The accompanying notes are an integral part of these consolidated financial statements.
The accompanying notes are an integral part of these consolidated financial statements.
The accompanying notes are an integral part of these consolidated financial statements.
The accompanying notes are an integral part of these consolidated financial statements.
Notes To Consolidated Financial Statements
March 31, 2014
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 7668 Warren Parkway, Suite 350, Frisco, Texas 75034 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”), and Halo Benefits, Inc. (“HBI”). 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 and field service
providers, lenders, and mortgage backed securities holders. HBI was originally established as an association benefit services
to customers throughout the United States and although a non-operating entity, remains a subsidiary due to its historical net
operating loss carryforward.
In August 2013, the Company
and its office lessor agreed to a final settlement whereby it would vacate its previously leased office facilities in Allen, Texas.
In doing so, the final settlement obligation of $254,023 is to be paid over twelve equal installments beginning in September 2013
through August 2014. This balance is included in the current portion of deferred rent. The final settlement released
previously
recognized rent expense which was included in accounts payable and deferred rent. The release of these obligations was credited
to rent expense which is included in general and administrative expense on the consolidated statements of operations. Additionally,
the final settlement included requirements that (1) the office lessor retain the Company’s $45,000 deposit and (2) the Company
sell certain furniture and equipment in the office.
Both
the cost of the furniture
and equipment and the related accumulated depreciation have been removed from the respective accounts, with the resulting income
statement impact being expensed in general and administrative expenses on the
consolidated
statements of operations.
In October 2013, the Company
entered into a senior unsecured convertible promissory note agreement of $1,500,000. The terms of the note include an interest
rate of 15% with a maturity date of October 10, 2016. See further discussion in Note 10 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 March 31, 2014, and for the three months ended March 31, 2014 and 2013, 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 months ended March 31, 2014,
are not necessarily indicative of the results that may be expected for the year ending December 31, 2014. 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 note sales, 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 March 31, 2014, the Company’s accounts receivable are made
up of the following percentages; HAM at 83% and HPA at 17%.
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 provides 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 March 31, 2014 and December 31, 2013, respectively;
|
|
Balance
at Beginning of Period
|
|
Increase
in the Provision
|
|
Accounts
Receivable
Write-offs
|
|
Balance
at End of Period
|
Three
Months ended March 31, 2014
|
|
|
|
|
|
|
|
|
Allowance
for doubtful accounts
|
|
$
|
375,665
|
|
|
$
|
62
|
|
|
$
|
62
|
|
|
$
|
375,665
|
|
Year
ended December 31, 2013
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Allowance
for doubtful accounts
|
|
$
|
375,665
|
|
|
$
|
1,197
|
|
|
$
|
1,197
|
|
|
$
|
375,665
|
|
As of March 31, 2014,
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 March 31, 2014, 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. For the three month
period ended March 31, 2014 and 2013, there were 4,835,127 and 5,563,777 shares, respectively, underlying potentially dilutive
convertible preferred stock and stock options outstanding. These shares were not included in dilutive weighted average shares
outstanding for the three months ended March 31, 2014 and 2013 because their effect is anti-dilutive due to the Company’s
reported 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 and derivative liabilities.
Principles of Consolidation
The consolidated financial
statements of the Company for the three months ended March 31, 2014 include the financial results of HCI, HGI, HBI, HPA and HAM.
All significant intercompany transactions and balances have been eliminated in consolidation.
The consolidated financial
statements of the Company for the three months ended March 31, 2013 include the financial results of HCI, HGI, HGM, HBI, HSIS,
HCIS, HPA, HAM, and EHF. 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.
Deposits and Other Assets
At March 31, 2014, deposits
and other assets was $33,333 ($40,000 in total origination fees offset by $6,666 in accumulated amortization) for the senior unsecured
promissory note discussed in Note 10. At December 31, 2013, deposits and other assets was $39,589, which included $36,667 in deferred
origination costs ($40,000 in total origination fees offset by $3,333 in accumulated amortization) for the senior unsecured promissory
note, with the remaining $2,922 as a prepaid vendor expense. The fees are to be amortized over the life of the promissory note.
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, 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 months ended March 31, 2014 and 2013.
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. 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 months ended March 31, 2014 or 2013.
The Company incurred no
penalties or interest for taxes for the three months ended March 31, 2014 or 2013. The Company is subject to a three year statute
of limitations by major tax jurisdictions for the fiscal years ended December 31, 2010, 2011 and 2012. The Company files income
tax returns in the U.S. federal jurisdiction.
Deferred Rent
As discussed in
Note 1, in August 2013, the Company and its office lessor agreed to a final settlement whereby it would vacate its
previously leased office facilities. In doing so, the final settlement obligation of $254,023 is to be paid over twelve
equal installments beginning in September 2013 through August 2014. At March 31, 2014 and December 31, 2013, the $105,843
and $169,349 balance, respectively, is included in current portion of deferred rent.
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 months ended March 31, 2014, the FDIC insured deposit accounts up
to $250,000. At March 31, 2014, 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.
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.
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
|
|
|
March 31,
|
|
|
2014
|
|
2013
|
Revenue:
|
|
|
|
|
|
|
|
|
Halo Asset Management
|
|
$
|
302,517
|
|
|
$
|
324,616
|
|
Halo Portfolio Advisors
|
|
|
289,771
|
|
|
|
532,069
|
|
Other
|
|
|
—
|
|
|
|
28,532
|
|
Net revenue
|
|
$
|
592,288
|
|
|
$
|
885,217
|
|
|
|
|
|
|
|
|
|
|
Operating income (loss):
|
|
|
|
|
|
|
|
|
Halo Asset Management
|
|
$
|
39,613
|
|
|
$
|
(25,562
|
)
|
Halo Portfolio Advisors
|
|
|
45,983
|
|
|
|
91,616
|
|
Other
|
|
|
—
|
|
|
|
(83,215
|
)
|
Less: Corporate expenses (a)
|
|
|
(521,332
|
)
|
|
|
(502,716
|
)
|
Operating income (loss):
|
|
$
|
(435,736
|
)
|
|
$
|
(519,877
|
)
|
|
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, and property, equipment and 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. In 2014, all interest expense is included in corporate
expenses above. In 2013, interest expense of $84,000 (majority of 2013 balance in “Other”) related to the secured
asset promissory note is included above in “Other”, with all remaining $20,158 of the $104,158 interest expense in
the consolidated statements of operations included in corporate expenses above.
For
the three months ended March 31, 2014 and 2013, 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 is actively
seeking growth of its asset units under management, both organically and via new client relationships. 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. 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
$11,036,519 as of March 31, 2014. However, of the accumulated deficit, $2,110,748 of expense was incurred as stock-based compensation,
$547,973 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 $3,844,240 total of these non-cash retained earnings reductions represents 35% of the total deficit balance. 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 March 31, 2014 and December 31, 2013, respectively:
Computers and purchased software
|
|
$
|
149,557
|
|
|
$
|
149,557
|
|
Furniture and equipment
|
|
|
235,515
|
|
|
|
235,515
|
|
|
|
|
385,072
|
|
|
|
385,072
|
|
Less: accumulated depreciation
|
|
|
(291,097
|
)
|
|
|
(276,724
|
)
|
|
|
$
|
93,975
|
|
|
$
|
108,348
|
|
Depreciation totaled $14,373
and $14,812 for the three months ended March 31, 2014 and 2013
, respectively.
NOTE
7. INVESTMENTS IN PORTFOLIO ASSETS
In December 2010, Equitas
Housing Fund, LLC (“EHF”), a subsidiary of the Company, 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 were 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 March 31, 2014, 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 $476,190
in accrued liabilities at March 31, 2014. Included in this accrual is $287,871 in accrued interest ($216,762 of this balance is
related to interest on the secured asset promissory note discussed in more detail in Note 12) and $188,319 in deferred compensation
to several senior management personnel. The Company had $345,524 in accrued liabilities at December 31, 2013. Included in this
accrual is $63,926 in deferred compensation to multiple senior management personnel, $277,042 in accrued interest ($218,568 of
this balance is related to interest on the secured asset promissory note discussed in Note 12), and $4,556 in other.
NOTE
9. NOTES PAYABLE TO RELATED PARTIES
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 balloon payment at maturity in September 2014. As of December 31, 2013, the 2011 Related Party Note was $182,379, all of which is included
in current portion of notes payable to related parties. As of March 31, 2014, the 2011 Related Party Note was $179,973, 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 December 31, 2013, the 2011
Consolidated Related Party Note balance was $270,180, of which $75,853 is included in current portion of notes payable to related
parties. As of March 31, 2014, the 2011 Consolidated Related Party Note balance was $267,730, of which $71,173 is included in
current portion of notes payable to related parties.
As of December 31, 2013,
a Company director had an outstanding advance to the Company of $50,000 for short term capital. During the three months ended
March 31, 2014, the director advanced an additional $300,000 for working capital. As of March 31, 2014, the outstanding advance
balance was $350,000. 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, and as such the entire balance is included in current portion of notes payable
to related parties. The advance accrues interest at a rate of 15%.
As of December 31, 2013,
the Company’s President and Chief Legal Officer had an outstanding advance balance of $30,000 for short term capital. During
the three months ended March 31, 2014, the President advanced an additional $40,000 for working capital. As of March 31, 2014,
the outstanding advance balance was $70,000. At the time of the filing of these consolidated financial statements, the Company
and the President had not finalized a maturity date for the advance repayment, and as such the entire balance is included in current
portion of notes payable to related parties. The advance accrues interest at a rate of 15%.
As of December 31, 2013,
the Company’s CEO and Director of the Board had an outstanding advance balance of $50,000 for short term capital. During
the three months ended March 31, 2014, the CEO advanced an additional $65,000 for working capital. As of March 31, 2014, the outstanding
advance balance was $115,000. At the time of the filing of these consolidated financial statements, the Company and the CEO had
not finalized a maturity date for the advance repayment, and as such the entire balance is included in current portion of notes
payable to related parties. The advance accrues interest at a rate of 15%.
As of March 31, 2014,
the notes payable to related party balance totaled $982,703, of which $786,146 is included in current portion of notes payable
to related parties in the consolidated financial statements. As of December 31, 2013, the notes payable to related party balance
totaled $582,559, of which $388,232 is included in current portion of notes payable to related parties in the consolidated financial
statements.
The Company incurred $21,750
and $8,093 of interest expense to directors, officers, and other related parties during the three months ended March 31, 2014
and 2013, respectively. Accrued interest due to directors and other related parties totaled $90,088 at March 31, 2014, of which
$71,110 is included in accrued and other current liabilities. Accrued interest due to directors and other related parties totaled
$81,160 at December 31, 2013, of which $58,149 is included in accrued and other current liabilities at December 31, 2013.
NOTE 10. NOTES PAYABLE
In October 2013, the Company
entered into a senior unsecured convertible promissory note agreement of $1,500,000. The terms of the note include an interest
rate of 15% with a maturity date of October 10, 2016. The Company, although not required, is entitled to capitalize any accrued
interest into the outstanding principal balance of the note up until maturity. At the maturity date, all unpaid principal and
accrued interest is due. As part of the promissory note, the Company was required to pay origination fees and expenses associated
with this note agreement (discussed in Other Assets Note 2), pay the subordinated debt originated in January 2010 (debt discussed
in Note 11), pay $375,000 to a related party note held by a director (discussed in Note 9 above), with the remaining use of proceeds
for general corporate purposes including payment of deferred compensation to several management personnel. Additionally, the noteholder
has the right, but not the obligation, to convert up to $1,000,000 of the principal balance of the note into common shares of
the Company. The $1,000,000 maximum conversion ratio would entitle the noteholder to a maximum total of 10% of the then outstanding
common stock of the Company, calculated on a fully diluted basis. Any conversion of the principal amount of this note into common
stock would effectively lower the outstanding principal amount of the note. As of March 31, 2014, the notes payable balance was
$1,610,751, which includes capitalized interest of $110,751. As of December 31, 2013, the notes payable balance was $1,551,828,
which includes capitalized interest of $51,828.
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. In October 2013, the company entered into a senior unsecured convertible
promissory note (discussed in Note 10) which required the use of those financing proceeds to pay down the subordinated debt. As
such, as of December 31, 2013, the remaining balance was $0.
As part of the Subordinated
Offering, the 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 price assumed
a cumulative debt raise of $750,000.
The Company
follows 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
December 31, 2013, the balance of the debt discount was $0 (fully amortized). Subsequent changes to the marked-to-market
value of the derivative liability will be recorded in earnings as derivative gains and losses. As of March 31, 2014, there
were 112,000 warrants outstanding with a derivative liability of $12,757. As of December 31, 2013, there were 112,000
warrants outstanding with a derivative liability of $15,772. The $3,015 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 $0.11 per share using the following
assumptions:
|
|
March 31, 2014
|
Risk-free rate
|
|
|
0.91
|
%
|
Expected volatility
|
|
|
588.90
|
%
|
Expected remaining life (in years)
|
|
|
3.00
|
|
Dividend yield
|
|
|
0.00
|
%
|
During August 2012, the
Company entered into an additional $25,000 subordinated term note with a then 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 March 31, 2014, the remaining balance of this note totals $19,583 of which $5,000 is included in current portion of subordinated
debt. As of December 31, 2013, the remaining balance of this note totals $21,250 of which $5,417 is 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.
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 originally
due December 31, 2013. The maturity date has been extended to December 31, 2014. 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. As of March 31,
2014, the accrued interest balance was $216,762. As of December 31, 2013, the accrued interest balance was $218,568. For the three
months ended March 31, 2014 and 2013, the Company incurred
$5,419
and $84,000 respectively,
in interest expense on the note.
NOTE 13. RELATED PARTY TRANSACTIONS
For the three months
ended March 31, 2014 and 2013, HAM recognized monthly servicing fee revenue totaling $103,575 and $104,278, respectively,
from an entity that is an affiliate of the Company.
For the three months ended
March 31, 2014 and 2013, the Company incurred interest expense to related parties (See Note 9).
NOTE 14. INCOME TAXES
For the three months
ended March 31, 2014 and 2013, the effective tax rate of 0% 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 March 31, 2014, 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 $5,200,000 available for federal income tax purposes, which
expire from 2024 to 2033. Separately, because of the changes in ownership that occurred on June 30, 2004 and September 30, 2009,
prior to GVC merging with HCI, and based on the Section 382 Limitation calculation, the Company will be allowed approximately
$6,500 per year of GVC Venture Corp.’s federal NOLs generated prior to June 30, 2004 until they would otherwise expire.
The Company would also be allowed approximately $159,000 per year of GVC Venture Corp.’s federal NOLs generated between
June 30, 2004 and September 30, 2009 until they would otherwise expire.
NOTE 15. COMMITMENTS AND CONTINGENCIES
The Company leases
various office equipment, each under a non-cancelable operating lease providing for minimum monthly rental payments. In
relation to its office facilities, as discussed in Note 1, effective August 31, 2013 the Company and its office lessor agreed
to a final settlement whereby it would vacate its previously leased office facilities in Allen, Texas. In doing so, the final
settlement obligation of $254,023, all of which was expensed during 2013, is to be paid over twelve equal installments
beginning in September 2013 through August 2014. This balance is included in current portion of deferred rent. As of March
31, 2014, the Company has not entered into any additional office lease whereby it is contractually committed. The
Company currently pays for its office space on a month to month basis, and will continue to do so for the foreseeable
future.
Future minimum rental
obligations, including its previous office lease space, as of March 31, 2014 are as follows:
Years Ending December 31:
|
|
|
|
|
|
2014
|
|
|
$
|
125,920
|
|
2015
|
|
|
|
14,601
|
|
Thereafter
|
|
|
|
—
|
|
Total minimum lease commitments
|
|
|
$
|
140,521
|
|
For
the three months ended March 31, 2014 and 2013, the Company incurred facilities rent expense totaling $29,742 and $107,321, 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 was 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 and added a new “control person”
claim which was not subject to the no evidence Motion for Summary Judgment heard on August 9, 2013. On September 25, 2013, Defendants
no evidence Motion for Summary Judgment was granted in its entirety. Defendants subsequently filed a no evidence Motion for Summary
Judgment on the final remaining “control person” claim which was heard before the court on October 21, 2013. On December
18, 2013 a final Order Granting Defendant’s Second No-Evidence Motion of Final Summary Judgment was signed. The Plaintiff’s
subsequently filed a motion for new trial. Following a hearing, the Plaintiff’s motion for new trial was denied by operation
of law. The Plaintiff’s Filed a Notice of Appeal on March 11, 2014.
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 in part and the remaining
matter remains 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 March 31, 2014, 438,300 option
shares have been exercised. Total stock options outstanding as of March 31, 2014 total 486,500. The weighted average
remaining contractual life of the outstanding options at March 31, 2014 is approximately 2.5 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, 2012
|
|
|
|
1,215,150
|
|
|
$
|
0.01
– 1.59
|
|
|
$
|
0.97
|
|
|
Granted
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
Exercised
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
Canceled
|
|
|
|
(533,450
|
)
|
|
|
0.01
– 0.94
|
|
|
|
0.93
|
|
|
Outstanding
at December 31, 2013
|
|
|
|
681,700
|
|
|
$
|
0.01 – 1.59
|
|
|
$
|
1.00
|
|
|
Granted
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
Exercised
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
Canceled
|
|
|
|
(195,200
|
)
|
|
|
0.94
– 1.59
|
|
|
|
0.96
|
|
|
Outstanding
at March 31, 2014
|
|
|
|
486,500
|
|
|
$
|
0.01 – 1.59
|
|
|
$
|
1.02
|
|
All stock options granted
under the Plan and as of December 31, 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 December 31, 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 March 31, 2014, 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 March 31, 2014, 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 March 31, 2014.
The Company’s total
common shares outstanding totaled 66,364,083 at March 31, 2014.
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 March 31, 2014, 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 March 31,
2014. As of March 31, 2014, 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 March 31, 2014. 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
March 31, 2014, 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 $668,689, of which $109,191 is an accrued (but undeclared) dividend
as of March 31, 2014. 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 March 31, 2014, 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
$549,770, of which $89,858 is an accrued (but undeclared) dividend as of March 31, 2014. 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 March 31, 2014, 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
$370,640, of which $60,640 is an accrued (but undeclared) dividend as of March 31, 2014. 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 March
31, 2014, 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 March 31, 2014, 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
There were no subsequent
events to disclose.