PZOO Pazoo Inc (CE)

Notes to Unaudited Condensed Consolidated Financial Statements

 

Note 1—DESCRIPTION OF BUSINESS, BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

 

Description of Business

The Company entered the pharmaceutical testing laboratory market with their acquisitions of MA & Associates, LLC which will operate pharmaceutical testing laboratories in Nevada, and Harris Lee Holdings, LLC which will operate pharmaceutical testing laboratories within other states, or license testing protocols as independently owned laboratories.  These pharmaceutical testing laboratories focus on providing quality control services to the medical cannabis industry.  The mission is to protect the public health by providing infrastructure and analytical services to legally-authorized cannabis producers and distributors as well as to regulators.  States that have legalized cannabis are developing cannabis health and safety criteria that we will fulfill through their testing laboratories.  Harris Lee Holdings, LLC, due to Colorado residency requirements, entered into an advisory agreement with Harris Lee Colorado, LLC, a related party. Harris Lee Holdings, LLC had sub-licensed the testing protocols to Harris Lee Colorado, LLC in exchange for management fees for each test conducted.  The Colorado MED approved the transfer of management of an existing laboratory, operating as Steep Hill Colorado, to Harris Lee Colorado, LLC (a related party) and Harris Lee Holdings, LLC has derived management fees from Harris Lee Colorado, LLC in the year ending December 31, 2016 and March 31, 2017.  However, because of the failure to transfer the MED license to Harris Lee Colorado, LLC, the Denver laboratory was closed by the end 2016.  The Company does not expect to re-commence operations in the near future. Lastly, the Company's wholly owned subsidiary, CK Distribution LLC, provides the marketing and sales agent for the distribution of non-controlled hemp products throughout the USA. Non-controlled hemp products are the items utilized by the industry that support grow facilities, infusion companies and dispensaries. On January 4, 2017 the Company's 100% wholly owned subsidiary MA & Associates received its final approval and Marijuana Testing License from the City of Las Vegas, NV and can now commence operations.

Further, the business consists of pazoo.com, an online, content driven, ad supported health and wellness web site for people and their pets. Additionally, this site has e-commerce functionality which allows pazoo.com to be an online retailer of nutritional foods/supplements, wellness goods, and fitness apparel. Pazoo, Inc. does not have any brick and mortar establishments.

 

Basis of Presentation

The accompanying unaudited condensed consolidated financial statements include the accounts of the Pazoo, Inc. ("Pazoo" or the "Company") and its wholly-owned subsidiaries MA & Associates, LLC, Harris Lee Holdings, LLC and CK Distributions, LLC. These unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States ("GAAP"). All significant inter-company transactions and accounts have been eliminated in consolidation.

In April 2017, the Company effected a 1-for-250 reverse stock split of the outstanding common stock (the "Reverse Stock Split") whereby every two hundred fifty (250) shares of outstanding common stock decreased to one (1) share of common stock. Similarly, the number of shares of common stock, par value $0.001 ("Common Stock") into which each outstanding Preferred stock is to be exercisable decreased on a 1-for-250 basis and the exercise price of each outstanding preferred stock to purchase common stock increased proportionately resulting in no effect from the reverse stock split. The impact of this reverse stock split has been retroactively applied to the consolidated financial statements and the related notes.

The accompanying unaudited condensed consolidated financial statements of the Company have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and with the instructions to Article 8 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete consolidated financial statements. In the opinion of management, all adjustments considered necessary for a fair presentation have been included. Operating results for the three month period ended March 31, 2017 are not necessarily indicative of the results that may be expected for the year ending December 31, 2017. The unaudited condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and footnotes thereto included in the Company's Annual Report on Form 10-K for the year ended December 31, 2016 as filed on April 21, 2017.

Use of Estimates

 

In accordance with GAAP the preparation of these condensed consolidated financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the condensed consolidated financial statements and the reported amount of revenues and expenses during the reporting period.

 

 

 

On an ongoing basis, management evaluates its estimates and judgments, including those related to revenue recognition, accrued expenses, financing operations, and contingencies and litigation. Management bases its estimates and judgments on historical experience and on various other factors that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions and conditions. The most significant accounting estimates inherent in the preparation of the Company's financial statements include estimates as to the appropriate carrying value of certain assets and liabilities which are not readily apparent from other sources. These accounting policies are described at relevant sections in the notes to the financial statements. 

 

 

Fair Value of Financial Instruments

 

The Company's financial instruments consist principally of cash, derivatives, convertible debt, and accounts payable. The Company believes that the recorded values of all of its other financial instruments approximate their fair values because of their nature and respective maturity dates or durations. The fair value of our long-term debt is determined by using estimated market prices. Assets and liabilities measured at fair value are categorized based on whether or not the inputs are observable in the market and the degree that the inputs are observable. The categorization of financial instruments within the valuation hierarchy is based upon the lowest level of input that is significant to the fair value measurement. The hierarchy is prioritized into three levels (with Level 3 being the lowest) defined as follows:

 

Level 1: Inputs are based on quoted market prices for identical assets or liabilities in active markets at the measurement date.

Level 2: Inputs include quoted prices for similar assets or liabilities in active markets and/or quoted prices for identical or similar assets or liabilities in markets that are not active near the measurement date.

Level 3: Inputs include management's best estimate of what market participants would use in pricing the asset or liability at the measurement date. The inputs are unobservable in the market and significant to the instrument's valuation.

 

The following table sets forth by level within the fair value hierarchy the Company's financial assets and liabilities that were accounted for at fair value as of March 31, 2017 and December 31, 2016.

 

Recent Accounting Pronouncements

 

February 2016, the Financial Accounting Standards Board ("FASB") issued new guidance related to how an entity should recognize lease assets and lease liabilities. The guidance specifies that an entity who is a lessee under lease agreements should recognize lease assets and lease liabilities for those leases classified as operating leases under previous FASB guidance. Accounting for leases by lessors is largely unchanged under the new guidance. The guidance is effective for us beginning in the first quarter of 2019. Early adoption is permitted.  In transition, lessees and lessors are required to recognize and measure leases at the beginning of the earliest period presented using a modified retrospective approach. The Company is evaluating the impact of adopting this guidance on our consolidated financial condition, results of operations and cash flows.

 

 

 

In January 2016, the FASB issued ASU 2016-01, Financial Instruments-Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities. The amendments in ASU 2016-01, among other things, requires equity investments (except those accounted for under the equity method of accounting, or those that result in consolidation of the investee) to be measured at fair value with changes in fair value recognized in net income; Requires separate presentation of financial assets and financial liabilities by measurement category and form of financial asset (i.e., securities or loans and receivables); Eliminate the requirement to disclose the fair value of financial instruments measured at amortized cost for entities that are not public business entities. The amendments in this ASU are effective for non-public companies for fiscal years beginning after December 15, 2018, and interim periods within fiscal years beginning December 15, 2019.  Early adoption of the amendments in the ASU is permitted as early as the fiscal years beginning after December 15, 2017, including interim periods within those fiscal years.  The adoption of this standard is not expected to have a material effect on the consolidated financial position and results of operations and statements of cash flows.

 

In September 2015, the FASB issued Accounting Standards Update (ASU) 2015-16—Business Combinations, as part of its initiative to reduce complexity in accounting standards (the Simplification Initiative). The amendment eliminates the requirement to retrospectively apply adjustments made to provisional amounts recognized in a business combination. The amendment is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2016. Early adoption is permitted. The Company adopted this guidance for the year ended December 31, 2017. The adoption of this standard is not expected to have a material effect on the consolidated financial position and results of operations and statements of cash flows

On May 28, 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers, which requires an entity to recognize the amount of revenue to which it expects to be entitled for the transfer of promised goods or services to customers. The ASU will replace most existing revenue recognition guidance in U.S. GAAP when it becomes effective. In August 2015, the FASB issued ASU No. 2015-14, Revenue from Contracts with Customers (Topic 606): Deferral of the Effective Date, which delayed the effective date of the new standard from January 1, 2017 to January 1, 2018. The FASB also agreed to allow entities to choose to adopt the standard as of the original effective date. This ASU permits the use of either the retrospective or cumulative effect transition method. The Company is evaluating the effect that ASU 2014-09 will have on our consolidated financial statements and related disclosures. The Company does not expect the adoption of this standard to have a material effect to the financial statements.

 

Other recent accounting pronouncements issued by the FASB did not or are not believed to have a material impact on our present or future consolidated financial statements.

Note 2—GOING CONCERN

 

During the three months ended March 2016 and 2017, the Company incurred net losses of $4,342,042 and $1,933,868, respectively. In addition, as of March 31, 2017, the Company had a working capital deficit of $9,477,866. These factors, among others, raise substantial doubt about the Company's ability to continue as a going concern. These consolidated financial statements do not include any adjustments relating to the recoverability and classification of assets or the amounts and classification of liabilities that might be necessary should the Company be unable to continue as a going concern. The Company's continuation as a going concern is dependent upon our ability to generate sufficient cash flow and raise additional capital to meet our obligations on a timely basis and ultimately attain profitability.  If the Company is unable to generate sufficient cash flow or raise additional capital, it could be forced to cease operations.  The Company's continuation as a going concern is dependent upon our ability to generate sufficient cash flow and raise additional capital to meet our obligations on a timely basis and ultimately attain profitability. The Company does not have sufficient capital for the next 12 months from the issuance of these financial statements.

 

The Company's liquidity is highly dependent on its ability to obtain additional capital in the near future. The Company's failure to raise new capital would impair its ability to both continue its current operations and could result in its failure to continue to operate as a going concern. Substantial doubt about its ability to continue as a going concern may also create negative reactions to the price of the Company's common stock, and the Company may not be able to obtain additional financing in the future. The Company is currently exploring potential transactions, specifically through the filing of its Form 14C in January 2017 which will set up the characteristics of the Series D Preferred stock in anticipation of a large financial investment. If the Company is unable to raise additional capital on terms acceptable to the Company and on a timely basis, the Company will be required to downsize or wind down its operations through liquidation, bankruptcy, or a sale of its assets. In addition, to the extent additional capital is raised through the sale of equity or convertible debt securities, such securities may be sold at a discount from the market price of the Company's common stock. The issuance of these securities could also result in significant dilution to some or all of the Company's stockholders, depending on the terms of the transaction. There are no assurances that the Company will be able to consummate additional capital raises.

 

 

 

Costs of assets acquired under capital leases were approximately $615,000 as of March 31, 2017 and December 31, 2016, respectively.  The capital lease represents a total of three leases for testing equipment. The leases hold an interest rate of 0% and monthly payments are approximately $17,000 per month. The depreciation for the three months ended March 31, 2017 and March 31, 2016 was $46,504 and $46,504, respectively. As of March 31, 2017 and December 31, 2016, accumulated depreciation related to assets under capital lease was approximately $190,151 and $159,401, respectively. All leased equipment is collateral under the respective lease agreements. As of March 31, 2017, the Company was currently in default of these lease agreements, as scheduled payments were not made. Commencing in 2017, the Company began making payments toward the capital leases again.

Note 4—LINES OF CREDIT

The Company entered into a line of credit with Wells Fargo in December 2015 in the amount of $25,000.  The credit line bears an interest rate of 9.75% annually, compounded daily, and there is no term on the account. There are no financial covenants and the guarantor on the account is Steve Basloe. The line of credit has been used for general operating expenses.

The Company entered into a line of credit with Wells Fargo in May 2016 in the amount of $5,000. The credit line bears an interest rate of 24.24% for the first year and then 9.75% annually, compounded daily, and there is no term on the account. There are no financial covenants and the guarantor on the account is David Cunic, the Company's CEO. The credit has been used for general operating expenses.

The combined lines of credit at December 31, 2016 totaled $21,039 compared to $19,172 at March 31, 2017.

Note 5—DERIVATIVE LIABILITIES

 

The Company evaluates all of it financial instruments to determine if such instruments are derivatives or contain features that qualify as embedded derivatives. For derivative financial instruments that are accounted for as liabilities, the derivative instrument is initially recorded at its fair value and is then re-valued at each reporting date, with changes in the fair value reported as charges or credits to income. For option-based derivative financial instruments, the Company uses the Black-Scholes option-pricing model to value the derivative instruments at inception and subsequent valuation dates. The classification of derivative instruments, including whether such instruments should be recorded as liabilities or as equity, is re-assessed at the end of each reporting period.

 

Under ASC-815 the conversion options embedded in the notes payable described in Note 6 require liability classification because they do not contain an explicit limit to the number of shares that could be issued upon settlement.

 

The following table summarizes the changes in the derivative liabilities during three months ended March 31, 2017:

 

 

 

The Company uses the Black Scholes Option Pricing Model to value its convertible debt and warrant derivative liabilities based upon the following assumptions during the three months ended March 31, 2017 and 2016:

 

 

During three months ended March 31, 2017 and 2016, the aggregate gain/(loss) on derivative liability was ($904,409) and ($2,406,761), respectively, consisting of initial derivative expense and the change in fair value of the derivative liabilities.

In January 2017, the company entered into a convertible note agreement for an aggregate total of $206,379. The interest rate is 12% and the conversion terms are 50% of the average of the lowest 3 trading prices during the 20 trading days prior to conversion. The maturity date is December 2017. The proceeds from the note were used to pay off previous notes from the lender. In addition, the Company paid back $44,575 as of March 31, 2017.

 

In February 2017, the Company entered into a convertible note agreement for a total of $63,800. The interest rate is 10% and the conversion terms are the lower of (a) $0.009 or (b) 45% of the lowest trading price during the 30 trading days prior to conversion. The maturity date is February 2018.

 

In March 2017, the Company entered into a convertible note agreement for a total of $33,000. The interest rate is 12% and the conversion terms are 65% of the average of the two lowest closing prices during the 15 trading days prior to conversion. The maturity date is December 2017.

The Company evaluated all convertible notes describe above under ASC 815 and determined that certain conversion features qualify as derivative liabilities (see Note 5).

During the three months ended March 31, 2017 the Company incurred approximately $286,000 of a gain in debt extinguishment primarily as a result of various notes converting to equity, with the corresponding derivative liability value at the date of conversion being written off to debt extinguishment as a gain, offset by the unamortized discount on the convertible debt at the time of conversion.

In addition to the funds received, noteholders converted $24,927 during the three months ended March 31, 2017 into common stock exclusive of accrued interest. At March 31, 2017, a total of 8 notes with a principle balance of $798,396 were past due. The Company has adequately accrued all default interest and associated penalties related to these instruments. Additionally, cross default clauses exist within certain other instruments containing terms which would make the notes immediately due and payable, however no cross default clauses have been triggered as of yet.

 

The Company received $364,500 of new cash additions in the three months ended March 31, 2017.  Cash payments consisted of $28,563. Interest added to the note payables in the three months ended March 31, 2017 totaled $7,516. The interest rates on the loans ranged from 8% to 12%.  These additions coincide as an advance on the 14C filing for the Preferred Series D Shares.

Note 8—STOCKHOLDERS' EQUITY (DEFICIT)

 

Common Stock Split

In 2017, the Company filed a Form 14-C in order to effectuate a 1-for-250 reverse stock split of the outstanding common stock (the "Reverse Stock Split") whereby every two hundred and fifty (250) shares of outstanding common stock decreases to one (1) share of common stock. The current Reverse Stock Split went effective on April 26, 2017. All shares and per share amounts have been retroactively restated for all periods presented.

Preferred Stock

 

In January 2017, the Company filed a Form 14-C Information Statement advising all shareholders of the Company that the Board of Directors, as ratified by the majority of the votes of equity holders in late April 2017, approved of a reverse stock split (at a ratio of 250:1) and setting forth the proposed terms and characteristics of the Series D Preferred Stock.  The Series D Preferred Stock will carry a 5% annual dividend, will have no voting rights prior to conversion, and will convert into common stock at a ratio which will be determined by the amount of debt to be retired, and new money to be invested, and the then outstanding common stock of the Company on a fully diluted basis (See, the filed Form 14C for more details)

 

The purpose of reconstituting the characteristics of the Series D Preferred Stock is to have the ability to consummate the contemplated sale of the Company's Series D Preferred Stock as set forth in the Form 14C. If, and when, the agreement has been finalized for the sale of the Series D Preferred Stock, the characteristics of the Series D Preferred Stock will be set forth in a Certificate of Designations to be filed with the Secretary of State of the State of Nevada.  If the characteristics are substantively different than as previously approved by the Board of Directors, and ratified by the majority of the votes of equity holders, new approval will be sought. The proposed terms of the agreement are to be 80% of the common stock on a fully diluted basis.

 

The conversion rates for all of the Preferred Series of Stock are not affected by the reverse stock split, effected in April 2017.

 

Series A

 

During 2017, 75 shares of Series A Preferred stock were issued for dividends.

 

Series B

 

In 2017, the Company issued an aggregate of 387,500 Series B Preferred Stock, valued at approximately $56,000, to Board Members as compensation in connection with MA and Associates, LLC receiving its license to operate.

 

Series C

 

In 2017, there have been no issuances or sales of Series C Preferred Stock.

 

Series D&E

 

In 2017, there have been no issuances or sales of Series D Preferred Stock or Series E Preferred Stock as the Certificate of Designation has not been filed as it depends on the 14C Filing offering the Preferred D Series Stock.

Common Stock

 

Issuances

During the three months ended, March 31, 2017, the Company issued an aggregate of 1,372,731 common shares in connection with conversion of debt and interest valued at $113,557.

 

Note 9—RELATED PARTY TRANSACTIONS

 

In July 2013, the Company entered into a consulting agreement with an affiliate of Mr. Basloe, a board member of the Company. The agreement provides for consulting on marketing-related services for the Company. Amounts incurred under this agreement for the three months ended March 31 2017 and 2016, totaled $9,200 and $6,500, respectively.

In 2016, the Company managed Harris Lee Colorado, LLC, an existing lab in Denver, Colorado, after receiving approval from the Colorado Marijuana Enforcement Division in February of 2016. Harris Lee Holdings, LLC has sub-licensed the testing protocols to Harris Lee Colorado, LLC in exchange for a management fee for each test conducted. The Colorado MED has recently approved the transfer of management of an existing laboratory, to Harris Lee Colorado, LLC (a related party) and Harris Lee Holdings, LLC has begun to derive management fees from Harris Lee Colorado, LLC.  The revenue derived from these management fees for the three months ended March 31, 2017 and 2016 are $0 and $30,515. The laboratory closed during 2016 and the Company does not have plans to re-open in the near future.

 

In August 2016, Pazoo, Inc. entered into a loan agreement with David Cunic, Company CEO, and totaling $5,000.  The note has an interest rate of 0.70% and the maturity date is August 2018. As of March 2017, $0 remains outstanding.

In September 2016, Pazoo, Inc. entered into a loan agreement with Steve Basloe, Company President, and totaling $2,500.  The note has an interest rate of 0.70% and the maturity date is September 2018. As of March 2017, $2,500 remains outstanding.

Note 10—COMMITMENTS AND CONTINGENCIES

On March 10, 2015, Harris Lee signed a 9-year licensing agreement with Steep Hill Labs, LLC, with options to renew for an additional 9 years. The purpose of the agreement is to take the Steep Hill licensing to additional states to test medical marijuana above and beyond the State of Nevada, namely Oregon and Colorado. Under the license agreement for the first two states (Oregon and Colorado), if certain gross revenue thresholds are met, the Company is obligated to pay an additional $250,000. In addition, the Company is obligated to pay certain royalties over the life of the license agreement to Steep Hill Labs, Inc, based on the greater of the number of tests ($5 dollars a test) or an escalating royalty rate (7% to 15%) of the initial purchase price. The Company has the option to enter into additional states with similar commitments and royalties.  In June 2016, the Company, due to the uncertainties surrounding the license agreement with Steep Hill, impaired 100% of the value of the Steep Hill Labs licenses due to the purported unsubstantiated termination of the license agreements in June 2016 between Steep Hill Labs and MA & Associates, LLC and Harris Lee, LLC respectively.

 

 

In 2015, MA and Associates, LLC entered into various capital lease agreements to finance fixed asset purchases for approximately $615,000. Total monthly payments over the 36 month terms are approximately $17,000.

 

The Company's subsidiary MA and Associates, LLC rents space in Nevada with a 60 month term ending in May of 2019, with monthly rent expense of $2,242.

The Company rents office space in New Jersey with a term ending on May of 2018 and monthly payments of approximately $700.

As of March 31, 2017 the Company was still obligated to pay the remaining portion under the original 2014 40% investment agreement with MA and Associates, LLC, consisting of $678,000 of cash and 50,000 shares of Series C Preferred Stock (valued at $35,000 as of March 31, 2017), totaling $713,581 and included in contingent consideration liability on the accompanying consolidated balance sheet and will be issued in the future after the testing laboratory is operational.

On or about April 21, 2017, Eri Eveland filed a Complaint in District Court of Denver County Colorado against Harris Lee Colorado, LLC, Harris Lee Holdings, LLC and Pazoo Inc.  Ms. Eveland is a former employee of Harris Lee Colorado, LLC and is claiming less than $15,000 in unpaid salary/wages.  Inasmuch as Ms. Eveland was not an employee of Harris Lee Holdings, LLC nor Pazoo, Inc., her claims against the Company are derivative in nature and based on theories of corporate alter ego.  The Company disputes any liability.  As of the date of this report, neither Harris Lee Holdings, LLC nor Pazoo, Inc. have been served with the Complaint.  The Company feels it has many valid defenses to this action and, once served, will seek to have the Complaint summarily dismissed as to the Company.