Notes To Consolidated Financial Statements
June 30, 2013
NOTE 1. ORGANIZATION AND RECENT DEVELOPMENTS
Halo Companies,
Inc. (“Halo”, “HCI” or the “Company”) was incorporated under the laws of the State of Delaware
on December 9, 1986. Its principal executive offices are located at One Allen Center, Suite 500, 700 Central Expy South, Allen,
Texas 75013 and its telephone number is 214-644-0065.
Unless otherwise provided
in footnotes, all references from this point forward in this Report to “we,” “us,” “our company,”
“our,” or the “Company” refer to the combined Halo Companies, Inc. entity, together with its subsidiaries.
Halo has multiple wholly-owned
subsidiaries including Halo Group Inc. (“HGI”), Halo Asset Management, LLC (“HAM”), Halo Portfolio Advisors,
LLC (“HPA”), Halo Select Insurance Services, LLC (“HSIS”), Halo Group Mortgage, LLC (“HGM”),
Halo Benefits, Inc. (“HBI”), and Equitas Housing Fund, LLC (“EHF”). HGI is the management and shared services
operating company. HAM provides asset management and mortgage servicing services to investors and asset owners including all aspects
of buying and managing distressed REO and non-performing loans. HPA exists to market the Company’s operations as a turnkey
solution for strategic business to business opportunities with HAM’s investors and asset owners, major debt servicers, lenders,
and mortgage backed securities holders. The remaining subsidiaries, currently non-operating entities, were established in previous
years to provide insurance brokerage, mortgage services, and association benefit services to customers throughout the United States.
EHF was set up as the Company’s investment in non-performing loans as discussed below in Note 7.
In November 2012,
the Company entered into a stock/unit purchase agreement for the sale of the Company’s subsidiaries Halo Debt Solutions,
Inc. (“HDS”), Halo Financial Services, LLC (“HFS”), and Halo Credit Solutions (“HCS”). The
purchase agreement was finalized at $250,000, which included a $25,000 down payment at closing and promissory note financing for
the remainder of the purchase price. The note receivable does not accrue interest. Any purchaser default on the promissory note
not properly cured would immediately declare the note due and payable. The Company recorded a gain on the sale of HDS, HFS and
HCS of $134,731. As of June 30, 2013, the buyer has paid (including the down payment) the Company $185,000. The remaining $65,000
promissory note receivable is included in current assets on the consolidated balance sheet for the period ended June 30, 2013.
Subsequent
to June 30, the Company received $65,000 of the remaining $65,000 promissory note receivable. The promissory note receivable has
been paid in full as of August 13, 2013.
In April 2013, the
Company eliminated the noncontrolling interest balance on its balance sheet when it effectively closed the non-operating subsidiary
Halo Choice Insurance Services, LLC (“HCIS”). See further discussion in Note 2 of the consolidated financial statements.
NOTE 2. SIGNIFICANT ACCOUNTING POLICIES
The interim consolidated
financial statements are unaudited; however, in the opinion of management, all adjustments considered necessary for fair presentation
of the results of the interim periods have been included (consisting of normal recurring accruals). The accompanying consolidated
financial statements as of June 30, 2013, and for the three and six months ended June 30, 2013 and 2012, include the accounts of
the Company and have been prepared in accordance with accounting principles generally accepted in the United States of America
(“GAAP”) for interim information. Accordingly, the financial statements do not include all of the information and footnotes
required by GAAP for complete financial statements and should be read in conjunction with the audited consolidated financial statements
and notes thereto included in our Annual Report on Form 10-K. The results of operations for the three and six months ended June
30, 2013, are not necessarily indicative of the results that may be expected for the year ended December 31, 2013. Certain balances
have been reclassified in prior periods to be consistent with current year presentation.
Revenue Recognition, Accounts
Receivable and Deferred Revenue
The Company recognizes
revenue in the period in which services are earned and realizable. To further understand the Company’s business, HAM earns
fees from its clients for its boarding and initial asset management fee, success fees, and its monthly servicing fee. The boarding
and initial asset management services are performed in the first 30-60 days of assets being boarded and include; IRR analysis
of loans boarded, detailed asset level workout exit strategy analysis, boarding the assets onto HAM’s proprietary software
platform and the integrated servicing platform, identification and oversight of custodial files, oversight of mortgage/deed assignment
from previous servicer, oversight of title policy administration work, and delinquent property tax research and exposure review.
HAM’s monthly success fees are earned for completing its default and asset disposition services including loan modification,
notes sales, obtaining a deed in lieu of foreclosure, originating owner finance agreements, and cash sales of REO properties owned
by the client. HAM’s servicing fees are earned monthly and are calculated on a monthly unit price for assets under management.
HAM and HPA receivables
are typically paid the month following services performed. As of June 30, 2013, the Company’s accounts receivable are made
up of the following percentages; HAM at 77% and HPA at 23%.
The Company maintains allowances
for doubtful accounts for estimated losses resulting from the inability of its customers to make required payments. Management
considers the following factors when determining the collectability of specific customer accounts: past transaction history with
the customer, current economic and industry trends, and changes in customer payment terms. The Company pro vides for estimated
uncollectible amounts through an increase to the allowance for doubtful accounts and a charge to earnings based on actual historical
trends and individual account analysis. Balances that remain outstanding after the Company has used reasonable collection efforts
are written-off through a charge to the allowance for doubtful accounts. The below table summarizes the Company’s allowance
for doubtful accounts as of June 30, 2013 and December 31, 2012, respectively;
|
|
Balance at Beginning of Period
|
|
Increase in the Provision
|
|
Accounts Receivable Write-offs
|
|
Balance at End of Period
|
Six Months ended June 30, 2013
|
|
|
|
|
|
|
|
|
Allowance for doubtful accounts
|
|
$
|
375,665
|
|
|
$
|
931
|
|
|
$
|
931
|
|
|
$
|
375,665
|
|
Year ended December 31, 2012
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Allowance for doubtful accounts
|
|
$
|
446,722
|
|
|
$
|
35,259
|
|
|
$
|
106,316
|
|
|
$
|
375,665
|
|
As of June 30, 2013,
the Company’s allowance for doubtful accounts is made up of the following percentages; HAM at 96% and HPA at 4%. The HAM
and HPA allowance is related to one client. The client is in a court appointed receivership and the Company is awaiting final
outcome of its receivable claim into the receivership to determine any potential recoverability. As of June 30, 2013, the Company
has fully reserved all outstanding accounts receivables of this client.
Net Income (Loss) Per Common Share
Basic net income (loss)
per share is computed by dividing (i) net income (loss) available to common shareholders (numerator), by (ii) the weighted average
number of common shares outstanding during the period (denominator). Diluted net income (loss) per share is computed using the
weighted average number of common shares and dilutive potential common shares outstanding during the period. At June 30, 2013 and
2012, there were 5,556,577 and 5,051,337 shares, respectively, underlying potentially dilutive convertible preferred stock and
stock options outstanding. For the period ending June 30, 2012, the 5,051,337 shares were not included in dilutive weighted average
shares because their effect is anti-dilutive due to the Company’s net loss.
Use of Estimates and Assumptions
The preparation of consolidated
financial statements in conformity with GAAP requires management to make estimates and assumptions that affect reported amounts
of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements
and the reported amounts of revenues and expenses during the reported period. Actual results could differ from those estimates.
Significant estimates include the Company’s revenue recognition method, valuation of equity based compensation and derivative
liabilities.
Principles of Consolidation
The consolidated financial
statements of the Company for the three and six months ended June 30, 2013 include the financial results of HCI, HGI, HGM, HBI,
HSIS, HCIS (defined below), HPA, HAM, and EHF. All significant intercompany transactions and balances have been eliminated in consolidation.
The consolidated financial
statements of the Company for the three and six months ended June 30, 2012 include the financial results of HCI, HGI, HCS, HDS,
HGM, HBI, HSIS, HCIS (defined below), HFS, HPA, HAM, and EHF. The financial results of HGR are included for the one month period
January 2012. All significant intercompany transactions and balances have been eliminated in consolidation.
Cash and Cash Equivalents
The Company considers all
liquid investments with a maturity of 90 days or less to be cash equivalents.
Note Receivable
In November 2012,
the Company entered into a stock/unit purchase agreement for the sale of the Company’s subsidiaries HDS, HFS, and HCS for
consideration of $250,000 (sale discussed in further detail above). As of June 30, 2013, the buyer has paid (including the down
payment) the Company $185,000. The remaining $65,000 note receivable is included in current assets on the consolidated balance
sheet as of June 30, 2013. The note receivable does not bear interest.
Deposits and Other Assets
During the year ended December
31, 2012, the Company established a $45,000 deposit held with the Company’s office lessor. The Deposits and Other Assets
balance was $45,000 at June 30, 2013.
Property, Equipment and Software
Property, equipment, and
software are stated at cost. Depreciation is provided in amounts sufficient to relate the cost of the depreciable assets to operations
over their estimated service lives, ranging from three to seven years. Provisions for depreciation are made using the straight-line
method.
Major additions and improvements
are capitalized, while expenditures for maintenance and repairs are charged to expense as incurred. Upon sale or retirement, the
cost of the property and equipment and the related accumulated depreciation are removed from the respective accounts, and any resulting
gains or losses are credited or charged to other general and administrative expenses.
Fair Value of Financial Instruments
The carrying value
of trade accounts receivable, note receivable, accounts payable, and accrued and other liabilities approximate fair value due to
the short maturity of these items. The estimated fair value of the notes payable and subordinated debt approximates the carrying
amounts as they bear market interest rates.
The Company considers
the warrants related to its subordinated debt to be derivatives, and the Company records the fair value of the derivative liabilities
in the consolidated balance sheets. Changes in fair value of the derivative liabilities are included in gain (loss) on change in
fair value of derivative in the consolidated statements of operations. The Company’s derivative liability has been classified
as a Level III valuation according to Accounting Standards Codification (“ASC”) 820.
Internally
Developed Software
Internally
developed legacy application software consisting of database, customer relations management, process management and internal reporting
modules are used in each of the Company’s subsidiaries. The Company accounts for computer software used in the business
in accordance with ASC 350 “Intangibles-Goodwill and Other”. ASC 350 requires computer software costs associated with
internal use software to be charged to operations as incurred until certain capitalization criteria are met. Costs incurred during
the preliminary project stage and the post-implementation stages are expensed as incurred. Certain qualifying costs incurred during
the application development stage are capitalized as property, equipment and software. These costs generally consist of internal
labor during configuration, coding, and testing activities. Capitalization begins when (i) the preliminary project stage is complete,
(ii) management with the relevant authority authorizes and commits to the funding of the software project, and (iii) it is probable
both that the project will be completed and that the software will be used to perform the function intended. Management has determined
that a significant portion of costs incurred for internally developed software came from the preliminary project and post-implementation
stages; as such, no costs for internally developed software were capitalized.
Long-Lived
Assets
Long-lived
assets are reviewed on an annual basis or whenever events or changes in circumstance indicate that the carrying amount of an asset
may not be recoverable. Recoverability of assets held and used is generally measured by a comparison of the carrying amount of
an asset to undiscounted future net cash flows expected to be generated by that asset. If it is determined that the carrying amount
of an asset may not be recoverable, an impairment loss is recognized for the amount by which the carrying amount of the asset
exceeds the fair value of the asset. Fair value is the estimated value at which the asset could be bought or sold in a transaction
between willing parties. There were no impairment charges for the three and six months ended June 30, 2013 and 2012.
Equity-Based
Compensation
The
Company accounts for equity instruments issued to employees in accordance with ASC 718 “Compensation-Stock Compensation”.
Under ASC 718, the fair value of stock options at the date of grant is recognized in earnings over the vesting period of the options
beginning when the specified events become probable of occurrence. For the three and six months ended June 30, 2013, there were
zero shares of stock options awarded as discussed in Note 16. All transactions in which goods or services are the consideration
received for the issuance of equity instruments are accounted for based on the fair value of the consideration received or the
fair value of the equity instrument issued, whichever is more reliably measurable. The measurement date of the fair value of the
equity instrument issued is the earlier of (i) the date on which the counterparty’s performance is complete, or (ii) the
date on which it is probable that performance will occur.
Income
Taxes
The
Company accounts for income taxes in accordance with ASC 740 “Income Taxes”. ASC 740 requires the use of the asset
and liability method whereby deferred tax assets and liability account balances are determined based on differences between financial
reporting and tax bases of assets and liabilities and are measured using the enacted tax rates and laws that will be in effect
when the differences are expected to reverse. These differences result in deferred tax assets and liabilities, which are included
in the Company’s consolidated balance sheets.
The
Company then assesses the likelihood of realizing benefits related to such assets by considering factors such as historical taxable
income and the Company’s ability to generate sufficient taxable income of the appropriate character within the relevant
jurisdictions in future years. Based on the aforementioned factors, if the realization of these assets is not likely a valuation
allowance is established against the deferred tax assets.
The
Company accounts for its position in tax uncertainties under ASC 740-10. ASC 740-10 establishes standards for accounting for uncertainty
in income taxes. ASC 740-10 provides several clarifications related to uncertain tax positions. Most notably, a “more likely-than-not”
standard for initial recognition of tax positions, a presumption of audit detection and a measurement of recognized tax benefits
based on the largest amount that has a greater than 50 percent likelihood of realization. ASC 740-10 applies a two-step process
to determine the amount of tax benefit to be recognized in the financial statements. First, the Company must determine whether
any amount of the tax benefit may be recognized. Second, the Company determines how much of the tax benefit should be recognized
(this would only apply to tax positions that qualify for recognition.) No additional liabilities have been recognized as a result
of the implementation. The Company has not taken a tax position that, if challenged, would have a material effect on the financial
statements or the effective tax rate during the three and six months ended June 30, 2013 or 2012.
The
Company incurred no penalties or interest for taxes for the three or six months ended June 30, 2013 or 2012. The Company is subject
to a three year statute of limitations by major tax jurisdictions for the fiscal years ended December 31, 2009, 2010, and 2011.
The Company files income tax returns in the U.S. federal jurisdiction.
Deferred Rent
Deferred rent of the Company
is comprised of two balances. First, the Company’s operating leases for its office facilities contain free rent periods during
the lease term. For these types of leases the Company recognizes rent expense on a straight line basis over the minimum lease term
and records the difference between the amounts charged to expense and the amount paid as deferred rent. As the free rent periods
have expired on the existing office facility leases, the Company expects the deferred rent balance to decrease over the remaining
rental period until the maturity date at which time the deferred rent balance will have been reduced to $0. This balance is included
within the consolidated balance sheets in both the current and long term portion of deferred rent. The second portion of the deferred
rent balance is comprised of a $257,012 reduction fee for a contractually agreed decrease in the Company’s office facilities
as discussed fully in Note 15. This balance has and will continue to reduce evenly over the remaining lease term beginning in August
2012 and ending August 2014. This balance is included within the consolidated balance sheets in both the current and long term
portion of deferred rent.
Non-controlling Interest
On
January 1, 2009, HSIS entered into a joint venture with another entity to form HCIS. HSIS contributed 49% of the opening equity
balance. Under a qualitative analysis performed in accordance with ASC 810 “Consolidation”, HCIS is a variable interest
entity and HSIS is the primary beneficiary as HSIS’s parent company, HGI, acts as the sole manager of the entity. Based on
this analysis, HSIS has consolidated HCIS with the non-controlling 51% interest included in non-controlling interest on the consolidated
balance sheets and consolidated statements of operations.
In April 2013, the Company closed the non-operating HCIS subsidiary.
With the closure of HCIS, there is no future income stream to offset the deficit in the non-controlling interest balance, and as
the non-controlling 51% entity will not reimburse HSIS for its share of cumulative losses, HSIS incurred an expense of $82,460,
included in other expense on the consolidated statements of operations. As of June 30, 2013, the non-controlling interest balance
was $0.
NOTE 3. CONCENTRATIONS OF CREDIT RISK
The Company maintains aggregate
cash balances, at times, with financial institutions, which are in excess of amounts insured by the Federal Deposit Insurance Corporation
(“FDIC”). During the three and six months ended June 30, 2013, the FDIC insured deposit accounts up to $250,000. At
June 30, 2013, the Company’s cash accounts were all less than the $250,000 FDIC insured amount and as such were insured in
full.
Financial instruments that
potentially subject the Company to concentrations of credit risk consist primarily of accounts receivable and note receivable.
In the normal course of
business, the Company extends unsecured credit to its customers. Because of the credit risk involved, management has provided an
allowance for doubtful accounts which reflects its estimate of amounts which will eventually become uncollectible. In the event
of complete non-performance by the Company’s customers, the maximum exposure to the Company is the outstanding accounts receivable
balance at the date of non-performance as well as the remaining note receivable balance held with one entity.
NOTE
4. OPERATING SEGMENTS
The
Company has several operating segments as listed below and as defined in Note 1. The results for these operating segments are
based on our internal management structure and review process. We define our operating segments by service industry. If the management
structure and/or allocation process changes, allocations may change. See the following summary of operating segment reporting;
Operating Segments
|
|
For the Three Months Ended
|
|
For the Six Months Ended
|
|
|
June 30,
|
|
June 30,
|
|
|
2013
|
|
2012
|
|
2013
|
|
2012
|
Revenue:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Halo Asset Management
|
|
$
|
2,284,338
|
|
|
$
|
386,806
|
|
|
$
|
2,608,954
|
|
|
$
|
1,637,512
|
|
Halo Portfolio Advisors
|
|
|
698,743
|
|
|
|
265,616
|
|
|
|
1,230,813
|
|
|
|
660,744
|
|
Other
|
|
|
—
|
|
|
|
107,858
|
|
|
|
28,531
|
|
|
|
378,862
|
|
Net revenue
|
|
$
|
2,983,081
|
|
|
$
|
760,280
|
|
|
$
|
3,868,298
|
|
|
$
|
2,677,118
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating income (loss):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Halo Asset Management
|
|
$
|
1,956,415
|
|
|
$
|
(41,516
|
)
|
|
$
|
1,930,853
|
|
|
$
|
813,855
|
|
Halo Portfolio Advisors
|
|
|
109,477
|
|
|
|
41,410
|
|
|
|
208,659
|
|
|
|
178,849
|
|
Other
|
|
|
(109,082
|
)
|
|
|
(62,969
|
)
|
|
|
(200,085
|
)
|
|
|
(109,686
|
)
|
Less: Corporate expenses (a)
|
|
|
(559,849
|
)
|
|
|
(671,546
|
)
|
|
|
(1,062,343
|
)
|
|
|
(1,338,488
|
)
|
Operating income (loss):
|
|
$
|
1,396,961
|
|
|
$
|
(734,621
|
)
|
|
$
|
877,084
|
|
|
$
|
(455,470
|
)
|
|
a.
|
Corporate
expenses include salaries,
benefits and other expenses,
including rent and general
& administrative expenses,
related to corporate office
overhead and functions that
benefit all operating segments.
Corporate expenses are expenses
that the Company does not
directly allocate to any segment
above. Allocating these indirect
expenses to operating segments
would require an imprecise
allocation methodology. Further,
there are no material amounts
that are the elimination or
reversal of transactions between
the above reportable operating
segments.
|
The
assets of the Company consist primarily of cash, trade accounts receivable, note receivable, and property/equipment/software. Cash
is managed at the corporate level of the Company and not at the segment level. Each of the remaining primary assets has been discussed
in detail, including the applicable operating segment for which the assets and liabilities reside, in the consolidated notes to
the financial statements. As such, the duplication is not warranted in this footnote.
All
debt of the Company is recorded at the corporate parent companies HCI and HGI, with the exception of the $1,200,000 secured asset
promissory note of EHF. However, this note was paid in full during the three months ended June 30, 2013, as discussed further in
Note 12. Interest expense related to the secured asset promissory note totaled $34,231 and $118,231 for the three and six months
ended June 30, 2013, and is included above in “Other” and in “Other Income (expense)” in the consolidated
statements of operations. The remaining $17,970 of the $52,201 interest expense for the three months ended June 30, 2013 and the
remaining $38,128 of the $156,359 in the consolidated statements of operations for the six months ended June 30, 2013 are included
in corporate expenses above.
For
the three and six months ended June 30, 2013 and 2012, there have been no material transactions between reportable units that would
materially affect an operating segment profit or loss. Intercompany transactions are eliminated in the consolidated financial statements.
NOTE
5. GOING CONCERN
The accompanying consolidated
financial statements have been prepared assuming that the Company will continue as a going concern, which contemplates the Company
will need to manage additional asset units under contract and/or additional financing to fully implement its business plan, including
continued growth and establishment of a stronger brand name of HAM’s asset management in the distressed asset sector. The
Company has recognized net income of $877,084 for the six months ended June 30, 2013, however, as included in the consolidated
statements of cash flows, the Company has used a material amount of its net cash provided by operating activities towards the repayment
of previously borrowed financing sources.
The Company is actively
seeking growth of its asset units under management, both organically and via new client relationships. Secondarily, there are no
assurances that additional financing will be available on favorable terms, or at all. If additional financing is not available,
the Company will need to reduce, defer or cancel development programs, planned initiatives and overhead expenditures. The failure
to adequately fund its capital requirements could have a material adverse effect on the Company’s business, financial condition
and results of operations. Moreover, the sale of additional equity securities to raise financing will result in additional dilution
to the Company’s stockholders, and incurring additional indebtedness could involve an increased debt service cash obligation,
the imposition of covenants that restrict the Company operations or the Company’s ability to perform on its current debt
service requirements. The Company has incurred an accumulated deficit of $9,801,902 as of June 30, 2013. However, of
the accumulated deficit, $2,110,748 of expense was incurred as stock-based compensation, $462,571 in depreciation expense, and
$279,241 in impairment loss on investment in portfolio assets, all of which are noncash expenses. Further, $906,278 of the accumulated
deficit is related to the issuance of stock dividends, also non cash reductions. The $3,758,838 total of these non-cash retained
earnings reductions represents 38% of the total deficit balance. Management, in the ordinary course of business, is trying to raise
additional capital through sales of common stock as well as seeking financing via equity or debt, or both from third parties. The
consolidated financial statements do not include any adjustments that might be necessary if the Company is unable to continue as
a going concern.
NOTE
6. PROPERTY, EQUIPMENT AND SOFTWARE
Property,
equipment and software consist of the following as of June 30, 2013 and December 31, 2012, respectively:
Computers and purchased software
|
|
$
|
219,270
|
|
|
$
|
159,159
|
|
Furniture and equipment
|
|
|
354,756
|
|
|
|
352,800
|
|
|
|
|
574,026
|
|
|
|
511,959
|
|
Less: accumulated depreciation
|
|
|
(394,648
|
)
|
|
|
(365,262
|
)
|
|
|
$
|
179,378
|
|
|
$
|
146,697
|
|
Depreciation
totaled $14,574, $29,386, $16,785 and $35,257 for the three and six months ended June 30, 2013 and 2012
,
respectively.
NOTE
7. INVESTMENTS IN PORTFOLIO ASSETS
In December 2010, EHF entered
into an agreement to purchase non-performing mortgage notes secured by the property, across the United States, for 6.6% of unpaid
principal balance. Total purchase price of the investment was $300,000. Payments of $20,759 were received during 2011 and applied
to the investment. During 2011, the seller’s estate, including the above mentioned non-performing mortgage notes purchased
for $300,000 was placed into receivership with a court appointed receiver of the seller. The receiver has asserted ownership of
the assets in receivership, including the referenced mortgage notes. As the Company’s right to these assets had been impaired,
the Company assessed its ability to reclaim the assets as remote and an impairment of the investment in portfolio assets was warranted.
Accordingly, the Company recognized impairment of the assets of $279,241 as of December 31, 2011. As of June 30, 2013, the Company
is still awaiting final outcome of any potential recoverability from the receivership and as such the value remains $0.
NOTE
8. ACCRUED AND OTHER LIABILITIES
The Company had $720,079
in accrued liabilities at June 30, 2013. Included in this accrual is $442,063 in deferred compensation to multiple senior management
personnel, $277,121 in accrued interest ($216,762 of this balance related to interest on the secured asset promissory note discussed
in more detail in Note 12), and $895 in other. The Company had $601,742 in accrued liabilities at December 31, 2012. Included in
this accrual was $77,296 in salaries and wages payable, $211,936 in deferred compensation to multiple senior management personnel,
$311,365 in accrued interest ($252,000 of this balance is discussed in more detail in Note 12), and $1,145 in other.
NOTE 9. NOTES PAYABLE TO RELATED PARTIES
The notes payable to related
parties reside as follows;
During March 2011, the
Company entered into one unsecured promissory note with a related party (a company director) in the amount of $250,000 (the “2011
Related Party Note”). The 2011 Related Party Note had a fixed interest amount of $50,000 and a maturity date of July 31,
2011. On September 20, 2011, the 2011 Related Party Note was amended to include the 2011 Related Party Note plus $52,426 of accrued
interest for a total note balance of $302,426. The 2011 Related Party Note has a 6% interest rate and is a monthly installment
note with final maturity of October 2013. Interest and principal is due upon maturity. As of June 30, 2013, the 2011 Related Party
Note was $197,120, all of which is included in current portion of notes payable to related parties. As of December 31, 2012, the
balance of the 2011 Related Party Note was $206,292, all of which is included in current portion of notes payable to related parties.
On September 1, 2011, several
previous related party notes totaling $370,639 were amended and consolidated (“the 2011 Consolidated Related Party Note”).
This note bears interest of 6% and has a maturity date of September 15, 2016. As of June 30, 2013, the 2011 Consolidated Related
Party Note balance was $282,601, of which $60,454 is included in current portion of notes payable to related parties. As of December
31, 2012, the 2011 Consolidated Related Party Note balance was $291,969, of which $49,837 is included in current portion of notes
payable to related parties.
As of December 31, 2012,
a Company director had an outstanding advance to the Company of $100,000, for short term capital. During the six months ended June
30, 2013, the director advanced an additional $100,000 to the Company for working capital. At the time of the filing of these consolidated
financial statements, the Company and the director had not finalized a maturity date for the advance repayment. The advance does
not accrue interest. As such, as of June 30, 2013, the advance balance was $200,000, all of which is included in current portion
of notes payable to related parties.
In December 2012, the Company’s
President and Chief Legal Officer advanced $28,000 to the Company for short term capital. During the six months ended June 30,
2013, an additional advance of $15,000 was made for working capital as well as the repayment of the entire $43,000 advanced. As
of June 30, 2013, the advance balance was $0. The advance did not accrue interest.
In December 2012, the Company’s
CEO and Director of the Board advanced $12,000 to the Company for short term capital. During the six months ended June 30, 2013,
an additional advance of $40,000 was made for working capital as well as the repayment of the entire $52,000 advanced. As of June
30, 2013, the advance balance was $0. The advance did not accrue interest.
As of June 30, 2013, the
notes payable to related party balance totaled $679,721, of which $457,574 is included in current portion of notes payable to related
parties in the consolidated financial statements. As of December 31, 2012, the notes payable to related party balance totaled $638,261,
of which $396,129 is included in current portion of notes payable to related parties in the consolidated financial statements.
The Company incurred $8,077,
$16,170, $9,018 and $18,483 of interest expense to directors, officers, and other related parties during the three and six months
ended June 30, 2013 and 2012, respectively. Accrued interest due to directors and other related parties totaled $86,040 at June
30, 2013, of which $56,207 is included in accrued and other current liabilities. Accrued interest due to directors and other related
parties totaled $90,579 at December 31, 2012, of which $55,927 is included in accrued and other current liabilities.
NOTE 10. NOTES PAYABLE
On August 15, 2011, the
Company entered into an agreement with LegacyTexas Bank (“LTB”) to refinance a previously outstanding $75,001 line
of credit into an 18 month note. The terms of the new note include an interest rate of 3% with a maturity date of February 15,
2013. As of June 30, 2013, the note payable balance was $0 (paid in full). As of December 31, 2012, the note payable balance was
$8,509, which is included in current portion of notes payable.
NOTE 11. SUBORDINATED DEBT
During January 2010, the
Company authorized a $750,000 subordinated debt offering (“Subordinated Offering”), which consists of the issuance
of notes paying a 16% coupon with a 1% origination fee at the time of closing. The maturity date of the notes was originally January
31, 2013, however, subsequent to December 31, 2012, the Company and the subordinated debt holders agreed to an extended maturity
date of April 30, 2013, and then again to December 31, 2013. Repayment terms of the notes included interest only payments through
July 31, 2010. Thereafter, level monthly payments of principal and interest are made as calculated on a 60 month payment amortization
schedule with final balloon payment due at maturity. The rights of holders of notes issued in the Subordinated Offering are subordinated
to any and all liens granted by the Company to a commercial bank or other qualified financial institution in connection with lines
of credit or other loans extended to the Company in an amount not to exceed $2,000,000, and liens granted by the Company in connection
with the purchase of furniture, fixtures or equipment. This includes the LTB debt disclosed in Note 10. Since inception of the
offering, the Company has raised $420,000 in the Subordinated Offering. As of June 30, 2013, the remaining balance of this offering,
less debt discount (discussed below), totals $151,667, all of which is included in current portion of subordinated debt.
As
part of the Subordinated Offering, t
he Company granted to investors common stock purchase warrants (the “Warrants”)
to purchase an aggregate of 200,000 shares of common stock of the Company at an exercise price of $0.01 per share. The 200,000
shares of common stock contemplated to be issued upon exercise of the Warrants are based on an anticipated cumulative debt raise
of $750,000. The investors are granted the Warrants pro rata based on their percentage of investment relative to the $750,000 aggregate
principal amount of notes contemplated to be issued in the Subordinated Offering. The Warrants shall have a term of seven years,
exercisable from January 31, 2015 to January 31, 2017. The Company will have a call option any time prior to maturity, so long
as the principal and interest on the notes are fully paid, to purchase the Warrants for an aggregate of $150,000. After the date
of maturity until the date the Warrants are exercisable, the Company will have a call option to purchase the Warrants for $200,000.
The call option purchase prices assume a cumulative debt raise of $750,000.
The Company adopted
the provisions of ASC 815, “Derivatives and Hedging”. ASC 815 requires freestanding contracts that are settled in a
company’s own stock to be designated as an equity instrument, assets or liability. Under the provisions of ASC 815, a contract
designated as an asset or liability must be initially recorded and carried at fair value until the contract meets the requirements
for classification as equity, until the contract is exercised or until the contract expires. Accordingly, the Company determined
that the warrants should be accounted for as derivative liabilities and has recorded the initial value as a debt discount which
will be amortized into interest expense using the effective interest method. As of June 30, 2013, the balance of the debt discount
was $0 (fully amortized). As of December 31, 2012, the balance of the debt discount was $1,454, included in current portion of
subordinated debt. Subsequent changes to the marked-to-market value of the derivative liability will be recorded in earnings as
derivative gains and losses. As of June 30, 2013, there were 112,000 warrants outstanding with a derivative liability of $19,367.
As of December 31, 2012, there were 112,000 warrants outstanding with a derivative liability of $29,351. The $9,984 decrease in
fair value is included in the consolidated statements of operations as gain on change in fair value of derivative
.
The Warrants
were valued using the Black-Scholes model, which resulted in the fair value of the warrants at $0.17 per share using the following
assumptions:
|
|
June 30, 2013
|
Risk-free rate
|
|
|
1.04
|
%
|
Expected volatility
|
|
|
565.13
|
%
|
Expected remaining life (in years)
|
|
|
3.5
|
|
Dividend yield
|
|
|
0.00
|
%
|
During August 2012, the
Company entered into an additional $25,000 subordinated term note with a current holder of the Company’s subordinated debt.
The note pays an 18% coupon rate with a maturity date of August 31, 2015. There are no warrants associated with this subordinated
term note. Repayment terms of the note include interest only payments through February 28, 2013. Thereafter, level monthly payments
of principal and interest are made as calculated on a 60 month payment amortization schedule with final balloon payment due at
maturity. The rights of the holder of this note is subordinated to any and all liens granted by the Company to a commercial bank
or other qualified financial institution in connection with lines of credit or other loans extended to the Company in an amount
not to exceed $2,000,000, and liens granted by the Company in connection with the purchase of furniture, fixtures or equipment.
As of June 30, 2013, the remaining balance of this note totals $23,750, of which $5,417 is included in current portion of subordinated
debt. As of December 31, 2012, the balance of this note totals $25,000.
As of June 30, 2013, the
subordinated debt balance was $175,417, of which $157,084 was included in current portion of subordinated debt. As of December
31, 2012, the subordinated debt balance was $247,546, of which $226,713 was included in current portion of subordinated debt.
NOTE 12. SECURED ASSET PROMISSORY NOTE
During
December 2010, the Company authorized a debt offering to be secured by real estate assets purchased in connection with Equitas
Housing Fund, LLC, (“Equitas Offering”). The Equitas Offering, which is now closed, generated $1,200,000 in proceeds.
Of the $1,200,000 in proceeds received in December 2010, $300,000 was used to acquire non-performing, residential mortgage notes
and the balance was used for mortgage note workout expenses and operational expenses of Halo Asset Management. The Secured Asset
Promissory Notes consist of a 25% coupon with a maturity date of December 31, 2012. Accrued interest is to be paid quarterly at
the end of each fiscal quarter beginning March 31, 2011 through maturity date and continuing until the promissory note has been
paid in full. The rights of the holders of the Secured Asset Promissory Notes include a security interest in the collateral of
the above mentioned securities of real estate properties. As of December 31, 2012, the Secured Asset Promissory Note balance was
$1,200,000.
In May
2013, the Secured Asset Promissory Note was paid in full, along with $150,000 of the outstanding accrued interest balance. Halo
and the secured asset promissory note holder agreed to include the remaining accrued interest in a promissory note due December
31, 2013. The new promissory note will accrue interest at a 10% annual rate, with interest only payments due periodically and final
balloon payment due at maturity. Subsequent to the payment and new promissory note of accrued interest, the Company is no longer
in default with its secured asset promissory note holder. As of June 30, 2013, the accrued interest balance was $216,762. As of
December 31, 2012, the accrued interest balance was $252,000. For the three and six months ended June 30, 2013 and 2012, the Company
incurred $34,231, $118,231, $75,000, and $150,000 respectively, in interest expense on the note.
NOTE 13. RELATED PARTY TRANSACTIONS
For the three and six months
ended June 30, 2013, HAM recognized monthly servicing fee revenue totaling $126,706 and $230,984 from an entity that is an affiliate
of the Company.
For the three and six months
ended June 30, 2013 and 2012, the Company incurred interest expense to related parties (See Note 9).
NOTE 14. INCOME TAXES
For both the three
and six months ended June 30, 2013 and for both the three and six months ended June 30, 2012, the quarterly effective tax rate
of 2% and 3% varies from the U.S. federal statutory rate primarily due to state income taxes, net losses, certain non-deductible
expenses and an increase in the valuation allowance associated with the net operating loss carryforwards. Our deferred tax assets
related to net operating loss carryforwards remain fully reserved due to uncertainty of utilization of those assets.
Deferred tax assets
and liabilities are computed by applying the effective U.S. federal and state income tax rate to the gross amounts of temporary
differences and other tax attributes. In assessing the realizability of deferred tax assets, management considers whether it is
more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred
tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become
deductible. Management considers the scheduled reversal of deferred tax liabilities, projected future taxable income, and tax planning
strategies in making this assessment. At June 30, 2013, the Company believed it was more likely than not that future tax benefits
from net operating loss carry-forwards and other deferred tax assets would not be realizable through generation of future taxable
income and are fully reserved.
The Company has net
operating loss (“NOL”) carry-forwards of approximately $3,900,000 available for federal income tax purposes, which
expire from 2013 to 2033.
NOTE 15. COMMITMENTS AND CONTINGENCIES
The Company leases its
office facilities and various office equipment under non-cancelable operating leases which provide for minimum monthly rental payments.
Pursuant to an office lease amendment dated September 2, 2011, the Company amended its office facilities agreement to reduce its
leased office facilities and make monthly cash payments of $43,552. In amending the agreement, the Company and lessor also agreed
to a reduction fee of $257,012, originally due by February 1, 2012, and subsequently agreed to be paid in equal installments over
the remaining lease term. The first payment was payable on August 1, 2012. The lease expires on August 28, 2014. This balance is
included in deferred rent.
Future minimum rental
obligations, including the reduction fee, under leases as of June 30, 2013 are as follows:
Years Ending December 31:
|
|
|
|
|
|
2013
|
|
|
$
|
339,983
|
|
2014
|
|
|
|
431,692
|
|
2015
|
|
|
|
1,218
|
|
Total minimum lease commitments
|
|
|
$
|
772,893
|
|
For the three
and six months ended June 30, 2013 and 2012, the Company incurred facilities rent expense totaling $112,142, $219,462, $102,942
and $202,848, respectively.
In
the ordinary course of conducting its business, the Company may be subject to loss contingencies including possible
disputes
or lawsuits. The Company notes the following;
The
Company and certain of its affiliates, officers and directors have been named as defendants in an action filed on December 12,
2011 in the 191
st
District Court of Dallas County, Texas. The Plaintiffs allege that the Company has misappropriated
funds in connection with offerings of securities during 2010 and 2011. The complaint further alleges that Defendants engaged in
fraudulent inducement, negligent misrepresentation, fraud, breach of fiduciary duty, negligence, breach of contract, unjust enrichment,
conversion, violation of the Texas Securities Act, and civil conspiracy. The Plaintiffs amended their Petition on April 24, 2012
and dropped the conversion and civil conspiracy claims. The action seeks an injunction and a demand for accounting along with
damages in the amount of $4,898,157. The Company has taken the position that the Plaintiff’s claims have no merit, and accordingly
is defending the matter vigorously. Defendants have filed a general denial of the claims as well as a Motion to Designate Responsible
Third Parties whom Defendants believe are responsible for any damages Plaintiffs may have incurred. Defendants have also filed
a Motion for Sanctions against the Plaintiffs and their counsel arguing, among other things, that (i) Plaintiffs’ claims
are “judicially stopped” from moving forward by virtue of the fact that the same Plaintiffs previously filed suit
against separate entities and parties with dramatically opposed and contradicting views and facts; (ii) Plaintiffs have asserted
claims against Defendants without any basis in law or fact; and (iii) Plaintiffs have made accusations against Defendants that
Plaintiffs know to be false. Additionally, Defendants have filed a no evidence Motion for Summary Judgment which was scheduled
to be heard in October of 2012. The Plaintiffs requested and were granted a six month continuance on the hearing of that motion.
The Plaintiffs have also filed a Motion to Stay the case pending the outcome of the Company’s lawsuit with the insurance
companies which the Company has opposed. Initially the motion to stay was granted and Defendants moved for reconsideration. The
parties were alerted that the court had reversed the Stay on appeal. The no evidence Motion for Summary Judgment is currently
set to be heard on August 9, 2013. Prior to the hearing, the Plaintiff’s filed a 3
rd
Amended Petition in which
they dropped any claim of fraud including fraudulent inducement, fraud, conversion and civil conspiracy.
As
noted above, the Company, in conjunction with its Directors and Officers insurance carrier, is defending the matter vigorously.
Based on the facts alleged and the proceedings to date, the Company believes
that the Plaintiffs’ allegations will prove to be false, and that accordingly, it is not probable or reasonably possible
that a negative outcome for the Company or the remaining Defendants will occur. As with any action of this type the timing and
degree of any effect upon the Company are uncertain. If the outcome of the action is adverse to the Company, it could have a material
adverse effect on our business prospects, financial position, and results of operation.
The Company and certain of its affiliates,
officers and directors named as defendants in an insurance action filed on April 27, 2012 in the United States District Court
for the Northern District of Texas. The Plaintiffs allege that it had no duty to indemnify the Company, its affiliates, officers
or directors because the claims set forth in the lawsuit mentioned herein above were not covered by the insurance policy issued
by Plaintiff in favor of Defendants. The action sought declaratory judgment that the Plaintiff had no duty to indemnify the Defendants
pursuant to the insurance policy that Defendants purchased from Plaintiff. The Company took the position that Plaintiff’s
claim had no merit, and defended the matter vigorously. Additionally, Defendants filed a counterclaim against the insurer alleging
breach of contract, violation of the Texas Insurance Code and violation of the duty of good faith and fair dealing. On March 12,
2013, Plaintiff and Defendants entered into an agreement whereby Plaintiff’s and Defendant’s claims, are to be dismissed
without prejudice while the underlying liability suit in the 191
st
District Court of Dallas County proceeds. An Agreed
Motion to Dismiss Without Prejudice was filed on March 12, 2013, and the parties are awaiting the court’s entry of the Agreed
Order of Dismissal Without Prejudice.
As
noted above, the Company has defended this matter vigorously. Based on the status of the litigation, it is not probable or reasonably
possible that a negative outcome for the Company or the remaining Defendants will occur. As with any action of this type the timing
and degree of any effect upon the Company are uncertain. If the outcome of the action is adverse to the Company, it could have
a material adverse effect on our financial position.
The
Company and certain of its affiliates, officers and directors have been named as defendants in an action filed on July 19, 2012
in the United States District Court for the Northern District of Texas. The Plaintiff alleges that it has no duty to defend or
indemnify the Company, its affiliates, officers or directors because the claims set forth in the lawsuit mentioned herein above
are not covered by the insurance policy written by Plaintiff in favor or Defendants. The action seeks declaratory judgment that
the Plaintiff has no duty to defend or indemnify the Defendants pursuant to the insurance policy that Defendants purchased from
Plaintiff. Initially, the Company took the position that Plaintiff’s claims had no merit, and defended the matter vigorously.
Additionally, Defendants filed a counterclaim against the insurer alleging breach of contract, violation of the Texas Insurance
Code and violation of the duty of good faith and fair dealing. Plaintiff has filed a Motion for Summary Judgment seeking a judgment
that it owes no duty to defend or indemnify Defendants. After careful consideration, Defendants decided not to oppose the Motion
for Summary Judgment and a response in opposition was not filed. The Motion for Summary Judgment was granted and the matter is
no longer pending before the court.
Based
on the current status of the litigation, the Company believes it is not probable or reasonably possible that a negative outcome
for the Company or the remaining Defendants will occur. As with any action of this type the timing and degree of any effect upon
the Company are uncertain. If the outcome of the action is adverse to the Company, it could have a material adverse effect on
our financial position.
NOTE
16. STOCK OPTIONS
The Company granted stock
options to certain employees under the HGI 2007 Stock Plan, as amended (the “Plan”). The Company was authorized to
issue 2,950,000 shares subject to options, or stock purchase rights under the Plan. These options (i) vest over a period no greater
than two years, (ii) are contingently exercisable upon the occurrence of a specified event as defined by the option agreements,
and (iii) expire three months following termination of employment or five years from the date of grant depending on whether or
not the options were granted as incentive options or non-qualified options. At September 30, 2009, pursuant to the terms of the
merger, all options granted prior to the merger were assumed by the Company and any options available for issuance under the Plan
but unissued, have been forfeited and consequently the Company has no additional shares subject to options or stock purchase rights
available for issuance under the Plan. As of June 30, 2013, 438,300 option shares have been exercised. Total stock options outstanding
through June 30, 2013 total 1,207,950. The weighted average remaining contractual life of the outstanding options at June 30, 2013
is approximately 2.4 years.
A summary of stock option activity in
the Plan is as follows:
|
|
|
|
|
|
Weighted
|
|
|
|
|
Exercise
|
|
Average
|
|
|
Number of
|
|
Price
|
|
Exercise
|
|
|
Options
|
|
Per Option
|
|
Price
|
|
Outstanding at December 31, 2011
|
|
|
|
1,462,350
|
|
|
|
$ 0.01 – 1.59
|
|
|
$
|
0.81
|
|
|
Granted
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
Exercised
|
|
|
|
(10,000
|
)
|
|
|
0.01
|
|
|
|
0.01
|
|
|
Canceled
|
|
|
|
(237,200
|
)
|
|
|
0.01
|
|
|
|
0.01
|
|
|
Outstanding at December 31, 2012
|
|
|
|
1,215,150
|
|
|
|
$ 0.01 – 1.59
|
|
|
$
|
0.97
|
|
|
Granted
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
Exercised
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
Canceled
|
|
|
|
(7,200
|
)
|
|
|
0.01
|
|
|
|
0.01
|
|
|
Outstanding at June 30, 2013
|
|
|
|
1,207,950
|
|
|
|
$ 0.01
– 1.59
|
|
|
$
|
0.97
|
|
All stock options granted
under the Plan and as of June 30, 2013 became exercisable upon the occurrence of the merger that occurred on September 30, 2009.
As such, equity-based compensation for the options was recognized in earnings from issuance date of the options over the vesting
period of the options effective September 30, 2009. Total compensation cost expensed over the vesting period of stock options was
$2,103,948, all of which was expensed as of September 30, 2011.
On July 19, 2010, the board
of directors approved the Company’s 2010 Incentive Stock Plan (“2010 Stock Plan”). The 2010 Stock Plan allows
for the reservation of 7,000,000 shares of the Company’s common stock for issuance under the plan. The 2010 Stock Plan became
effective July 19, 2010 and terminates July 18, 2020. As of June 30, 2013, 20,000 shares were granted under the 2010 Stock Plan
with an exercise price of $0.34 per option. These are the only shares that have been issued under the 2010 Stock Plan. The shares
granted vested immediately and can become exercisable for so long as the Company remains a reporting company under the Securities
Exchange Act of 1934. Total compensation cost expensed over the vesting period of the stock options was $6,800, all of which was
expensed in the year ended December 31, 2012. As of June 30, 2013, none of the shares issued under the 2010 Stock Plan have been
exercised.
NOTE 17. SHAREHOLDERS’ (DEFICIT) EQUITY
Common Stock
On December 13, 2010 (“the
Closing”), the Company was party to an Assignment and Contribution Agreement (the “Agreement”). Pursuant
to the terms of Agreement, the members of Equitas Asset Management, LLC, (“EAM”), a non Halo entity, which owned 100%
of the interests of Equitas Housing Fund, LLC (“EHF”), assigned and contributed 100% of the interests of EAM to HAM
(a Halo subsidiary) in exchange for shares of 21,200,000 shares of the Company’s Common Stock, $0.001 par value, of the Company.
The Agreement did not constitute a business combination.
The Company issued 7,500,000
shares of Halo common stock in exchange for $3,000,000 in debt or equity capital. The aggregate of 7,500,000 shares of Halo common
stock will be subject to clawback (and cancellation) by Halo in the event that EAM does not generate at least three million dollars
($3,000,000) in new capital to Halo within twelve months following the closing. Halo shall have the right to claw back 2.5 shares
of Halo common stock for every dollar not raised within the twelve months. Any cash generated by EAM will need to be designated
for use in Halo’s general operations and not that of the EHF business to release the clawback rights.
The Company issued 13,700,000
shares of Halo common stock for the purchase of intangible assets owned by EAM which included trade secrets and business processes
used in the EHF business. The aggregate 13,700,000 shares of Halo common stock shall be subject to clawback (and cancellation)
by Halo in the event that EAM fails to generate at least $10,000,000 of net operating cash flows from the EHF business within twenty-four
months following the closing. Halo shall have the right to claw back 1.37 shares of Halo common for every dollar not generated
from the net operating cash flows of the EHF business. Once the $10,000,000 in net operating cash flows from the EHF business is
generated, the clawback rights will be released.
In applying
the guidance of ASC 505 “Equity” to the above transactions, the clawback provisions create a performance commitment
that has not been met. As such, although the transaction did provide for a grant date at which time the equity shares are issued
and outstanding, the equity shares have not met the measurement date requirements required by ASC 505. Accordingly, the par value
of the shares issued and outstanding have been recorded at the grant date and as the clawback rights are released and the measurement
dates established, the fair value of the transactions will be determined and recorded. The pro-rata fair value of equity issued
in connection with fund raising efforts at each measurement date will be recorded as debt issuance costs or a reduction in the
equity proceeds raised by the counter party. The pro-rata fair value of equity issued in connection with the purchase of intangible
assets at the measurement date will be recorded as amortization expense because the amortization period of the underlining asset
purchase and the clawback release rights are commensurate.
As mentioned above, the
Agreement provides for “clawback” provisions, pursuant to which all of the shares of Halo Common Stock issued to the
member of EAM are subject to forfeiture in the event certain financial metrics are not timely achieved. The financial metrics call
for significant cash generation by EHF within the first 12 months, and within the first 24 months following the closing date. We
refer you to Section 2(b)(i) and (ii) of the Agreement, for the specifics of the clawback provisions. As of December 31, 2012,
no cash was generated by EHF. The times to meet both the 12 month and 24 month financial metrics have lapsed and the metrics have
not been met. Based upon the events that have transpired, and the lack of progress toward the financial metrics, the Company demanded
that the recipients of the shares of Halo Common Stock give effect to both clawback provisions and immediately forfeit back all
of the Halo shares issued to such recipients – an aggregate of 21,200,000 shares. Additionally, the Company has instructed
the Company’s transfer agent to cancel all of the shares of Company Common Stock issued pursuant to the Agreement. To date,
the Company’s transfer agent has refused to cancel the shares without either (i) presentation of the physical certificates
to the transfer agent, or (ii) a court order requiring the transfer agent to cancel. At the time of issuing these consolidated
financial statements, the Company has been unsuccessful in its attempts to procure the physical certificates for presentment to
the transfer agent, and the Company has yet to secure a court order requiring the transfer agent to cancel the certificates. Accordingly,
the 21,200,000 shares issued are still outstanding at June 30, 2013.
The Company’s
total
common shares outstanding totaled 66,364,083 at June 30, 2013.
Preferred Stock
In
connection with the merger, the Company authorized 1,000,000 shares of Series Z Convertible Preferred Stock with a par value of
$0.01 per share (the “Series Z Convertible Preferred”).
The number of shares of Series Z Preferred Stock may
be decreased by resolution of the Board; provided, however, that no decrease shall reduce the number of Series Z Preferred Shares
to less than the number of shares then issued and outstanding. In the event any Series Z Preferred Shares shall be converted,
(i) the Series Z Preferred Shares so converted shall be retired and cancelled and shall not be reissued and (ii) the authorized
number of Series Z Preferred Shares set forth in this section shall be automatically reduced by the number of Series Z Preferred
Shares so converted and the number of shares of the Corporation’s undesignated Preferred Stock shall be deemed increased
by such number. The Series Z Convertible Preferred is convertible into common shares at the rate of 45 shares of common per one
share of Series Z Convertible Preferred. The Series Z Convertible Preferred has liquidation and other rights in preference to all
other equity instruments. Simultaneously upon conversion of the remaining Series A Preferred, Series B Preferred, and Series C
Preferred and exercise of any outstanding stock options issued under the HGI 2007 Stock Plan into Series Z Convertible Preferred,
they will automatically, without any action on the part of the holders, be converted into common shares of the Company. Since the
merger, in connection with the exercise of stock options into common stock and converted Series A Preferred, Series B Preferred
and Series C Preferred as noted above, 82,508
shares of Series Z Convertible Preferred were automatically
authorized and converted into shares of the Company’s common stock leaving 917,492 shares of authorized undesignated Preferred
Stock in the Company in accordance with the Series Z Convertible Preferred certificate of designation.
As of June 30, 2013,
there were 82,508 shares of Series Z Preferred authorized with zero shares issued and outstanding.
The Company authorized
175,000 shares of Series X Convertible Preferred Stock with a par value of $0.01 per share (the “Series X Preferred”).
The number of shares of Series X Preferred may be decreased by resolution of the Board; provided, however, that no decrease shall
reduce the number of Series X Preferred to less than the number of shares then issued and outstanding. In the event any Series
X Preferred Shares shall be redeemed, (i) the Series X Preferred so redeemed shall be retired and cancelled and shall not be reissued
and (ii) the authorized number of Series X Preferred Shares set forth in this section shall be automatically reduced by the number
of Series X Preferred Shares so redeemed and the number of shares of the Corporation's undesignated Preferred Stock shall be deemed
increased by such number. The Series X Preferred Shares rank senior to the Company’s common stock to the extent of $10.00
per Series X Preferred Shares and on a parity with the Company’s common stock as to amounts in excess thereof. The holders
of Series X Preferred shall not have voting rights. Holders of the Series X Preferred shall be entitled to receive, when and as
declared by the board of directors, dividends at an annual rate of 9% payable in cash when declared by the board. Holders of Series
X Preferred have a liquidation preference per share equal to $10.00. The liquidation preference was $1,436,770 as of June 30, 2013.
As of June 30, 2013, there were 143,677 shares authorized with 143,677 shares issued and outstanding. Of the 143,677 shares issued
and outstanding, 53,677 shares were related to the 2010 conversion from notes payable due to related parties. The remaining 90,000
shares were issued for cash consideration.
In April 2012, the Company
authorized 100,000 shares of Series E Convertible Preferred Stock (the “Series E Preferred”) with a par value of $0.001
per share, at ten dollars ($10.00) per share with a conversion rate of fifty (50) shares of the Company’s common stock for
one share of Series E Preferred. The number of shares of Series E Preferred may be decreased by resolution of the Board; provided,
however, that no decrease shall reduce the number of Series E Preferred to less than the number of shares then issued and outstanding.
In the event any Series E Preferred Shares shall be converted, (i) the Series E Preferred so converted shall be retired and cancelled
and shall not be reissued and (ii) the authorized number of Series E Preferred Shares set forth shall be automatically reduced
by the number of Series E Preferred Shares so converted and the number of shares of the Corporation's undesignated Preferred Stock
shall be deemed increased by such number. The Series E Preferred Shares rank senior to the Company’s common stock to the
extent of $10.00 per Series E Preferred Shares and on a parity with the Company’s common stock as to amounts in excess thereof.
The holders of Series E Preferred shall not have voting rights. Holders of the Series E Preferred shall be entitled to receive,
when and as declared by the board of directors, dividends at an annual rate of 9% payable in cash or common stock when declared
by the board. Holders of Series E Preferred have a liquidation preference per share equal to $10.00. The liquidation preference
was $700,000 as of June 30, 2013. Each share of Series E Preferred, if not previously converted by the holder, will automatically
be converted into common stock at the then applicable conversion rate after thirty six months from the date of purchase. As of
June 30, 2013, there were 70,000 shares issued and outstanding with total cash consideration of $700,000, convertible into 3,500,000
shares of the Company’s common stock.
The HGI Series A Convertible
Preferred Stock (the “Series A Preferred”) has a par value of $0.001 per share and has a liquidation preference of
the greater of (a) the consideration paid to the Company for such shares plus all accrued but unpaid dividends, if any or (b) the
per share amount the holders of the Series A Preferred would be entitled to upon conversion, as defined in the Series A Preferred
certificate of designation. The liquidation preference was $629,376, of which $69,877 is an accrued (but undeclared) dividend as
of June 30, 2013. Holders of the Series A Preferred are entitled to receive, if declared by the board of directors, dividends at
a rate of 8% payable in cash or common stock of the Company. The Series A Preferred is convertible into the Company’s common
stock at a conversion price of $1.25 per share. The Series A Preferred is convertible, either at the option of the holder or the
Company, into shares of the Company’s Series Z Convertible Preferred Stock, and immediately, without any action on the part
of the holder, converted into common stock of the Company. The Series A Preferred is redeemable at the option of the Company at
$1.80 per share prior to conversion. As of June 30, 2013, there have been 127,001 shares of Series A Preferred converted or redeemed.
The Series A Preferred does not have voting rights. The Series A Preferred ranks senior to the following capital stock of the Company:
(a) Series B Preferred, and (b) Series C Preferred.
The HGI Series B Convertible
Preferred Stock (the “Series B Preferred”) has a par value of $0.001 per share and has a liquidation preference of
the greater of (a) the consideration paid to the Company for such shares plus all accrued but unpaid dividends, if any or (b) the
per share amount the holders of the Series B Preferred would be entitled to upon conversion. The liquidation preference was $517,336,
of which $57,424 is an accrued (but undeclared) dividend as of June 30, 2013. Holders of the Series B Preferred are entitled to
receive, if declared by the board of directors, dividends at a rate of 8% payable in cash or common stock of the Company. The Series
B Preferred is convertible into the Company’s common stock at a conversion price of $1.74 per share. The Series B Preferred
is convertible, either at the option of the holder or the Company, into shares of the Company’s Series Z Convertible Preferred
Stock, and immediately, without any action on the part of the holder, converted into common stock of the Company. The Series B
Preferred is redeemable at the option of the Company at $2.30 per share prior to conversion. As of June 30, 2013, there have been
270,044 shares of Series B Preferred converted or redeemed. The Series B Preferred does not have voting rights. Series B Preferred
ranks senior to the following capital stock of the Company: the Series C Preferred.
The HGI Series C Convertible
Preferred Stock (the “Series C Preferred”) has a par value of $0.001 per share and has a liquidation preference of
the greater of (a) the consideration paid to the Company for such shares plus all accrued but unpaid dividends, if any or (b) the
per share amount the holders of the Series C Preferred would be entitled to upon conversion. The liquidation preference was $348,826,
of which $38,826 is an accrued (but undeclared) dividend as of June 30, 2013. Holders of the Series C Preferred are entitled to
receive, if declared by the board of directors, dividends at a rate of 8% payable in cash or common stock of the Company. The Series
C Preferred is convertible into the Company’s common stock at an initial conversion price of $2.27 per share. The Series
C Preferred is convertible, either at the option of the holder or the Company, into shares of the Company’s Series Z Convertible
Preferred Stock, and immediately, without any action on the part of the holder, converted into common stock of the Company. The
Series C Preferred is redeemable at the option of the Company at $2.75 per share prior to conversion. As of June 30, 2013, there
have been 28,000 shares of Series C Preferred converted or redeemed. The Series C Preferred does not have voting rights. Series
C Preferred ranks senior to the following capital stock of the Company: None.
The Company had issued
and outstanding at June 30, 2013,
372,999 shares of Series A Preferred, 229,956 shares of Series
B Preferred, and 124,000 shares of Series C Preferred, all with a par value of $0.001.
NOTE 18. SUBSEQUENT EVENTS
Subsequent
to June 30, 2013, the Company received $65,000 of the remaining $65,000 promissory note receivable (discussed in Note 1). The
promissory note receivable has been paid in full as of August 13, 2013.
There
were no other subsequent events to disclose.