Form 10-K for MEDBOX, INC.
Our business involves contracting with business owners for our services and the sale of marijuana-related products such as our Medbox dispensing system and our line of tabletop medical vaporizers. We expect to transition to the sale of a portable line of vaporizers in the second quarter of 2015.
We began our business model with entering into one-time consulting agreements to help our clients obtain a license to sell or cultivate marijuana and to assist them with the build out of a location for their business, including the sale to the client of a Medbox dispensing system, pursuant to a consulting agreement that we refer to as our “Turn-Key Business Establishment Agreement”. We are now transitioning to a recurring revenue model, whereby we will continue to enter into Turn-Key Business Establishment Agreements, together with additional revenue generating agreements for providing ongoing consulting to the established business in the areas of regulatory compliance, security, operations and other matters that leverage our expertise and knowledge in this industry. We also intend to retain the rights to manage business locations on a day-to-day basis and then seek to assign such rights to third parties, in return for recoupment of a percentage of the management fee to operate the business. Our clients establish dispensaries for the sale of marijuana for medical use or retail operations for the sale of marijuana for recreational use or cultivation centers for the cultivation of marijuana. Historically, we have generated revenue from various sources on a “one-time basis” for services that we provide to clients in helping them create, license, build out and open dispensaries and cultivation centers. Our discussion of our result of operations is based on our prior business model.
The following discussion should be read in conjunction with the consolidated financial statements and related notes provided in Item 8 “Financial Statements and Supplementary Data” in this Annual Report on Form 10-K.
Overview of Results
The Company reported a consolidated net loss of $16,541,334 for the year ended December 31, 2014, an increase of $12,749,894 compared to a loss of $3,791,440 for the same period of 2013. This was primarily due to a few key factors related to a reduction in revenue, an increase in non-cash stock based compensation, an increase in interest expenses due to use of convertible debentures carrying a high financing cost, an increase in expenses related to being a public company and costs associated with the SEC and Department of Justice investigations, increased costs related to pursuing new licenses in new markets, costs of re-valuing slow moving inventory of the old style vaporizers and a slight increase in sales and marketing expenses.
During 2014, the Company hired a new CEO and CFO and reconstituted its Board of Directors. In an effort to attract new talent to management and the Board of Directors, the Company introduced a new stock compensation plan that added $4.4 million to operating costs.
Additionally, the Company’s revenue model is significantly different in 2014 as compared to 2013. This difference is mainly due to the fact that the Company is moving away from the business model of obtaining licenses for clients for a one-time, upfront fee. The Company is in the process of modifying its business model to provide ongoing management and support services for clients so that consulting contracts would continue over a longer period. During our transition period to a new business model, expenses to secure new contracts and licenses are incurred and revenue is deferred principally until new licenses are obtained and new dispensaries and cultivation centers begin operating.
The Company’s subsidiary Vaporfection International, Inc. (VII) was acquired on April 1, 2013. Accordingly, the VII expenses did not exist for the first quarter of 2013, but were included in total amounts for the year of 2014. For purposes of comparison, the VII expenses are presented as a separate line item in the management discussion and analysis section.
Revenue consisted of Medbox system sales, location build-outs fees, referral fees and consulting service fees, which are often bundled together in a single offering to clients and revenue from sales of vaporizers and accessories from
VII. For the year ended December 31, 2014 consolidated net revenues decreased by $1,432,951 compared to the same period of 2013 mostly due to a reduction in consulting and build outs revenue by $1,610,444 as offset by an increase in referral fees revenue by $203,165.
For the year For the ended year ended December 31, December 31, Revenue Description 2014 2013 Increase (Decrease) Consulting and Build-outs $ 157,200 $ 1,767,644 $ (1,610,444 ) Sale of locations and management rights, unrelated parties 175,000 150,000 25,000 Sale of territory rights, related party 75,301 75,301 VII-Product sales 85,741 144,439 (58,698 ) Referral fees 203,165 - 203,165 Gross revenues 696,407 2,062,083 (1,365,676 ) Allowances and refunds (67,275 ) - (67,275 ) Net revenues $ 629,132 $ 2,062,083 $ (1,432,951 )
The consulting and build out revenue for the year 2013 was due mostly to achievement of milestones and delivery of facilities in Arizona to our clients. The consulting revenue for the year ended December 31, 2014 decreased by $1,610,444
The Company obtained a provisional license in the State of Oregon and fully built out the location and the dispensary location there. The dispensary is expected to open in the second quarter of 2015.
Sale of locations and management rights
Revenue from the sale of locations and management rights to operate locations increased by $25,000 during the year ended December 31, 2014 as compared to the year ended December 31, 2013. This increase is due mostly to the sale of management rights in an Arizona location for $175,000. The revenue from sale of the locations for the year ended December 31, 2013 consisted of the sale of one location in Arizona for $150,000.
Sale of territories, related party
On March 28, 2014, the Company entered into a sale for exclusive rights with a related party to place the Medbox patented dispensing systems in Denver, Colorado for $500,000. This $500,000 is being recognized ratably over the five year term of the agreement, with $75,301 recognized as revenue in the twelve months ended December 31, 2014.
There was no similar revenue in the comparable period of 2013.
During the year ended December 31, 2014, the Company entered into an agreement with MJ Holdings, Inc., (the “Referral Agreement”) a publicly traded company that provides real estate financing and related solutions to licensed marijuana operators. Medbox will market MJ Holdings’ real estate financial products and offerings to its consulting clients and will refer all incoming real estate financing related opportunities to MJ Holdings (See Note 10 – Marketable securities to the Notes to our Consolidated Financial Statements in this Report for more information). Pursuant to the Referral Agreement, MJ Holdings, Inc. agreed to issue to the Company, 33,333 warrants to purchase common stock of MJ Holdings, Inc. on each month’s anniversary during the six month term of the contract. The revenue recognized for the year ended December 31, 2014 from the Referral Agreement was $203,165. There was no comparable revenue during 2013.
During the year ended December 31, 2014, the Company generated $85,741 from the sale of vaporizer products and accessories through VII. VII was acquired on April 2, 2013 and, therefore, there was no comparable income for vaporizer sales in 2013. We plan to release our new portable vaporizer product to the general public during the second quarter of 2015. We expect the new vaporizer product to restore sales volume for our subsidiary VII.
Cost of revenue includes costs incurred to obtain permits and licenses before the license is granted and the location is secured as well as costs for our dispensing systems construction and sales, location build-out, repurchases of licenses or rights from former clients that can be resold to new clients and the costs associated with operating VII which include the cost of producing vaporizers and accessories, adjustments for valuations of inventory, fulfilment activities associated with sales orders and operation of the Company’s inventory management department.
For the year ended For the year ended Increase Costs of Revenue December 31, 2014 December 31, 2013 (Decrease) Cost of inventory and build-outs $ 884,958 $ 2,161,909 $ (1,276,951 ) New markets development costs 1,990,815 276,468 1,714,347 Write off of vaporizer inventory 329,154 - 329,154 Charge for abandoned site 140,000 - 140,000 Charges from escrow deposits 235,757 - 235,757 VII-Product cost 215,967 222,372 (6,405 ) Total costs of revenue $ 3,796,651 $ 2,660,749 $ 1,135,902
Total costs of inventory and build-outs decreased by $1,276,951 during the year ended December 31, 2014 as compared to the same period of 2013. The decrease was due mainly to the completion of numerous projects in Arizona during 2013. We did not have comparable project completions in 2014.
New markets development costs
The decrease in cost of inventory and build outs from 2013 to 2014 was totally offset by an increase of $1,714,347 in costs associated with the pursuit of licenses in the States of Washington, Nevada and Illinois as result of new legislation changes there. After obtaining final approvals, the Company will have to invest additional funds to bring locations in those states to the level of compliance required by the applicable state and/or city and to perform the interior build-out.
The Company incurred costs of $215,967 for the year ended December 31, 2014 associated with VII which included the cost of producing vaporizers and accessories, fulfilment activities associated with sales orders, and the operation of the Company’s purchasing department. As previously described, this amount cannot be directly compared to the ended December 31, 2013 due to the fact that VII was acquired on April 2, 2013.
Write off of vaporizer inventory
During the third quarter of 2014, the Company wrote down slow moving, older models of its vaporizer inventory with a charge to cost of revenue of $329,154.
Charge for abandoned site
During the year ended December 31, 2014, due to unfavorable terms demanded by the sellers to extend the escrow and closing date the Company allowed the escrows to expire on three agreements with an aggregate purchase price of $3,195,000 and had to forfeit $140,000 in earnest money.
Charges from escrow deposits
During 2014, the Company entered into numerous real estate contracts to secure locations during the licensing process. The contracts allow the Company to demonstrate to licensing authorities that the locations are available for use as a dispensary or cultivation location. The contracts are generally structured with an escrow deposit, a deferred closing until a license is granted and periodic withdrawals from the deposit to compensate the seller for holding the property off the market in escrow during the pendency of the license application. The periodic
Operating expenses consist of all other costs incurred during the period other than cost of revenue. Operating expenses increased by $7,089,385 during year ended December 31, 2014 as compared to the year ended December 31, 2013. This was primarily due to an increase of $6,652,770 in general and administrative costs, further described below.
Sales and Marketing expenses
Sales and marketing expenses include public relations and promotion, lobbying, purchased advertising, travel and entertainment and outside consulting services for sales and marketing and sales lead generation. Sales and marketing expenses increased by $269,244 during the year ended December 31, 2014 compared to the year ended December 31, 2013 principally due to an increase in VII sales and marketing expenses related to product promotions and lobbying in order to promote the Company in the states/markets of interest.
Research and development
Research and development consists of engineering work done on the software enhancements of the Medbox, additional research on vaporizers, and patent-related expenses. Our research and development expenses for the year ended December 31, 2014 increased by $167,371 as compared to the year ended December 31, 2013. The increase is due to the Company’s investments in developing the new vaporizer, additional investment in development of new tracking technologies for cultivation facilities that we intend to sell to our clients as a package with their consulting agreements, upgrading the point-of-sale system and software for new generations of the dispensing machines, as well as for patent attorneys fees to manage and apply for patents to protect the Company’s intellectual property.
General and administrative
General and administrative expenses include costs of being a public company, legal, lobbying, accounting, payroll, consulting, rent and other costs. The Company’s general and administrative expenses increased by $6,652,770 for the year ended December 31, 2014 as compared to year ended December 31, 2013.
The increase is primarily due to the introduction in 2014 of the Company’s new stock-based compensation plan for executive officers and directors with the related cost of $4,415,799. Additional reasons for the increase include higher costs associated with being a public company, which totaled $517,653 for the year ended December 31, 2014, an increase of $1,020,124 in legal costs due to the SEC and Department of Justice investigation into the Company’s financial reporting, related party transactions and other matters (see Note 19 to the Notes to our Consolidated Financial Statements in this Report for more information) and an increase in employee and independent contractors costs of $426,920 as the Company added staff to build infrastructure and support future growth, as well as additional expenses of $278,952 related to warrants settlement with various previous owners of VII.
Other Income (Expense)
Other income (expense) swung from income of $6,905 to expense of $3,088,751 for the year ending December 31, 2014, an increase of $3,095,656. This is primarily due to expense caused by a change in fair value of derivative liabilities of $1,805,990 related to the new convertible notes and the interest charge from the convertible notes payable in the amount of $1,282,761. The convertible notes payable funded in the third quarter of 2014 and, accordingly, there are no corresponding charges in 2013.
As a result of the factors set forth above, our net loss increased by $12,749,894 to $16,541,334 for the year ended December 31, 2014 compared to $3,791,440 for the year ended December 31, 2013.
Liquidity and Capital Resources
As of December 31, 2014, the Company had cash on hand decrease by $66,821 to $101,182 as compared to cash on hand of $168,003 on December 31, 2013. This was due to the net loss and cash used in operating activities of $6,319,400 which was financed by stock sale proceeds of $2,442,859 and net proceeds from issuance of convertible notes payable of $3,475,000.
Cash Flow During the year ended December 31, 2014 cash was primarily used to fund operations and in the process of pursuing license applications. See below for additional discussion and analysis regarding cash flow. For the year ended December 31, Cash flow 2014 2013 Net cash used in operating activities $ (6,319,400 ) $ (3,743,397 ) Net cash used in investing activities (418,797 ) (1,499,451 ) Net cash provided by financing activities 6,671,376 4,383,949 Net increase (decrease) in cash $ (66,821 ) $ (858,899 )
The cash flows used in operating activities increased by $2,576,003 for the year ended December 31, 2014 as compared to the year ended December 31, 2013. This was primarily due to the increase in net loss of $12,749,894 offset by the non-cash charge of $4,415,799 for the Company’s stock-based compensation awards, non-cash change in fair value of derivative liability of $1,805,990 and amortization of the debt discount related to convertible debentures of $935,290 an increase in accounts payable of $2,117,217, an increase in deferred revenue of $805,394, and cash provided by customer deposits of $248,985.
Cash Flows – Investing Activities
The cash flows used in investing activities decreased by $1,080,654 for the year ended December 31, 2014 compared to the year ended December 31, 2013. This was due primarily to advances on investments of $1,250,000 during 2013, for which there were no corresponding advances during 2014. On February 8, 2013, the Company entered into an agreement with Bio-Tech Medical Software, Inc. (“Bio-Tech”) which would allow the Company to purchase 833,333 shares of common stock of Bio-Tech, representing 25% of Bio-Tech’s total issued and outstanding shares of common stock, for $1,500,000. The Company advanced $600,000 of such amount upon execution of the Bio-Tech agreement with the remaining balance of $900,000 due and payable in installments at various dates by August 25, 2013. On March 12, 2013, the Company entered into an agreement with three members of MedVend Holdings LLC (“MedVend”) whereby the Company would acquire 50% of their equity interest in MedVend. The purchase price of the equity interest was $4,100,000. The Company paid an advance of $300,000 upon execution of the contract for the right to purchase and another $300,000 was disbursed as an additional investment to MedVend. In addition, during 2014, the Company received proceeds from repayment of a note receivable in the amount of $115,000, issued in 2013.
The increase above was partially offset by a purchase of property held for resale in 2014 for $399,594.
Cash Flows – Financing Activities
The cash flows provided from financing activities increased by $2,287,427 for the year ended December 31, 2013 compared to the year ended December 31, 2013. During 2014 we raised approximately $6,671,376 including $3,475,000 from new issuance of convertible debentures net of issuance costs and $2,442,859 from the issuance of the Company’s common stock and $828,517 from the issuance of notes payable as compared to $4,383,949 raised during 2013 including $4,486,541 from the issuance of the Company’s common stock and $810,000 in capital contributed by related parties less payments of $896,285 as payments on notes payable.
Management believes that the Company’s cash balances on hand, cash flows expected to be generated from operations, proceeds from current and future expected debt issuances and proceeds from future share capital issuances will be sufficient to fund the Company’s net cash requirements through March, 2016. However, in order to execute the Company’s long-term growth strategy, which may include selected acquisitions of businesses that may bolster the expansion of the Company’s management services business, and purchases of real estate which would be used as a basis for opening and expanding retail dispensary and cultivation facilities in regulated markets, the Company will need to raise additional funds through public or private equity offerings, debt financings, or other means.
Our financial statements were prepared on a going concern basis. The going concern basis assumes that the Company will continue in operation for the foreseeable future and will be able to realize its assets and discharge its liabilities in the normal course of business. During the year ended December 31, 2014, the Company had a net loss of approximately $16.5 million, negative cash flow from operations of $6.3 million and negative working capital of $10.0 million. The Company will need to raise capital in order to fund its operations. These factors, among others, raise substantial doubt about the Company’s ability to continue as a going concern. The ability to continue as a going concern is dependent on the Company’s ability to raise additional capital and implement a business plan. The financial statements do not include any adjustments that might be necessary if the Company is unable to continue as a going concern.
During 2014, the Company closed two convertible notes payable agreements with accredited investors which yielded $3.75 million in funding for the Company. In accordance with the same convertible notes payable agreements, we anticipate receiving an additional $3.0 million from the same accredited investors in the first half of 2015, subject to the Company’s registration statement on Form S-1 to be filed with the SEC becoming effective.
The Company plans to re-file its Registration Statement on Form S-1 filed in connection with the July 2014 and September 2014 convertible notes payable agreements to include financial information from this Form 10-K on or about March 2015.
Our license backlog includes 12 provisional licenses subject to final approval by governmental authorities which may or may not lead to the release of new licenses in accordance the authorities’ stated timelines. If final licenses are granted, we will receive additional funding from customers in 2015 as a result of sales of the licenses, entering into consulting arrangements, entering into and assigning management agreement rights and from the sale of real property relating to the opening of new dispensary and cultivation locations.
After the form S-1 is declared effective, the Company is planning to conduct a road show to raise additional equity capital. The Company will continue to execute on its business model by attempting to raise additional capital through the sales of debt or equity securities or other means, however there is no guarantee that such financing will be available on terms acceptable to the Company, or at all. If the Company is unable to obtain adequate debt or equity financing, it may be forced to slow or reduce the scope of operations and expansion, and its business would be materially affected.
A change in the regulatory requirements in some states for acquiring retail dispensary and cultivation licenses has made it important for us or our clients to acquire real estate either through lease arrangements or purchase in order to secure a license. This has required the Company to spend cash for earnest deposits on various real estate location opportunities during 2014 and thereafter. The Company intends to find a partner for the acquisition of the various locations so that the Company can apply for more licenses, however, the timing of those partnerships may require the Company to acquire ownership of the underlining real estate for a period of time. This process requires significant cash outlay for the earnest money that has ranged from $10,000 to $100,000 per property.
A summary of our active real estate purchase transactions as of March 11, 2015 is as follows:
Additional rents/fees paid
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