|
|
|
50,000
|
|
|
|
50,000
|
|
Unsecured notes payable to 10 stockholders, due on demand, interest at 10%. The Company is obligated to accept the principal at face value plus accrued interest as partial payment for shares the lenders may purchase from the Company upon exercise of the lenders’ option to acquire shares from the Company.
|
|
|
60,815
|
|
|
|
60,815
|
|
Unsecured notes payable to a third party in the amount of $25,000, due on September 17, 2018, interest at 12%. Accrued interest due semi-annually, January 5 and July 5 of each year. The note holder has the right to convert 20% of the then outstanding principal into common shares at $0.10 per share.
|
|
|
25,000
|
|
|
|
25,000
|
|
Unsecured notes payable to directors totaling $28,000 and a note payable to a third party in the amount of $9,000, due on April 22, 1995, interest at 8%. Each lender has the right to convert any portion of the principal and interest into common stock at a price per share equal to the price per share under a prior private placement transaction. These notes payable are in default.
|
|
|
37,000
|
|
|
|
37,000
|
|
Unsecured notes payable to a financing company, payable in nine monthly installments, interest ranging from 5.1% to 7.3%, maturing in April, July and October 2018.
|
|
|
6,732
|
|
|
|
16,841
|
|
Total notes payable
|
|
|
362,223
|
|
|
|
372,332
|
|
Less notes payable current portion
|
|
|
(362,223
|
)
|
|
|
(297,332
|
)
|
Total notes payable long term, net of current portion
|
|
$
|
-
|
|
|
$
|
75,000
|
|
MEDIZONE INTERNATIONAL, INC., SUBSIDIARY AND AFFILIATE
Notes to Consolidated Financial Statements
December 31, 2017 and 2016
NOTE 8 - NOTES PAYABLE – RELATED PARTIES
In July 2016, the Company converted $228,109 of accounts payable – related parties, and $1,389,772 of accrued expenses – related parties into three promissory notes aggregating $1,617,881. The amounts converted represent accrued expenses and accrued wages prior to 2009 owed to certain officers and executives of the Company. The three notes have similar terms and specify payment terms, trigger events and a default rate of 5% per annum. During 2017, the Company made total payments towards the principal of $23,202 The Company is currently in default with the terms of the promissory notes and is accruing interest at 5% per annum on the outstanding balance, with any payments made to be applied towards interest first. As of December 31, 2017, the Company owes $48,899 in accrued interest related to these notes (see Note 10).
NOTE 9 - WARRANT LIABILITY
The Company accounts for its common stock warrants under ASC 480,
Distinguishing Liabilities from Equity.
Any financial instrument, other than an outstanding share, that, at inception, embodies an obligation to purchase the issuer’s equity shares, or is indexed to such an obligation, which requires or may require the issuer to settle the obligation by transferring assets, is classified as a liability. This liability is to be fair valued at each reporting period, with the changes in fair value recognized as gain (loss) on change in fair value of warrant liability. The fair value of the warrants to purchase common stock is estimated using the Black-Scholes valuation model. The significant assumptions used in estimating the fair value of warrant liabilities include the exercise price, volatility of the stock underlying the warrant, risk-free interest rate, estimated fair value of the stock underlying the warrants and the estimated life of the warrants.
In October 2016, the Company issued warrants to purchase up to $1,000,000 in common stock with the number of shares to be determined based on a 20-day average stock price prior to the date of exercise, discounted 40%. The warrants were exercisable between January 31, 2017 and January 30, 2018. Since the price of the warrants was yet to be determined, the Company recorded a common stock warrant liability of $937,951 on the warrants’ issuance date and, revalued the warrants on December 31, 2017 and 2016. The estimate was calculated using the following inputs:
Input
|
|
December 31, 2017
|
|
|
December 31, 2016
|
|
Risk-free interest rate
|
|
|
1.28
|
%
|
|
|
.85
|
%
|
Expected life in years
|
|
1 month
|
|
|
1 year
|
|
Dividend yield
|
|
|
—
|
|
|
|
—
|
|
Volatility
|
|
|
136.3
|
%
|
|
|
120.0
|
%
|
Stock price
|
|
$
|
0.04
|
|
|
$
|
0.11
|
|
For the year ended December 31, 2017, the Company recorded a decrease of $294,655 in the warrant liability, for a total liability of $690,508. The warrants expired on January 30, 2018.
NOTE 10 - COMMITMENTS AND CONTINGENCIES
Litigation
The Company may be subject to certain claims and lawsuits arising in the normal course of business. In the opinion of management, uninsured losses, if any, resulting from the ultimate resolution of these matters will not have a material effect on the Company’s consolidated financial position, results of operations, or cash flows.
Rakas vs. Medizone International, Inc.
- A former consultant brought this action against the Company claiming the Company had failed to pay consulting fees under a consulting agreement. In September 2001, the parties agreed to settle the matter for $25,000. The Company, however, did not have the funds to pay the settlement and the plaintiff moved the court to enter a default judgment in the amount of $143,000 in January 2002. On May 8, 2002, the court vacated the default judgment and requested that the Company post a bond of $25,000 to cover the settlement previously entered into by the parties. The Company has been unable to post the required bond amount as of the date of this report. Therefore, the Company has recorded in accounts payable, the original default judgment in the amount of $143,000, plus fees totaling $21,308, as of December 31, 2017 and 2016. The Company intends to contest the claim if and when it is able to do so in the future.
MEDIZONE INTERNATIONAL, INC., SUBSIDIARY AND AFFILIATE
Notes to Consolidated Financial Statements
December 31, 2017 and 2016
NOTE 10 - COMMITMENTS AND CONTINGENCIES (Continued)
Related Party Agreements
In July 2016, the Company issued notes to its former CEO Edwin Marshall, former Director of Operations, Jill Marshall, and Michael Shannon, President of CFGH that were in settlement of $228,109 of accounts payable – related parties, and $1,389,772 of accrued expenses – related parties into three promissory notes payable – related parties aggregating to $1,617,881. The principal amounts of the promissory notes issued were $1,065,189; $444,583 and $111,109, respectively. The promissory notes were issued in settlement of our liability to these three individuals for accrued and unpaid compensation owed for periods prior to December 31, 2009. Payment of the amounts owning under the terms of the notes is due upon the earlier to occur of (a) a change in control of the Company (as defined in the notes), (b) the executive’s death or (c) the executive’s disability as (defined in the notes or in the respective executive’s written employment agreement). In addition, in the case of the notes payable to our former executives, payment of the notes would be triggered by the Company’s failure to pay the executive’s base salary in accordance with the terms and conditions of the executive’s employment agreement because of disability.
In February 2017, Mr. Marshall and Dr. Marshall resigned from their positions with us and their employment was terminated. At that time, we entered into the Ed Marshall Severance Agreement and a similar severance agreement with Dr. Marshall (collectively, the “Marshall Severance Agreements”). Under the terms of the Marshall Severance Agreements, we agreed to the modification of the promissory notes we previously issued to the Marshalls (collectively, the “Marshall Notes”) to require monthly principal payments to Mr. Marshall of $14,000 and to Dr. Marshall of $6,900 and to waive interest except in the event of a default. We made the first payments under the Marshall Notes, but have been in default under the Marshall Notes since April 2017, and as of December 31, 2017, we owed principal of owe principal payments for approximately nine months totaling $122,500 to Mr. Marshall and to Dr. Marshall totaling $58,600. In addition, under the terms of the Marshall Notes, as a result of our default, the Marshall Notes now accrue default until payment of the default amounts at the rate of 5% of the total amount of the notes.
On March 1, 2017, the Company entered into an employment agreement with David Esposito to fill the position of Chairman and Interim CEO. The agreement stated the terms of his employment and compensation. Mr. Esposito’s compensation consisted of: (1) an annual base salary of $225,000; (2) a potential target bonus of up to 50% of base salary based on performance goals determined by the Board of Directors of the Company; (3) equity awards, and (4) standard employee benefits, including vacation. Mr. Esposito stepped down from his position as Interim CEO upon the appointment of David Dodd as the Company’s CEO effective September 18, 2017. As of September 30, 2017, the Company has accrued wages to Mr. Esposito of $123,750. Mr. Esposito remains as the Company’s Chairman of the Board of Directors.
On September 15, 2017, the Company entered into an employment agreement with David Dodd as the Company’s CEO and a member of the Board of Directors of the Company. The agreement states the terms of his employment and compensation which consists of: (1) an annual base salary of $250,000; (2) an initial target bonus of up to 65% of annual base salary based on targets established by the Board of Directors; (3) a signing bonus of 1,000,000 shares of restricted stock; (4) an additional 1,000,000 shares of restricted stock that will vest upon successful commercialization of the AsepticSure
®
system in the US market; and (5) benefits as offered to other executive employees. Mr. Dodd voluntarily surrendered the 1,000,000 restricted shares he received as a signing bonus on January 2, 2018. The Company also agreed to a change of control agreement that will pay severance compensation to Mr. Dodd in the event his employment is terminated by the Company without cause or by Mr. Dodd for good reason, as defined in the agreement.
On November 1, 2017, the Company entered into an employment agreement with Philip Theodore as the Company’s Executive Vice President, Operations and Administration. The agreement states the terms of his employment and compensation which consists of (1) an annual base salary of $175,000; (2) an initial target bonus of up to 45% of his annual base salary based on targets established by the Board of Directors; (3) a signing bonus of 300,000 shares of restricted stock upon his appointment; (4) an additional 300,000 shares of restricted stock that will vest upon successful commercialization of the AsepticSure
®
system in the US market; and (5) benefits as offered to other executive employees. Mr. Theodore voluntarily surrendered the 300,000 restricted shares he received as a signing bonus upon his appointment on January 3, 2018. The Company also agreed to a change of control agreement that will pay severance compensation to Mr. Theodore in the event that his employment is terminated by the Company without cause or by Mr. Theodore for good reason, as defined in the agreement.
MEDIZONE INTERNATIONAL, INC., SUBSIDIARY AND AFFILIATE
Notes to Consolidated Financial Statements
December 31, 2017 and 2016
NOTE 10 - COMMITMENTS AND CONTINGENCIES (Continued)
Related Party Agreements
(Continued)
In November 2017, the Company entered into change of control agreements with Michael Shannon, President of CFGH and Stephanie Sorensen, the Company’s Chief Financial Officer, with similar terms with the change of control agreements entered into with Mr. Dodd and Mr. Theodore.
Supply and License Agreement
On October 26, 2017, the Company entered into a supply and license agreement with Innovasource, LLC, (“Innovasource”) a leading manufacturer of cleaning, deodorizing and disinfecting products. Innovasource has agreed to supply the Company with its custom-formulated disinfectant product and has granted the Company an exclusive, non-transferable limited license to use its intellectual property in the marketing and sale of the AsepticSure
®
system in the US. The supply agreement has a five-year term that automatically renews for two-year terms unless either party provides notice of non-renewal prior to the expiration of the current term.
Distribution and License Agreements
In December 2016, the Company terminated a Distribution and License Agreement with a distributor due to lack of market development by the distributor. On October 25, 2017, the Company entered into an exclusive distribution agreement with Aglon a/s for the countries of Norway, Sweden, Finland, Denmark, and Iceland.
Other Payables
As of December 31, 2017, and 2016, the Company has recorded other payables totaling $224,852 related to certain past due payables for which the Company has not received invoices or demands for over 10 years. The statute of limitations relating to these payables has passed. Although management of the Company does not believe that the amounts will be paid, the amounts have been recorded as other payables until such time as the Company is certain that no liability exists.
Operating Leases
The Company operates a certified laboratory located at Innovation Park, Queen’s University in Kingston, Ontario, Canada, which provides a primary research and development platform. The lease term is June 30, 2016 through June 29, 2018 with a monthly lease payment of $3,550 Canadian dollars (“CD”) plus the applicable goods and services tax (“GST”). The future minimum lease payments due under this agreement are $21,300 CD plus the applicable goods and services tax. The Company has a month-to-month cancelable lease for office space located in Michigan, with monthly payments of approximately $1,000.
NOTE 11 - EQUITY TRANSACTIONS
Recapitalization
On December 15, 2016, the Company’s stockholders approved the Board of Directors’ recommendation to increase the number of authorized shares of common stock from 395,000,000 to 500,000,000 shares in order to provide the Company with sufficient authorized shares to accomplish its objectives. The Company filed an amendment to modify its Articles of Incorporation with the State of Nevada on January 4, 2017, which was approved by the Secretary of State on January 24, 2017.
The Company’s amended Articles of Incorporation include a class of preferred stock, par value $0.00001, with authorized shares of 50,000,000. To date, no shares of preferred stock have been issued. The rights and preferences of the authorized preferred shares will be determined by the Company’s Board of Directors.
Common Stock Issuances
During January 2016, the Company issued 500,000 restricted shares of common stock to a consultant. The fair value of the shares on the date of grant was $48,000, or $0.096 per share. The Company recorded compensation expense of $48,000 in connection with the issuance of the shares.
MEDIZONE INTERNATIONAL, INC., SUBSIDIARY AND AFFILIATE
Notes to Consolidated Financial Statements
December 31, 2017 and 2016
NOTE 11 - EQUITY TRANSACTIONS (Continued)
Common Stock Issuances (continued)
During May 2017, the Company issued 250,000 restricted shares of common stock to a consultant. The fair value of the shares on the date of the grant was $17,500, or $0.07 per share. The Company recorded compensation expense of $17,500 in connection with the issuance of the shares.
During the year ended December 31, 2017, the Company granted three of its executives and officers a total of 2,300,000 restricted shares of common stock upon their appointment to their positions. The aggregate value of the shares on their dates of grant was $228,000, with values ranging from $0.06 to $0.15 per share. The Company recorded compensation expense of $228,000 in connection with the issuance of the shares.
During the year ended December 31, 2017, the Company issued and sold 11,833,334 restricted shares of common stock for net proceeds of $675,000 and an average price of $0.06 per share as part of a private offering to accredited investors, which included the Company’s Chairman and Interim CEO, its current CEO, Executive Vice President, Administration and Operations, Executive Vice President, Chief Commercial Officer and an independent director.
Common Stock Options and Awards
The Company recognizes stock-based compensation expense for grants of stock option awards, stock awards, restricted stock units and restricted stock under the Company’s Incentive Plan to employees and nonemployee members of the Company’s Board of Directors. In addition, the Company grants stock options to nonemployee consultants from time to time in consideration for services performed for the Company.
The Company’s 2016 Equity Incentive Award Plan (the “2016 Plan”) was approved on December 15, 2016 by the stockholders to replace the Company’s 2008 Equity Incentive Plan, 2009 Incentive Stock Plan, 2012 Equity Incentive Award Plan, and the 2014 Equity Incentive Plan (collectively, the “Prior Plans”). Options and awards previously granted under the Prior Plans that have not yet expired by their terms will remain outstanding until their expiration dates. Following adoption of the 2016 Plan, the Company no longer made any grants or awards under the Prior Plans. The 2016 Plan reserves a total of 10,000,000 shares of common stock for awards. Awards under the 2016 Plan expire 10 years from the date of grant. Under the 2016 Plan, as of December 31, 2017, the Company had granted options, net of forfeitures, for the purchase of a total of 6,400,000 shares, had awarded 2,300,000 fully vested restricted shares, and an additional 1,300,000 shares to vest upon achievement of certain performance milestones. No shares are available for future grants or awards under the 2016 Plan.
The Company estimates the fair value of each stock option award by using the Black-Scholes option-pricing model, which model requires the use of exercise behavior data and the use of a number of assumptions including volatility of the Company’s stock price, the weighted average risk-free interest rate, and the expected life of the options. Because the Company does not pay dividends, the dividend rate variable used in the Black-Scholes option-pricing model is zero. Under the provisions of ASU 2016-09, the Company has elected to recognize forfeitures as they occur to determine the amount of compensation cost to be recognized in each period. For the year ended December 31, 2017 and 2016, the Company recorded stock-based compensation of $565,651 $ and $0, respectively, of which $89,064 related to the modification of vesting relating to 750,000 options issued in 2014 to Mr. Esposito. As of December 31, 2017, the Company had outstanding unvested options for a total of 325,000 shares with related unrecognized expense of approximately $19,760 and weighted average remaining life of 7.59 years. The Company will recognize this expense over the service period or when the achievement of the required milestones becomes probable.
During 2017, the Company estimated the fair value of the stock options at the date of each grant based on the following weighted average assumptions:
Risk-free interest rate
|
|
1.36% to 1.99
|
%
|
Expected life
|
|
5 years
|
|
Expected volatility
|
|
98.38% to 101.86
|
%
|
Dividend yield
|
|
|
0.00
|
%
|
MEDIZONE INTERNATIONAL, INC., SUBSIDIARY AND AFFILIATE
Notes to Consolidated Financial Statements
December 31, 2017 and 2016
NOTE 11 - EQUITY TRANSACTIONS (Continued)
Common Stock Options and Awards (continued)
The following is a summary of the status of the Company’s outstanding options as of December 31, 2017 and changes during the year then ended:
|
|
Number of Shares
|
|
|
Weighted Average
Exercise Price
|
|
|
Weighted Average Remaining Contractual Term (Years)
|
|
|
Aggregate Intrinsic Value
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As of December 31, 2016
|
|
|
20,715,000
|
|
|
$
|
0.143
|
|
|
|
2.08
|
|
|
$
|
261,220
|
|
Granted
|
|
|
6,900,000
|
|
|
|
0.097
|
|
|
|
|
|
|
|
|
|
Forfeited
|
|
|
(7,550,000
|
)
|
|
|
0.202
|
|
|
|
|
|
|
|
|
|
Surrendered
|
|
|
(1,977,500
|
)
|
|
|
0.128
|
|
|
|
|
|
|
|
|
|
As of December 31, 2017
|
|
|
18,087,500
|
|
|
|
0.102
|
|
|
|
3.72
|
|
|
|
-
|
|
Exercisable
|
|
|
17,762,500
|
|
|
|
0.103
|
|
|
|
3.79
|
|
|
|
-
|
|
No shares are expected to vest within the next 60 days. In December 2017, former and current directors, officers, employees and consultants voluntarily surrendered 1,977,500 shares in an effort to reduce the number of shares reserved resulting in an increase in shares available to be used for additional financing efforts. As of December 31, 2017, the aggregate intrinsic value of the outstanding vested options was $0. No shares were exercised in 2017.
A summary of unvested stock option activity for the year ended December 31, 2017 is presented below:
|
|
Number of Shares
|
|
|
Weighted Average Grant Date Fair Value
|
|
|
|
|
|
|
|
|
Non-vested balance as of December 31, 2016
|
|
|
1,075,000
|
|
|
$
|
0.11
|
|
Awarded
|
|
|
1,000,000
|
|
|
|
0.08
|
|
Vested
|
|
|
(250,000
|
)
|
|
|
0.06
|
|
Forfeited
|
|
|
(500,000
|
)
|
|
|
0.10
|
|
Surrendered
|
|
|
(1,000,000
|
)
|
|
|
0.1095
|
|
Non-vested balance as of December 31, 2017
|
|
|
325,000
|
|
|
|
0.08
|
|
Warrants
During October 2016, the Company issued warrants to purchase up to $1,000,000 in common stock with the number of shares determined based on a 20-day average stock price prior to the date of exercise with the exercise prices discounted 40%. The warrants were exercisable between January 31, 2017 and January 30, 2018. The warrants expired on January 30, 2018.
During May 2017, the Company issued a warrant to purchase up to 750,000 shares of common stock at an exercise price of $0.10 per share to a third-party consultant. The warrant will vest when certain milestones are achieved and will expire three years from the date of issuance.
During October 2017, the Company issued a warrant to purchase up to 1,000,000 shares of common stock at an exercise price of $0.10 per share to a supplier. The warrant immediately vested and will expire five years from the date of issuance. The Company recorded expense of $33,960 resulting from the issuance of this warrant.
MEDIZONE INTERNATIONAL, INC., SUBSIDIARY AND AFFILIATE
Notes to Consolidated Financial Statements
December 31, 2017 and 2016
NOTE 12 - GOING CONCERN
The Company’s consolidated financial statements are prepared in accordance with US GAAP, which assumes an entity is a going concern and contemplates the realization of assets and the settlement of liabilities in the normal course of business. The Company has incurred significant recurring losses from its inception through December 31, 2017, which have resulted in an accumulated deficit of $40,085,981 as of December 31, 2017. The Company has minimal cash, has a working capital deficit of $4,667,093, and a total stockholders’ deficit of $4,546,654 as of December 31, 2017. The Company has relied almost exclusively on debt and equity financing to sustain its operations. Accordingly, there is substantial doubt about its ability to continue as a going concern.
Continuation of the Company as a going concern is dependent upon obtaining additional capital and ultimately, upon the Company attaining profitable operations. The Company will require substantial additional funds to create a commercial organization to continue to develop its products, obtain FDA approval, product manufacturing, and to fund additional losses, until revenues are sufficient to cover the Company’s operating expenses. If the Company is unsuccessful in obtaining the necessary additional funding, it will most likely be forced to substantially reduce or cease operations.
The Company believes that it will need approximately $1,500,000 during the next 12 months for continued commercial operations, research and development, as well as for general corporate purposes.
During 2017, the Company raised a total of $675,000 through the sale of 11,833,334 shares of common stock at an average price of $0.06 per share.
On January 31, 2018, the Company raised net proceeds of $250,000 from the sale of identical unsecured convertible promissory notes and secured an equity credit line for up to $10,000,000 shares of common stock pursuant to certain terms of the agreement being met and sufficient shares outstanding available for sale (see Note 13).
The ability of the Company to continue as a going concern is dependent on successfully accomplishing the plan described in the preceding paragraphs and eventually attaining profitable operations. The consolidated financial statements do not include any adjustments relating to the recoverability and classification of asset carrying amounts or the amount and classification of liabilities that might result from the outcome of this uncertainty.
NOTE 13 - SUBSEQUENT EVENTS
The Company evaluated subsequent events through the filing date of the Annual Report on Form 10-K and determined to disclose the following events.
On January 30, 2018, the Company entered into an employment agreement with Jude Dinges as the Company’s Executive Vice President – Chief Commercial Officer. The agreement states the terms of his employment and compensation which consists of (1) an annual base salary of $175,000; (2) an initial target bonus of up to 45% of his annual base salary based on targets established by the Board of Directors; (3) a signing bonus of 300,000 restricted shares of common stock vesting upon successful commercialization of the AsepticSure
®
system in the US market; and (4) benefits as offered to other executive employees. The Company also agreed to a change of control provision that will pay severance compensation to Mr. Dinges in the event that he is terminated by the Company without cause or by Mr. Dinges for good reason, as defined in the agreement.
On January 31, 2018, the Company raised net proceeds of $250,000 from the sale of identical unsecured convertible promissory notes in the aggregate principal amount of $305,000 to two specialized investment firms. The notes accrue interest (payable at maturity of the notes) at a rate of 8% per annum and mature six months from the issue date. The notes were issued with original issue discount of $35,000, and $20,000 was subtracted from the proceeds to reimburse the investors for their legal fees and other transaction expenses in connection with the preparation of the notes and the related transaction documentation. Accordingly, the net proceeds the Company received for each note was $125,000. If we fail to pay the principal of and interest on the Notes when due, the interest rate increases to a default rate of 24% per annum until paid, plus a 40% penalty is added to the outstanding balance of the Note and other penalties as set forth in the Note. The notes are convertible at any time at the option of the investors into shares of common stock at a conversion price of $0.05 per share, subject to adjustment upon the occurrence of certain events of default with respect to the notes.
MEDIZONE INTERNATIONAL, INC., SUBSIDIARY AND AFFILIATE
Notes to Consolidated Financial Statements
December 31, 2017 and 2016
NOTE 13 - SUBSEQUENT EVENTS (Continued)
Also, on January 31, 2018, the Company entered into an equity purchase agreement (the “Equity Purchase Agreement”) with the Investors, which was subsequently amended on March 16, 2018 (as amended, the “Purchase Agreement”), pursuant to which the investors committed to purchase in the aggregate up to $10,000,000 of value of common stock. In consideration of their commitment under the Purchase Agreement, on January 31, 2018, the Company issued to each Investor 4,087,193 shares of common stock (the “Commitment Shares”) as a commitment fee. The Company’s right to issue and sell shares of common stock under the Equity Purchase Agreement to the investors is subject to the satisfaction of certain conditions, including, but not limited to, an effective registration statement for resale of such shares by the investors. On February 12, 2018, the Company filed a Registration Statement with the Securities and Exchange Commission on Form S-1 to register 22,233,427 shares of common stock that may be issued under the Equity Purchase Agreement for resale by the investors. The Securities and Exchange Commission is reviewing the Registration Statement.
Between January 1 and March 13, 2018, the Company’s former and current directors, executives, employees and consultants voluntarily surrendered restricted stock awards for a total of 1,300,000 shares of common stock and stock option grants for the purchase of a total of 7,280,000 shares to increase the number of shares available for financing transactions under the Equity Purchase Agreement.