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EX-10.13 - LETTER AGREEMENT - GILLA INC.glla_ex1013.htm
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EX-31.1 - CERTIFICATION - GILLA INC.glla_ex311.htm
EX-32.2 - CERTIFICATION - GILLA INC.glla_ex322.htm
EX-32.1 - CERTIFICATION - GILLA INC.glla_ex321.htm
EXCEL - IDEA: XBRL DOCUMENT - GILLA INC.Financial_Report.xls


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
 
FORM 10-Q
 
þ
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the quarterly period ended March 31, 2014
 
OR
 
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the transition period from _______________ to _______________
 
Commission File Number: 000-28107
 
GILLA INC.
(Exact Name of Registrant as Specified in its Charter)
 
Nevada
 
88-0335710
(State or Other Jurisdiction of Incorporation or Organization)
 
(I.R.S. Employer Identification Number)
 
112 North Curry Street, Carson City, NV
 
89703
(Address of Principal Executive Offices)
 
(Zip Code)

(416) 843-2881
Registrant’s telephone number, including area code

Not Applicable
(Former name, Former Address and Former Fiscal year, if changed since last report.)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. þ Yes  o No
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). o Yes   þ No
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
 
Large accelerated filer
o
Accelerated filer
o
Non-accelerated filer
o (Do not check if a smaller reporting company)
Smaller reporting company
þ

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). o Yes  þ No

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
 
68,318,007 Common Shares - $0.0002 Par Value as of May 20, 2014
 


 
 
 
 
 
GILLA, INC.
 
INDEX TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 
     
Page
 
PART I - Financial Information
     
         
Item 1.
Financial Statements (unaudited)
     
         
 
Condensed Consolidated Balance Sheets as of March 31, 2014 (Unaudited) and December 31, 2013 (Audited)
 
3
 
         
 
Unaudited Condensed Consolidated Statements of Operations for the Three Months Ended March 31, 2014 and 2013 and for the period from November 29, 2011 (date of inception) through March 31, 2014
 
4
 
         
 
Unaudited Condensed Consolidated Statement of Changes in Shareholders’ Deficiency for the period from November 29, 2011 (date of inception) through March 31, 2014
 
5
 
         
 
Unaudited Condensed Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2014 and 2013 and for the period from November 29, 2011 (date of inception) through March 31, 2014
 
6
 
         
 
Notes to Unaudited Condensed Consolidated Financial Statements
 
7
 
         
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operation
 
16
 
         
Item 3.
Quantitative and Qualitative Disclosures About Market Risk
 
22
 
         
Item 4.
Control and Procedures
 
22
 
         
PART II - Other Information
     
         
Item 1.
Legal Proceedings
 
23
 
         
Item 1A.
Risk Factors
 
23
 
         
Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
 
23
 
         
Item 3.
Defaults Upon Senior Securities
 
23
 
         
Item 4.
Mine Safety Disclosures
 
23
 
         
Item 5.
Other Information
 
23
 
         
Item 6.
Exhibits
 
24
 
         
SIGNATURES
 
25
 

 
 
2

 
 
Gilla Inc.
(A Development Stage Company)
Condensed Consolidated Balance Sheets
 (Amounts expressed in US Dollars)

   
March 31,
2014
(Unaudited)
   
December 31,
2013
(Audited)
 
ASSETS
 
Current assets
           
Cash and cash equivalents
  $ 42,481     $ 355,860  
Funds held in trust (note 11)
    -       20,000  
Accounts receivable
    112,382       100  
Inventory (note 7)
    118,680       90,914  
Prepaid expenses and vendor deposits
   
155,233
      15,199  
Loan receivable (note 6)
    73,084       -  
Total current assets
   
501,860
      482,073  
                 
Property and equipment (note 8)
    6,983       3,882  
Website development
    62,789       42,789  
Goodwill (note 5)
    167,422       -  
Total long term assets
   
237,194
      46,671  
                 
Total assets
  $ 739,054     $ 528,744  
                 
LIABILITIES AND SHAREHOLDERS’ DEFICIENCY
 
Current liabilities
               
Accounts payable
    387,380     $ 125,163  
Accrued liabilities
    26,212       56,838  
Accrued interest- related parties (note 15)
    4,388       78,838  
Loans from shareholders (note 9)
    458,755       20,615  
Due to related parties (note 15)
    863,027       767,426  
Note payable, related party (note 10)
    -       225,000  
Total current liabilities
    1,739,762       1,273,880  
                 
Long term liabilities
               
Convertible debentures to be issued (note 11)
    -       45,000  
Convertible debentures (note 11)
    443,361       434,514  
Total long term liabilities
    443,361       479,514  
                 
Total liabilities
    2,183,123       1,753,394  
                 
Going concern (note 3)
               
Commitments and contingencies (note 16)
               
Related party transactions (note 15)
               
                 
SHAREHOLDERS’ DEFICIENCY
 
Common stock (note 12)
               
$0.0002 par value, 300,000,000 shares authorized; 68,318,007 and 67,066,977 shares issued and outstanding as of March 31, 2014 and December 31, 2013, respectively
    13,663       13,413  
Additional paid-in capital
    1,593,887       1,285,637  
Shares to be issued (note 14)
    139,500       37,500  
Deficit accumulated during the development stage
    (3,270,444 )     (2,605,961 )
Accumulated other comprehensive income
    79,325       44,761  
Total shareholders’ deficiency
    (1,444,069 )     (1,224,650 )
                 
Total liabilities and shareholders’ deficiency
  $ 739,054     $ 528,744  

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements
 
3

 
 
Gilla Inc.
(A Development Stage Company)
Unaudited Condensed Consolidated Statements of Operations and Comprehensive Loss
 (Amounts expressed in US Dollars)
 
   
For the Three Months Ended March 31,
2014
   
For the Three Months Ended March 31,
 2013
   
For the Period from November 29, 2011
(Date of Inception) to March 31, 2014
 
                   
                   
Revenue
  $ 19,261       -     $ 96,238  
Cost of goods sold
    32,022       -       93,643  
Gross profit (loss)
    (12,761 )     -       2,595  
                         
Operating expenses
                       
Administrative
    400,599       128,861       1,447,183  
Consulting fees-related parties (note 15)
    161,828       129,675       1,083,484  
Depreciation
    700       341       2,895  
Total operating expenses
    563,127       258,877       2,533,562  
                         
Loss from operations
    (575,888 )     (258,877 )     (2,530,967 )
                         
Other income (expenses):
                       
Foreign exchange
    (20,978 )     (1,759 )     (27,738 )
Gain (Loss) on loan receivable written off (note 6)
    19,867       -       (1,538 )
Loss on acquisition of Snoke Distribution Canada Ltd.
    -       -       (292,226 )
Loss on deposit written off
    -       -       (162,371 )
Loss on settlement of debt
    (27,563 )             (27,563 )
Amortization of debt discount
    (8,847 )     -       (18,361 )
Interest expense, net
    (51,074 )     (17,691 )     (204,778 )
                         
Total other expenses
    (88,595 )     (19,450 )     (734,575 )
                         
Net loss before income taxes
    (664,483 )     (278,327 )     (3,265,542 )
Income taxes
    -       -       -  
Net loss
  $ (664,483 )   $ (278,327 )   $ (3,265,542 )
                         
Loss per weighted average number of shares outstanding (basic and diluted)
  $ (0.010 )   $ (0.004 )        
                         
Weighted average number of shares outstanding (basic and diluted)
    67,723,122       62,277,766          
                         
                         
Comprehensive loss:
                       
Net loss
  $ (664,483 )   $ (278,327 )   $ (3,265,542 )
                         
Foreign exchange translation adjustment
    34,565       12,262       79,323  
                         
Comprehensive loss
  $ (629,918 )   $ (266,065 )   $ (3,186,219 )
 
The accompanying notes are an integral part of these unaudited condensed consolidated financial statements
 
4

 
 
Gilla Inc.
(A Development Stage Company)
Unaudited Condensed Consolidated Statement of Changes in Shareholders’ Deficiency
For the period from November 29, 2011 (Date of Inception) to March 31, 2014
(Amounts expressed in US Dollars)
 
   
Common Stock
   
Additional
Paid-In
   
Shares to be
   
Deficit Accumulated During the Development
   
Accumulated Other Comprehensive
       
   
Shares
   
Amount
   
Capital
   
Issued
   
Stage
   
Income (Loss)
   
Total
 
Balance, November 29, 2011 (Date of inception)
    -     $ -     $ -     $ -     $ -     $ -     $ -  
                                                         
Issuance of shares for seed capital, November 2011 at $0.0002 per share
    25,000,000       5,000       -       -       (4,902 )     -       98  
                                                         
Foreign currency translation loss
    -       -       -       -       -       (228 )     (228 )
                                                         
Net loss
    -       -       -       -       (34,334 )     -       (34,334 )
                                                         
Balance, December 31, 2011 (audited)
    25,000,000     $ 5,000     $ -     $ -     $ (39,236 )   $ (228 )   $ (34,464 )
                                                         
Common shares issued for cash at $0.025 per share, November 2012
    400,000       80       9,920       -       -       -       10,000  
                                                         
Common shares issued for cash at $0.03 per share, November 2012
    4,366,667       873       130,127       -       -       -       131,000  
                                                         
Effect of reverse acquisition, November 21, 2012
    29,477,766       5,895       -       -       -       -       5,895  
                                                         
Common shares issued for settlement of loans at $0.05 per share, November 2012
    800,000       160       39,840       -       -       -       40,000  
                                                         
Issuance of shares and warrants at $0.05 per share as the result of a private placement, November 2012
    1,900,000       380       94,731       -       -       -       95,111  
                                                         
Issuance of shares and warrants at $0.05 per share as the result of a private placement, December 2012
    333,333       67       16,600       -       -       -       16,667  
                                                         
Foreign currency translation loss
    -       -       -       -       -       (2,846 )     (2,846 )
                                                         
Net loss
    -       -       -       -       (1,063,803 )     -       (1,063,803 )
                                                         
Balance, December 31, 2012 (audited)
    62,277,766     $ 12,455     $ 291,218     $ -     $ (1,103,039 )   $ (3,074 )   $ (802,440 )
                                                         
Common shares issued for cash at $0.035 per share, 200,000 shares were issued on September 25, 2013, 76,485 shares were issued on November 19, 2013
    276,485       55       9,622       -       -       -       9,677  
                                                         
Common shares issued for consultant fees at $0.053 on September 25, 2013
    942,784       189       49,811       -       -       -       50,000  
                                                         
Common shares issued on settlement of related party loan at fair value, 1,000,000 shares were issued on September 25, 2013, 428,571 were issued on November 19, 2013
    1,428,571       286       61,143       -       -       -       61,429  
                                                         
Loss on common shares issued on settlement of related party loan
    -       -       (11,429 )     -       -       -       (11,429 )
                                                         
Common shares issued on settlement of shareholder loan at fair value, 973,960 were issued on September 25, 2013, 417,411 were issued on November 19, 2013
    1,391,371       278       59,551       -       -       -       59,829  
                                                         
Loss on common shares issued on settlement of shareholder loan
    -       -       (11,129 )     -       -       -       (11,129 )
                                                         
Common shares issued for cash at $0.05 per share on October 8, 2013
    50,000       10       2,490       -       -       -       2,500  
                                                         
Common shares issued for consultant fees at $0.05 on November 27, 2013
    400,000       80       19,920       -       -       -       20,000  
                                                         
Common shares issued for consultant fees at $0.0583 on November 27, 2013
    300,000       60       17,440       -       -       -       17,500  
                                                         
Common share subscription for settlement of consulting fees at $0.05
    -       -       -       10,000       -       -       10,000  
                                                         
Common share subscription for settlement of consulting fees at $0.142
    -       -       -       10,000       -       -       10,000  
                                                         
Common shares subscribed to for cash at $0.035
    -       -       -       17,500       -       -       17,500  
                                                         
Embedded conversion feature of debenture
    -       -       797,000                               797,000  
                                                         
Foreign currency translation gain
    -       -       -       -       -       47,835       47,835  
                                                         
Net loss
    -       -       -       -       (1,502,922 )     -       (1,502,922 )
                                                         
Balance, December 31, 2013 (audited)
    67,066,977     $ 13,413     $ 1,285,637     $ 37,500     $ (2,605,961 )   $ 44,761     $ (1,224,650  
                                                         
Common shares issued on settlement of consulting fees at fair value on January 8, 2014
    200,000       40       37,960       (10,000 )     -       -       28,000  
                                                         
Common shares issued for cash at $0.035 on January 8, 2014
    500,000       100       17,400       (17,500 )     -       -       -  
                                                         
Common share issued for settlement of consulting fees at $0.1426 on March 28, 2014
    280,433       56       39,944       (10,000 )     -       -       30,000  
                                                         
Common share issued for settlement of consulting fees at $0.1293 on March 28, 2014
    270,597       54       34,946       -       -       -       35,000  
                                                         
Common shares to be issued to settle advertising production costs at $0.10
    -       -       -       84,500       -       -       84,500  
                                                         
Common shares to be issued for acquisition of subsidiary at $0.11
    -       -       -       55,000       -       -       55,000  
                                                         
Embedded conversion feature of debenture
    -       -       178,000       -       -       -       178,000  
                                                         
Foreign currency translation gain
    -       -       -       -       -       34,564       34,564  
                                                         
Net loss
    -       -       -       -       (664,483 )     -       (664,483 )
                                                         
Balance, March 31, 2014 (unaudited)
    68,318,007     $ 13,663     $ 1,593,887     $ 139,500     $ (3,270,444 )   $ 79,325     $ (1,444,069 )
 
The accompanying notes are an integral part of these unaudited condensed consolidated financial statements
 
5

 
Gilla Inc.
(A Development Stage Company)
Unaudited Condensed Consolidated Statements of Cash Flows
(Amounts Expressed in US Dollars)
 
   
For the Three Months
Ended
March 31,
2014
   
For the Three Months
Ended
March 31,
2013
   
For the Period from November 29, 2011
(Date of Inception) to
March 31,
2014
 
CASH FLOWS FROM OPERATING ACTIVITIES :
                 
Net loss
 
$
(664,483)
   
$
(278,327)
   
$
(3,265,542)
 
Adjustments to reconcile net loss to net cash used in operating activities:
                       
Depreciation
   
700
     
341
     
2,895
 
(Gain) loss on loan receivable written-off
   
(19,867)
     
-
     
1,538
 
Amortization of debt discount
   
8,847
     
-
     
18,361
 
Loss on acquisition Snoke Distribution Canada Ltd.
   
-
     
-
     
292,226
 
Loss on settlement of debt
   
27,563
             
27,563
 
Loss on deposit written-off
   
-
     
-
     
162,371
 
Cash acquired in acquisition of Drinan Marketing Ltd.
   
8,812
     
-
     
8,812
 
Loans to subsidiary prior to acquisition
   
(109,978)
     
-
     
(109,978)
 
Shares issued for services
   
65,000
     
-
     
172,500
 
Changes in operating assets and liabilities
                       
Accounts receivable
   
56
     
-
     
(44)
 
Funds held in trust
   
20,000
     
-
     
-
 
Prepaid expenses and vendor deposits
   
(55,658)
     
502
     
(70,987)
 
Inventory deposit
   
-
     
-
     
(162,371)
 
Inventory
   
32,708
     
-
     
(58,206)
 
Accounts payable
   
12,240
     
15,462
     
138,606
 
Accrued liabilities
   
(29,599)
     
20,341
     
46,910
 
Related party payables
   
119,753
     
131,147
     
731,603
 
Accrued interest-related party
   
(74,274)
     
-
     
3,244
 
  Net cash used in operating activities
   
(658,180)
     
(110,534)
     
(2,060,499)
 
                         
CASH FLOWS FROM INVESTING ACTIVITIES:
                       
Factoring loan
   
-
     
(19,867)
     
(19,867)
 
Development of website
   
(20,000)
     
-
     
(62,789)
 
Acquisition of property and equipment
   
-
     
-
     
(6,123)
 
  Net cash used in investing activities
   
(20,000)
     
(19,867)
     
(88,779)
 
                         
CASH FLOWS FROM FINANCING ACTIVITIES:
                       
Shareholder loan received (paid)
   
452,583
     
-
     
451,492
 
Net proceeds from loans payable
   
-
     
-
     
282,840
 
Net proceeds from related parties
   
35,525
     
121,479
     
371,615
 
Proceeds from promissory note
   
-
     
-
     
200,000
 
Repayment of related party note payable
   
(225,000)
     
-
     
(225,000)
 
Repayment of debt
   
-
     
-
     
(50,000)
 
Proceeds from sale of convertible debentures
   
80,000
     
-
     
846,000
 
Proceeds from share subscriptions
   
-
     
-
     
17,500
 
Proceeds from sale of common stock
   
-
     
-
     
264,955
 
  Net cash provided by financing activities
   
343,108
     
121,479
     
2,159,402
 
Effect of exchange rate changes on cash
   
21,693
     
4,080
     
32,357
 
                         
Net increase in cash
 
$
(313,379)
   
$
(4,842)
   
$
42,481
 
                         
Cash at beginning of year
   
355,860
     
11,444
     
-
 
                         
Cash at end of year
 
$
42,481
   
$
6,602
   
$
42,481
 
                         
Supplemental Schedule of Cash Flow Information:
                       
Cash paid for interest
 
$
96,051
   
$
-
   
$
120,466
 
Cash paid for income taxes
 
$
-
   
$
-
   
$
-
 
                         
Non cash financing activities:
                       
Common stock issued in settlement of related party and shareholder loans
 
$
-
   
$
-
   
$
138,700
 
Common stock issued for reverse acquisition
 
$
-
   
$
-
   
$
5,895
 
Common stock issued for payment of consulting fees payable
 
$
65,000
   
$
-
   
$
172,500
 
Debentures issued for settlement of consulting fees payable to related party
 
$
-
   
$
-
   
$
50,000
 
Debentures issued for settlement of related party and shareholder loans
 
$
53,000
   
$
-
   
$
504,000
 
 
The accompanying notes are an integral part of these unaudited condensed consolidated financial statements
 
6

 
 
 Gilla Inc.
(A Development Stage Company)
Notes to Unaudited Condensed Consolidated Financial Statements
For the Three Months Ended March 31, 2014
 (Amounts expressed in US Dollars)

1. NATURE OF OPERATIONS
 
Gilla Inc. (“Gilla”, the “Company” or the “Registrant”) was incorporated under the laws of the state of Nevada on March 28, 1995 under the name of Truco, Inc. The shareholders approved a name change on March 22, 1996, March 18, 1997, September 13, 1999, October 3, 2000, April 23, 2003 and February 27, 2007 to Web Tech, Inc., Cynergy, Inc., Mercantile Factoring Credit Online Corp., Incitations, Inc., Osprey Gold Corp. and to its present name, respectively.

On November 21, 2012, the Company closed the acquisition of Snoke Distribution Canada Ltd. (“Snoke Distribution”) through the issuance of 29,766,667 Common Shares of the Registrant.

Prior to the acquisition, the Company was a mineral-property development company specializing in acquiring and consolidating mineral properties with production potential and future growth through its exploration activities and its discoveries. Acquisition and development emphasis was focused on properties containing gold and other strategic minerals that were located in Africa.

On February 28, 2014, the Company closed the acquisition of all of the issued and outstanding shares of Drinan Marketing Limited (“DML”), a private limited company engaged in the sales and distribution of electronic cigarettes (E-cigarettes) in Ireland.  The Company will issue to the sellers 500,000 shares of the Company’s common stock valued at $0.11 per share and warrants for the purchase of 1,000,000 shares of the Company’s common stock.  

The current business of the Company consists of the design, marketing and distribution of electronic cigarettes (“E-cigarettes”) and accessories. An E-cigarette is an electronic inhaler meant to simulate and substitute for traditional cigarettes. E-cigarettes are often designed to mimic traditional smoking implements, such as cigarettes or cigars, in their use and/or appearance, but do not burn tobacco. E-cigarettes generally use a heating element that vaporizes a liquid solution. When used, some E-cigarettes release nicotine, while others merely release flavored vapor, which allows users to replicate the smoking experience, nicotine free. The Company distributes its products through retail and wholesale sales channels and also plans to launch an online sales platform in the current fiscal year. 
 
The Company is in the development stage as defined by Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”), subtopic 915-10 Development Stage Entities (“ASC 915-10”). To date, the Company, has generated minimal sales revenues, has incurred expenses and has sustained losses. Consequently, its operations are subject to all the risks inherent in the establishment of a new business enterprise. For the period from November 29, 2011 (date of inception) through March 31, 2014, the Company has accumulated losses of $3,270,444.
 
2. REVERSE MERGER TRANSACTION AND ACCOUNTING
 
On November 21, 2012, the Company merged with Snoke Distribution, a corporation existing under the laws of Ontario (the "Merger"). Pursuant to the Merger, the Registrant acquired all of the outstanding common shares of Snoke Distribution through the issuance of Common Shares of the Registrant to the shareholders of Snoke Distribution.

In anticipation of the closing of the Merger, on August 23, 2012, Snoke Distribution amended its Articles of Incorporation to effect a 250,000-to-1 stock split of its issued and outstanding shares of common stock.

As a result of the Merger and pursuant to the resolutions, Snoke Distribution became a wholly-owned subsidiary of the Registrant and the Registrant issued shares of its common stock to shareholders of Snoke Distribution at a rate of 1 share of the Registrant’s common stock for each Snoke Distribution common share. Immediately prior to the Merger, the Registrant had 29,477,766 shares of common stock outstanding.
 
Following the Merger, the Registrant had 59,244,433 shares of common stock outstanding after the share exchange and the issuance of 29,766,667 Common Shares to the shareholders of Snoke Distribution, which included a private placement of $141,000 into Snoke Distribution.
 
At closing of the Merger, the Registrant also closed a private placement of $135,000 at a price of $0.05 per Gilla Common Share, each entitled to a half warrant to purchase one Common Share at an exercise price of $0.10 per Common Share for a period of six months following the Merger. The private placement resulted in the issuance of 2,700,000 shares and 1,350,000 warrants of the Registrant’s common stock from treasury. Following the Merger and the private placement, the Registrant had 61,944,433 shares of common stock outstanding.
  
In connection with the Merger, existing stockholders of the Company retained 29,477,766 Common Shares. All reference to common stock shares and per share amounts have been retroactively restated to effect the reverse acquisition as if the transaction had taken place as of the beginning of the earliest period presented.

 
7

 
During the year ended December 31, 2012, the Company recorded $292,226 as loss on acquisition expense and the significant components of the transaction are as follows:
 
Assets acquired:
 
$
4
 
Liabilities assumed:
   
(286,360
)
Common stock retained:
   
(5,895
)
Foreign Exchange Difference
   
25
 
Net loss:
 
$
(292,226
)

The transaction has been accounted for as a reverse merger, and Snoke Distribution is the acquiring company on the basis that Snoke Distribution’s senior management became the entire senior management of the merged entity and there was a change of control of the Company. In accordance with Accounting Standards Codification (“ASC”) 805-10-40, Business Combinations; Reverse Acquisitions, Snoke Distribution was the acquiring entity for accounting purposes. While the transaction is accounted for using the purchase method of accounting, in substance the transaction was a recapitalization of the Snoke Distribution’s capital structure. Following the reverse merger, the historical financial statements of Snoke Distribution became the historical financial statements of the Company.
 
3. GOING CONCERN UNCERTAINTIES

These unaudited condensed consolidated financial statements have been prepared on a going concern basis, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. As shown in these unaudited condensed consolidated financial statements, the Company has incurred a deficit accumulated during the development stage of $3,270,444 and used $2,060,499 in cash for operating activities from date of inception through March 31, 2014. The ability of the Company to continue as a going concern is in doubt and dependent upon achieving a profitable level of operations or on the ability of the Company to obtain necessary financing to fund ongoing operations. Management believes that the Company will not be able to continue as a going concern for the next twelve months without additional financing or increased revenues.
 
To meet these objectives, the Company continues to seek other sources of financing in order to support existing operations and expand the range and scope of its business. However, there are no assurances that any such financing can be obtained on acceptable terms and in a timely manner, if at all. Failure to obtain the necessary working capital would have a material adverse effect on the business prospects and, depending upon the shortfall, the Company may have to curtail or cease its operations.
 
These unaudited condensed consolidated financial statements do not include any adjustments to the recorded assets or liabilities that might be necessary should the Company have to curtail operations or be unable to continue in existence.
 
4. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and with the instructions to Form 10-Q. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete consolidated financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Interim results are not necessarily indicative of the results that may be expected for a full year. During the three months ended March 31, 2014, the Company has updated its policy on Advertising Costs and added a new policy for Goodwill. These condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto included in the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2013, as filed with the U.S. Securities and Exchange Commission.
 
The accounting policies of the Company are in accordance with accounting principles generally accepted in the United States of America. Outlined below are those policies considered particularly significant:
 
(a) Basis of Consolidation

These unaudited condensed consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries, Gilla Operations, LLC, Charlie’s Club, Inc., Gilla Enterprises Inc., Drinan Marketing Ltd. and Snoke Distribution Canada Ltd. and its wholly-owned subsidiary Snoke Distribution USA, LLC. All inter-company accounts and transactions have been eliminated in preparing these unaudited condensed consolidated financial statements.
 
(b) Foreign Currency Translation

The Company’s Canadian subsidiary maintains its books and records in Canadian dollars (CAD) which is also its functional currency. The Company’s Irish subsidiary maintains its books in Euros (EUR) which is also its functional currency. The Company and its U.S. subsidiaries maintain their books and records in United States dollars (USD) which is both the Company’s functional currency and reporting currency. The accounts of the Company are translated into United States dollars in accordance with provisions of ASC 830, Foreign Currency Matters. Transactions denominated in currencies other than the functional currency are translated into the functional currency at the exchange rates prevailing at the dates of the transaction. Monetary assets and liabilities denominated in foreign currencies are translated using the exchange rate prevailing at the balance sheet date. Non-monetary assets and liabilities are translated using the historical rate on the date of the transaction. Revenue and expenses are translated at average rates in effect during the reporting periods. All exchange gains or losses arising from translation of these foreign currency transactions are included in net income (loss) for the year. In translating the financial statements of the Company's Canadian and Irish subsidiaries from their functional currencies into the Company's reporting currency of United States dollars, balance sheet accounts are translated using the closing exchange rate in effect at the balance sheet date and income and expense accounts are translated using an average exchange rate prevailing during the reporting period. Adjustments resulting from the translation, if any, are included in cumulative other comprehensive income (loss) in shareholders' equity. The Company has not, to the date of these unaudited condensed consolidated financial statements, entered into derivative instruments to offset the impact of foreign currency fluctuations.
 
(c) Earnings (Loss) Per Share
 
Basic earnings (loss) per share are computed by dividing net income (loss) by the weighted average number of common shares outstanding for the year, computed under the provisions of Accounting Standards Codification subtopic 260-10, Earnings per Share (“ASC 260-10”). Diluted earnings (loss) per share is computed by dividing net income (loss) by the weighted average number of common shares outstanding plus common stock equivalents (if dilutive) related to convertible preferred stock, stock options and warrants for each year. There were no common stock equivalent shares outstanding at March 31, 2014 and 2013 that have been included in the diluted loss per share calculation as the effects would have been anti-dilutive.
 
8

 
(d) Financial Instruments

Financial assets and financial liabilities are recognized in the statement of financial position when the Company has become party to the contractual provisions of the instruments.
 
The Company’s financial instruments consist of cash and cash equivalents, accounts receivable, accounts payable, accrued liabilities, loan from shareholder and loans payable. The fair values of these financial instruments approximate their carrying value, due to their short term nature. Fair value of a financial instrument is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The Company’s financial instruments recorded at fair value in the consolidated balance sheets are categorized based upon the level of judgment associated with the inputs used to measure their fair value. Hierarchical levels, defined by FASB ASC No. 820, Fair Value Measurement and Disclosure (“ASC 820”), with the related amount of subjectivity associated with the inputs to value these assets and liabilities at fair value for each level, are as follows:
 
 
Level 1
 -
Unadjusted quoted prices in active markets for identical assets or liabilities;
 
Level 2
 -
Observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets with insufficient volume or infrequent transactions (less active markets); or model-derived valuations in which all significant inputs are observable or can be derived principally from or corroborated by observable market data for substantially the full term of the assets or liabilities; and
 
Level 3
 -
Inputs that are not based on observable market data.
 
Cash and cash equivalents are reflected on the consolidated balance sheets at fair value and classified as Level 1 hierarchy because measurements are determined using quoted prices in active markets for identical assets.

Fair value measurements of accounts receivable, accounts payable, accrued liabilities, and loans payable are classified under Level 3 hierarchy because inputs are generally unobservable and reflect management’s estimates of assumptions that market participants would use in pricing the financial instruments.

(e) Advertising Costs

In accordance with FASB ASC 720, the Company expenses the production costs of advertising the first time the advertising takes place.  For the three month period ended March 31, 2014, $134,500 in production costs were incurred and have been allocated to prepaid expenses and vendor deposits on the consolidated balance sheet, no production costs were expensed during the period.  The Company expenses all other advertising costs as incurred. During the three month period ended March 31, 2014, the Company expensed $71,639 (March 31, 2013: $2,510) as corporate promotions.
  
(f) Goodwill

Goodwill represents the excess purchase price over the estimated fair value of net assets acquired by the Company in business combinations. The Company accounts for goodwill and intangible assets in accordance with ASC 350 “Intangibles-Goodwill and Other” (“ASC 350”). ASC 350 requires that goodwill and other intangibles with indefinite lives be tested for impairment annually or on an interim basis if events or circumstances indicate that the fair value of an asset has decreased below its carrying value. In addition, ASC 350 requires that goodwill be tested for impairment at the reporting unit level (operating segment or one level below an operating segment) on an annual basis and between annual tests when circumstances indicate that the recoverability of the carrying amount of goodwill may be in doubt. Application of the goodwill impairment test requires judgment, including the identification of reporting units; assigning assets and liabilities to reporting units, assigning goodwill to reporting units, and determining the fair value. Significant judgments required to estimate the fair value of reporting units include estimating future cash flows, determining appropriate discount rates and other assumptions. Changes in these estimates and assumptions or the occurrence of one or more confirming events in future periods could cause the actual results or outcomes to materially differ from such estimates and could also affect the determination of fair value and/or goodwill impairment at future reporting dates.

(g) Comprehensive Income or Loss
 
The Company reports comprehensive income or loss in its unaudited condensed consolidated financial statements. In addition to items included in net income or loss, comprehensive income or loss includes items charged or credited directly to stockholders’ equity, such as foreign currency translation adjustments and unrealized gains or losses on available for sale marketable securities.
 
(h) Use of Estimates

The preparation of consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the 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 revenue and expenses during the period. Actual results could differ from these estimates, and such differences could be material.  The key sources of estimation uncertainty at the balance sheet date, which have a significant risk of causing a material adjustment to the carrying amounts of assets within the next financial year, include reserves and write downs of receivables and inventory, useful lives of property and equipment, impairment of goodwill, impairment of property and equipment, valuing equity securities, valuation of convertible debenture conversion options and deferred taxes and related valuation allowances.  Certain of our estimates could be affected by external conditions, including those unique to our industry and general economic conditions.  It is possible that these external factors could have an effect on our estimates that could cause actual results to differ from our estimates.  The Company re-evaluates all of its accounting estimates at least quarterly based on the conditions and records adjustments when necessary.
 
(i) Website Development Costs

Under the provisions of FASB-ASC Topic 350, the Company capitalizes costs incurred in the website application and infrastructure development stage.  Capitalized costs will be amortized over the estimated useful life of the website.  The Company has not yet recorded amortization of the website development costs as the development has not yet been completed.  Ongoing website post- implementation cost of operations, including training and application, will be expensed as incurred.
 
9

 
 
(j) Convertible Debt Instruments

The Company accounts for convertible debt instruments when the Company has determined that the embedded conversion options should not be bifurcated from their host instruments in accordance with ASC 470-20 Debt with Conversion and Other Options. The Company records, when necessary, discounts to convertible notes for the intrinsic value of conversion options embedded in debt instruments based upon the differences between the fair value of the underlying common stock at the commitment date of the note transaction and the effective conversion price embedded in the note. The Company amortizes the respective debt discount over the term of the notes, using the straight-line method, which approximates the effective interest method. The Company records, when necessary, induced conversion expense, at the time of conversion for the difference between the reduced conversion price per share and the original conversion price per share.

(k) Recent Accounting Pronouncements
 
The Company has reviewed all recently issued, but not yet effective, accounting pronouncements and does not expect the future adoption of any such pronouncements to have a significant impact on its results of operations, financial condition or cash flow.

5. BUSINESS COMBINATION

On February 28, 2014, the Company closed the acquisition of all the issued and outstanding shares of DML, a private limited company organized under the laws of Ireland. DML is engaged in the sales and distribution of E-cigarettes in Ireland.  The following summarizes the fair value of the assets acquired, liabilities assumed and the consideration transferred at the acquisition date:

Assets acquired:
     
Cash
  $ 8,828  
Receivables
    112,576  
Inventory
    60,777  
Loan receivable
    84,936  
Fixed, assets
    3,826  
Goodwill
    167,422  
Total assets acquired
  $ 438,365  
         
Liabilities assumed:
       
Accounts payable
  $ 253,247  
Loans payable
    130,118  
Total liabilities assumed
  $ 383,365  
         
Consideration-500,000 Common Shares, to be issued
  $ 55,000  

In consideration for the acquisition, the Company will issue 500,000 shares of the Company’s Common Stock and Common Share Purchase Warrants (“Warrants”) for the purchase of 1,000,000 shares of the Company’s Common Stock.  The Warrants will vest upon DML achieving cumulative E-cigarette sales revenues of over $1,500,000 beginning on the closing date. The Warrants are to be exercisable over 3 years with an exercise price of $0.25 per Common Share.   
 
6. LOAN RECEIVABLE

On March 13, 2013, the Company entered into a factoring agreement with DML, who at the time was a third party, in which the Company advanced $19,867 in cash to DML to purchase a receivable owing to DML from a customer (the “Receivable”) at face value. The Receivable purchased was required to be paid by the applicable customer on or before the date that is 30 days after the date of issue of the Receivable. In addition to payment of the account, the Company was to receive an additional fee of 2% of the face amount of the Receivable.  Default interest of 1/10th of 1% per day shall be calculated on the outstanding amount accruing from the due date until the amount is paid in full.  The Receivable is secured by a general security agreement covering all assets of DML and a first security interest in respect of all receivables purchased by the Company under the factoring agreement.

Default interest in the amount of $1,538 was accrued on the Receivable. During the year ended December 31, 2013, the Company determined the Receivable to be uncollectable and as a result recorded a loss of $21,405.

On February 28, 2014, the Company acquired DML. As a result, the Company reversed the write-off of the Receivable and recorded a gain of $19,867.  This amount will be treated as an intercompany loan, no interest will be accrued and it will be eliminated upon consolidation.  In addition, the Company has a loan receivable of $73,084 from previous shareholders of DML.
 
7. INVENTORY

Inventory consists of the following:
 
   
March 31,
2014
   
December 31,
2013
 
E-cigarettes and accessories
  $
102,185
    $ 74,419  
Packaging
   
16,495
      16,495  
    $ 118,680     $ 90,914  
 
 
10

 
 
8. PROPERTY AND EQUIPMENT
 
   
March 31,
2014
   
December 31,
2013
 
   
Cost
   
Accumulated Depreciation
   
Net
   
Net
 
Furniture and equipment
  $ 2,530     $ 1,300     $ 1,230     $ 1,439  
Computer hardware
    3,471       1,335       2,136       2,443  
Motor vehicle
    4,822       1,205       3,617       -  
    $ 10,823     $ 3,840     $ 6,983     $ 3,882  

Depreciation expense for the three months ended March 31, 2014 and 2013 amounted to $700 and $341 respectively.
 
9. LOANS FROM SHAREHOLDERS
 
The Company has outstanding loans from shareholders at March 31, 2014 and December 31, 2013 as follows:
 
   
March 31,
 2014
   
December 31,
2013
 
Non-interest bearing, unsecured, no specific terms of repayment
  $ 6,455     $ 6,512  
Bears interest of 10% per annum on a cumulative basis, secured by the assets of the Company, matures on August 13, 2014
    452,300       -  
Bears interest of 1% per month on a cumulative basis, secured by the assets of the Company, no specific terms of repayment
    -       14,103  
    $ 458,755     $ 20,615  

During the three months ended March 31, 2014, the Company repaid $17,370 of loans from shareholders consisting of $13,569 in principal and $3,801 in interest.  The amount was repaid with $13,935 of cash and amounts of $3,435 were settled with the issuance of $3,000 of Unsecured Subordinated Convertible Debentures (note 11).

The Company accrued interest of $172 during the three months ended March 31, 2014 (March 31, 2013: $7,585) on this loan.

On February 13, 2014, the Company entered into a secured promissory note with a shareholder, whereby the Company agreed to pay the party the aggregate unpaid principal amount of CAD $500,000 on or before August 13, 2014, bearing interest at a rate of 10% per annum, such interest will accrue monthly and be added to the principal. The note is secured by a general security agreement over the assets of the Company.

The Company accrued interest of $5,700 during the three months ended March 31, 2014 (March 31, 2013: $nil) on this note.
 
10. NOTE PAYABLE, RELATED PARTY
 
a)     On November 15, 2012, the Company entered into a Convertible Revolving Credit Note (the “Note”), with a related party, for $225,000 due on or before February 15, 2014, bearing interest at a rate of 6% per annum. Interest is accrued and added to the principal amount of the Note at the maturity date. The Note may be repaid, in whole or in part, without penalty with five days prior written notice. At any time subsequent to 30 days after the maturity date, the outstanding principal amount and any accrued and unpaid interest is convertible in to common stock at a conversion price of the lower of $0.01 per share or the average of the bid prices for the common stock of the Company for the 15 trading days prior to the notice of conversion.
 
On February 14, 2014, the Company repaid all amounts due on this Note.

During the three months ended March 31, 2014, the Company accrued $1,638 of interest on this Note (March 31, 2013:$3,351). At repayment the accrued interest on the above Note was $17,015.

 
11

 
b)     On September 30, 2013, the Company entered into a Secured Promissory Note (the “Secured Note”) with a related party for $200,000 due on or before January 1, 2015, bearing interest at a rate of 1.5% per month. Interest is accrued and added to the principal amount of the Secured Note at the maturity date. The related party will also be paid an establishment fee of 2.0%. The Secured Note is secured by a general security agreement.

During the year ended December 31, 2013, the Company accrued $9,000 in interest on the Secured Note and paid $3,000 of the accrued interest resulting in accrued interest payable of $6,000 on the Secured Note at December 31, 2013.

On December 23, 2013, the Company issued a $200,000 Unsecured Subordinated Convertible Debenture, maturing on January 31, 2016 and bearing interest at a rate of 12% per annum in settlement of the Secured Note (note 11).  Upon settlement of the Secured Note, the establishment fee of 2.0% was waived by the related party.
 
11. CONVERTIBLE DEBENTURES
 
On September 3, 2013, December 23, 2013 and February 11, 2014, the Company issued $425,000, $797,000 and $178,000 of Unsecured Subordinated Convertible Debentures (“Debentures”), respectively. The Debentures mature on January 31, 2016 and bear interest at a rate of 12% per annum, which is payable quarterly in arrears. The Debentures are convertible into common stock of the Company at a fixed conversion rate of $0.07 per share at any time prior to the maturity date. Of the $178,000 Debentures issued during the three months ended March 31, 2014, $3,000 was issued in settlement of loans to shareholders (note 9) and $50,000 was issued in settlement of loans to related parties (note 15).

As at December 31, 2013, the Company received $45,000 in advance for Debentures not yet issued.  Of this amount $25,000 was received by the Company in cash and $20,000 was collected by the Company’s lawyer and held in trust. The Company received the funds held in trust on February 21, 2014. These Debentures were issued February 11, 2014.

The Company evaluated the terms and conditions of the Debentures under the guidance of ASC 815, Derivatives and Hedging. The conversion feature met the definition of conventional convertible for purposes of applying the conventional convertible exemption. The definition of conventional contemplates a limitation on the number of shares issuable under the arrangement. The instrument was convertible into a fixed number of shares and there were no down round protection features contained in the contracts.

Since a portion of the Debentures were issued as an exchange of nonconvertible instruments at the nonconvertible instruments maturity date, the guidance of ASC 470-20-30-19 & 20 was applied. The fair value of the newly issued Debentures was equal to the redemption amounts owed at the maturity date of the original instruments. Therefore there was no gain or loss on extinguishment of debt recorded. After the exchange occurred, the Company was required to consider whether the new hybrid contracts embodied a beneficial conversion feature (“BCF”).

For the face value $425,000 Debentures that were issued on September 3, 2013, the calculation of the effective conversion amount did not result in a BCF because the effective conversion price was greater than the Company’s stock price on the date of issuance, therefore no BCF was recorded. However, for the face value $797,000 Debentures that were issued on December 23, 2013 and the face value $178,000 Debentures that were issued on February 11, 2014, the calculation of the effective conversion amount did result in a BCF because the effective conversion price was less than the Company’s stock price on the date of issuance and a BCF in the amounts of $797,000 and $178,000, respectively, were recorded in additional paid-in capital. The BCF which represents debt discount is accreted over the life of the loan using the effective interest rate. For the three months ended March 31, 2014, the Company recorded interest expense in the amount of $8,847 related to debt discount.

12. COMMON STOCK

The Company is authorized to issue 300,000,000 Common Shares of $0.0002 par value common stock. As at March 31, 2014 and December 31, 2013, 68,318,007 and 67,066,977 Common Shares were issued and outstanding, respectively.

During the three months ended March 31, 2014, the Company:
 
 
Issued 200,000 Common Shares at a fair value of $0.19 as settlement of $10,000 in consulting fees owing to an unrelated party. The amount allocated to Shareholders’ Deficiency, based on the fair value, amounted to $38,000. The balance of $28,000 represents a loss on the settlement;
 
Issued 500,000 Common Shares valued at $0.035 for cash proceeds of $17,500;
 
Issued 280,433 Common Shares valued at $0.1426 for settlement of  $40,000 consulting fees owing to an unrelated party; and
 
Issued 270,597 Common Shares valued at $0.1293 for settlement of  $35,000 consulting fees owing to an unrelated party.
 
During the year ended December 31, 2013 the Company:
 
 
Issued 276,485 Common Shares valued at $0.035 for cash proceeds of $9,677;
 
Issued 942,784 Common Shares at an average price of $0.053 as settlement of $50,000 in consulting fees owing to an unrelated party;
 
Issued 1,428,571 Common Shares at a fair value of $0.043 per share as settlement of a related party loan in the amount of $50,000. The amount allocated to Shareholders’ Deficiency, based on the fair value, amounted to $61,429. The balance of $11,429 represents a loss on the settlement of the related party debt and was also allocated to equity;
 
Issued 1,391,371 Common Shares at a fair value of $0.043 per share as settlement of a loan from shareholder in the amount of $48,700. The amount allocated to Shareholders’ Deficiency, based on the fair value, amounted to $59,829. The balance of $11,129 represents a loss on the settlement of the shareholder loan and was also allocated to equity;
  Issued 50,000 Common Shares valued at $0.05 for cash proceeds of $2,500;
  Issued 400,000 Common Shares valued at $0.05 as settlement of $20,000 in consulting fees owing to unrelated parties; and
  Issued 300,000 Common Shares valued at $0.0583 as settlement of $17,500 in consulting fees owing to unrelated parties.

 
 
12

 
 
13. WARRANTS
 
The following schedule summarizes the outstanding warrants at March 31, 2014 and December 31, 2013:
 
   
March 31,
2014
   
December 31,
2013
   
No. of Warrants
   
WAEP
   
No. of Warrants
   
WAEP
 
Beginning of year
   
-
   
$
-
     
1,516,667
   
$
0.10
 
Issued
   
1,000,000
     
0.25
     
-
     
-
 
Expired
   
-
     
-
     
(1,516,667)
     
(0.10)
 
End of year
   
1,000,000
   
$
0.25
     
-
   
$
-
 

(a) On February 28, 2014, as part of the acquisition of DML, the Company issued Warrants to acquire 1,000,000 shares of the Company’s Common Stock.  The Warrants will vest upon DML achieving cumulative E-cigarette sales revenues of over $1,500,000 beginning on the closing date. The Warrants are to be exercisable over 3 years with an exercise price of $0.25 per Common Share.   

The fair value of these issued Warrants of $109,471 was determined using the Black Scholes option-pricing model with the following weighted average assumptions:

Risk-free interest rate
 
0.90
%
Expected life
 
3 years
 
Estimated volatility in the market price of the Common Shares
 
340
%
Dividend yield
 
Nil
 
 
The Company estimates the probability of DML achieving the vesting provision (cumulative E-cigarette sales revenue of $1,500,000) to be 100%. The probability weighted fair value of the Warrants is being amortized  and recorded as stock based compensation expense using the percentage of the total vesting provision achieved in each quarter based on sales revenue.
  
(b) During fiscal 2012, the Company issued warrants to acquire 1,516,667 Common Shares. The warrants were included in units issued as part of a private placement. Each unit of the private placement was comprised of one Common Share of the Company and one half purchase warrant. Each warrant entitles the holder to acquire one Common Share of the Company at a price of $0.10 per share. The warrants expired 6 months from the date of issuance.

The fair value of these issued warrants of $18,835 was determined using the Black Scholes option-pricing model with the following weighted average assumptions:

Risk-free interest rate
 
0.09
%
Expected life
 
6 months
 
Estimated volatility in the market price of the Common Shares
 
461
%
Dividend yield
 
Nil
 

No stock based compensation expense was recorded since the warrants were issued as a part of the private placement of common stock.
 
14. SHARES TO BE ISSUED

On March 31, 2014, the Company had $139,500 in unissued share liability consisting of the following:
 
 
The Company acquired all of the issued and outstanding shares of Drinan Marketing Limited with 500,000 Common shares of  the Company valued at $0.11, the shares have not yet been issued; and 
     
 
The Company settled $84,500 in amounts owing as a result of the production costs of advertising with 845,000 Common Shares of the Company valued at $0.10, the shares have not yet been issued.
 
On December 31, 2013, the Company had $37,500 in unissued share liability, consisting of the following:
 
 
The Company settled $10,000 in consulting fees payable to an unrelated party with 200,000 Common Shares valued at $0.05, the shares were issued on January 8, 2014;
     
 
The Company received $17,500 in cash for the purchase of 500,000 Common Shares valued at $0.035, the shares were issued on January 8, 2014; and
     
 
The Company settled $10,000 in consulting fees payable to an unrelated party with 70,423 Common Shares valued at $0.142, the shares were issued on March 28, 2014.

15. RELATED PARTY TRANSACTIONS

Transactions with related parties are incurred in the normal course of business and are measured at the exchange amount, which is the amount of consideration established and agreed to between the related parties.
 
(a)
The Company’s current and former officers and shareholders have advanced funds on an unsecured, non-interest bearing basis to the Company for travel related and working capital purposes. The Company has not entered into any agreement on the repayment terms for these advances. 
 
 
13

 
 
Advances from related parties during the periods ended March 31, 2014 and December 31, 2013 were as follows:
 
   
March 31,
2014
   
December 31,
2013
 
Advances by Officers of the Company, two of which are also Directors
  $ 297,083     $ 226,430  
Advances by a corporation owned by two Officers, one of which is also a Director
    294,329       255,215  
Advances by persons related to an Officer and Director of the Company
    63,741       55,907  
Advances by Officers of the Company one of which is also a Director, bears interest at 1.5% per month
    188,510       214,265  
Advances by a corporation related by virtue of common Officers and Directors
    19,364       15,609  
    $ 863,027     $ 767,426  
 
During the three months ended March 31, 2014, the Company settled $50,000 of amounts owing to an Officer of the Company with the issuance of a $50,000 Unsecured Subordinated Convertible Debenture (note 10).

During the three months ended March 31, 2014, the Company settled $220,075 of the loans owing the an Officer and Director of the Company with cash.

(b)
Interest accrued to related parties during the periods ended March 31, 2014 and December 31, 2013 were as follows:
 
   
March 31,
2014
   
December 31,
2013
 
             
Interest accrued on advances by Officers of the Company, one of which is also a Director
  $ 4,388     $ 57,461  
Interest accrued on related party Secured Note (note 10)
    -       6,000  
Interest accrued on related party Convertible Revolving Credit Note (note 10)
    -       15,377  
    $ 4,388     $ 78,838  
 
(c)
 Transactions with related parties during the periods ended March 31, 2014 and 2013 were as follows:

During the three months ended March 31, 2014, the Company expensed $3,761 in rent expense payable to a Corporation related by virtue of common officers and directors.  The Company also expensed $47,055 in travel and entertainment expenses incurred by Officers and Directors of the Company.

During the three months ended March 31, 2014 and 2013, the Company expensed consulting fees payable to related parties
as follows:

   
March 31,
2014
   
March 31,
2013
 
Directors
  $ 33,900     $ 67,800  
Officers
    -       33,900  
Corporation owned by two Officers, one of which is also a Director
    108,428       -  
Persons related to an Officer and Director
    19,500       27,975  
                 
    $ 161,828     $ 129,675  
 
16. COMMITMENTS AND CONTINGENCIES

(a) Operating Lease

The future minimum payment under an operating lease for the use of a vehicle amounts to approximately $1,448. The lease expires on May 31, 2014. Minimum annual lease payments are as follows:
 
December 31, 2014
 
1,448
 
   
$
1,448
 
 
(b) Rental Lease for Snoke Distribution USA LLC
 
Effective April 23, 2012, the Company entered into an operating lease agreement for a rental premises in Hollywood, Florida, USA. The terms of this agreement are to be for a period of 2 years beginning May 1, 2012 and ending April 30, 2014 with payments made monthly and annual rent in year 1 of $37,800 and year 2 of $38,924 plus Florida sales tax of 7%. The Company has the option to extend the lease for 3 consecutive years at 3% annual increase in rental amounts.  The Company did not extend the lease and has since moved premises, the new rental premises is on a month to month basis.
 
Minimum annual lease payments under this lease are as follows:
 
December 31, 2014
 
3,472
 
   
$
3,472
 

(c) Litigation

The Company is subject to certain legal proceedings and claims, which arise in the ordinary course of its business. Although occasional adverse decisions or settlements may occur, the Company believes that the final disposition of such matters should not have a material adverse effect on its financial position, results of operations or liquidity. There was no outstanding litigation as of March 31, 2014.

 
14

 
(d) Consulting Agreement

The Company entered into a consulting services agreement with a related party on April 1, 2013.  The Company agreed to pay fees with respect to various professional services to be provided to it under the agreement.  The agreement may be terminated by either party by notice in writing to the other party given not less than 90 days prior to the effective date of termination.
 
17. FINANCIAL INSTRUMENT AND RISK FACTORS

(i) Credit Risk

Credit risk is the risk of financial loss to the Company if a customer or counterparty to a financial instrument fails to meet its contractual obligations. The Company’s credit risk is primarily attributable to fluctuations in the realizable values of its cash and accounts receivable. Cash accounts are maintained with major international financial institutions of reputable credit and therefore bear minimal credit risk.  The Company minimizes its exposure to credit risk related to its receivables by requiring all orders to be prepaid before delivery of the product.

(ii) Liquidity Risk

Liquidity risk is the risk that the Company will not be able to meet its financial obligations as they fall due. The Company’s approach to managing liquidity risk is to ensure, as far as possible, that it will have sufficient liquidity to meet its liabilities when due, under both normal and stressed conditions, without incurring unacceptable losses or risking damage to the Company’s reputation. The Company manages liquidity risk by closely monitoring changing conditions in its investees, participating in the day to day management and by forecasting cash flows from operations and anticipated investing and financing activities.

(iii) Foreign Currency Risk

Currency risk is the risk that the fair value or future cash flows of a financial instrument will fluctuate because of changes in foreign exchange rates. The Company purchases inventory in a foreign currency, at March 31, 2014, the Company included $27,766 in inventory purchased in a foreign currency on its balance sheet.  The Company does not use derivative financial instruments to reduce its exposure to this risk.

(iv) Interest Rate Risk

Interest rate risk is the risk that the fair value or future cash flows of a financial instrument will fluctuate because of changes in market interest rates. The Company is exposed to interest rate risk on its fixed interest rate financial instruments.  These fixed-rate instruments subject the Company to a fair value risk.
 
18. SEGMENTED INFORMATION

The Company currently operates in only one business segment, namely, designing, marketing and distributing E-cigarettes and accessories in North America and Ireland.  At March 31, 2014 and December 31, 2013, total assets by geographic location are as follows:

   
March 31,
2014
   
December 31,
2013
 
Canada
  $ 1,269     $
3,960
 
United States
   
512,064
     
524,784
 
Ireland
    225,721          
    $
739,054
    $
528,744
 

During the three month period ended March 31, 2014 and 2013, total revenues by geographic location are as follows:

   
March 31,
2014
   
March 31,
2013
 
Canada
  $ -     $ -  
United States
    -       -  
Ireland
    19,261       -  
    $ 19,261     $ -  

19. SUBSEQUENT EVENTS

On April 15, 2014, the Company received forms of election whereby holders of the Debentures elected to convert a total of $50,000 of the Unsecured Subordinated Convertible Debentures into Common Shares of the Company pursuant to the Convertible Debenture Offering. These shares remain unissued.
 
 
15

 
 
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION
 
The following discussion of the financial condition and results of operations of the Company should be read in conjunction with the financial statements and the related notes thereto included elsewhere in this Quarterly Report on Form 10-Q (this “Report”). This Report contains certain forward-looking statements and the Company's future operating results could differ materially from those discussed herein. Our disclosure and analysis included in this Report concerning our operations, cash flows and financial position include forward-looking statements. Statements that are predictive in nature, that depend upon or refer to future events or conditions, or that include words such as “expect”, “anticipate”, “intend”, “plan”, “believe”, “estimate”, “may”, “project”, “will likely result”, and similar expressions are intended to identify forward-looking statements. Such forward-looking statements include (i) the ability to raise additional capital; and (ii) expectations regarding anticipated growth.  Such forward-looking statements are subject to certain risks, uncertainties and assumptions, and are more fully described under “Part I, Item 1A - Risk Factors” of our Annual Report on Form 10-K for the year ended December 31, 2013. New risks and uncertainties arise from time to time, and it is impossible for us to predict these events or how they may affect us. In any event, these and other important factors, including those set forth in Item 1A – “Risk Factors” of our Annual Report on Form 10-K for the year ended December 31, 2013 may cause actual results to differ materially from those indicated by our forward-looking statements. We assume no obligation to update or revise any forward-looking statements we make in this Report, except as required by applicable securities laws.

Except as otherwise stated or required by the context, references in this document to “Gilla” the “Registrant”, the “Company,” “we,” and “our” refer to Gilla Inc.
 
Overview

Gilla was incorporated under the laws of the state of Nevada on March 28, 1995 under the name of Truco, Inc. The shareholders approved a name change on March 22, 1996, March 18, 1997, September 13, 1999, October 3, 2000, April 23, 2003 and February 27, 2007 to Web Tech, Inc., Cynergy, Inc., Mercantile Factoring Credit Online Corp., Incitations, Inc., Osprey Gold Corp. and to its present name, respectively. Gilla’s address is 112 N. Curry Street, Carson City, Nevada, 87803.
 
The current business of the Company consists of the design, marketing and distribution of electronic cigarettes (“E-cigarettes”) and accessories. An E-cigarette is an electronic inhaler meant to simulate and substitute for traditional cigarettes. E-cigarettes are often designed to mimic traditional smoking implements, such as cigarettes or cigars, in their use and/or appearance, but do not burn tobacco. E-cigarettes generally use a heating element that vaporizes a liquid solution. When used, some E-cigarettes release nicotine, while others merely release flavored vapor, which allows users to replicate the smoking experience, nicotine free. The Company distributes its products through retail and wholesale sales channels and also plans to launch an online sales platform in the current fiscal year.

Recent Developments

On November 21, 2012, Gilla closed the acquisition of Snoke Distribution Canada Ltd. (“Snoke Distribution”), a corporation existing under the laws of Ontario (the “Merger”). Pursuant to the Merger, the Registrant acquired all of the outstanding common shares of Snoke Distribution through the issuance of Common Shares of the Registrant to the shareholders of Snoke Distribution. As a result of the Merger, Snoke Distribution became a wholly-owned subsidiary of the Registrant.  The Merger was accounted for as a reverse merger.

Gilla Operations, LLC (“Gilla Operations”) was incorporated on May 2, 2013 under the laws of the State of Florida. Gilla Operations is a wholly-owned subsidiary of the Company and, since its incorporation, has been the primary operating subsidiary of the Company in the United States.

Charlie’s Club, Inc. (“Charlie’s Club”) was incorporated on November 15, 2013 under the laws of the State of Florida. Charlie’s Club is a wholly-owned subsidiary of the Company and is expected to carry on the Company’s e-commerce sales initiative.

Gilla Enterprises Inc. (“Gilla Enterprises”) was incorporated on December 20, 2013 under the laws of the Province of Ontario. Gilla Enterprises is a wholly-owned subsidiary of the Company and, since its incorporation, has been the primary operating subsidiary of the Company in Canada.

On January 8, 2014, the Company issued 200,000 Common Shares at a price of $0.05 per Common Share, as a settlement of $10,000 in consulting fees owing to an unrelated party.

On January 8, 2014, the Company issued and sold, on a private placement basis, 500,000 Common Shares at a price of $0.035 per Common Share for aggregate gross proceeds of $17,500.

On February 11, 2014, the Company issued $178,000 of Convertible Debentures pursuant to the Convertible Debenture Offering.

On February 13, 2014, the Company entered into a secured promissory note with a shareholder, whereby the Company agreed to pay the party the aggregate unpaid principal amount of CAD $500,000 on or before August 13, 2014, bearing interest at a rate of 10% per annum.

On February 14, 2014, the Company repaid the outstanding principal amount of $225,000, together with the accrued and unpaid interest, and the convertible revolving credit note due to a related party was retired.
 
 
16

 
 
On February 28, 2014, the Company closed the acquisition of Drinan Marketing Limited (“DML”), a private company engaged in the sale and distribution of E-cigarettes in Ireland.  The acquisition of DML was completed pursuant to the terms of a Letter Agreement dated January 22, 2014 and a Purchase and Sale Agreement dated as of January 23, 2014. The Company acquired all of the issued and outstanding shares of DML from Andrew Hennessy and Michele Hennessy (the “Sellers”). At the closing of the acquisition of DML, the Company issued to the Sellers five hundred thousand (500,000) shares of the Company’s common stock (the “Gilla Shares”) and warrants for the purchase of one million (1,000,000) shares of the Company’s common stock (the “Warrants”). The Warrants will vest upon DML achieving cumulative E-cigarette sales revenues of over one million five hundred thousand U.S. Dollars (US$1,500,000) beginning on the closing date. The Warrants are to be exercisable over three (3) years with an exercise price of $0.25 per common share. Pursuant to the Letter Agreement, the Company will enter into a management agreement with Andrew Hennessy, pursuant to which Mr. Hennessy will become an employee of the Company. Mr. Hennessy will be paid 6,250 Euros per month of net salary after payroll tax deduction, and have the ability to participate in such management bonus compensation plan and stock option plan as the Company’s Board of Directors may authorize in the future.

On March 28, 2014, the Company issued 280,433 Common Shares at a price of $0.1426 per Common Share, as a settlement of $40,000 in consulting fees owing to unrelated parties.

On March 28, 2014, the Company issued 270,597 Common Shares at a price of $0.1293 per Common Share, as a settlement of $35,000 in consulting fees owing to unrelated parties.

Subsequent Events

On April 15, 2014, the Company received forms of election whereby holders of the Convertible Debentures elected to convert a total of $50,000 of the Unsecured Subordinated Convertible Debentures into Common Shares of the Company pursuant to the Convertible Debenture Offering. These shares remain unissued.
 
RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDED MARCH 31, 2014 AND MARCH 31, 2013

The Company is in the development stage as defined by Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”), subtopic 915-10 Development Stage Entities (“ASC 915-10”). To date, the Company, has generated minimal sales revenues, has incurred expenses and has sustained losses. Consequently, its operations are subject to all the risks inherent in the establishment of a new business enterprise. For the period from November 29, 2011 (date of inception) through March 31, 2014, the Company has accumulated losses of $3,270,444.

Revenue

For the three month period ended March 31, 2014, the Company generated $19,261 in revenues from the sales of E-cigarettes and accessories. As of March 31, 2014, the Company only operated one business segment, namely designing, marketing and distributing white label E-cigarettes and accessories in North America and Europe. On February 28, 2014, the Company closed the acquisition of Drinan Marketing Limited (“DML”), a private company engaged in the sales and distribution of E-cigarettes in Ireland, representing a geographical extension to the current business segment moving forward.

The Company’s cost of goods for the three month period ended March 31, 2014 was $32,022 which represents E-cigarette product and the related packaging. Gross loss for the three month period ended March 31, 2014 was $12,761. The Company incurred higher than usual cost of goods sold due to one-time expenses related to packaging and the requirement of minimum order thresholds from its suppliers to refine the Company’s white label sales strategy.

For the period from November 29, 2011 (date of inception) to March 31, 2014, the Company generated $96,238 in revenues and $2,595 in gross profit. The Company targets 30-35% gross margins for new white label, wholesale and retail customers. The Company also plans to launch an online sales platform in the upcoming quarter and targets margins in the range of 40-50% for this initiative.
 
Operating Expenses

For the three month period ended March 31, 2014, the Company incurred administrative expense of $400,599, consulting fees to related parties of $161,828 and depreciation expense of $700. Administrative costs were primarily comprised of rent, legal and audit fees, marketing fees, travel expenses and subcontractor fees. Total operating expenses for the three month period ended March 31, 2014 were $563,127. For the three month period ended March 31, 2013, the Company incurred administrative expense of $128,861, consulting fees to related parties of $129,675 and depreciation expense of $341. Total operating expenses for the three month period ended March 31, 2013 were $258,877. The increase in administrative expense of $271,738 and increase of consulting fees due to related parties of $32,153 is attributable to the Company’s focus on generating sales of E-cigarettes and the result of consulting expenses increasing due to the hiring of officers and consultants.

 
17

 
 
For the period from November 29, 2011 (date of inception) to March 31, 2014, the Company incurred administrative expenses of $1,447,183, consulting fees due to related parties of $1,083,484 and depreciation expense of $2,895. Total operating expenses for this period was $2,533,562.

Loss from Operations

For the three month period ended March 31, 2014 the Company incurred a loss from operations of $575,888 as compared to $258,877 for the three month period ended March 31, 2013 due to the reasons discussed above. For the period from November 29, 2011 (date of inception) to March 31, 2014, the Company incurred a loss from operations of $2,530,967.

Other Expenses

For the three month period ended March 31, 2014, the Company incurred a foreign exchange loss of $20,978, gain on loan receivable written off of $19,867 (see “Loss on write off of Loan Receivable”), loss on settlement of $27,563, amortization of debt discount loss of $8,847 and interest expense of $51,074 for total other expenses of $88,595.

For the three month period ended March 31, 2013, the Company incurred a foreign exchange loss of $1,759 and interest expense of $17,691 for total other expenses of $19,450.

The increase in interest expense of $33,383 is attributable to interest on advances from related parties, loans from shareholders and other promissory notes and the issuance of convertible debentures.

For the period from November 29, 2011 (date of inception) to March 31, 2014, the Company incurred a foreign exchange loss of $27,738, loss on loan receivable written off of $1,538, loss on acquisition of Snoke Distribution of $292,226, loss on deposit written off of $162,371, loss on settlement of $27,563, amortization of debt discount of $18,361, and interest expense of $204,778 for total other expenses of $734,575.

Loss on write off of Loan Receivable
 
On March 13, 2013, the Company entered into a factoring agreement with DML, who at the time was a third party, in which the Company advanced $19,867 in cash to DML to purchase a receivable owing to DML from a customer (the “Receivable”) at face value. The Receivable purchased was required to be paid by the applicable customer on or before the date that is 30 days after the date of issue of the Receivable. In addition to payment of the account, the Company was to receive an additional fee of 2% of the face amount of the Receivable. Default interest of 1/10th of 1% per day shall be calculated on the outstanding amount accruing from the due date until the amount is paid in full. The Receivable is secured by a general security agreement covering all assets of DML and a first security interest in respect of all receivables purchased by the Company under the factoring agreement.

Default interest in the amount of $1,538 was accrued on the Receivable. During the year ended December 31, 2013, the Company determined the Receivable to be uncollectable and as a result recorded a loss of $21,405.

On February 28, 2014, the Company acquired DML. As a result, the Company reversed the write-off of the Receivable and recorded a gain of $19,867.
 
Net Loss and Comprehensive Loss

Net loss amounted to $664,483 for the three month period ended March 31, 2014 compared to $278,327 for the three month period ended March 31, 2013. For the period from November 29, 2011 (date of inception) to March 31, 2014, the Company incurred a net loss of $3,265,542. The increase in net loss is primarily attributable to an increase in consulting expenses resulting from the hiring of officers and other consultants as well as an increase in administrative expenses due to the Company’s focus on generating sales.

Comprehensive loss amounted to $629,918 for the three month period ended March 31, 2014 compared to $266,065 for the three month period ended March 31, 2013. For the period from November 29, 2011 (date of inception) to March 31, 2014, the Company incurred a comprehensive loss of $3,186,219. The change in comprehensive loss compared to net loss was due to foreign currency translation adjustments resulting from the Company’s translation of financial statements from Canadian Dollars and EUROS to U.S. Dollars.
 
Inflation
 
Through the period covered by this Report, inflation has not had a significant impact on the Company’s net sales and revenues and on income from continuing operations.
 
 
18

 
 
Liquidity and Capital Resources

As at March 31, 2014, the Company had total assets of $739,054 (December 31, 2013: $528,744) consisting of cash and cash equivalents of $42,481, accounts receivable of $112,382, inventory of $118,680, prepaid expenses and vendor deposits of $155,233, loan receivable of $73,084, property and equipment of $6,983, website development of $62,789 and goodwill of $167,422. The increase in assets at March 31, 2014 from December 31, 2013, is primarily the result of the acquisition of DML and related accounts receivable, inventory and capitalized website development costs incurred in the website application and infrastructure development stage.

As at March 31, 2014, the Company had total liabilities of $2,183,123 (December 31, 2013: $1,753,394) consisting of accounts payable of $387,380, accrued liabilities of $26,212, accrued interest due to related parties of $4,388, loans from shareholders of $458,755, amounts due to related parties of $863,027 and convertible debentures of $443,361. The increase