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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
 
FORM 10-K

þ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the Fiscal Year Ended December 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)
 
15540 Biscayne Blvd, North Miami, Florida
 
33160
(Address of Principal Executive Offices)
 
 (Zip Code)
                                                 
Registrant's telephone number, including area code (416) 843-2881

Securities registered pursuant to Section 12(g) of the Act:

Common Stock, $0.0002 Par Value Per Share

(Title of Class)
 
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
 
o
 Yes
þ
 No
 
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.
 
o
 Yes
 þ
 No

Check whether the issuer (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, and (2) has been subject to such filing requirements for the past 90 days.  Yes þ     No  o
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes þ   No  
   
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (Sec. 229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.o
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.
   
Large accelerated filer
  o
   
Accelerated filer
o
 
Non-accelerated filer
  o
   
Smaller reporting company
þ
 

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

The aggregate market value of the voting common stock held by non-affiliates of the Registrant on June 30, 2014, was approximately $17,111,988 based on the average bid and asked prices on such date of $0.25. The registrant does not have any non-voting equities.

The Registrant had 92,698,018 shares of common stock (“Common Shares” or “Common Stock”), $0.0002 par value per share, outstanding on March 30, 2015.
 


 
 
 
 
 
TABLE OF CONTENTS
 
FORM 10-K
 
FOR FISCAL YEAR ENDED DECEMBER 31, 2014
 
   
Page
 
Part I
 
         
ITEM 1.
Business
 
5
 
         
ITEM 1A.
Risk Factors
 
17
 
         
ITEM 1B.
Unresolved Staff Comments
 
27
 
         
ITEM 2.
Properties
 
27
 
         
ITEM 3. 
Legal Proceedings
 
27
 
         
ITEM 4.
Mine Safety Disclosures
 
27
 
         
Part II
 
         
ITEM 5.
Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
 
28
 
         
ITEM 6
Selected Financial Data
 
29
 
         
ITEM 7. 
Management’s Discussion and Analysis of Financial Condition and Results of Operation
 
30
 
         
ITEM 7A
Quantitative and Qualitative Disclosures About Market Risk
 
44
 
         
ITEM 8. 
Financial Statements and Supplementary Data
 
45
 
         
ITEM 9.  
Changes in and Disagreements With Accountants on Accounting and Financial Disclosure
 
46
 
         
ITEM 9A.  
Controls and Procedures
 
46
 
         
ITEM 9B.
Other Information
 
47
 
         
Part III
 
         
ITEM 10. 
Directors, Executive Officers and Corporate Governance
 
48
 
         
ITEM 11. 
Executive Compensation
 
52
 
         
ITEM 12. 
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
 
54
 
         
ITEM 13.  
Certain Relationships and Related Transactions, and Director Independence
 
55
 
         
ITEM 14.
Principal Accounting Fees and Services
 
58
 
         
ITEM 15. 
Exhibits, Financial Statement Schedules
 
58
 
         
Signatures
       
 
 
 
3

 
 
Cautionary Language Regarding Forward-Looking Statements
 
This Annual Report on Form 10-K (this “Report” or “Annual Report”) contains forward-looking statements that are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995 under Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended.  These forward-looking statements are based on management's expectations as of the filing date of this Report with the Securities and Exchange Commission ("SEC"). 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, but are not limited to statements concerning the Company's operations, performance, financial condition, business strategies, and other information and that involve substantial risks and uncertainties. Such forward-looking statements are subject to certain risks, uncertainties and assumptions, including prevailing market conditions and are more fully described under “Part I, Item 1A -  Risk Factors” of this Report. 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 of this Report under the caption “Risk Factors,” 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.
 
 
4

 

PART I

ITEM 1.  BUSINESS

GENERAL DEVELOPMENT OF THE BUSINESS

Gilla (the “Company”, the “Registrant” or “Gilla”) was incorporated under the laws of the state of Nevada on March 28, 1995 under the name of Truco, Inc. The Company later changed its name to Web Tech, Inc., and then to Cynergy, Inc., Mercantile Factoring Credit Online Corp., Incitations, Inc., Osprey Gold Corp. and to its present name. The Company adopted the present name, Gilla Inc., on February 27, 2007. Gilla’s address is 15540 Biscayne Blvd, North Miami, Florida 33160.

On November 15, 2012, the Company entered into a convertible revolving credit note (the “Credit Note”) with a related party, whereby the Company agreed to pay the party the aggregate unpaid principal amount of $225,000 on or before February 15, 2014, bearing interest at a rate of 6% per annum. On February 14, 2014, the Company repaid all amounts due under the Credit Note.

On November 21, 2012, the Company completed a business combination transaction (the “Merger”), pursuant to which it acquired all of the issued and outstanding common shares of Snoke Distribution Canada Ltd. (“Snoke Distribution”) in exchange for issuing 29,766,667 of its Common Shares to the former shareholders of Snoke Distribution. Upon the completion of the Merger, Snoke Distribution became a wholly-owned subsidiary of the Company, its senior management became the entire senior management of the Company and the Company began to focus exclusively on its current business consisting of the design, marketing and distribution of electronic cigarettes, vaporizers, e-liquids and accessories (collectively, “E-cigarettes”).

On April 13, 2013, Mr. Henry J. Kloepper was appointed as Lead Independent Director and Chairman of the Audit Committee. Mr. Kloepper also serves as Chairman of the Compensation and Governance Committees.

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.

On August 21, 2013, the Company announced that its board of directors (the “Board of Directors”) had approved a non-brokered private placement offering (the “Convertible Debenture Offering”) of unsecured subordinated convertible debentures (“Convertible Debentures”) for aggregate gross proceeds of up to $2,000,000. The Convertible Debentures mature on January 31, 2016, bear interest at a rate of 12% per annum, payable quarterly in arrears, and are convertible at the option of the holder into Common Shares at a conversion price of $0.10 per Common Share at any time prior to the maturity date. The conversion price was subsequently amended to be $0.07 per Common Share. The proceeds of the Convertible Debenture Offering were used to repay debt and for the purchase of inventory and technology, product development, marketing, and working capital and general administrative purposes.

On September 3, 2013, the Company issued $425,000 of Convertible Debentures pursuant to the terms of the Convertible Debenture Offering for aggregate gross proceeds of $425,000. The Convertible Debentures were initially issued at a conversion price of $0.10 per Common Share and, on October 28, 2013, were reissued at a conversion price of $0.07 per Common Share. All the other terms and conditions of the re-issued Convertible Debentures remained the same.

On September 25, 2013, the Company issued and sold, on a private placement basis, 200,000 Common Shares at a price of $0.035 per Common Share, for aggregate gross proceeds of $7,000. As part of this transaction, on November 19, 2013, the Company also issued and sold, on a private placement basis, 76,485 Common Shares at a price of $0.035 per Common Share, for aggregate gross proceeds of $2,677.

On September 25, 2013, the Company issued 942,784 Common Shares at a price of $0.053 per Common Share, as settlement of $50,000 in consulting fees owed to an unrelated party.
 
 
5

 

On September 25, 2013, the Company issued 1,000,000 Common Shares at a price of $0.035 per Common Share, as settlement of $35,000 of debt owed pursuant to related party loans. As part of this transaction, on November 19, 2013, the Company also issued 428,571 Common Shares at a price of $0.035 per Common Share, as settlement of $15,000 of debt owed pursuant to loans made to the Company by such related parties.

On September 25, 2013, the Company issued 973,960 Common Shares at a price of $0.035 per Common Share, as settlement of $34,091 of debt owed pursuant to shareholder loans. As part of this transaction, on November 19, 2013, the Company also issued 417,411 Common Shares at a price of $0.035 per Common Share, as settlement of $14,609 of debt owed pursuant to shareholder loans.

On September 30, 2013, the Company issued a secured promissory note (the “Related Party Note”) in connection with a loan to it by a related party in the principal amount of $200,000. The outstanding principal amount of the Related Party Note, together with accrued and unpaid interest at a rate of 1.5% per month, was paid in full and the Related Party Note was retired on December 23, 2013.

On October 8, 2013, the Company issued and sold, on a private placement basis, 50,000 Common Shares at a price of $0.05 per Common Share, for aggregate gross proceeds of $2,500.

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 which operates as one of the Company’s e-commerce sales platforms.

On November 27, 2013, the Company issued 400,000 Common Shares at a price of $0.05 per Common Share, as a settlement of $20,000 in consulting fees owed to an unrelated party.

On November 27, 2013, the Company issued 300,000 Common Shares at a price of $0.0583 per Common Share, as a settlement of $17,500 in consulting fees owed to an unrelated party.

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 December 23, 2013, the Company issued an additional $797,000 of Convertible Debentures pursuant to the terms of the Convertible Debenture Offering.

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 owed 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 an additional $178,000 of Convertible Debentures pursuant to the terms of the Convertible Debenture Offering.

On February 13, 2014, the Company entered into a secured promissory note (the “Secured 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. The Secured Note is secured by a general security agreement over the assets of the Company. On November 10, 2014, the Secured Note maturity date was extended until January 1, 2016.

On February 14, 2014, the Company repaid all amounts due under the Credit Note, as described in the second paragraph of this section, above.

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 in Ireland. The Company issued to the sellers 500,000 Common Shares valued at a price of $0.11 per Common Share and warrants for the purchase of 1,000,000 Common Shares of the Company. The warrants were to vest upon DML achieving cumulative E-cigarette sales revenues of over $1,500,000 beginning on the closing date and exercisable over three years with an exercise price of $0.25 per Common Share. No value has been assigned to the warrants as there is 0% probability of achieving the vesting provision. The Company issued the 500,000 Common Shares to the sellers on June 2, 2014. On October 6, 2014, the Company appointed liquidators for the purpose of winding up DML by way of a voluntary liquidation by reason of its liabilities.
 
 
6

 

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 owed to an unrelated party.

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 owed to an unrelated party.

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 Convertible Debentures into Common Shares of the Company pursuant to the terms of the Convertible Debentures. On May 30, 2014, the Company issued 714,286 Common Shares at a price of $0.07 per Common Share, as a result of these elections received on April 15, 2014 to convert $50,000 of the Convertible Debentures.

On May 30, 2014, the Company issued 835,000 Common Shares at a price of $0.10 per Common Share, as a settlement of $83,500 in advertising production costs owed to unrelated parties.

On May 30, 2014, the Company issued 10,000 Common Shares at a price of $0.10 per Common Share, as a settlement of $1,000 in advertising production costs owed to related parties.

On May 30, 2014, the Company issued 92,500 Common Shares at a price of $0.19 per Common Share, as a settlement of $17,500 in consulting fees owed to an unrelated party.

On June 2, 2014, the Company issued 55,000 Common Shares at a price of $0.25 per Common Share, as a settlement of $13,750 in consulting fees owed to an unrelated party.

On July 15, 2014, the Company entered into a secured promissory note (the “Secured Note No.2”) with a shareholder, whereby the Company agreed to pay the party the aggregate unpaid principal amount of $100,000 on or before July 18, 2014, bearing interest at a rate of 10% per annum. The Secured Note No.2 is secured by the general security agreement issued with the Secured Note. On November 10, 2014, the Secured Note No.2 maturity date was extended until January 1, 2016.

On July 25, 2014, the Company issued and sold, on a private placement basis, 1,401,333 Common Shares at a price of $0.15 per Common Share, for aggregate gross proceeds of $210,200. Of the total gross proceeds of the private placement, $190,250 was received prior to the quarter ended June 30, 2014 and booked as an unissued share liability as at June 30, 2014. On July 25, 2014 and in connection to the private placement, the Company issued 10,640 warrants to purchase Common Shares of the Company exercisable over one year with an exercise price of $0.15 per Common Share.

On July 29, 2014, the Company issued 300,000 Common Shares at a price of $0.18 per Common Share, as a prepayment of $54,000 in consulting fees, to an unrelated party.

On August 1, 2014, the Company entered into a revolving credit facility (the “Credit Facility”) with a consortium of participants that includes two of the Company’s senior executive officers (the “Lender”), whereby the Lender would make a revolving credit facility in the aggregate principal amount of CAD $500,000 for the exclusive purpose of purchasing inventory for sale in the Company’s ordinary course of business to approved customers. The agent who arranged the Credit Facility was not a related party of the Company. The Credit Facility bears interest at a rate of 15% per annum on all drawn advances and a standby fee of 3.5% per annum on the undrawn portion of the Credit Facility. The Credit Facility shall mature on August 1, 2015 whereby the outstanding advances together with all accrued and unpaid interest thereon shall be due and payable. On August 1, 2014 and in connection to the Credit Facility, the Company issued 250,000 warrants to purchase Common Shares of the Company exercisable over two years with an exercise price of $0.30 per Common Share. The Company’s Chief Executive Officer and Chief Financial Officer are both participants of the consortium of participants of the Credit Facility, each having committed to provide ten percent of the principal amount of the Credit Facility. Neither the Chief Executive Officer nor the Chief Financial Officer will participate in the warrants issued in connection with the Credit Facility and both parties have been appropriately abstained from voting on the Board of Directors to approve the Credit Facility, where applicable.

On August 15, 2014, the Company issued 10,919 Common Shares at a price of $0.15 per Common Share, as a settlement of $1,638 of shareholder loans.
 
 
7

 

Gilla Operations Worldwide Limited (“Gilla Worldwide”) was incorporated on August 25, 2014 under the laws of Ireland. Gilla Worldwide is a wholly-owned subsidiary of the Company and, since its incorporation, has been the primary operating subsidiary of the Company in Europe.

Gilla Franchises, LLC (“Gilla Franchises”) was incorporated on September 8, 2014 under the laws of the State of Florida. Gilla Franchises is a wholly-owned subsidiary of the Company.

Gilla Biscayne, LLC (“Gilla Biscayne”) was incorporated on September 8, 2014 under the laws of the State of Florida. Gilla Biscayne is a wholly-owned subsidiary of Gilla Franchises and, since its incorporation, has been the primary operating subsidiary for the Company’s first retail location in the United States.

On September 17, 2014, the Company issued 182,749 Common Shares at a price of $0.15 per Common Share, as a settlement of $27,412 in consulting fees owed to an unrelated party.

On September 29, 2014, the Company issued and sold, on a private placement basis, 1,333,334 Common Shares at a price of $0.15 per Common Share, for aggregate gross proceeds of $200,000.

On September 30, 2014, the Company issued 63,559 Common Shares at a price of $0.236 per Common Share, as compensation for $15,000 in consulting fees to an unrelated party.

On September 30, 2014, the Company received forms of election whereby holders of the Convertible Debentures elected to convert a total of $800,000 of the Convertible Debentures into Common Shares of the Company pursuant to the terms of the Convertible Debentures. On November 4, 2014, the Company issued 11,428,572 Common Shares at a price of $0.07 per Common Share, as a result of these elections received on September 30, 2014 to convert $800,000 of the Convertible Debentures.

On September 30, 2014, the Company settled $78,559 in interest payable on the Convertible Debentures and issued 523,726 Common Shares at a price of $0.15 per Common Share on November 4, 2014.

On September 30, 2014, the Company settled $107,676 in consulting fees payable to related parties and issued 717,840 Common Shares at a price of $0.15 per Common Share on November 4, 2014.

On October 7, 2014, Dr. Blaise A. Aguirre and Mr. Christopher Rich were appointed as members of the Board of Directors of the Company.

On October 9, 2014, the Company issued 100,000 Common Shares at a price of $0.16 per Common Share, as a settlement of $16,000 in consulting fees owed to an unrelated party.

On November 10, 2014, the Company entered into an amendment with a shareholder (the “Secured Note Amendment”) whereby both parties agreed to extend the maturity date of both the Secured Note, dated February 13, 2014, and the Secured Note No.2, dated July 15, 2014, to January 1, 2016, with all other terms of the respective notes remaining the same. The Secured Note Amendment also granted the shareholder an early repayment right to repay both the Secured Note and the Secured Note No.2 if the Company were to complete an equity raise with gross proceeds greater than or equal to one million dollars ($1,000,000) prior to the repayment dates of each of the respective notes. On November 10, 2014 and in connection to the Secured Note Amendment, the Company issued 250,000 warrants to purchase Common Shares of the Company at an exercise price of $0.20 per Common Share, such warrants expiring on January 1, 2016.

On November 10, 2014, the Company received a form of election whereby a holder of a Convertible Debenture elected to convert a total of $275,000 of the Convertible Debentures into Common Shares of the Company pursuant to the terms of the Convertible Debentures. On November 20, 2014, the Company issued 3,928,571 Common Shares at a price of $0.07 per Common Share, as a result of this election received on November 10, 2014 to convert $275,000 of the Convertible Debentures.

On November 10, 2014, the Company settled $26,093 in interest payable on the Convertible Debentures and issued 173,953 Common Shares at a price of $0.15 per Common Share on November 20, 2014.
 
 
8

 

On November 10, 2014, the Company settled $32,081 in interest payable to a shareholder on the Secured Note and Secured Note No.2 and issued 218,669 Common Shares at a price of $0.15 per Common Share on November 20, 2014.

On November 14, 2014, Dr. Blaise A. Aguirre was appointed as a member of the Audit Committee.

On December 17, 2014, the Company issued 800,000 Common Shares at a price of $0.15 per Common Share, as compensation of $120,000 in consulting fees to an unrelated party.

On December 31, 2014, the Company issued 500,000 Common Shares at a price of $0.15 per Common Share, as a settlement of $75,000 in consulting fees owed to a related party.

On December 31, 2014, the Company issued and sold, on a private placement basis, 490,000 Common Shares at a price of $0.15 per Common Share, for aggregate gross proceeds of $73,500.

Subsequent Events

On January 30, 2015, the Company entered into a supply and distribution agreement with an e-cigarette company distributing primarily to the United Kingdom, whereby the Company is to supply white label products for the clients existing brand. In connection with this agreement, the Company issued 250,000 warrants to purchase Common Shares of the Company exercisable over two years with an exercise price of $0.30 per Common Share.

On March 9, 2015, the Company received forms of election whereby holders of the Convertible Debentures elected to convert a total of $52,000 of the Convertible Debentures into Common Shares of the Company pursuant to the terms of the Convertible Debentures. Such Common Shares remain unissued as of the date of the filing of this Report.

On March 9, 2015, the Company settled $1,095 in interest payable to holders of the Convertible Debentures and agreed to issue 7,303 Common Shares at a price of $0.15 per Common Share. Such Common Shares remain unissued as of the date of the filing of this Report.

On March 18, 2015, the Company entered into a letter of intent (the “LOI”) to acquire all of the issued and outstanding shares of a Florida based e-liquids manufacturer (the “Target”). The total purchase price would be $1,500,000 (the “Purchase Price”) payable to the vendors as (i) $600,000 in cash payable on closing, (ii) $600,000 in common stock of the Company issued on closing, and (iii) $300,000 in promissory notes issued to the vendors, due eighteen (18) months from the closing date, non-interest bearing and secured by shares of common stock of the Company. The Purchase Price is subject to confirmatory due diligence of the Target’s overall business operations. The Company will maintain the existing management team and operational structure of the Target. The transaction is expected to close on or before May 15, 2015 or such other date as agreed between the parties.

BUSINESS OF ISSUER

The current business of the Company consists of the design, marketing and distribution of electronic cigarettes, vaporizers, e-liquids and accessories (collectively, “E-cigarettes”). 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 has a two-pronged business model: white-label solutions, including branding, marketing and sales support; and e-commerce solutions like Charlie’s Club, a members-only online E-cigarette monthly subscription service featuring free hardware and no contracts.
 
 
9

 

Consolidation Strategy:

The Company intends to selectively pursue acquisitions to quickly penetrate certain market channels and new geographies. The Company plans to consolidate the fragmented e-liquid industry. This global industry is ripe for consolidation as there are a large number of independent producers in the United States and Europe that the Company believes can be acquired at accretive multiples. A number of these e-liquid producers have experienced exponential growth and have developed trade secrets in their e-liquid products. Many of these e-liquid producers struggle to drive organic growth, because they have limited access to the capital and expertise needed to run larger operations. Management believes the Company is well placed to consolidate the industry, having a management skillset well-suited for an M&A driven strategy, access to the capital markets and strong institutional buy-in for the overall strategy. The Company has identified a strong pipeline of potential acquisitions and is currently in discussions with a number of targets.

Please refer to the consolidated financial statements contained elsewhere in this Report for additional information regarding the Company’s financial condition and results of operations.

The Company’s Products

The Company’s current products include E-cigarettes, vaporizers, e-liquids and certain related accessories (collectively, the “Products”), which, in each case, are manufactured and supplied to the Company by third parties for resale. These styles are as follows:

E-Cigarettes:

A two-piece, metal E-cigarette that comes in disposable and rechargeable versions and is comprised of the following key components:

●  
Cartomizer - The cartomizer is a device consisting of an atomizer and cartridge in one piece that connects to the battery. It contains a small heating coil consisting of a simple filament and wicking material that vaporizes liquid, and is surrounded by a liquid-soaked poly-foam. The cartomizer is disposed and replaced after the liquid is exhausted. Users have compared one cartomizer to the equivalent of approximately 1.5 packs of cigarettes.

●  
Battery - The battery is a lithium-ion rechargeable battery activated by an electronic airflow sensor that is triggered by drawing breath through the E-cigarette device. The Company’s E-cigarettes are available in a range of sizes that may appeal to the user.

●  
E - Liquid - A solution of propylene glycol (See E-liquids below).

Vaporizers:

A two-piece, rechargeable vaporizer which is comprised of the following key components:

● 
Clearomizer - The clearomizer is the reusable tank that connects to the battery in which the e-liquid solution is deposited. Inside the clearomizer is a wicking material that one end absorbs the liquid solution and the other end is wrapped around a small heating coil outside of the clearomizer. Users have compared a filled clearomizer to the equivalent of approximately 3 packs of cigarettes.

● 
Battery - The battery is a lithium-ion rechargeable battery, available different voltage capacities: 650mAh, 900mAh and 1100mAh. The Vaporizer is activated by the user pressing and holding down a LED button located on the exterior of the battery which activates the heating coil.

● 
E-Liquid - A solution of propylene glycol (See E-liquids below).
 
 
10

 

E-liquids:

A solution of propylene glycol (an organic compound that facilitates the vapor effect that can be found in many pharmaceutical and cosmetic products such as moisturizers), vegetable glycerin, flavors and a variable percentage of nicotine. The Company offers over 200 flavors of E-cigarettes and e-liquids which are available in nicotine strengths of 0mg, 6mg, 12mg, 18mg and 24mg.

Related Accessories:

The Company offers a full range of E-cigarette and vaporizer accessories such as carrying cases, chargers and replacement components (such as atomizer heads and clearomizers) for the Company’s full range of Products.

Supply, Distribution, Principal Markets & Marketing Methods

The Company has entered into supply relationships providing for the supply of the Company’s Products for purposes of resale to its customers. The Company intends to focus on marketing and distributing its Products through white label and online distribution channels, including retail and wholesale buying groups, retail networks and through a number of websites. As part of these plans, the Company plans to continue to develop and offer its Products on a “white label”, private branded basis. These intended sales channels are described in more detail below.

White Label Distribution:

The Company is actively pursuing opportunities and relationships to develop and offer its Products on a “white label”, private branded basis. Management of the Company believes that there is an opportunity to supply Products on a custom branded basis to a variety of customers for purposes of resale. These potential customers may include wholesale and retail customers that have or wish to develop a private label to identify a brand with a store, a concept known as the store brand. In addition, management also believes that there may be other potential customers that, having identified a business opportunity in the sale of E-cigarettes and, in particular, the Company’s Products, may assess that setting up their own production lines and facilities or supply channels may require a substantial investment in equipment, human resources, trademarks and so forth, or may otherwise not be commercially feasible. In such cases, a viable alternative is to source Products from the Company, which has already sourced a supply of Products that can be provided to the customer on a custom branded basis.

To this end, the Company has entered into exclusive supply agreements such as the three-year exclusive agreement with Scandinavian Tobacco Group United Kingdom Ltd., the UK-based subsidiary of the world-leading cigar manufacturer and pipe tobacco company to supply, brand and distribute a proprietary line of E-cigarettes, vaporizers and e-liquids in the United Kingdom. The Company intends to seek similar opportunities to enter into white label supply agreements in other markets worldwide. The Company has procured white label opportunities in the UK, Ireland and North America.

E-Commerce:

The Company intends to distribute its branded Products through its websites and other online sales platforms. Through its e-commerce sales initiatives, the Company seeks to generate recurring purchases of its exclusive brands of E-cigarettes and vaporizers from customers who are legally allowed to purchase tobacco products in the United States and the European Union. The Company has engaged multiple marketing agencies to assist it in the development of its e-commerce platform and digital marketing strategy. Management expects that its marketing strategy will continue to evolve expanding on various forms of social media as a key element in its marketing strategies and in further establishing and growing the Company’s business.

To this end, during the third quarter of 2014, the Company announced the launch of “Charlie’s Club”, a subscription-based, members-only E-cigarette service featuring free hardware, no contracts and monthly delivery of E-cigarettes. Charlie’s Club members choose one of the three flexible membership packages to subscribe for the delivery of monthly E-cigarette refills based on a member’s consumption preferences. Charlie’s Club also has a dynamic affiliate program, offering incentives and compensation in return for advertising and lead generation. Affiliates have access to free professional marketing materials, including banners, videos, text links, coupons and more, along with monthly payment generation and sub-affiliate tracking. The Company intends to seek similar opportunities in other markets worldwide to launch new e-commerce services.
 
 
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Employees

As at the date of this Report, the Company has eight key individuals engaged as consultants and three full-time employees. Collectively, these consultants and employees oversee day-to-day operations of the Company supporting management, administrative, bookkeeping, accounting, sales, marketing, and digital media functions of the Company. As required, the Company also engages consultants to provide services to the Company, including legal and corporate services. The Company has no unionized employees.

Being in the growth-stage, the Company intends to increase (or decrease) its number of employees as appropriate to achieve the Company’s objectives. The Company intends to focus on identifying, attracting and retaining talented, highly motivated, customer-focused, team-orientated employees to support its growth.

Competition

The market for the Company’s Products is very competitive and subject to rapid technological change and regulatory requirements. The E-cigarette industry is extremely competitive with low barriers to entry. There can be no assurance that the Company will be in a stronger position to respond quickly to potential acquisitions and other market opportunities, new or emerging technologies and changes in customer requirements. Market disruption will be caused when new products or brands are able to differentiate from the market. Failure to maintain and enhance the Company’s competitive position could materially adversely affect the business and its prospects.

The Company faces intense competition from direct and indirect competitors, including “big tobacco,” “big pharma,” and other known and established or yet to be formed E-cigarette companies, each of whom pose a competitive threat to the Company and its future business prospects. The Company expects competition to intensify in the future. Certain of these businesses are either currently competing with the Company or are focusing significant resources on providing products that will compete with the Company’s E-cigarette product offerings in the future.

The Company’s principal competitors can be classified into three main categories: i) tobacco companies, ii) other E-cigarette companies, and iii) pharmaceutical companies. The Company competes primarily on the basis of product quality, brand recognition, brand loyalty, service, marketing, advertising and price. The Company is subject to highly competitive conditions in all aspects of the business, and barriers to entry into the online business are low. The competitive environment and the Company’s competitive position can be significantly influenced by weak economic conditions, erosion of consumer confidence, competitors’ introduction of low-priced products or innovative products, cigarette excise taxes, higher absolute prices and larger gaps between price categories, and product regulation that diminishes the ability to differentiate tobacco products.

Traditional tobacco companies, including Reynolds American Inc., Altria Group Inc., Lorillard Inc., Phillip Morris International Inc., British American Tobacco PLC and Imperial Tobacco Group PLC are expanding into various E-cigarette markets throughout the world. Each of these companies has recently rolled out their own E-cigarette offerings in markets where the Company currently sells its Products. Because of their well-established sales and distribution channels, marketing expertise and significant resources, “big tobacco” may be better positioned than small competitors to capture a larger share of the E-cigarette market. The Company also faces competition from smaller tobacco companies that are much larger, better funded, and more established than the Company.

The Company faces direct competition from independent pure play E-cigarette companies, including Vapor Corp., Electronic Cigarettes International Group Ltd. and other private E-cigarette companies that currently market competing products. The Company also faces indirect competitors such as the traditional tobacco companies offering cigarettes, Nicotine Replacement Therapies (NRT) and smokeless tobacco products. It is likely that these companies will enter the market as the E-cigarette industry grows. There can be no assurance that the Company will be able to compete successfully against any of these traditional tobacco players and smaller competitors, some of whom have greater resources, capital, industry experience, market penetration or developed distribution networks.
 
 
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Intellectual Property

The Company seeks to protect its intellectual property using a combination of trademarks, trade secrets, copyrights and contractual provisions. Trademarks are expected to form an integral part of the Company’s brand marketing.

The Company has and generally plans to continue to enter into non-disclosure, confidentially and intellectual property assignment agreements with all new employees as a condition of employment. In addition, the Company will also generally enter into confidentiality and non-disclosure agreements with consultants, manufacturers’ representatives, distributors, suppliers and others to attempt to limit access to, use and disclosure of our proprietary information.

Trademarks

The Company owns the European Community trademark for the “YECIG” brand of E-cigarettes and vaporizers. The Company has also filed the United States trademark for the “Charlie’s Club” brand of E-cigarettes and vaporizers which is currently being examined by the U.S. Patent and Trademark Office.

Patents

The Company does not own any domestic or foreign patents relating to E-cigarettes or vaporizers.

Government Regulations

Government authorities in the United States, the European Union, Canada and in other countries extensively regulate, among other things, the research, development, testing, approval, manufacturing, labeling, post-approval monitoring and reporting, packaging, promotion, storage, advertising, distribution, marketing and export and import of electronic products for the vaporization and administration of inhaled doses of nicotine including E-cigarettes, cigars, cigarillos and pipes, as well as cartridges of nicotine solutions and related products. The Company must comply with these regulations, as applicable, in the jurisdictions where it offers and sells its Products. The process of obtaining regulatory approvals and the subsequent compliance with applicable federal, state, local and foreign statutes and regulations require the expenditure of substantial time and financial resources. The following is a summary of certain regulatory matters generally affecting the E-cigarette marketplace in Canada and the United States, which does not purport to be a comprehensive overview of all applicable laws and regulations that may impact the Company’s business.

United States

The United States Food and Drug Administration (the “FDA”) is permitted to regulate E-cigarettes as “tobacco products” under the Family Smoking Prevention and Tobacco Control Act of 2009 (the “Tobacco Control Act”), based on the December 2010 U.S. Court of Appeals for the D.C. Circuit’s decision in Sottera, Inc. v. Food & Drug Administration, 627 F.3d 891 (D.C. Cir. 2010). Furthermore, the FDA is not permitted to regulate E-cigarettes as “drugs” or “devices” or a “combination product” under the Federal Food, Drug and Cosmetic Act unless marketed for therapeutic purposes.

Since the Company does not market E-cigarettes for therapeutic purposes, the Company’s Products that contain nicotine are subject to being classified as “tobacco products” under the Tobacco Control Act. Although the FDA is prohibited from issuing regulations banning all cigarettes or all smokeless tobacco products, or requiring the reduction of nicotine yields of a tobacco product to zero, the Tobacco Control Act grants the FDA broad authority to impose restrictions over the design, manufacture, distribution, sale, marketing and packaging of tobacco. Furthermore, The FDA is required to issue future regulations regarding the promotion and marketing of tobacco products sold or distributed over the internet, by mail order or through other non-face-to-face transactions in order to prevent the sale of tobacco products to minors.
 
 
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The Tobacco Control Act also requires an establishment of a Tobacco Products Scientific Advisory Committee to provide advice, information and recommendations with respect to the safety, dependence or health issues related to tobacco products.

The Tobacco Control Act could result in a decrease in tobacco product sales in the United States, including the sales of the Company’s Products.

The FDA has previously indicated that it intends to regulate E-cigarettes under the Tobacco Control Act through the issuance of deeming regulations that would include E-cigarettes under the definition of a “tobacco product” under the Tobacco Control Act subject to the FDA’s jurisdiction. On April 25, 2014, the FDA announced a proposed rule (the “Proposed Rule”) seeking to establish, for the first time, federal regulatory authority over, among other tobacco products, E-cigarettes (collectively, “Deemed Tobacco Products”).

If approved by the FDA in its current form, the final Proposed Rule would mandate with respect to Deemed Tobacco Products such as E-cigarettes:

a prohibition on sales to those younger than 18 years of age and requirements for verification by means of photographic identification;
health warnings on product packages and in advertisements; and
a ban on vending machine sales unless the vending machines are located in a facility where the retailer ensures that individuals under 18 years of age are prohibited from entering at any time.

Also under the Proposed Rule, manufacturers of newly Deemed Tobacco Products would be subject to, among other requirements, the following:

registration with, and reporting of product and ingredient listings to, the FDA;
no marketing of new tobacco products prior to FDA review;
no direct and implied claims of reduced risk such as “light”, “low” and “mild” descriptions unless FDA confirms (a) that scientific evidence supports the claim and (b) that marketing the product will benefit public health;
payment of user fees; and
no distribution of free samples.

In addition, the Proposed Rule would require any “new tobacco product,” defined as any Deemed Tobacco Product that was not commercially marketed as of the “grandfathering” date of February 15, 2007, to obtain premarket approval before it could be marketed in the U.S. The premarket approval could take any of the following three pathways: (1) submission of a premarket tobacco product application (“PMTA”) and receipt of a marketing authorization order; (2) submission of a substantial equivalence (“SE”) report and receipt of an SE order; or (3) submission of a request for an exemption from SE requirements and receipt of an SE exemption determination. FDA has proposed a compliance policy that would delay enforcement of PMTA and SE requirements for two years after the effective date of the final Proposed Rule. We cannot predict if our Products, all of which would be considered “non-grandfathered,” will receive the required premarket approval from FDA. Failure to obtain premarket approval could prevent the Company from marketing and selling non-grandfathered Products in the U.S. and, thus, may have a material effect the business, financial condition and results of operations.

The Proposed Rule contemplates enforcement actions being brought against products determined to be adulterated and misbranded. The Proposed Rule’s comment period ended on August 8, 2014. It is not known when the Proposed Rule could become final. The Proposed Rule contains various compliance dates based on the publication date of the final Rule in the Federal Register.

The application of the Tobacco Control Act to E-cigarettes could impose, among other things, restrictions on the content of nicotine in E-cigarettes, the advertising, marketing and sale of E-cigarettes, the use of certain flavorings and the introduction of new products. We cannot predict the scope of such regulations or the impact they may have on the Company specifically or the E-cigarette industry generally, though if enacted, they could have a material adverse effect on the business, results of operations and financial condition.

State and local governments currently legislate and regulate tobacco products, including what is considered a tobacco product, how tobacco taxes are calculated and collected, to whom tobacco products can be sold and by whom, in addition to where tobacco products, specifically cigarettes may be smoked and where they may not. Certain municipalities have enacted local ordinances which preclude the use of E-cigarettes where traditional tobacco burning cigarettes cannot be used and certain states have proposed legislation that would categorize E-cigarettes as tobacco products, equivalent to their tobacco burning counterparts. If these bills become laws, E-cigarettes may lose their appeal as an alternative to traditional cigarettes; which may have the effect of reducing the demand for the Company’s Products and as a result have a material adverse effect on our business, results of operations and financial condition.
 
 
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The Company may be required to discontinue, prohibit or suspend sales of its Products to states that require us to obtain a retail tobacco license. If the Company is unable to obtain certain licenses, approvals or permits and if the Company is not able to obtain the necessary licenses, approvals or permits for financial reasons or otherwise and/or any such license, approval or permit is determined to be overly burdensome to the Company then the Company may be required to cease sales and distribution of its Products to those states, which would have a material adverse effect on the Company’s business, results of operations and financial condition.

As a result of FDA import alert 66-41 (which allows the detention of unapproved drugs promoted in the U.S.), U.S. Customs has from time to time temporarily and in some instances indefinitely detained certain products. If the FDA modifies the import alert from its current form which allows U.S. Customs discretion to release the products, to a mandatory and definitive hold the Company will no longer be able to ensure a supply of saleable product, which will have material adverse effect on the Company’s business, results of operations and financial condition.

At present, neither the Prevent All Cigarette Trafficking Act (which prohibits the use of the U.S. Postal Service to mail most tobacco products and which amends the Jenkins Act, which would require individuals and businesses that make interstate sales of cigarettes or smokeless tobacco to comply with state tax laws) nor the Federal Cigarette Labeling and Advertising Act (which governs how cigarettes can be advertised and marketed) apply to E-cigarettes. The application of either or both of these federal laws to E- cigarettes would have a material adverse effect on the Company’s business, results of operations and financial condition.

The tobacco industry expects significant regulatory developments to take place over the next few years, driven principally by the World Health Organization’s Framework Convention on Tobacco Control (“FCTC”). The FCTC is the first international public health treaty on tobacco, and its objective is to establish a global agenda for tobacco regulation with the purpose of reducing initiation of tobacco use and encouraging cessation. Regulatory initiatives that have been proposed, introduced or enacted include:

the levying of substantial and increasing tax and duty charges;
restrictions or bans on advertising, marketing and sponsorship;
the display of larger health warnings, graphic health warnings and other labeling requirements;
restrictions on packaging design, including the use of colors and generic packaging;
restrictions or bans on the display of tobacco product packaging at the point of sale, and restrictions or bans on cigarette vending machines;
requirements regarding testing, disclosure and performance standards for tar, nicotine, carbon monoxide and other smoke constituents levels;
requirements regarding testing, disclosure and use of tobacco product ingredients;
increased restrictions on smoking in public and work places and, in some instances, in private places and outdoors;
elimination of duty free allowances for travelers; and
encouraging litigation against tobacco companies.

If E-cigarettes are subject to one or more significant regulatory initiates enacted under the FCTC, the Company’s business, results of operations and financial condition could be materially and adversely affected.
 
 
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European Union

On April 3, 2014, the European Union adopted the Tobacco Product Directive which will regulate E-cigarettes containing nicotine. In particular, the Tobacco Product Directive introduces a number of new regulatory requirements for E-cigarettes. For example, it (1) restricts the amount of nicotine that E-cigarettes can contain (2) requires E-cigarettes and refill containers to be sold in child and tamper-proof packaging and nicotine liquids to contain only “ingredients of high purity”; (3) provides that E-cigarettes must deliver nicotine doses at “consistent levels under normal conditions of use” and come with health warnings, instructions for their use, information on “addictiveness and toxicity”, an ingredients list, and information on nicotine content; (4) significantly restricts the advertising and promotion of E-cigarettes; and (5) requires E-cigarette manufacturers and importers to notify EU Member States before placing new products on the market and to report annually to Member States (including on their sales volumes, types of users and their “preferences”).

The new Tobacco Product Directive came into force in May 2014 and gives Member States a two-year transition period to bring national legislation into line with the Tobacco Product Directive. Its effect will depend on how Member States transpose the Directive into their national laws. Member States may decide, for example, to introduce further rules affecting E-cigarettes (for example, age restrictions) provided that these are compatible with the principles of free movement of goods in the TFEU. For example, the Children and Families Act 2014 includes provisions that allow the Secretary of State to make regulations that prohibit the sale of E-cigarettes to people under the age of 18. The Tobacco Product Directive also includes provisions that allow Member States to ban specific E-cigarettes or types of E-cigarettes in certain circumstances if there are grounds to believe that they could present a serious risk to human health. If at least 3 Member States impose a ban and this is found to be duly justified, the European Commission could implement an EU wide ban. Similarly, the Tobacco Product Directive provides that Member States may prohibit a certain category of tobacco or related products on grounds relating to a specific situation in that Member State for public health purposes. Such measures must be notified to the European Commission to determine whether they are justified.

There is also existing legislation at the EU level and in Member States regulating medicinal products and medical devices. E-cigarettes are regarded by the competent authorities in some Member States as medicinal products and/or medical devices, and therefore require a marketing authorization (for medicinal products) prior to being placed on the market (as well as complying with all other requirements relating to medical products and devices). In the United Kingdom, for example, the MHRA has announced that E-cigarettes will be regulated as medicines in the future. Following the adoption of the Tobacco Products Directive, the MHRA will regulate as medicines a range of nicotine containing products including E-cigarettes that make medicinal claims or are above the limit set out in the Directive. This means that such E-cigarettes will only be able to be sold in the United Kingdom if a marketing authorization is first obtained from the MHRA.

There are also other national laws in Member States regulating E-cigarettes. It is not clear what impact the new Tobacco Product Directive will have on these laws.

Canada

Health Canada has advised that electronic smoking products (i.e., electronic products for the vaporization and administration of inhaled doses of nicotine including electronic cigarettes, cigars, cigarillos and pipes, as well as cartridges of nicotine solutions and related products) fall within the scope of the Food and Drugs Act. All of these products require market authorization prior to being imported, advertised or sold in Canada. Market authorization is granted by Health Canada following successful review of scientific evidence demonstrating safety, quality and efficacy with respect to the intended purpose of the health product. To date, no electronic smoking product has been authorized for sale by Health Canada.

In the absence of evidence establishing otherwise, an electronic smoking product delivering nicotine is regulated as a New Drug under Division 8, Part C of the Food and Drug Regulations. In addition, the delivery system within an electronic smoking kit that contains nicotine must meet the requirements of the Medical Devices Regulations. Appropriate establishment licences issued by Health Canada are also needed prior to importing, and manufacturing electronic cigarettes. Products that are found to pose a risk to health and/or are in violation of the Food and Drugs Act and related Regulations may be subject to compliance and enforcement actions in accordance with the Health Products and Food Branch Inspectorate's Compliance and Enforcement Policy (POL-0001). According to Health Canada regulations, it is not permissible to import, advertise or sell electronic smoking products without the appropriate authorizations, and persons that violate these regulations are subject to repercussions from Health Canada, including but not limited to, seizure of the products.
 
 
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Any of the Company’s Products that contain nicotine are currently prohibited from being imported, advertised or sold anywhere in Canada. However, as no scientific evidence demonstrating safety, quality and efficacy with respect to the intended purpose of E-cigarettes has been submitted to Health Canada to date, there is the possibility that in the future Health Canada may modify or retract the current prohibitions currently in place. However, there can be no assurance that the Company will be in total compliance, remain competitive, or financially able to meet future requirements and regulations imposed by Health Canada.

To date, Health Canada has not imposed any restrictions on E-cigarettes that do not contain nicotine. E-cigarettes that do not make any health claim and do not contain nicotine may be legally be sold in Canada. Thus, vendors can openly sell E-cigarette devices with nicotine-free cartridges. E-cigarettes are subject to standard product regulations in Canada, including the Canada Consumer Product Safety Act and the Consumer Packaging and Labelling Act.

At present, neither the Tobacco Act (which regulates the manufacture, sale, labelling and promotion of tobacco products) nor the Tobacco Products Labelling Regulations (Cigarettes and Little Cigars) (which governs how cigarettes can be advertised and marketed) apply to E-cigarettes. The application of these federal laws to E-cigarettes would have a material adverse effect on the Company’s business, results of operations and financial condition.

ITEM 1A. RISK FACTORS

In addition to other information in this Report, the following risk factors should be carefully considered in evaluating our business because such factors may have a significant impact on our business, operating results, liquidity and financial condition. The materialization of any of the risks set forth below would mean that the Company’s actual results could differ materially from those projected in any forward-looking statements.  These risks described below, as well as additional risks and uncertainties not presently known to us, or that we currently consider to be immaterial, may impact our business, operating results, liquidity and financial condition. If any of such risks occur, our business, operating results, liquidity and financial condition could be materially affected in an adverse manner. Under such circumstances, the trading price of our securities could decline, and you may lose all or part of your investment.

Risks Related to the Company’s Business

The Company’s auditors have issued an opinion expressing uncertainty regarding the Company’s ability to continue as a going concern. If the Company is not able to continue operations, investors could lose their entire investment in the Company.
 
The Company has a history of operating losses, and may continue to incur operating losses for the foreseeable future. This raises substantial doubts about the Company’s ability to continue as a going concern. The Company’s auditors issued an opinion in their audit report dated March 31, 2015 expressing uncertainty about the Company’s ability to continue as a going concern. This means that there is substantial doubt whether the Company can continue as an ongoing business without additional financing and/or generating profits from its operations. If the Company is unable to continue as a going concern and the Company fails, investors in the Company could lose their entire investment.

A lack of diversification will increase the risk of an investment in the Company. Results of operations and financial condition may deteriorate if the Company fails to diversify.

The Company’s business focus is in the lifestyle products industry, specifically the E-cigarette, vaporizer and e-liquid industry (E-cigarettes, vaporizers and e-liquids, collectively referred to as “E-cigarettes”), as a designer, marketer and distributor to the consumer goods market. Larger companies have the ability to manage their risk by diversification. However, the Company lacks diversification, in terms of both the nature and geographic scope. As a result, the Company will likely be impacted more acutely by factors affecting its industry or the regions in which it operates than if the Company were more diversified, enhancing the risk profile. If the Company cannot diversify or expand operations, the Company’s financial condition and results of operations could deteriorate.
 
 
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The market for E-cigarettes is a niche market, subject to a great deal of uncertainty, and is still evolving.

E-cigarettes, having recently been introduced to market, are at an early stage of development, represent a niche market and are evolving rapidly and are characterized by an increasing number of market entrants. The Company’s future sales and any future profits are substantially dependent upon the widespread acceptance and use of E-cigarettes. Rapid growth in the use of, and interest in, E-cigarettes is recent, and may not continue on a lasting basis. The demand and market acceptance for these products is subject to a high level of uncertainty. Therefore, the Company is subject to all of the business risks associated with a new enterprise in a niche market, including risks of unforeseen capital requirements, failure of widespread market acceptance of E-cigarettes, in general or, specifically the Company’s Products, failure to establish business relationships and competitive disadvantages as against larger and more established competitors. Results of operations may be adversely affected by decreases in the general level of economic activity and the demand for E-cigarette products.

The Company is dependent on its management to manage and operate the business.

The Company manages its capital structure and makes adjustments to it, based on the funds available to the Company, in order to maintain its daily operations. The Board of Directors does not establish quantitative return on capital criteria for management, but rather relies on the expertise of the Company’s management to sustain the future development of the business. In part, the Company’s success is largely dependent on the continued service of the members of the management team, who are critical in establishing corporate strategies, focus and future growth. The Company’s success will depend on the ability to attract and retain a qualified and competent management team in order to manage operations. Therefore, the Company’s operations may be severely disrupted, and may incur additional expenses to recruit and retain new officers. In addition, if any of the Company’s executives join a competitor or forms a competing business, the Company may lose existing customers.

Management has no experience in the E-cigarette or tobacco industries.

The Company’s management team has no prior experience in the E-cigarette or tobacco industry, which could impair the Company’s ability to comply with legal and regulatory requirements. There can be no assurance that the management team will be able to implement and affect programs and policies in an effective and timely manner that adequately respond to increased legal and regulatory compliance imposed by such laws and regulations. Failure to comply with such laws and regulations could lead to the imposition of fines and penalties and further result in the deterioration of the Company’s operations.

The market for E-cigarettes and smokeless tobacco products is relatively new and emerging. If the market develops more slowly or differently than the Company expects, the business, growth prospects and financial condition would be adversely affected.

The market for E-cigarettes and smokeless tobacco products is relatively new and many may not achieve or sustain high levels of demand and market acceptance. While traditional tobacco products are well established and revenue from traditional cigarette sales represent a substantial majority of total industry revenue, smokeless tobacco products and E-cigarettes only represent a small portion of the industry. The can be no assurance that E-cigarettes become widely adopted, or the market for smokeless products develop as the Company expects. If the market for E-cigarettes develops more slowly, or differently than expected, the business, growth prospects and financial condition of the Company would be adversely affected. In addition, if the Company fails to successfully market, brand and bring its Products to market, the business could face material adverse effects.

The Company may experience intense competition in the industry which it currently operates.

The market for the Company’s Products is very competitive and subject to rapid technological change and regulatory requirements. The E-cigarette industry is extremely competitive with low barriers to entry. There can be no assurance that the Company will be in a stronger position to respond quickly to potential acquisitions and other market opportunities, new or emerging technologies and changes in customer requirements. Market disruption will be caused when new products or brands are able to differentiate from the market. Failure to maintain and enhance the Company’s competitive position could materially adversely affect the business and its prospects.
 
 
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The Company faces intense competition from direct and indirect competitors, including “big tobacco,” “big pharma,” and other known and established or yet to be formed E-cigarette companies, each of whom pose a competitive threat to the Company and its future business prospects. The Company expects competition to intensify in the future. Certain of these businesses are either currently competing with the Company or are focusing significant resources on providing products that will compete with the Company’s E-cigarette product offerings in the future.

The Company’s principal competitors can be classified into three main categories: i) tobacco companies, ii) other E-cigarette companies, and iii) pharmaceutical companies. The Company competes primarily on the basis of product quality, brand recognition, brand loyalty, service, marketing, advertising and price. The Company is subject to highly competitive conditions in all aspects of the business, and barriers to entry into the online business are low. The competitive environment and the Company’s competitive position can be significantly influenced by weak economic conditions, erosion of consumer confidence, competitors’ introduction of low-priced products or innovative products, cigarette excise taxes, higher absolute prices and larger gaps between price categories, and product regulation that diminishes the ability to differentiate tobacco products.

Traditional tobacco companies, including Reynolds American Inc., Altria Group Inc., Lorillard Inc., Phillip Morris International Inc., British American Tobacco PLC and Imperial Tobacco Group PLC are expanding into various E-cigarette markets throughout the world. Each of these companies has recently rolled out their own E-cigarette offerings in markets where the Company currently sells its Products. Because of their well-established sales and distribution channels, marketing expertise and significant resources, “big tobacco” may be better positioned than small competitors to capture a larger share of the E-cigarette market. The Company also faces competition from smaller tobacco companies that are much larger, better funded, and more established than the Company.

The Company faces direct competition from independent pure play E-cigarette companies, including Vapor Corp., Electronic Cigarettes International Group Ltd. and other private E-cigarette companies that currently market competing products. The Company also faces indirect competitors such as the traditional tobacco companies offering cigarettes, Nicotine Replacement Therapies (NRT) and smokeless tobacco products. It is likely that these companies will enter the market as the E-cigarette industry grows. There can be no assurance that the Company will be able to compete successfully against any of these traditional tobacco players and smaller competitors, some of whom have greater resources, capital, industry experience, market penetration or developed distribution networks.

Conventional tobacco sales have been declining, which could have a material adverse effect on the Company.

Conventional tobacco sales, in terms of volume, have been declining in the United States as a result of many regulatory restrictions, increased awareness in smoking cessation and a general decline in social acceptability of smoking. Although the E-cigarette industry is growing rapidly, it represents a small portion of the overall tobacco industry. A continual decline in tobacco sales could adversely affect the growth of the E-cigarette niche, which could have a material adverse effect on the business, results of operations and financial condition.

The Company competes with foreign importers who may not comply with government regulations.

The Company faces competition from foreign importers of E-cigarettes who may illegally ship their products into the United States, the European Union, Canada or any other market for direct delivery to customers. These market participants may not have the added cost and expense of complying with government regulations and taxes, and as a result, will be able to offer their products at a more competitive price, potentially allowing them to capture a larger market share. Moreover, should the Company be unable to sell certain of its Products during any regulatory approval process, there can be no assurances that the Company will be able to recapture those customers lost to foreign domiciled competitors during any “blackout” periods, during which the Company may be unable to sell its Products. This competitive disadvantage may have a material adverse effect on the business, results of operations and our financial condition.
 
 
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The Company is substantially dependent on a third party. The Company’s sustained operations are materially dependent on foreign manufacturers.

The Company is substantially dependent on foreign manufacturers. The Company’s success depends on foreign manufacturers’ ability to deliver product on a timely basis to meet operational needs. Changes in business conditions, wars, governmental changes and other factors beyond the Company’s control which are not presently anticipated, could affect the ability of a manufacturer to meet the Company’s needs. Furthermore, if the Company experiences significant growth and demand for its Products, there can be no assurance that the additional supply of product will be available in a timely manner. Loss of any of the Company’s manufacturers, or the disruption in the supply of our Products, could have a material adverse effect on existing relationships with our customers and distribution networks.

Warranty claims, product liability claims and product recalls could harm the business, results of operations and financial condition.

The Company is inherently exposed to potential warranty and product liability claims, in the event that the Company’s Products fail to perform as expected or such failure of our Products results, or is alleged to result, in bodily injury or property damage (or both). Such claims may arise despite quality controls, proper testing and instruction for use of our Products, either due to a defect during manufacturing or due to the individual’s improper use of the product. In addition, if any of the Company’s designed Products are, or are alleged, to be defective, then the Company may be required to participate in a recall.

The tobacco industry in general has historically been subject to frequent product liability claims. As a result, the Company may experience product liability claims from the marketing and sale of E-cigarettes. Any product liability claim brought against the Company, with or without merit, could result in:

  
liabilities that substantially exceed our product liability insurance, which we would then be required to pay from other sources, if available;
  
an increase of our product liability insurance rates or the inability to maintain insurance coverage in the future on acceptable terms, or at all;
  
damage to our reputation and the reputation of our products, resulting in lower sales;
  
regulatory investigations that could require costly recalls or product modifications;
  
litigation costs; and
  
the diversion of management’s attention from managing our business.

Any one or more of the foregoing could have a material adverse effect on the business, results of operations and financial condition.

The Company does not own the patents and intellectual property rights on the hardware in its Products.

The Company does not own the patents and proprietary rights the hardware contained in its Products. Competitors offering similar products that the Company designs could potentially result in a decrease in revenue, which would adversely affect the business, prospects, financial condition and operating results.

The Company must comply with regulations imposed by government authorities and may be required to obtain the approval of various government agencies to market its Products.

E-cigarettes are new to the marketplace and may be subject to regulation as a tobacco product and possibly as a drug and drug device if marketed using therapeutic claims. Most E-cigarettes and vaporizers are sold as a means of delivering nicotine to the body. Government authorities in the United States, the European Union, Canada and in other countries extensively regulate, among other things, the research, development, testing, approval, manufacturing, labeling, post-approval monitoring and reporting, packaging, promotion, storage, advertising, distribution, marketing and export and import of electronic products for the vaporization and administration of inhaled doses of nicotine including E-cigarettes, vaporizers, cigars, cigarillos and pipes, as well as cartridges of nicotine solutions and related products. The Company must comply with these regulations, as applicable, in the jurisdictions where it offers and sells its Products. The process of obtaining regulatory approvals and the subsequent compliance with applicable federal, state, local and foreign statutes and regulations require the expenditure of substantial time and financial resources.
 
 
20

 
 
 
The Food and Drug Administration (“FDA”) is the regulatory agency which oversees tobacco products in the United States. The FDA has previously indicated that it intends to regulate E-cigarettes under the Tobacco Control Act through the issuance of deeming regulations that would include E-cigarettes under the definition of a “tobacco product” under the Tobacco Control Act subject to the FDA’s jurisdiction. On April 25, 2014, the FDA announced a proposed rule (the “Proposed Rule”) seeking to establish, for the first time, federal regulatory authority over, among other tobacco products, E-cigarettes (collectively, “Deemed Tobacco Products”).

If approved by the FDA in its current form, the final Proposed Rule would mandate with respect to Deemed Tobacco Products such as E-cigarettes:

a prohibition on sales to those younger than 18 years of age and requirements for verification by means of photographic identification;
health warnings on product packages and in advertisements; and
a ban on vending machine sales unless the vending machines are located in a facility where the retailer ensures that individuals under 18 years of age are prohibited from entering at any time.

Also under the Proposed Rule, manufacturers of newly Deemed Tobacco Products would be subject to, among other requirements, the following:

registration with, and reporting of product and ingredient listings to, the FDA;
no marketing of new tobacco products prior to FDA review;
no direct and implied claims of reduced risk such as “light”, “low” and “mild” descriptions unless FDA confirms (a) that scientific evidence supports the claim and (b) that marketing the product will benefit public health;
payment of user fees; and
no distribution of free samples.

On April 3, 2014, the European Union adopted the Tobacco Product Directive which will regulate E-cigarettes containing nicotine. In particular, the Tobacco Product Directive introduces a number of new regulatory requirements for E-cigarettes. For example, it (1) restricts the amount of nicotine that E-cigarettes can contain (2) requires E-cigarettes and refill containers to be sold in child and tamper-proof packaging and nicotine liquids to contain only “ingredients of high purity”; (3) provides that E-cigarettes must deliver nicotine doses at “consistent levels under normal conditions of use” and come with health warnings, instructions for their use, information on “addictiveness and toxicity”, an ingredients list, and information on nicotine content; (4) significantly restricts the advertising and promotion of E-cigarettes; and (5) requires E-cigarette manufacturers and importers to notify EU Member States before placing new products on the market and to report annually to Member States (including on their sales volumes, types of users and their “preferences”).

In Canada, Health Canada has advised that electronic smoking products (i.e., electronic products for the vaporization and administration of inhaled doses of nicotine including electronic cigarettes, cigars, cigarillos and pipes, as well as cartridges of nicotine solutions and related products) fall within the scope of the Food and Drugs Act. All of these products require market authorization prior to being imported, advertised or sold in Canada. Market authorization is granted by Health Canada following successful review of scientific evidence demonstrating safety, quality and efficacy with respect to the intended purpose of the health product. To date, no electronic smoking product has been authorized for sale by Health Canada.

Any of the Company’s Products that contain nicotine are currently prohibited from being imported, advertised or sold anywhere in Canada. However, as no scientific evidence demonstrating safety, quality and efficacy with respect to the intended purpose of E-cigarettes has been submitted to Health Canada to date, there is the possibility that in the future Health Canada may modify or retract the current prohibitions currently in place. However, there can be no assurance that the Company will be in total compliance, remain competitive, or financially able to meet future requirements and regulations imposed by Health Canada.
 
 
21

 

The Company’s Products are subject to product safety regulations by federal, state, and local organizations. Accordingly, the Company may be required, or may voluntarily determine to, obtain approval of our Products from one or more of the organizations engaged in regulating product safety. These approvals could require significant time and resources from the Company’s technical staff, and, if redesign were necessary, could result in a delay in the introduction of our products in various markets or ultimately require the Company to exit from that market as there is little control of the manufacturing processes. There can be no assurance that the Company will obtain any or all of the approvals that may be required to market our Products, or come to an agreement with a manufacturer to redesign the product if necessary.

The Company may be subject to litigation in the ordinary course of business.

From time to time, the Company may be subject to various legal proceedings and claims, either asserted or unasserted. Any such claims, whether with or without merit, could be time-consuming and expensive to defend and could divert management’s attention and resources. These claims may arise under theories of contract, tort, including products liability, or other legal theories. The expenses and other resources given to any such claim, claims, and/or the outcome of any such claim or litigation, even if the company were to prevail on the merits, could have a material adverse effect on the business, results of operations and financial condition of the Company.

The Company may become dependent on foreign sales to maintain operations.

If the FDA or other state or federal government agencies restrict or prohibit the sale E-cigarettes in the U.S., in part or in whole, the Company’s ability to maintain operations will become dependent on the ability to successfully commercialize its Products and brands in foreign jurisdictions where our Products can be sold. The Company’s inability to establish distribution channels in foreign jurisdictions, specifically those that allow for the sale of E-cigarettes will deprive the Company of the operating revenue that may be required to fund any domestic regulatory approvals to maintain our business operations.

The Company’s products face intense media attention and public pressure.

E-cigarettes are new to the marketplace and since its introduction, certain members of the media, politicians, government regulators and advocate groups, including independent medical physicians have called for an outright ban of all such devices, pending regulatory reviews and a demonstration of safety. A partial or outright ban would have a material adverse effect on the business, results of operation and financial condition.

The Company may be exposed to 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. In the event that inventory will have to be purchased in a foreign currency, the Company may be exposed to foreign currency risk as the Company does not use derivative financial instruments to reduce exposure.

Risks Associated with the Company’s Common Shares

There is no predictable method by which investors in the securities of the Company shall be able to realize any gain or return on their investment in the Company, or shall be able to recover all or any substantial portion of the value of their investment. There is, currently no public market for the securities of the Company, and no assurance can be given that a market will develop or that an investor will be able to liquidate his investment without considerable delay, if at all. Consequently, should the investor suffer a change in circumstances arising from an event not contemplated at the time of his investment, and should the investor therefore wish to transfer the common stock owned by him, he may find he has only a limited or no ability to transfer or market the common stock. Accordingly, purchasers of the common stock need to be prepared to bear the economic risk of their investment for an indefinite period of time. If a market should develop, the price may be highly volatile. Factors such as those discussed in this “Risk Factors” section may have a significant impact upon the market price of the securities of the Company. Owing to what may be expected to be the low price of the securities, many brokerage firms may not be willing to effect transactions in the securities.
 
 
22

 

Even if an investor finds a broker willing to effect a transaction in these securities, the combination of brokerage commissions and any other selling costs may exceed the selling price. Further, many lending institutions will not permit the use of such securities as collateral for any loans. The Company has no agreement with any securities broker or dealer that is a member of the National Association of Securities Dealers, Inc., to act as a market maker for the Company’s securities. Should the Company fail to obtain one or more market makers for the Company’s securities, the trading level and price of the Company’s securities will be materially and adversely affected. Should the Company happen to obtain only one market maker for the Company’s securities, the market maker would in effect dominate and control the market for such securities. The Company’s registered securities are covered by a Securities and Exchange Commission rule that imposes additional sales practice requirements on broker-dealers who sell such securities to persons other than established customers and accredited investors. For purposes of the rule, the phrase “accredited investors” means, in general terms, institutions with assets in excess of $5,000,000, or individuals having a net worth in excess of $1,000,000 or having an annual income that exceeds $200,000 (or that, when combined with a spouse’s income, exceeds $300,000). For transactions covered by the rule, the broker-dealer must make a special suitability determination for the purchaser and receive the purchaser’s written, agreement to the transaction prior to the sale. Consequently, the rule may affect the ability of broker-dealers to sell the Company’s securities and also may affect the ability of investors in securities of the Company to sell their securities in any market that might develop therefore.

Of the currently issued and outstanding shares of common stock of the Company, approximately 24,250,066 shares (approximately 26.16% of the total number of shares outstanding) are owned by, or are under the direct or indirect control of Company insiders. That number of shares is enough to dominate and control the price and trading volume in the Company’s securities. Because those shares are controlled by such a limited number of persons, selling decisions can be expected to have a substantial impact upon (or “overhang” over) the market, if any, for the common stock. Any sale of a large number of shares over a short period of time could significantly depress the market price of the common stock.

The majority of the Company’s authorized but unissued common stock remains unissued. The Board of Directors has authority to issue such unissued shares without the consent or vote of the stockholders of the Company. The issuance of these shares may dilute the interests of investors in the securities of the Company and will reduce their proportionate ownership and voting power in the Company.

The Company is subject to compliance with securities law, which exposes the Company to potential liabilities, including potential rescission rights.

The Company has offered and sold common stock to investors pursuant to certain exemptions from the registration requirements of the Securities Act of 1933, as well as those of various state securities laws. The basis for relying on such exemptions is factual; that is, the applicability of such exemptions depends upon the Company’s conduct and that of those persons contacting prospective investors and making the offering. The Company has not received a legal opinion to the effect that any of our prior offerings were exempt from registration under any federal or state law. Instead, the Company has relied upon the operative facts as the basis for such exemptions, including information provided by investors themselves.

If any prior offering did not qualify for such exemption, an investor would have the right to rescind its purchase of the securities if it so desired. It is possible that if an investor should seek rescission, such investor would succeed. A similar situation prevails under state law in those states where the securities may be offered without registration in reliance on the partial preemption from the registration or qualification provisions of such state statutes under the National Securities Markets Improvement Act of 1996. If investors were successful in seeking rescission, the Company would face severe financial demands that could adversely affect our business and operations. Additionally, if the Company did not in fact qualify for the exemptions upon which it has relied, the Company may become subject to significant fines and penalties imposed by the SEC and state securities agencies.

The Company does not intend to pay cash dividends in the foreseeable future.

On January 17, 2008, the Board of Directors declared a cash dividend to its common stock Shareholders of Record on February 4, 2008 in the amount of $0.035 per share of common stock, which was distributed on February 15, 2008. The Company currently intends to retain all future earnings for use in the operation and expansion of the Company’s business. The Company does not intend to pay any cash dividends in the foreseeable future but will review this policy as circumstances dictate.
 
 
23

 

There is currently no market for the Company’s securities and there can be no assurance that any market will ever develop or that the Company’s common stock will be listed for trading. Therefore, investors may be unable to liquidate their investments in the Company’s common stock.

The Company’s securities have been trading on the over-the-counter market until it was moved to Pink Sheets in February 2011, under the symbol “GLLA” as the trading activity was not sufficient for continuing to trade over the counter. The Company is a fully reporting OTC Markets company and trades on the OTC QB under the symbol “GLLA.” There has not been any established trading market for the Company’s common stock and there is currently no market for the Company’s securities. Even if the Company is ultimately approved for trading on an exchange, there can be no assurance as the prices at which the Company’s common stock will trade if a trading market develops, of which there can be no assurance. Until an orderly market develops, (if ever) in the Company’s common stock, there can be no assurance that investors will be able to liquidate their investments.

The Company’s common stock is subject to the Penny Stock Regulations.

Once it commences trading, (if ever) the Company’s common stock could be subject to the SEC’s “penny stock” rules to the extent that the price remains less than $5.00. Those rules, which require delivery of a schedule explaining the penny stock market and the associated risks before any sale, may further limit your ability to sell your shares.

The SEC has adopted regulations which generally define “penny stock” to be an equity security that has a market price of less than $5.00 per share. The Company’s common stock currently has no “market price” and when and if a trading market develops, may fall within the definition of penny stock and subject to rules that impose additional sales practice requirements on broker-dealers who sell such securities to persons other than established customers and accredited investors (generally those with assets in excess of $1,000,000, or annual incomes exceeding $200,000 or $300,000, together with their spouse).

For transactions covered by these rules, the broker-dealer must make a special suitability determination for the purchase of such securities and have received the purchaser’s prior written consent to the transaction. Additionally, for any transaction, other than exempt transactions, involving a penny stock, the rules require the delivery, prior to the transaction, of a risk disclosure document mandated by the Commission relating to the penny stock market. The broker-dealer also must disclose the commissions payable to both the broker-dealer and the registered representative, current quotations for the securities and, if the broker-dealer is the sole market maker, the broker-dealer must disclose this fact and the broker-dealers presumed control over the market. Finally, monthly statements must be sent disclosing recent price information for the penny stock held in the account and information on the limited market in penny stocks. Consequently, the `penny stock` rules may restrict the ability of broker-dealers to sell the Company’s common stock and may affect the ability of investors to sell their common stock in the secondary market.

The Company’s common stock is illiquid and may in the future be subject to price volatility unrelated to the Company’s operations.

The Company’s common stock has no market price and, if and when a market price is established, could fluctuate substantially due to a variety of factors, including market perception of the Company’s ability to achieve our planned growth, quarterly operating results of other companies in the same industry, trading volume in the Company’s common stock, changes in general conditions in the economy and the financial markets or other developments affecting the Company’s competitors or us. In addition, the stock market is subject to extreme price and volume fluctuations. This volatility has had a significant effect on the market price of securities issued by many companies for reasons unrelated to their operating performance and could have the same effect on the Company’s common stock. Sales of substantial amounts of common stock, or the perception that such sales could occur, could adversely affect the market price of the Company’s common stock (if and when a market price is established) and could impair the Company’s ability to raise capital through the sale of the Company’s equity securities.
 
 
24

 

Other Risks

The Company’s ability to continue as a going concern is dependent on the ability to further implement its business plan, raise capital, and generate revenues.

The time required for the Company to become profitable from operations is highly uncertain, and the Company cannot assure that it will achieve or sustain operating profitability or generate sufficient cash flow to meet its planned capital expenditures. If required, the Company’s ability to obtain additional financing from other sources also depends on many factors beyond its control, including the state of the capital markets and the prospects for its business. The necessary additional financing may not be available to the Company or may be available only on terms that would result in further dilution to the current owners of its common stock.

The Company cannot assure that it will generate sufficient cash flow from operations or obtain additional financing to meet its obligations. Should any of these events not occur, its financial condition will be adversely affected.

The Company’s new line of business has a limited operating history and, accordingly, investors will not have any basis on which to evaluate the Company’s ability to achieve its business objectives.

The Company has limited operating results to date. Since the Company does not have an established operating history or regular sales as of yet, investors will have no basis upon which to evaluate the Company’s ability to achieve its business objectives.

The absence of any significant operating history for the Company makes forecasting its revenue and expenses difficult, and the Company may be unable to adjust its spending in a timely manner to compensate for unexpected revenue shortfalls or unexpected expenses.

As a result of the absence of any operating history for the Company, it is difficult to accurately forecast the Company’s future revenue. In addition, the Company has limited meaningful historical financial data upon which to base planned operating expenses. Current and future expense levels are based on the Company’s operating plans and estimates of future revenue. Revenue and operating results are difficult to forecast because they generally depend on the Company’s ability to promote and sell its Products. As a result, the Company may be unable to adjust its spending in a timely manner to compensate for any unexpected revenue shortfall, which would result in further substantial losses. The Company may also be unable to expand its operations in a timely manner to adequately meet demand to the extent it exceeds expectations.

The Company’s limited operating history does not afford investors a sufficient history on which to base an investment decision.

The Company is currently in the early stages of developing its business. There can be no assurance that at this time that the Company will operate profitably or will have adequate working capital to meet its obligations as they become due.

Investors must consider the risks and difficulties frequently encountered by early stage companies, particularly in rapidly evolving markets. Such risks include the following:

  
competition;
  
ability to anticipate and adapt to a competitive market;
  
ability to effectively manage expanding operations; amount and timing of operating costs and capital expenditures relating to expansion of our business, operations, and infrastructure; and
  
dependence upon key personnel to market and sell our services and the loss of one of our key managers may adversely affect the marketing of our services.

The Company cannot be certain that its business strategy will be successful or that the Company will successfully address these risks. In the event that the Company does not successfully address these risks, its business, prospects, financial condition, and results of operations could be materially and adversely affected and the Company may not have the resources to continue or expand its business operations.
 
 
25

 

Dependence on the Company’s management, without whose services, the Company’s business operations could cease.

At this time, the Company’s management is wholly responsible for the development and execution of the business plan. The Company’s management is under no contractual obligation to remain employed by the Company, although they have no present intent to leave. If the Company’s management should choose to leave the Company for any reason before the Company has hired additional personnel, the Company’s operations may fail. Even if the Company is able to find additional personnel, it is uncertain whether the Company could find qualified management who could develop the business along the lines described herein or would be willing to work for compensation the Company could afford. Without such management, the Company could be forced to cease operations and investors in the Company’s common stock or other securities could lose their entire investment.

Lack of additional working capital may cause curtailment of any expansion plans while the raising of capital through a sale of equity securities would dilute existing shareholders’ percentage of ownership.

The Company’s available capital resources may not be adequate to fund its working capital requirements. Any shortage of capital could affect the Company’s ability to fund its working capital requirements to sustain operations. If the Company requires additional capital, funds may not be available on acceptable terms, if at all. In addition, if the Company raises additional capital through the sale of equity or convertible debt securities, the issuance of these securities could dilute existing shareholders. If funds are not available, the Company could be placed in the position of having to cease all operations.

The Company does not presently have a traditional credit facility with a financial institution. This absence may adversely affect the Company’s operations.

The Company does not presently have a traditional credit facility with a financial institution. The absence of a traditional credit facility with a financial institution could adversely impact the Company’s operations. If adequate funds are not otherwise available, the Company may be required to delay, scale back or eliminate portions of its operations. Without such credit facilities, the Company could be forced to cease operations and investors in the Company’s common stock or other securities could lose their entire investment.

The Company’s success is substantially dependent on general economic conditions and business trends, particularly concerning the demand for lifestyle products. A downturn of which could adversely affect the Company’s operations.

The success of the Company’s operations depends to a significant extent upon a number of factors relating to personal and business spending. These factors include economic conditions, activity in the financial markets, general business conditions, personnel cost, inflation, interest rates and taxation. The Company’s business is affected by the general condition and economic stability of its customers and their continued willingness to purchase the Company’s products in the future. An overall decline in the demand for lifestyle products could cause a reduction in the Company’s sales and the Company could face a situation where it is unable to achieve sales and thereby be forced to cease operations.

The Company will need to increase the size of its organization, and may experience difficulties in managing growth.

The Company eight key individuals engaged as consultants and three full-time employees. The Company expects to experience a period of significant expansion in headcount, facilities, infrastructure and overhead and anticipates that further expansion will be required to address potential growth and market opportunities. Future growth will impose significant added responsibilities on members of management, including the need to identify, recruit, maintain and integrate managers. The Company’s future financial performance and its ability to compete effectively will depend, in part, on its ability to manage any future growth effectively.

The Company may not have adequate internal accounting controls. While the Company has certain internal procedures in its budgeting, forecasting and in the management and allocation of funds, the Company’s internal controls may not be adequate.
 
 
26

 

The Company is constantly striving to improve its internal accounting controls. While the Company believes that its internal controls are adequate for its current level of operations, the Company believes that it may need to employ additional accounting staff as the Company’s operations ramp up. The Company has appointed an outside Independent Director as Chairman of the Audit Committee, however there is no guarantee that actions undertaken by the Audit Committee will be adequate or successful or that such improvements will be carried out on a timely basis. If, in the future, the Company does not have adequate internal accounting controls, the Company may not be able to appropriately budget, forecast and manage its funds. The Company may also be unable to prepare accurate accounts on a timely basis to meet its continuing financial reporting obligations and the Company may not be able to satisfy its obligations under U.S. securities laws.

ITEM 1B. UNRESOLVED STAFF COMMENTS

None.

ITEM 2.  PROPERTIES

The Company occupies office space at 15540 Biscayne Blvd., North Miami, FL 33160. The Company entered into an operating lease agreement for the rental property in North Miami, Florida, USA for a period of 2 years, commencing on August 15, 2014 and ending on August 14, 2016, with payments made monthly and annual rent in year 1 of $28,020 and year 2 of $30,420. The landlord waived and forgave payment for the first month of the operating lease as part of the agreement. The Company has a one time option to extend the lease for an additional 2 year period with an annual rent increase of $1,200 per each year of the extended term.

The Company also entered into a rental lease agreement for a rental premises in Dublin, Ireland for a period of 1 year, commencing on September 17, 2014 and ending on September 16, 2015, with payments made monthly and annual rent in year 1 of EUR 22,200.

The Company has no investments in real estate.

ITEM 3.  LEGAL PROCEEDINGS

We are not currently a party in any material legal proceeding or any material governmental regulatory proceeding nor are we currently aware of any pending or potential material legal proceeding or governmental regulatory proceeding proposed to be initiated against us.

ITEM 4.  MINE SAFETY DISCLOSURES
 
Not applicable.
 
 
 
27

 

PART II

ITEM 5.   MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

The Company’s securities have been trading on the over-the-counter market until it was moved to Pink Sheets in February 2011, under the symbol “GLLA” as the trading activity was not sufficient for continuing to trade over the counter. The Company is a fully reporting OTC Markets company and trades on the OTC QB under the symbol “GLLA.” The following table sets forth for the periods indicated the range of high and low closing bid quotations per share as reported by the over-the-counter market. These quotations represent inter-dealer prices, without retail markups, markdowns or commissions and may not necessarily represent actual transactions. The market for the Common Stock has been sporadic and there have been long periods during which there were few, if any, transactions in the Common Stock and no reported quotations. Accordingly, reliance should not be placed on the quotes listed below, as the trades and depth of the market may be limited, and therefore, such quotes may not be a true indication of the current market value of the Company’s Common Stock. 
  
2013
 
HIGH
   
LOW
 
First Quarter
 
$
0.13
   
$
0.01
 
Second Quarter
 
$
0.10
   
$
0.04
 
Third Quarter
 
$
0.06
   
$
0.03
 
Fourth Quarter
 
$
0.24
   
$
0.03
 

2014
 
HIGH
   
LOW
 
First Quarter
 
$
0.24
   
$
0.09
 
Second Quarter
 
$
0.33
   
$
0.14
 
Third Quarter
 
$
0.29
   
$
0.14
 
Fourth Quarter
 
$
0.30
   
$
0.14
 

On December 31, 2014, the closing price of the Company’s Common Stock as reported on the OTC QB was $0.28 per share. On December 31, 2014, the Company had in excess of 439 beneficial stockholders of our Common Stock and 92,698,018 shares of our Common Stock were issued and outstanding.

DIVIDENDS
 
On January 17, 2008, the Board of Directors of the Company declared a cash dividend to its Common Stock Shareholders of Record on February 4, 2008 in the amount of $0.035 per share of Common Stock, which was distributed on February 15, 2008. The Company has not determined when it shall make its next dividend payment.
 
RECENT SALES OF UNREGISTERED SECURITIES

During the period covered by this Report, we did not have any sales of securities in transactions that were not registered under the Securities Act of 1933, as amended, that have not been previously reported in a Form 8-K or Form 10-Q, except for the following:

On October 9, 2014, the Company issued 100,000 Common Shares at a price of $0.16 per Common Share, as a settlement of $16,000 in consulting fees owed to an unrelated party.

On November 10, 2014, the Company received a form of election whereby a holder of a Convertible Debenture elected to convert a total of $275,000 of the Convertible Debentures into Common Shares of the Company pursuant to the terms of the Convertible Debentures. On November 20, 2014, the Company issued 3,928,571 Common Shares at a price of $0.07 per Common Share, as a result of this election received on November 10, 2014 to convert $275,000 of the Convertible Debentures.

On November 10, 2014, the Company settled $26,093 in interest payable on the Convertible Debentures and issued 173,953 Common Shares at a price of $0.15 per Common Share on November 20, 2014.

 
 
28

 
 
On November 10, 2014, the Company settled $32,081 in interest payable to a shareholder on the Secured Note and Secured Note No.2 and issued 218,669 Common Shares at a price of $0.15 per Common Share on November 20, 2014.

On December 17, 2014, the Company issued 800,000 Common Shares at a price of $0.15 per Common Share, as compensation of $120,000 in consulting fees to an unrelated party.

On December 31, 2014, the Company issued 500,000 Common Shares at a price of $0.15 per Common Share, as a settlement of $75,000 in consulting fees owed to a related party.

On December 31, 2014, the Company issued and sold, on a private placement basis, 490,000 Common Shares at a price of $0.15 per Common Share, for aggregate gross proceeds of $73,500.

The Company issued all the foregoing Common Shares in reliance upon the exemption from the registration requirements of the Securities Act provided by Section 4(2) of the Securities Act or Regulation D promulgated thereunder.

Subsequent Events

On March 9, 2015, the Company received forms of election whereby holders of the Convertible Debentures elected to convert a total of $52,000 of the Convertible Debentures into Common Shares of the Company, pursuant to the exemption from the registration provided by Section 4(2) of the Securities Act and Regulation D promulgated thereunder. Such shares remain unissued as of the filing of this Report.

On March 9, 2015, the Company settled $1,095 in interest payable to holders of the Convertible Debentures and agreed to issue 7,303 Common Shares at a price of $0.15 per Common Share, pursuant to the exemption from the registration provided by Section 4(2) of the Securities Act and Regulation D promulgated thereunder. Such shares remain unissued as of the filing of this Report.

ITEM 6.   SELECTED FINANCIAL DATA
 
Earnings per share for each of the fiscal years shown below are based on the weighted average number of Common Shares outstanding.

   
Years ended December 31,
 
   
2014
   
2013
 
Revenues
 
$
608,035
   
$
76,977
 
                 
Net Loss
 
$
(3,096,390
)
 
$
(1,502,922
)
                 
Earnings (Loss) Per Share
 
$
(0.042
)
 
$
(0.024
)
                 
Total assets
 
$
1,086,485
   
$
528,744
 
                 
Total liabilities
 
$
2,639,901
   
$
1,753,394
 
 
 
29

 
  
ITEM 7.   MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION

The information and financial data discussed below is derived from the audited consolidated financial statements of Gilla Inc. for the year ended December 31, 2014. The financial statements were prepared and presented in accordance with United States generally accepted accounting principles and are expressed in U.S. Dollars. The information and financial data discussed below is only a summary and should be read in conjunction with the financial statements and related notes of Gilla Inc. contained elsewhere in this Annual Report, which fully represent the financial condition and operations of Gilla Inc., but which are not necessarily indicative of future performance.

Overview

Gilla (the “Company”, the “Registrant” or “Gilla”) was incorporated under the laws of the state of Nevada on March 28, 1995 under the name of Truco, Inc. The Company later changed its name to Web Tech, Inc., and then to Cynergy, Inc., Mercantile Factoring Credit Online Corp., Incitations, Inc., Osprey Gold Corp. and to its present name. The Company adopted the present name, Gilla Inc., on February 27, 2007. Gilla’s address is 15540 Biscayne Blvd, North Miami, Florida 33160.

Recent Development of the Business

On November 15, 2012, the Company entered into a convertible revolving credit note (the “Credit Note”) with a related party, whereby the Company agreed to pay the party the aggregate unpaid principal amount of $225,000 on or before February 15, 2014, bearing interest at a rate of 6% per annum. On February 14, 2014, the Company repaid all amounts due under the Credit Note.

On November 21, 2012, the Company completed a business combination transaction (the “Merger”), pursuant to which it acquired all of the issued and outstanding common shares of Snoke Distribution Canada Ltd. (“Snoke Distribution”) in exchange for issuing 29,766,667 of its Common Shares to the former shareholders of Snoke Distribution. Upon the completion of the Merger, Snoke Distribution became a wholly-owned subsidiary of the Company, its senior management became the entire senior management of the Company and the Company began to focus exclusively on its current business consisting of the design, marketing and distribution of electronic cigarettes, vaporizers, e-liquids and accessories (collectively, “E-cigarettes”).

On April 13, 2013, Mr. Henry J. Kloepper was appointed as Lead Independent Director and Chairman of the Audit Committee. Mr. Kloepper also serves as Chairman of the Compensation and Governance Committees.

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.

On August 21, 2013, the Company announced that its board of directors (the “Board of Directors”) had approved a non-brokered private placement offering (the “Convertible Debenture Offering”) of unsecured subordinated convertible debentures (“Convertible Debentures”) for aggregate gross proceeds of up to $2,000,000. The Convertible Debentures mature on January 31, 2016, bear interest at a rate of 12% per annum, payable quarterly in arrears, and are convertible at the option of the holder into Common Shares at a conversion price of $0.10 per Common Share at any time prior to the maturity date. The conversion price was subsequently amended to be $0.07 per Common Share. The proceeds of the Convertible Debenture Offering were used to repay debt and for the purchase of inventory and technology, product development, marketing, and working capital and general administrative purposes.

On September 3, 2013, the Company issued $425,000 of Convertible Debentures pursuant to the terms of the Convertible Debenture Offering for aggregate gross proceeds of $425,000. The Convertible Debentures were initially issued at a conversion price of $0.10 per Common Share and, on October 28, 2013, were reissued at a conversion price of $0.07 per Common Share. All the other terms and conditions of the re-issued Convertible Debentures remained the same.
 
 
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On September 25, 2013, the Company issued and sold, on a private placement basis, 200,000 Common Shares at a price of $0.035 per Common Share, for aggregate gross proceeds of $7,000. As part of this transaction, on November 19, 2013, the Company also issued and sold, on a private placement basis, 76,485 Common Shares at a price of $0.035 per Common Share, for aggregate gross proceeds of $2,677.

On September 25, 2013, the Company issued 942,784 Common Shares at a price of $0.053 per Common Share, as settlement of $50,000 in consulting fees owed to an unrelated party.

On September 25, 2013, the Company issued 1,000,000 Common Shares at a price of $0.035 per Common Share, as settlement of $35,000 of debt owed pursuant to related party loans. As part of this transaction, on November 19, 2013, the Company also issued 428,571 Common Shares at a price of $0.035 per Common Share, as settlement of $15,000 of debt owed pursuant to loans made to the Company by such related parties.

On September 25, 2013, the Company issued 973,960 Common Shares at a price of $0.035 per Common Share, as settlement of $34,091 of debt owed pursuant to shareholder loans. As part of this transaction, on November 19, 2013, the Company also issued 417,411 Common Shares at a price of $0.035 per Common Share, as settlement of $14,609 of debt owed pursuant to shareholder loans.

On September 30, 2013, the Company issued a secured promissory note (the “Related Party Note”) in connection with a loan to it by a related party in the principal amount of $200,000. The outstanding principal amount of the Related Party Note, together with accrued and unpaid interest at a rate of 1.5% per month, was paid in full and the Related Party Note was retired on December 23, 2013.

On October 8, 2013, the Company issued and sold, on a private placement basis, 50,000 Common Shares at a price of $0.05 per Common Share, for aggregate gross proceeds of $2,500.

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 which operates as one of the Company’s e-commerce sales platforms.

On November 27, 2013, the Company issued 400,000 Common Shares at a price of $0.05 per Common Share, as a settlement of $20,000 in consulting fees owed to an unrelated party.

On November 27, 2013, the Company issued 300,000 Common Shares at a price of $0.0583 per Common Share, as a settlement of $17,500 in consulting fees owed to an unrelated party.

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 December 23, 2013, the Company issued an additional $797,000 of Convertible Debentures pursuant to the terms of the Convertible Debenture Offering.

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 owed 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 an additional $178,000 of Convertible Debentures pursuant to the terms of the Convertible Debenture Offering.

On February 13, 2014, the Company entered into a secured promissory note (the “Secured 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. The Secured Note is secured by a general security agreement over the assets of the Company. On November 10, 2014, the Secured Note maturity date was extended until January 1, 2016.
 
 
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On February 14, 2014, the Company repaid all amounts due under the Credit Note, as described above.

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 in Ireland. The Company issued to the sellers 500,000 Common Shares valued at a price of $0.11 per Common Share and warrants for the purchase of 1,000,000 Common Shares of the Company. The warrants were to vest upon DML achieving cumulative E-cigarette sales revenues of over $1,500,000 beginning on the closing date and exercisable over three years with an exercise price of $0.25 per Common Share. No value has been assigned to the warrants as there is 0% probability of achieving the vesting provision. The Company issued the 500,000 Common Shares to the sellers on June 2, 2014. On October 6, 2014, the Company appointed liquidators for the purpose of winding up DML by way of a voluntary liquidation by reason of its liabilities.

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 owed to an unrelated party.

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 owed to an unrelated party.

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 Convertible Debentures into Common Shares of the Company pursuant to the terms of the Convertible Debentures. On May 30, 2014, the Company issued 714,286 Common Shares at a price of $0.07 per Common Share, as a result of these elections received on April 15, 2014 to convert $50,000 of the Convertible Debentures.

On May 30, 2014, the Company issued 835,000 Common Shares at a price of $0.10 per Common Share, as a settlement of $83,500 in advertising production costs owed to unrelated parties.

On May 30, 2014, the Company issued 10,000 Common Shares at a price of $0.10 per Common Share, as a settlement of $1,000 in advertising production costs owed to related parties.

On May 30, 2014, the Company issued 92,500 Common Shares at a price of $0.19 per Common Share, as a settlement of $17,500 in consulting fees owed to an unrelated party.

On June 2, 2014, the Company issued 55,000 Common Shares at a price of $0.25 per Common Share, as a settlement of $13,750 in consulting fees owed to an unrelated party.

On July 15, 2014, the Company entered into a secured promissory note (the “Secured Note No.2”) with a shareholder, whereby the Company agreed to pay the party the aggregate unpaid principal amount of $100,000 on or before July 18, 2014, bearing interest at a rate of 10% per annum. The Secured Note No.2 is secured by the general security agreement issued with the Secured Note. On November 10, 2014, the Secured Note No.2 maturity date was extended until January 1, 2016.

On July 25, 2014, the Company issued and sold, on a private placement basis, 1,401,333 Common Shares at a price of $0.15 per Common Share, for aggregate gross proceeds of $210,200. Of the total gross proceeds of the private placement, $190,250 was received prior to the quarter ended June 30, 2014 and booked as an unissued share liability as at June 30, 2014. On July 25, 2014 and in connection to the private placement, the Company issued 10,640 warrants to purchase Common Shares of the Company exercisable over one year with an exercise price of $0.15 per Common Share.

On July 29, 2014, the Company issued 300,000 Common Shares at a price of $0.18 per Common Share, as a prepayment of $54,000 in consulting fees, to an unrelated party.

On August 1, 2014, the Company entered into a revolving credit facility (the “Credit Facility”) with a consortium of participants that includes two of the Company’s senior executive officers (the “Lender”), whereby the Lender would make a revolving credit facility in the aggregate principal amount of CAD $500,000 for the exclusive purpose of purchasing inventory for sale in the Company’s ordinary course of business to approved customers. The agent who arranged the Credit Facility was not a related party of the Company. The Credit Facility bears interest at a rate of 15% per annum on all drawn advances and a standby fee of 3.5% per annum on the undrawn portion of the Credit Facility. The Credit Facility shall mature on August 1, 2015 whereby the outstanding advances together with all accrued and unpaid interest thereon shall be due and payable. On August 1, 2014 and in connection to the Credit Facility, the Company issued 250,000 warrants to purchase Common Shares of the Company exercisable over two years with an exercise price of $0.30 per Common Share. The Company’s Chief Executive Officer and Chief Financial Officer are both participants of the consortium of participants of the Credit Facility, each having committed to provide ten percent of the principal amount of the Credit Facility. Neither the Chief Executive Officer nor the Chief Financial Officer will participate in the warrants issued in connection with the Credit Facility and both parties have been appropriately abstained from voting on the Board of Directors to approve the Credit Facility, where applicable.
 
 
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On August 15, 2014, the Company issued 10,919 Common Shares at a price of $0.15 per Common Share, as a settlement of $1,638 of shareholder loans.

Gilla Operations Worldwide Limited (“Gilla Worldwide”) was incorporated on August 25, 2014 under the laws of Ireland. Gilla Worldwide is a wholly-owned subsidiary of the Company and, since its incorporation, has been the primary operating subsidiary of the Company in Europe.

Gilla Franchises, LLC (“Gilla Franchises”) was incorporated on September 8, 2014 under the laws of the State of Florida. Gilla Franchises is a wholly-owned subsidiary of the Company.

Gilla Biscayne, LLC (“Gilla Biscayne”) was incorporated on September 8, 2014 under the laws of the State of Florida. Gilla Biscayne is a wholly-owned subsidiary of Gilla Franchises and, since its incorporation, has been the primary operating subsidiary for the Company’s first retail location in the United States.

On September 17, 2014, the Company issued 182,749 Common Shares at a price of $0.15 per Common Share, as a settlement of $27,412 in consulting fees owed to an unrelated party.

On September 29, 2014, the Company issued and sold, on a private placement basis, 1,333,334 Common Shares at a price of $0.15 per Common Share, for aggregate gross proceeds of $200,000.

On September 30, 2014, the Company issued 63,559 Common Shares at a price of $0.236 per Common Share, as compensation for $15,000 in consulting fees to an unrelated party.

On September 30, 2014, the Company received forms of election whereby holders of the Convertible Debentures elected to convert a total of $800,000 of the Convertible Debentures into Common Shares of the Company pursuant to the terms of the Convertible Debentures. On November 4, 2014, the Company issued 11,428,572 Common Shares at a price of $0.07 per Common Share, as a result of these elections received on September 30, 2014 to convert $800,000 of the Convertible Debentures.

On September 30, 2014, the Company settled $78,559 in interest payable on the Convertible Debentures and issued 523,726 Common Shares at a price of $0.15 per Common Share on November 4, 2014.

On September 30, 2014, the Company settled $107,676 in consulting fees payable to related parties and issued 717,840 Common Shares at a price of $0.15 per Common Share on November 4, 2014.

On October 7, 2014, Dr. Blaise A. Aguirre and Mr. Christopher Rich were appointed as members of the Board of Directors of the Company.

On October 9, 2014, the Company issued 100,000 Common Shares at a price of $0.16 per Common Share, as a settlement of $16,000 in consulting fees owed to an unrelated party.

On November 10, 2014, the Company entered into an amendment with a shareholder (the “Secured Note Amendment”) whereby both parties agreed to extend the maturity date of both the Secured Note, dated February 13, 2014, and the Secured Note No.2, dated July 15, 2014, to January 1, 2016, with all other terms of the respective notes remaining the same. The Secured Note Amendment also granted the shareholder an early repayment right to repay both the Secured Note and the Secured Note No.2 if the Company were to complete an equity raise with gross proceeds greater than or equal to one million dollars ($1,000,000) prior to the repayment dates of each of the respective notes. On November 10, 2014 and in connection to the Secured Note Amendment, the Company issued 250,000 warrants to purchase Common Shares of the Company at an exercise price of $0.20 per Common Share, such warrants expiring on January 1, 2016.
 
 
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On November 10, 2014, the Company received a form of election whereby a holder of a Convertible Debenture elected to convert a total of $275,000 of the Convertible Debentures into Common Shares of the Company pursuant to the terms of the Convertible Debentures. On November 20, 2014, the Company issued 3,928,571 Common Shares at a price of $0.07 per Common Share, as a result of this election received on November 10, 2014 to convert $275,000 of the Convertible Debentures.

On November 10, 2014, the Company settled $26,093 in interest payable on the Convertible Debentures and issued 173,953 Common Shares at a price of $0.15 per Common Share on November 20, 2014.

On November 10, 2014, the Company settled $32,081 in interest payable to a shareholder on the Secured Note and Secured Note No.2 and issued 218,669 Common Shares at a price of $0.15 per Common Share on November 20, 2014.

On November 14, 2014, Dr. Blaise A. Aguirre was appointed as a member of the Audit Committee.

On December 17, 2014, the Company issued 800,000 Common Shares at a price of $0.15 per Common Share, as compensation of $120,000 in consulting fees to an unrelated party.

On December 31, 2014, the Company issued 500,000 Common Shares at a price of $0.15 per Common Share, as a settlement of $75,000 in consulting fees owed to a related party.

On December 31, 2014, the Company issued and sold, on a private placement basis, 490,000 Common Shares at a price of $0.15 per Common Share, for aggregate gross proceeds of $73,500.

Subsequent Events

On January 30, 2015, the Company entered into a supply and distribution agreement with an e-cigarette company distributing primarily to the United Kingdom, whereby the Company is to supply white label products for the clients existing brand. In connection with this agreement, the Company issued 250,000 warrants to purchase Common Shares of the Company exercisable over two years with an exercise price of $0.30 per Common Share.

On March 9, 2015, the Company received forms of election whereby holders of the Convertible Debentures elected to convert a total of $52,000 of the Convertible Debentures into Common Shares of the Company pursuant to the terms of the Convertible Debentures. Such Common Shares remain unissued as of the date of the filing of this Report.

On March 9, 2015, the Company settled $1,095 in interest payable to holders of the Convertible Debentures and agreed to issue 7,303 Common Shares at a price of $0.15 per Common Share. Such Common Shares remain unissued as of the date of the filing of this Report.

On March 18, 2015, the Company entered into a letter of intent (the “LOI”) to acquire all of the issued and outstanding shares of a Florida based e-liquids manufacturer (the “Target”). The total purchase price would be $1,500,000 (the “Purchase Price”) payable to the vendors as (i) $600,000 in cash payable on closing, (ii) $600,000 in common stock of the Company issued on closing, and (iii) $300,000 in promissory notes issued to the vendors, due eighteen (18) months from the closing date, non-interest bearing and secured by shares of common stock of the Company. The Purchase Price is subject to confirmatory due diligence of the Target’s overall business operations. The Company will maintain the existing management team and operational structure of the Target. The transaction is expected to close on or before May 15, 2015 or such other date as agreed between the parties.
 
 
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Critical Accounting Policies

Basis of Preparation

The Company's consolidated financial statements have been prepared in accordance with generally accepted accounting principles in the United States of America (“U.S. GAAP”) for annual financial statements and with Form 10-K and article 8 of the Regulation S-X of the United States Securities and Exchange Commission (“SEC”).

Basis of Consolidation

These audited consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries; Gilla Operations, LLC; Charlie’s Club, Inc.; Gilla Enterprises Inc.; Gilla Operations Worldwide Limited; Gilla Franchises, LLC and its wholly-owned subsidiary Gilla Biscayne, LLC; and Snoke Distribution Canada Ltd. and its wholly-owned subsidiary Snoke Distribution USA, LLC. The Company deconsolidated DML at October 6, 2014 but the operations of DML for the period from the date of acquisition of February 28, 2014 to the date of deconsolidation are included in the operations of the Company for the year ended December 31, 2014. All inter-company accounts and transactions have been eliminated in preparing these audited consolidated financial statements.

Foreign Currency Translation

The Company’s Canadian subsidiaries maintain their books and records in Canadian dollars (CAD) which is also their 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 audited consolidated financial statements, entered into derivative instruments to offset the impact of foreign currency fluctuations.

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 December 31, 2014 and 2013 that have been included in the diluted loss per share calculation as the effects would have been anti-dilutive.
 
 
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Financial Instruments

Financial assets and financial liabilities are recognized in the balance sheet when the Company has become party to the contractual provisions of the instruments.

The Company’s financial instruments consist of cash, funds held in trust, accounts receivable, accounts payable, accrued interest, due to related parties, accrued liabilities, note payable, convertible debentures, loan from shareholders and credit facility. 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 funds held in trust 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 interest, due to related parties, accrued liabilities, note payable, convertible debentures, loan from shareholders and credit facility 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.

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 year ended December 31, 2014, $136,200 in production costs were incurred, $90,800 of which have been allocated to prepaid expenses and vendor deposits on the consolidated balance sheet, $45,400 in production costs were expensed during the period representing the release of the first phase of the Company’s online advertising campaign.  The Company expenses all other advertising costs as incurred. During the year ended December 31, 2014, the Company expensed $314,001 (December 31, 2013: $57,330) as corporate promotions.

Property and Equipment

Property and Equipment are measured at cost less accumulated depreciation and accumulated impairment losses. Costs include expenditures that are directly attributable to the acquisition of the asset. Gains and losses on disposal of an item of property and equipment are determined by comparing the proceeds from disposal with the carrying amount of property and equipment, and are recognized in the statement of operations.

Depreciation is recognized in the statement of operations on a straight-line basis over the estimated useful lives of each part of an item of property and equipment, since this most closely reflects the expected pattern of consumption of the future economic benefits embodied in the asset.

The estimated useful lives of the respective assets are as follows:

●  Furniture and equipment
3 years
●  Computer hardware
3 years

Depreciation methods, useful lives and residual values are reviewed at each financial year-end and adjusted if appropriate.
 
 
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Revenue Recognition

The Company records revenue when the following criteria are met: persuasive evidence of an arrangement exists, delivery has occurred, the selling price to the customer is fixed and determinable, and collectability is reasonably assured. For the Company’s membership program the Company records revenue on collection of the monthly fee and after delivery of the products has occurred. Delivery is not considered to have occurred until the customer assumes the risks and rewards of ownership. Customers take delivery at the time of shipment for terms designated free on board shipping point. For sales designated free on board destination, customers take delivery when the product is delivered to the customer's delivery site. Provisions for sales incentives, product returns, and discounts to customers are recorded as an offset to revenue in the same period the related revenue is recorded.  The Company does not currently record a provision for product returns as to date sales in the membership program have been minimal and any returns related to sales through the Company’s wholesale distribution channels become the responsibility of the manufacturer. Therefore, any related provision for product returns was not deemed material for the years ended December 31, 2014 and 2013.

Inventory

Inventory consists of E-cigarettes and accessories as well as related packaging.  Inventory is stated at the lower of cost as determined by the first-in, first-out (FIFO) cost method, or market value. The Company measures inventory write-downs as the difference between the cost of inventory and market value. At the point of any inventory write-downs to market, the Company establishes a new, lower cost basis for that inventory, and any subsequent changes in facts and circumstances do not result in the restoration of the former cost basis or increase in that newly established cost basis.

The Company reviews product sales and returns from the previous 12 months and future demand forecasts and writes off any excess or obsolete inventory. The Company also assesses inventory for obsolescence by testing the products to ensure they have been properly stored and maintained so that they will perform according to specifications. In addition, the Company assesses the market for competing products to determine that the existing inventory will be competitive in the marketplace.

If there were to be a sudden and significant decrease in future demand for our products, or if there were a higher incidence of inventory obsolescence because of rapidly changing technology and customer requirements, the Company could be required to write down inventory and accordingly gross margin could be adversely affected.

Income Taxes

The Company follows Accounting Standards Codification subtopic 740-10, Income Taxes (“ASC 740-10”) which requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been included in the financial statement or tax returns. Under this method, deferred tax assets and liabilities are determined based on the difference between financial statements and tax bases of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse. Temporary differences between taxable income reported for financial reporting purposes and income tax purposes include, but are not limited to, accounting for intangibles, debt discounts associated with convertible debt, equity based compensation and depreciation and amortization.  A valuation allowance is provided to reduce the deferred tax assets reported if based on the weight of available evidence it is more likely than not that some portion or all of the deferred tax assets will not be realized.

Impairment of Long Lived Assets

Long-lived assets to be held and used by the Company are periodically reviewed to determine whether any events or changes in circumstances indicate that the carrying amount of the asset may not be recoverable. For long-lived assets to be held and used, the Company bases its evaluation on impairment indicators such as the nature of the assets, the future economic benefit of the assets, any historical or future profitability measurements, as well as other external market conditions or factors that may be present. In the event that facts and circumstances indicate that the carrying amount of an asset or asset group may not be recoverable and an estimate of future undiscounted cash flows is less than the carrying amount of the asset, an impairment loss will be recognized for the difference between the carrying value and the fair value.
 
 
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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.

Comprehensive Income or Loss

The Company reports comprehensive income or loss in its audited 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.

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, accruals, impairment of property and equipment, valuing stock based compensation, 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.

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 are amortized over the estimated useful life of the website which the Company considers to be five years.  Ongoing website post- implementation cost of operations, including training and application, will be expensed as incurred.

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.
 
 
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Warrants

The Company accounts for common stock purchase warrants at fair value in accordance with ASC 815-40, Derivatives and Hedging. The Black-Scholes option pricing valuation method is used to determine fair value of these warrants consistent with ASC 718, Compensation – Stock Compensation. Use of this method requires that the Company make assumptions regarding stock value, dividend yields, expected term of the warrants and risk free interest rates.

Stock Issued in Exchange for Services

The valuation of the Company’s common stock issued in exchange for services is valued at an estimated fair market value as determined by the most readily determinable value of either the stock or services exchanged. Values of the stock are based upon other sales and issuances of the Company’s common stock within the same general time period.

Recent Accounting Pronouncements

The Company has reviewed all recently issued, but not yet effective, accounting pronouncements and other than the below, 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.

In June 2014, the FASB issued Accounting Standards Update (ASU) No. 2014-10, Development Stage Entities (Topic 915): Elimination of Certain Financial Reporting Requirements, Including an Amendment to Variable Interest Entities Guidance in Topic 810, Consolidation. This ASU does the following among other things: a) eliminates the requirement to present inception-to-date information on the statements of income, cash flows, and shareholders’ equity, b) eliminates the need to label the financial statements as those of a development stage entity, c) eliminates the need to disclose a description of the development stage activities in which the entity is engaged, and d) amends FASB ASC 275, Risks and Uncertainties, to clarify that information on risks and uncertainties for entities that have not commenced planned principal operations is required. The amendments in ASU No. 2014-10 related to the elimination of Topic 915 disclosures and the additional disclosure for Topic 275 are effective for public companies for annual and interim reporting periods beginning after December 15, 2014. Early adoption is permitted. The Company early adopted this ASU beginning with the quarterly period ended June 30, 2014.

In August 2014, the FASB issued ASU No. 2014-15, Presentation of Financial Statements—Going Concern: Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern (“ASU 2014-15”). ASU 2014-15 requires an entity to evaluate whether there are conditions or events that raise substantial doubt about the entity’s ability to continue as a going concern within one year after the date that the financial statements are issued (or within one year after the financial statements are available to be issued when applicable) and to provide related footnote disclosures in certain circumstances. ASU 2014-15 is effective for the annual period ending after December 15, 2016, and for annual and interim periods thereafter with early adoption permitted. We do not expect the adoption of ASU 2014-15 to have a material impact on our consolidated financial statements.

Results of Operations – Year ended December 31, 2014 compared to the year ended December 31, 2013.

Revenue

For the year ended December 31, 2014, the Company generated $581,822 in sales from the white label sales of electronic cigarettes, vaporizers, e-liquids and accessories (collectively, “E-cigarettes”) as compared to $76,977 in sales for the year ended December 31, 2013. For the year ended December 31, 2014, the Company also generated consulting revenue of $26,213 (as discussed below) for total sales and revenues in the year ended December 31, 2014 of $608,035. For the year ended December 31, 2014, E-cigarette sales of $581,822 of was generated in three geographic locations, $558,420 was generated in Ireland, $11,953 was generated in Canada and the remaining $11,449 was generated in the United States. For the year ended December 31, 2013, E-cigarette sales of $76,977 was all generated in the United States.
 
 
39

 

The Company’s cost of goods sold for the year ended December 31, 2014 was $490,720 which represents E-cigarette products and the related packaging as compared to $61,621 for the year ended December 31, 2013. Gross profit for the year ended December 31, 2014 was $91,102 as compared to $15,356 for the comparative period. The Company incurred higher than usual cost of goods sold in the year ended December 31, 2014 due to one-time expenses related to packaging setup for a white label clients.

During the year ended December 31, 2014, the Company’s Irish subsidiary, Drinan Marketing Limited (“DML”), generated $26,213 in revenues from consulting services provided to clients in the tobacco industry. On October 6, 2014, the Company appointed liquidators for the purpose of winding up DML by way of a voluntary liquidation by reason of its liabilities, as such, the Company does not expect to generate consulting revenues moving forward.

Operating Expenses

For the year ended December 31, 2014, the Company incurred administrative expense of $1,472,196, consulting fees to related parties of $628,956, depreciation and amortization expense of $9,449, loss on sale of fixed asset of $654, bad debt expense of $27,731 and impairment of inventory expense of $101,458. Administrative costs were primarily comprised of rent, legal and audit fees, marketing fees, travel expenses and subcontractor fees. As a result of the expected voluntary liquidation of DML, bad debt expense relates to the write off of uncollectible DML receivables. The impairment of inventory relates to i) the write off of the full value of DML’s inventory in the amount of $60,301, as a result of the DML liquidation, and ii) the impairment of inventory held in Florida, USA in the amount of $41,157 due to inventory obsolescence. Total operating expenses for the year ended December 31, 2014 were $2,240,444. For the year ended December 31, 2013, the Company incurred administrative expense of $707,811, consulting fees to related parties of $644,695 and depreciation and amortization expense of $1,518. Total operating expenses for the year ended December 31, 2013 were $1,354,024. The increase in administrative expense of $764,385 is attributable to the liquidation of DML, the Company’s upfront investments to grow sales of E-cigarettes and the result of consulting expenses increasing due to the hiring of additional consultants. The decrease in consulting fees due to related parties of $15,739 is attributable to the effects of foreign exchange translation.

Loss from Operations

For the year ended December 31, 2014, the Company incurred a loss from operations of $2,123,129 as compared to $1,338,668 for the year ended December 31, 2013 due to the reasons discussed above.

Other Expenses

For the year ended December 31, 2014, the Company incurred a foreign exchange loss of $43,010, amortization of debt discount of $715,314, gain on deconsolidation of DML of $126,867, loss on loan receivable of $65,850, gain on settlement of debt of $435 and interest expense of $276,389. The amortization of debt discount for the year ended December 31, 2014 of $715,314 included $661,522 related to the conversion of Convertible Debentures in the aggregate amount of $1,125,000. As a result of the loss of control and resulting deconsolidation of DML, the Company recorded a gain on deconsolidation in the amount of $126,867. The Company also wrote off its investment in DML in the amount of $55,000, the intercompany receivable owing from DML in the amount of $233,659 and also the Company released $34,036 in currency translation adjustments retained in other comprehensive income into income. Additionally, the Company also wrote off the entire loan receivable from the previous shareholder of DML and recorded a loss on loan receivable. For the year ended December 31, 2013, the Company incurred a foreign exchange loss of $5,013, amortization of debt discount of $9,514, loss on loan receivable written off of $21,405 and interest expense of $128,322. For the year ended December 31, 2014, the Company incurred total other expenses of $973,261 as compared to $164,254 for the year ended December 31, 2013.

Net Loss and Comprehensive Loss

Net loss amounted to $3,096,390 for the year ended December 31, 2014 compared to a loss of $1,502,922 for the year ended December 31, 2013. The increase in net loss is primarily attributable to increases in administrative expenses due to the Company’s focus on generating sales, an increase in interest expense, amortization of debt discount expense and the effects relating to the deconsolidation of DML.

Comprehensive loss amounted to $3,009,240 for the year ended December 31, 2014 compared to a loss of $1,455,087 for the year ended December 31, 2013. 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.
 
 
 
40

 
 
Liquidity and Capital Resources

For the year ended December 31, 2014 compared to the year ended December 31, 2013

As at December 31, 2014, the Company had total assets of $1,086,485 (December 31, 2013: $528,744) consisting of cash of $496,724, accounts receivable of $37,421, inventory of $78,901, prepaid expenses and vendor deposits of $378,252, property and equipment of $1,864 and website development of $93,323. The increase in assets at December 31, 2014 from December 31, 2013, is primarily the result of increased cash, increased prepaid expenses and vendor deposits, and capitalized website development costs incurred in the website application and infrastructure development stage.

As at December 31, 2014, the Company had total liabilities of $2,639,901 (December 31, 2013: $1,753,394) consisting of accounts payable of $309,139, accrued liabilities of $69,017, accrued interest due to related parties of $39,279, loans from shareholders of $34,739, amounts due to related parties of $1,144,789, advances on Credit Facility of $387,110, long term loans from shareholders of $531,000, long term amounts due to a related party of $100,000 and Convertible Debentures of $24,828. The increase in liabilities can be primarily attributed to an increase in consulting fees accrued to officers and other parties, advances on Credit Facility, increased loans from shareholders with the issuance of the Secured Note and the Secured Note No.2.

At December 31, 2014, the Company had negative working capital of $992,775 and an accumulated deficit of $5,702,351.

Net cash used in operating activities

For the year ended December 31, 2014, the Company used cash of $1,315,018 (December 31, 2013: $797,702) in operating activities to fund administrative, marketing and sales. The increase is attributable to the increase in operations and changes in the operating assets and liabilities as discussed above including the deconsolidation of DML.

Net cash used in investing activities

For the year ended December 31, 2014, net cash used in investing activities was $54,919 (December 31, 2013: $64,666) website development and disposal of capital assets. For the year ended December 31, 2013, net cash used in investing was $64,666 attributable to website development, a factoring loan advance and the addition of capital assets.

Net cash flow from financing activities

Net cash provided by financing activities for the year ended December 31, 2014 was $1,426,399, compared to $1,193,046 for the year ended December 31, 2013. The increase was attributable to the proceeds from the issuance of a Secured Note (see “Secured Note”), issuance of a Secured Note No.2 (see “Secured Note No.2”), advances from the Credit Facility (see “Credit Facility”) and the proceeds from Common Share subscriptions. The Company also retired a revolving Credit Note due to a related party in the principal amount of $225,000, together with the accrued and unpaid interest.

Secured Note

On February 13, 2014, the Company entered into a Secured 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 Secured Note is secured by a general security agreement over the assets of the Company. During the year ended December 31, 2014, the Company and the shareholder extended the maturity date of the Secured Note to January 1, 2016.
 
 
41

 

The Company accrued interest of $39,043 during the year ended December 31, 2014 (December 31, 2013: $nil) on the Secured Note which is included in accrued liabilities. During the year ended December 31, 2014, the Company settled $30,690 in interest on the Secured Note with the issuance of Common Shares.

Secured Note No.2

On July 15, 2014, the Company entered into a Secured Note No.2 with a shareholder, whereby the Company agreed to pay the party the aggregate unpaid principal amount of $100,000 on or before July 18, 2014, bearing interest at a rate of 10% per annum, such interest will accrue monthly and be added to the principal. The Secured Note No.2 is secured by the general security agreement issued with the Secured Note. During the year ended December 31, 2014, the Company and the shareholder extended the maturity date of the Secured Note No.2 to January 1, 2016.

The Company accrued interest of $4,662 during the year ended December 31, 2014 (December 31, 2013: $nil) on the Secured Note No. 2 which is included in accrued liabilities. During the year ended December 31, 2014, the Company settled $2,111 in interest on the Secured Note No.2 with the issuance of Common Shares.

Credit Facility

On August 1, 2014, the Company entered into a Credit Facility with an unrelated party acting as an agent to a consortium of participants, whereby the Lender would make a revolving credit facility in the aggregate principal amount of CAD $500,000 for the exclusive purpose of purchasing inventory for sale in the Company’s ordinary course of business to approved customers. The Credit Facility shall bear interest at a rate of 15% per annum on all drawn advances and a standby fee of 3.5% per annum on the undrawn portion of the Credit Facility. The Credit Facility shall mature on August 1, 2015 whereby the outstanding advances together with all accrued and unpaid interest theron shall be due and payable. On August 1, 2014, and in connection to the Credit Facility, the Company issued 250,000 warrants to purchase Common Shares of the Company exercisable over two years with an exercise price of $0.30 per Common Share. The Company’s Chief Executive Officer and Chief Financial Officer are both participants of the consortium of participants of the Credit Facility, each having committed to provide ten percent of the principal amount of the Credit Facility.

During the year ended December 31, 2014, the Company was advanced $387,110 (CAD $449,083) from the Credit Facility for the purchase of inventory including $77,453 (CAD $89,852) of advances from the Company’s Chief Executive Officer and Chief Financial Officer as their participation in the Credit Facility.

During the year ended December 31, 2014, the Company paid $1,786 of standby fees and $23,577 of interest as a result of the Credit Facility.
 
 
42

 
 
Satisfaction of Our Cash Obligations for the Next 12 Months

These audited 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 audited consolidated financial statements, at December 31, 2014, the Company has an accumulated deficit of $5,702,351, a working capital deficiency of $992,775 and negative cash flows from operating activities of $1,315,018 for the year ended December 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 audited 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.

Off-Balance Sheet Arrangements

We have no off balance sheet arrangements.

Inflation

The Company does not believe that inflation has had a material effect on our business, financial condition or results of operations. If our costs were to become subject to significant inflationary pressures, it may not be able to fully offset such higher costs through price increases. The Company’s inability or failure to do so could adversely affect our business, financial condition and results of operations.

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.

Material Commitments

a)  
Operating Lease - Vehicle

The future minimum payment under an operating lease for the use of a vehicle amounts to approximately $799. The lease expires on April 30, 2016. Minimum annual lease payments are as follows:

2015
 
$
9,587
 
2016
   
3,196
 
   
$
12,783
 

b)  
Rental Leases - Premises

Effective August 15, 2014, the Company entered into an operating lease agreement for a rental premises in Miami, Florida, USA. The terms of this agreement are to be for a period of 2 years commencing on August 15, 2014 and ending August 14, 2016 with payments made monthly and annual rent in year 1 of $28,020 and year 2 of $30,420. The landlord waived and forgave payment for the first month of the operating lease as part of the agreement. The Company has a one time option to extend the lease for an additional 2 year period with an annual rent increase of $1,200 per each year of the extended term.

2015
 
$
28,720
 
2016
   
21,548
 
   
$
50,268
 
 
 
43

 


Effective September 17, 2014, the Company entered into a rental lease agreement for a rental premises in Dublin, Ireland. The terms of this agreement are for a period of 1 year commencing on September 17, 2014 and ending on September 16, 2015 with payments made monthly and annual rent in the 1 year of EUR 22,200.

2015
 
18,689
 

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

This item is not applicable to smaller reporting companies.
 
 
44

 
 
ITEM 8.  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
 
 
GILLA INC.
CONSOLIDATED FINANCIAL STATEMENTS
Years Ended December 31, 2014 and 2013
(Amounts expressed in US Dollars)




 
  45

 
 
TABLE OF CONTENTS
Report of Independent Registered Public Accounting Firm
    F-2  
         
Consolidated Balance Sheets as at December 31, 2014 and 2013
    F-3  
         
Consolidated Statements of Operations and Comprehensive Loss for the years ended December 31, 2014 and 2013
    F-4  
         
Consolidated Statement of Changes in Stockholders’ Deficiency for the years ended December 31, 2014 and 2013
 
F-5 to F-6
 
         
Consolidated Statements of Cash Flows for the years ended December 31, 2014 and 2013
    F-7  
         
         
Notes to Consolidated Financial Statements
 
F-8 to F-25
 
 
F-1 

 


Schwartz Levitsky Feldman llp
CHARTERED ACCOUNTANTS
LICENSED PUBLIC ACCOUNTANTS
TORONTO MONTREAL



REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM


To the Stockholders of
Gilla Inc.
 
We have audited the accompanying consolidated balance sheets of Gilla Inc. (the “Company”) as at December 31, 2014 and 2013, and the related consolidated statements of operations and comprehensive loss, cash flows and changes in stockholders' deficiency for the years then ended. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States).  Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting.  Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting.  Accordingly, we express no such opinion. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation.  We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2014 and 2013, and the results of its operations and its cash flows for the years then ended in conformity with generally accepted accounting principles in the United States of America.

The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern.  As discussed in note 2 to the consolidated financial statements, the Company has limited revenues and expects to continue to incur significant expenses from operations. The Company’s future success is dependent upon its ability to raise sufficient capital, not only to cover its operating expenses, but also to continue to develop and be able to profitably market its products. Those factors raise substantial doubt about its ability to continue as a going concern.  The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.
 
 
 
 
/s/ SCHWARTZ LEVITSKY FELDMAN LLP
   
 
2300 Yonge Street, Suite 1500, Box 2434
Toronto, Ontario M4P 1E4
 
Tel: 416 785 5353
Fax: 416 785 5663
 
   
Toronto, Ontario, Canada Chartered Accountants
March 31, 2015 Licensed Public Accountants
   
 
 
 
F-2

 


Gilla Inc.
Consolidated Balance Sheets
As at December 31, 2014 and 2013
(Amounts expressed in US Dollars)
 
Current assets
  December 31,
2014
   
December 31,
2013
 
ASSETS
 
Cash
 
$
496,724
   
$
355,860
 
Funds held in trust
   
-
     
20,000
 
Accounts receivable
   
37,421
     
100
 
Inventory (note 6)
   
78,901
     
90,914
 
Prepaid expenses and vendor deposits
   
378,252
     
15,199
 
Total current assets
   
991,298
     
482,073
 
Long term assets
               
Property and equipment (note 7)
   
1,864
     
3,882
 
Website development (note 8)
   
93,323
     
42,789
 
Total long term assets
   
95,187
     
46,671
 
                 
Total assets
 
$
1,086,485
   
$
528,744
 
                 
LIABILITIES
 
Current liabilities
               
Accounts payable
 
$
309,139
   
$
125,163
 
Accrued liabilities
   
69,017
     
56,838
 
Accrued interest - related parties (note 17)
   
39,279
     
78,838
 
Loans from shareholders (note 9)
   
34,739
     
20,615
 
Due to related parties (note 17)
   
1,144,789
     
767,426
 
Note payable - related party (note 11)
   
-
     
225,000
 
Credit facility (note 10)
   
387,110
     
-
 
Total current liabilities
   
1,984,073
     
1,273,880
 
                 
Long term liabilities
               
Loan from shareholders (note 9)
   
531,000
     
-
 
Due to related party (note 17)
   
100,000
     
-
 
Convertible debentures to be issued (note 12)
   
-
     
45,000
 
Convertible debentures (note 12)
   
24,828
     
434,514
 
Total long term liabilities
   
655,828
     
479,514
 
                 
Total liabilities
   
2,639,901
     
1,753,394
 
                 
Going concern (note 2)
               
Related party transactions (note 17)
               
Commitments and contingencies (note 19)
               
Subsequent events (note 22)
               
STOCKHOLDERS’ DEFICIENCY
 
Common stock (note 13)
 
$
18,542
   
$
13,413
 
Additional paid-in capital
   
3,998,482
     
1,285,637
 
Shares to be issued (note 16)
   
-
     
37,500
 
Accumulated deficit
   
(5,702,351)
     
(2,605,961)
 
Accumulated other comprehensive income
   
131,911
     
44,761
 
Total shareholders’ deficiency
   
(1,553,416)
     
(1,224,650)
 
                 
Total liabilities and stockholders’ deficiency
 
$
1,086,485
   
$
528,744
 
The accompanying notes are an integral part of these consolidated financial statements
 
F-3

 

Gilla Inc.
Consolidated Statements of Operations and Comprehensive Loss
For the Years ended December 31, 2014 and 2013
(Amounts expressed in US Dollars)

   
2014
   
2013
 
             
Sales
  $ 581,822     $ 76,977  
Cost of goods sold
    490,720       61,621  
Gross profit (loss)
    91,102       15,356  
                 
Consulting revenue
    26,213       -  
Net revenue
    117,315       15,356  
                 
Operating expenses
               
Administrative
    1,472,196       707,811  
Consulting fees - related parties (note 17)
    628,956       644,695  
Depreciation and amortization
    9,449       1,518  
Loss on sale of fixed asset
    654       -  
Bad debt expense
    27,731       -  
Impairment of inventory (note 6)
    101,458       -  
Total operating expenses
    2,240,444       1,354,024  
                 
Loss from operations
    (2,123,129 )     (1,338,668 )
                 
Other income (expenses):
               
Foreign exchange
    (43,010 )     (5,013 )
Loss on loan receivable written off (note 5)
    (65,850 )     (21,405 )
Gain on settlement of debt
    435       -  
Gain on deconsolidation of subsidiary (note 15)
    126,867       -  
Amortization of debt discount
    (715,314 )     (9,514 )
Interest expense, net
    (276,389 )     (128,322 )
                 
Total other expenses
    (973,261 )     (164,254 )
                 
Net loss before income taxes
    (3,096,390 )     (1,502,922 )
Income taxes
    -       -  
Net loss
  $ (3,096,390 )   $ (1,502,922 )
                 
Loss per share (basic and diluted)
  $ (0.042 )   $ (0.024 )
                 
Weighted average number of shares outstanding during the year
    73,140,380       63,319,808  
                 
                 
Comprehensive loss:
               
Net loss
  $ (3,096,390 )   $ (1,502,922 )
                 
Foreign exchange translation adjustment for the year
    87,150       47,835  
                 
Comprehensive loss
  $ (3,009,240 )   $ (1,455,087 )
 
 
The accompanying notes are an integral part of these consolidated financial statements
 
 
F-4

 

Gilla Inc.
Consolidated Statement of Changes in Stockholders’ Deficiency
For the Years Ended December 31, 2014 and 2013
(Amounts expressed in US Dollars)
   
Common Stock
                           
   
Shares
   
Amount
 
Additional
Paid-In Capital
 
Shares to be
Issued
 
Accumulated
Deficit
   
Accumulated Other Comprehensive
Income (loss)
   
Total Stockholders’
Deficiency
 
Balance, December 31, 2012
 
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
 
67,066,977
 
$
13,413
 
$
1,285,637
$
37,500
$
(2,605,961)
 
$
44,761
 
$
(1,224,650)
 
                                       
 
F-5

 
Common shares issued for settlement of consulting fees at $0.05 on January 8, 2014
 
200,000
   
40
   
9,960
 
(10,000)
 
-
   
-
   
-
 
                                       
Common shares issued for cash at $0.035 per share on January 8, 2014
 
500,000
   
100
   
17,400
 
(17,500)
 
-
   
-
   
-
 
                                       
Common shares issued for settlement of consulting fees at $0.1426 per share on March 28, 2014
 
280,433
   
56
   
39,944
 
(10,000)
 
-
   
-
   
30,000
 
                                       
Common shares issued for settlement of consulting fees at $0.1293 per share on March 28, 2014
 
270,597
   
54
   
34,946
 
-
 
-
   
-
   
35,000
 
                                       
Common shares issued for settlement of advertising production costs at $0.10 per share on May 30, 2014
 
835,000
   
167
   
83,333
 
-
 
-
   
-
   
83,500
 
                                       
Common shares issued for settlement of related party advertising production costs at $0.10 per share on May 30, 2014
 
10,000
   
2
   
998
 
-
 
-
   
-
   
1,000
 
                                       
Common shares issued for settlement of consulting fees at $0.19 per share on May 30, 2014
 
92,500
   
19
   
17,481
 
-
 
-
   
-
   
17,500
 
                                       
Common shares issued for conversion of convertible debentures at $0.07 per share on May 30, 2014
 
714,286
   
143
   
49,857
 
-
 
-
   
-
   
50,000
 
                                       
Common shares issued for acquisition of subsidiary at $0.11 per share on June 2, 2014
 
500,000
   
100
   
54,900
 
-
 
-
   
-
   
55,000
 
                                       
Common shares issued for settlement of consulting fees at $0.25 per share on June 2, 2014
 
55,000
   
11
   
13,739
 
-
 
-
   
-
   
13,750
 
                                       
Common shares issued for cash at $0.15 per share on July 25, 2014
 
1,401,333
   
280
   
209,920
 
-
 
-
   
-
   
210,200
 
                                       
Common shares issued for settlement of consulting fees at $0.18 per share on July 29, 2014
 
300,000
   
60
   
53,940
 
-
 
-
   
-
   
54,000
 
                                       
Common shares issued for settlement of a shareholder loan at $0.15 per share on August 15, 2014
 
10,919
   
2
   
1,636
 
-
 
-
   
-
   
1,638
 
                                       
Common shares issued for settlement of consulting fees at $0.15 per share on September 17, 2014
 
182,749
   
37
   
27,375
 
-
 
-
   
-
   
27,412
 
                                       
Common shares issued for cash at $0.15 per share on September 29, 2014
 
1,333,334
   
267
   
199,733
 
-
 
-
   
-
   
200,000
 
                                       
Common shares issued for settlement of consulting fees at $0.236 per share on September 30, 2014
 
63,559
   
13
   
14,987
 
-
 
-
   
-
   
15,000
 
                                       
Common shares issued for settlement of consulting fees at $0.16 per share on October 9, 2014
 
100,000
   
20
   
15,980
 
-
 
-
   
-
   
16,000
 
                                       
Common shares issued for conversion of convertible debentures at $0.07 per share on November 4, 2014
 
11,428,572
   
2,286
   
797,714
 
-
 
-
   
-
   
800,000
 
                                       
Common shares issued for settlement of interest payable on convertible debentures at $0.15 per share on November 4, 2014
 
523,726
   
105
   
78,454
 
-
 
-
   
-
   
78,559
 
                                       
Common shares issued for settlement of related party consulting fees at $0.15 per share on November 4, 2014
 
717,840
   
144
   
107,532
 
-
 
-
   
-
   
107,676
 
                                       
Common shares issued for conversion of convertible debentures at $0.07 per share on November 20, 2014
 
3,928,571
   
786
   
274,214
 
-
 
-
   
-
   
275,000
 
                                       
Common shares issued for settlement of interest payable to a shareholder at $0.15 per share on November 20, 2014
 
218,669
   
44
   
32,757
 
-
 
-
   
-
   
32,801
 
                                       
Common shares issued for settlement of interest payable to a shareholder on convertible debentures at $0.15 per share on November 20, 2014
 
173,953
   
35
   
26,058
 
-
 
-
   
-
   
26,093
 
                                       
Common shares issued for settlement of consulting fees at $0.15 per share on December 17, 2014
 
800,000
   
160
   
119,840
 
-
 
-
   
-
   
120,000
 
                                       
Common shares issued for settlement of related party consulting fees at $0.15 per share on December 31, 2014
 
500,000
   
100
   
74,900
 
-
 
-
   
-
   
75,000
 
                                       
Common shares issued for cash at $0.15 per share on December 31, 2014
 
490,000
   
98
   
73,402
 
-
 
-
   
-
   
73,500
 
                                       
Stock based compensation
 
-
   
-
   
103,845
 
-
 
-
   
-
   
103,845
 
                                       
Embedded conversion feature of convertible debentures
 
-
   
-
   
178,000
 
-
 
-
   
-
   
178,000
 
                                       
Foreign currency translation gain
 
-
   
-
   
-
 
-
 
-
   
87,150
   
87,150
 
                                       
Net loss
 
-
   
-
   
-
 
-
 
(3,096,390)
   
-
   
(3,096,390)
 
                                       
Balance, December 31, 2014
 
92,698,018
 
$
18,542
 
$
3,998,482
$
-
$
(5,702,351)
 
$
131,911
 
$
(1,553,416)
 
 
The accompanying notes are an integral part of these consolidated financial statements
 
 
F-6

 

Gilla Inc.
Consolidated Statements of Cash Flows
For the Years Ended December 31, 2014 and 2013
(Amounts Expressed in US Dollars)
 
 
   
2014
   
2013
 
CASH FLOWS FROM OPERATING ACTIVITIES :
           
Net loss
  $ (3,096,390 )   $ (1,502,922 )
Items not requiring an outlay of cash
               
Depreciation
    2,783       1,518  
Amortization
    6,666       -  
Loss on loan receivable written-off
    65,850       21,405  
Amortization of debt discount
    715,314       9,514  
Stock based compensation
    103,845       -  
Loss on disposal of fixed asset
    654       -  
Bad debt expense
    27,731       -  
Impairment of inventory
    101,458       -  
Gain on deconsolidation of subsidiary
    (126,867 )     -  
Gain on settlement of debt
    (435 )     -  
Common shares issued for services
    185,750       107,500  
Changes in operating assets and liabilities                
Accounts receivable
    40,550       (100 )
Funds held in trust
    20,000       (20,000 )
Prepaid expenses and vendor deposits
    (177,427 )     (14,530 )
Inventory
    (30,413 )     (90,914 )
Accounts payable
    380,509       54,901  
Accrued liabilities
    66,143       48,056  
Related party payables
    438,641       510,352  
Accrued interest-related party
    (39,380 )     77,518  
Net cash used in operating activities
    (1,315,018 )     (797,702 )
                 
CASH FLOWS FROM INVESTING ACTIVITIES:
               
Factoring loan
    -       (19,867 )
(Acquisition) disposal of property and equipment
    2,281       (2,010 )
Website development
    (57,200 )     (42,789 )
Net cash used in investing activities
    (54,919 )     (64,666 )
                 
CASH FLOWS FROM FINANCING ACTIVITIES:
               
Net cash acquired from Drinan Marketing Ltd.
    8,812       -  
Proceeds from credit facility
    387,110       -  
Loans to subsidiary prior to acquisition
    (109,978 )     -  
Shareholder loan received (paid)
    546,131       (43,697 )
Net proceeds from related parties
    255,624       241,066  
Repayment of related party note payable
    (225,000 )     -  
Proceeds from promissory note
    -       200,000  
Proceeds from sale of convertible debentures
    80,000       766,000  
Proceeds from common share subscriptions
    -       17,500  
Proceeds from issuance of common stock
    483,700       12,177  
Net cash provided by financing activities
    1,426,399       1,193,046  
Effect of exchange rate changes on cash
    84,402       13,738  
                 
Net increase in cash
  $ 140,864       344,416  
                 
Cash at beginning of year
    355,860       11,444  
                 
Cash at end of year
  $ 496,724       355,860  
                 
Supplemental Schedule of Cash Flow Information:
               
Cash paid for interest
  $ 165,437     $ 24,415  
Cash paid for income taxes
  $ -     $ -  
                 
Non cash financing activities:
               
Common stock issued for settlement of related party and shareholder loans
  $ 1,638     $ 98,700  
Common stock issued in settlement of interest payable
  $ 137,453     $ -  
Common stock issued for payment of consulting fees payable
  $ 348,662     $ 107,500  
Common stock issued for payment of consulting fees payable to related parties
  $ 182,676     $ -  
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     $ 451,000  



The accompanying notes are an integral part of these consolidated financial statements
 
 
F-7

 
 
 

Gilla Inc.
Notes to Consolidated Financial Statements
December 31, 2014 and 2013
(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 (as defined in note 13) 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 issued to the sellers 500,000 Common Shares valued at $0.11 per share and warrants for the purchase of 1,000,000 Common Shares of the Company. On October 6, 2014, the Company appointed liquidators for the purpose of winding up DML by way of a voluntary liquidation by reason of its liabilities.

The current business of the Company consists of the design, marketing and distribution of electronic cigarettes, vaporizers, e-liquids and accessories (“E-cigarettes”). 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 has a two-pronged business model: white-label solutions, including branding, marketing and sales support; and e-commerce solutions like Charlie’s Club, a members-only online e-cigarette monthly subscription service featuring free hardware and no contracts.

2. GOING CONCERN

These audited 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 audited consolidated financial statements, at December 31, 2014, the Company has an accumulated deficit of $5,702,351, a working capital deficiency of $992,775 and negative cash flows from operating activities of $1,315,018 for the year ended December 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 audited 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.
 
F-8

 
 
3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

(a) Basis of Preparation

The Company's consolidated financial statements have been prepared in accordance with generally accepted accounting principles in the United States of America (“U.S. GAAP”) for annual financial statements and with Form 10-K and article 8 of the Regulation S-X of the United States Securities and Exchange Commission (“SEC”).

(b) Basis of Consolidation

These audited consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries; Gilla Operations, LLC; Charlie’s Club, Inc.; Gilla Enterprises Inc.; Gilla Operations Worldwide Limited; Gilla Franchises, LLC and its wholly-owned subsidiary Gilla Biscayne, LLC; and Snoke Distribution Canada Ltd. and its wholly-owned subsidiary Snoke Distribution USA, LLC. The Company deconsolidated DML at October 6, 2014 but the operations of DML for the period from the date of acquisition of February 28, 2014 to the date of deconsolidation are included in the operations of the Company for the year ended December 31, 2014. All inter-company accounts and transactions have been eliminated in preparing these audited consolidated financial statements.
 
(c) Foreign Currency Translation

The Company’s Canadian subsidiaries maintain their books and records in Canadian dollars (CAD) which is also their 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 audited consolidated financial statements, entered into derivative instruments to offset the impact of foreign currency fluctuations.
 
(d) 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 December 31, 2014 and 2013 that have been included in the diluted loss per share calculation as the effects would have been anti-dilutive.
 
(e) Financial Instruments

Financial assets and financial liabilities are recognized in the balance sheet when the Company has become party to the contractual provisions of the instruments.
 
 
F-9

 
 
 
The Company’s financial instruments consist of cash, funds held in trust, accounts receivable, accounts payable, accrued interest, due to related parties, accrued liabilities, note payable, convertible debentures, loan from shareholders and credit facility. 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 funds held in trust 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 interest, due to related parties, accrued liabilities, note payable, convertible debentures, loan from shareholder and credit facility 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.

(f) 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 year ended December 31, 2014, $136,200 in production costs were incurred, $90,800 of which have been allocated to prepaid expenses and vendor deposits on the consolidated balance sheet, $45,400 in production costs were expensed during the period representing the release of the first phase of the Company’s online advertising campaign. The Company expenses all other advertising costs as incurred. During the year ended December 31, 2014, the Company expensed $314,001 (December 31, 2013: $57,330) as corporate promotions.

(g) Property and Equipment

Property and Equipment are measured at cost less accumulated depreciation and accumulated impairment losses. Costs include expenditures that are directly attributable to the acquisition of the asset. Gains and losses on disposal of an item of property and equipment are determined by comparing the proceeds from disposal with the carrying amount of property and equipment, and are recognized in the statement of operations.
 
Depreciation is recognized in the statement of operations on a straight-line basis over the estimated useful lives of each part of an item of property and equipment, since this most closely reflects the expected pattern of consumption of the future economic benefits embodied in the asset.
 
The estimated useful lives of the respective assets are as follows:
 
 
Furniture and equipment
3 years
Computer hardware
3 years
 
 
Depreciation methods, useful lives and residual values are reviewed at each financial year-end and adjusted if appropriate.
 
(h) Revenue Recognition

The Company records revenue when the following criteria are met: persuasive evidence of an arrangement exists, delivery has occurred, the selling price to the customer is fixed and determinable, and collectability is reasonably assured. For the Company’s membership program the Company records revenue on collection of the monthly fee and after delivery of the products has occurred. Delivery is not considered to have occurred until the customer assumes the risks and rewards of ownership. Customers take delivery at the time of shipment for terms designated free on board shipping point. For sales designated free on board destination, customers take delivery when the product is delivered to the customer's delivery site. Provisions for sales incentives, product returns, and discounts to customers are recorded as an offset to revenue in the same period the related revenue is recorded. The Company does not currently record a provision for product returns as to date sales in the membership program have been minimal and any returns related to sales through the Company’s wholesale distribution channels become the responsibility of the manufacturer. Therefore, any related provision for product returns was not deemed material for the years ended December 31, 2014 and 2013.
 
 
F-10

 
 
 
(i) Inventory
 
Inventory consists of E-cigarettes and accessories as well as related packaging. Inventory is stated at the lower of cost as determined by the first-in, first-out (FIFO) cost method, or market value. The Company measures inventory write-downs as the difference between the cost of inventory and market value. At the point of any inventory write-downs to market, the Company establishes a new, lower cost basis for that inventory, and any subsequent changes in facts and circumstances do not result in the restoration of the former cost basis or increase in that newly established cost basis.

The Company reviews product sales and returns from the previous 12 months and future demand forecasts and writes off any excess or obsolete inventory. The Company also assesses inventory for obsolescence by testing the products to ensure they have been properly stored and maintained so that they will perform according to specifications. In addition, the Company assesses the market for competing products to determine that the existing inventory will be competitive in the marketplace.

If there were to be a sudden and significant decrease in future demand for our products, or if there were a higher incidence of inventory obsolescence because of rapidly changing technology and customer requirements, the Company could be required to write down inventory and accordingly gross margin could be adversely affected.

(j) Income Taxes

The Company follows Accounting Standards Codification subtopic 740-10, Income Taxes (“ASC 740-10”) which requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been included in the financial statement or tax returns. Under this method, deferred tax assets and liabilities are determined based on the difference between financial statements and tax bases of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse. Temporary differences between taxable income reported for financial reporting purposes and income tax purposes include, but are not limited to, accounting for intangibles, debt discounts associated with convertible debt, equity based compensation and depreciation and amortization. A valuation allowance is provided to reduce the deferred tax assets reported if based on the weight of available evidence it is more likely than not that some portion or all of the deferred tax assets will not be realized.

(k) Impairment of Long Lived Assets

Long-lived assets to be held and used by the Company are periodically reviewed to determine whether any events or changes in circumstances indicate that the carrying amount of the asset may not be recoverable. For long-lived assets to be held and used, the Company bases its evaluation on impairment indicators such as the nature of the assets, the future economic benefit of the assets, any historical or future profitability measurements, as well as other external market conditions or factors that may be present. In the event that facts and circumstances indicate that the carrying amount of an asset or asset group may not be recoverable and an estimate of future undiscounted cash flows is less than the carrying amount of the asset, an impairment loss will be recognized for the difference between the carrying value and the fair value.

(l) 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.
 
 
F-11

 

(m) Comprehensive Income or Loss
 
 
The Company reports comprehensive income or loss in its audited 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.
 
 
(n) 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, accruals, impairment of property and equipment, valuing stock based compensation, 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.
 
 
(o) 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 are amortized over the estimated useful life of the website which the Company considers to be five years. Ongoing website post- implementation cost of operations, including training and application, will be expensed as incurred.
 
 
(p) 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.

(q) Warrants

The Company accounts for common stock purchase warrants at fair value in accordance with ASC 815-40, Derivatives and Hedging. The Black-Scholes option pricing valuation method is used to determine fair value of these warrants consistent with ASC 718, Compensation – Stock Compensation. Use of this method requires that the Company make assumptions regarding stock value, dividend yields, expected term of the warrants and risk free interest rates.

(r) Stock Issued in Exchange for Services

The valuation of the Company’s common stock issued in exchange for services is valued at an estimated fair market value as determined by the most readily determinable value of either the stock or services exchanged. Values of the stock are based upon other sales and issuances of the Company’s common stock within the same general time period.
 
 
F-12

 

(s) Recent Accounting Pronouncements

The Company has reviewed all recently issued, but not yet effective, accounting pronouncements and other than the below, 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.

In June 2014, the FASB issued Accounting Standards Update (ASU) No. 2014-10, Development Stage Entities (Topic 915): Elimination of Certain Financial Reporting Requirements, Including an Amendment to Variable Interest Entities Guidance in Topic 810, Consolidation. This ASU does the following among other things: a) eliminates the requirement to present inception-to-date information on the statements of income, cash flows, and shareholders’ equity, b) eliminates the need to label the financial statements as those of a development stage entity, c) eliminates the need to disclose a description of the development stage activities in which the entity is engaged, and d) amends FASB ASC 275, Risks and Uncertainties, to clarify that information on risks and uncertainties for entities that have not commenced planned principal operations is required. The amendments in ASU No. 2014-10 related to the elimination of Topic 915 disclosures and the additional disclosure for Topic 275 are effective for public companies for annual and interim reporting periods beginning after December 15, 2014. Early adoption is permitted. The Company early adopted this ASU beginning with the quarterly period ended June 30, 2014.

In August 2014, the FASB issued ASU No. 2014-15, Presentation of Financial Statements—Going Concern: Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern (“ASU 2014-15”). ASU 2014-15 requires an entity to evaluate whether there are conditions or events that raise substantial doubt about the entity’s ability to continue as a going concern within one year after the date that the financial statements are issued (or within one year after the financial statements are available to be issued when applicable) and to provide related footnote disclosures in certain circumstances. ASU 2014-15 is effective for the annual period ending after December 15, 2016, and for annual and interim periods thereafter with early adoption permitted. We do not expect the adoption of ASU 2014-15 to have a material impact on our consolidated financial statements.

4. 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
   
112,460
 
Inventory
   
60,777
 
Loan receivable
   
84,936
 
Fixed, assets
   
3,826
 
Goodwill
   
167,538
 
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
 
$
55,000
 

In consideration for the acquisition, the Company issued 500,000 Common Shares at $0.11 per share and 1,000,000 warrants (“Warrants”), each to acquire one Common Share of the Company. 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.
 
 
F-13

 

On October 6, 2014, the Company’s wholly owned subsidiary DML held a meeting of DML’s creditors, whereby DML, with the approval of the Company as its sole shareholder, agreed that DML, by reason of its liabilities, be wound up by way of a voluntary liquidation (see note 15).

5. 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 issuance 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.

As a result of DML’s expected voluntary liquidation by reason of its liabilities, the Company wrote off the entire loan receivable from the previous shareholder of DML and recorded a loss on loan receivable of $85,717.

6. INVENTORY

Inventory consists of the following:
 
 
   
December 31,
2014
   
December 31,
2013
 
E-cigarettes and accessories
 
$
78,901
   
$
74,419
 
Packaging
   
-
     
16,495
 
   
$
78,901
   
$
90,914
 
 
 
During the year ended December 31, 2014, the Company wrote off the full value of DML’s inventory in the amount of $60,301 as a result of DML’s liquidation and impaired the inventory located in Florida in the amount of $41,157 due to inventory obsolescence. During the year ended December 31, 2014, the Company recorded an impairment of inventory of $101,458.

7. PROPERTY AND EQUIPMENT
 
 
   
December 31,
2014
   
December 31,
2013
 
   
Cost
   
Accumulated Depreciation
   
Net
   
Net
 
Furniture and equipment
 
$
2,504
   
$
1,909
   
$
595
   
$
1,439
 
Computer hardware
   
3,446
     
2,177
     
1,269
     
2,443
 
   
$
5,950
   
$
4,086
   
$
1,864
   
$
3,882
 

Depreciation expense for the year ended December 31, 2014 and 2013 amounted to $2,783 and $1,518 respectively.
 
 
F-14

 
 

8. WEBSITE DEVELOPMENT

   
December 31,
2014
   
December 31,
2013
   
Cost
   
Accumulated Amortization
   
Net
   
Net
Charlie’s Club Website
 
$
99,989
   
$
6,666
   
$
93,323
   
$
42,789

Amortization expense for the year ended December 31, 2014 and 2013 amounted to $6,666 and Nil respectively.

The estimated amortization expense for the next 4 years ending December 31, 2015, 2016, 2017 and 2018 approximates $19,998 per year, for the year ending December 31, 2019 it approximates $13,331.

9. LOANS FROM SHAREHOLDERS
 
The Company has outstanding loans from shareholders at December 31, 2014 and 2013 as follows:
 
 
   
December 31,
2014
   
December 31,
2013
 
Non-interest bearing, unsecured, no specific terms of repayment
 
$
5,000
   
$
6,512
 
Bears interest of 10% per annum on a cumulative basis, secured by the assets of the Company, matures on January 1, 2016
   
100,000
     
-
 
Bears interest of 10% per annum on a cumulative basis, secured by the assets of the Company, matures on January 1, 2016
   
431,000
     
-
 
Bears interest of 1.5% per month on a cumulative basis, unsecured, no specific terms of repayment
   
29,739
         
Bears interest of 1% per month on a cumulative basis, secured by the assets of the Company, no specific terms of repayment
   
-
     
14,103
 
   
$
565,739
   
$
20,615
 

During the year ended December 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 Convertible Debentures (note 12), resulting in a $435 gain on settlement of debt.

The Company accrued interest of $172 during the year ended December 31, 2014 (December 31, 2013: $15,399) on this loan.

On February 13, 2014, the Company entered into a secured promissory note (the “Secured Note”) with a shareholder, whereby the Company agreed to pay the party the aggregate unpaid principal amount of CAD $500,000 (USD $431,000) 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 Secured Note is secured by a general security agreement over the assets of the Company. During the year ended December 31, 2014 the Company and the shareholder extended the maturity date of the Secured Note to January 1, 2016.

The Company accrued interest of $39,043 during the year ended December 31, 2014 (December 31, 2013: $nil) on the Secured Note which is included in accrued liabilities. During the year ended December 31, 2014, the Company settled $30,690 in interest on the Secured Note with the issuance of common shares.

On July 15, 2014, the Company entered into a secured promissory note (the “Secured Note No.2”) with a shareholder, whereby the Company agreed to pay the party the aggregate unpaid principal amount of $100,000 on or before July 18, 2014, bearing interest at a rate of 10% per annum, such interest will accrue monthly and be added to the principal. The Secured Note No.2 is secured by the general security agreement issued with the Secured Note. During the year ended December 31, 2014, the Company and the shareholder extended the maturity date of the Secured Note No.2 to January 1, 2016.

The Company accrued interest of $4,662 during the year ended December 31, 2014 (December 31, 2013: $nil) on the Secured Note No. 2 which is included in accrued liabilities. During the year ended December 31, 2014, the Company settled $2,111 in interest on the Secured Note No.2 with the issuance of common shares.

On August 15, 2014, the Company settled CAD $1,500 (USD $1,378) of non-interest bearing shareholder loans with the issuance of 10,919 Common Shares of the Company resulting in a loss of $260.
 
F-15

 

10. CREDIT FACILITY

On August 1, 2014, the Company entered into a revolving credit facility (the “Credit Facility”) with an unrelated party acting as an agent to a consortium of participants (the “Lender”), whereby the Lender would make a revolving credit facility in the aggregate principal amount of CAD $500,000 for the exclusive purpose of purchasing inventory for sale in the Company’s ordinary course of business to approved customers. The Credit Facility shall bear interest at a rate of 15% per annum on all drawn advances and a standby fee of 3.5% per annum on the undrawn portion of the Credit Facility. The Credit Facility shall mature on August 1, 2015 whereby the outstanding advances together with all accrued and unpaid interest theron shall be due and payable. On August 1, 2014, and in connection to the Credit Facility, the Company issued 250,000 warrants to purchase Common Shares of the Company exercisable over two years with an exercise price of $0.30 per Common Share. The Company’s Chief Executive Officer and Chief Financial Officer are both participants of the consortium of participants of the Credit Facility, each having committed to provide ten percent of the principal amount of the Credit Facility.

During the year ended December 31, 2014, the Company was advanced $387,110 (CAD $449,083) from the Credit Facility for the purchase of inventory including $77,453 (CAD $89,852) of advances from the Company’s Chief Executive Officer and Chief Financial Officer as their participation in the Credit Facility.

During the year ended December 31, 2014, the Company paid $1,786 of standby fees and $23,577 of interest as a result of the Credit Facility.

11. NOTE PAYABLE - RELATED PARTY
 
a) On November 15, 2012, the Company entered into a convertible revolving credit note (the “Credit Note”), with a related party, for $225,000 due on or before February 15, 2014, bearing interest at a rate of 6% per annum payable at the maturity date. The Credit Note could 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 could be converted into 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 under the Credit Note.

During the year ended December 31, 2014, the Company accrued $1,638 of interest on the Credit Note (2013:$15,377). At the repayment date, the accrued interest on the Credit Note was $17,015.

b) On September 30, 2013, the Company entered into a secured promissory note with a related party (the “Related Party Note”) for $200,000 due on or before January 1, 2015, bearing interest at a rate of 1.5% per month payable at the maturity date. The related party was also to be paid an establishment fee of 2.0%. The Related Party Note was secured by a general security agreement.

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

On December 23, 2013, the Company issued a $200,000 Convertible Debenture, maturing on January 31, 2016 and bearing interest at a rate of 12% per annum in settlement of the Related Party Note (note 12). Upon settlement of the Related Party Note, the establishment fee of 2.0% was waived by the related party.

12. 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 (the “Convertible Debentures”), respectively. The Convertible Debentures mature on January 31, 2016 and bear interest at a rate of 12% per annum, which is payable quarterly in arrears. The Convertible Debentures are convertible into Common Shares 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 Convertible Debentures issued on February 11, 2014, $3,000 were issued in settlement of loans from shareholders (note 9) and $50,000 was issued in settlement of loans from related parties (note 17).
 
F-16

 

As at December 31, 2013, the Company received $45,000 in advance for Convertible 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 Convertible 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 Convertible 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 Convertible 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 Convertible 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 Convertible Debentures that were issued on December 23, 2013 and the face value $178,000 Convertible 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 year ended December 31, 2014, the Company recorded interest expense in the amount of $715,314 related to debt discount, which includes $661,522 related to the conversion of Convertible Debentures in the aggregate amount of $1,125,000.

On April 15, 2014, the Company received forms of election whereby holders of the Convertible Debentures elected to convert a total of $50,000 into Common Shares of the Company at $0.07 per share pursuant to the Convertible Debenture offering. On May 30, 2014, the Company issued 714,286 Common Shares on the conversion of the Convertible Debentures.

On September 30, 2014, the Company received forms of election whereby holders of the Convertible Debenture elected to convert a total of $800,000 into Common Shares of the Company at $0.07 per share pursuant to the Convertible Debenture offering. On November 4, 2014, the Company issued 11,428,572 Common Shares on the conversion of the Convertible Debentures.

On November 10, 2014, the Company received forms of election whereby holders of the Convertible Debenture elected to convert a total of $275,000, into Common Shares of the Company at $0.07 per share pursuant to the Convertible Debenture offering. On November 20, 2014, the Company issued 3,928,571 Common Shares on the conversion of the Convertible Debentures.

During the year ended December 31, 2014, the Company settled $104,652 in interest payable on the Convertible Debentures with 697,679 Common Shares of the Company which were issued in November 2014.

13. COMMON STOCK

Authorized: 300,000,000 Common Shares of $0.0002 par value (the “Common Shares”)

Issued and Outstanding:
 
   
December 31,
 
   
2014
      , 2013  
92,698,018 Common Shares (2013: 67,066,977)
  $ 18,542     $ 13,413  

 
F-17

 

During the year ended December 31, 2014, the Company:
 
 
Issued 200,000 Common Shares for settlement of $10,000 in consulting fees owing to an unrelated party.
 
Issued 500,000 Common Shares valued at $0.035 per share for cash proceeds of $17,500;
 
Issued 280,433 Common Shares valued at $0.1426 per share for settlement of $40,000 in consulting fees owing to an unrelated party;
 
Issued 270,597 Common Shares valued at $0.1293 per share for settlement of $35,000 in consulting fees owing to an unrelated party;
 
Issued 835,000 Common Shares valued at $0.10 per share for settlement of $83,500 owing as a result of the production costs of advertising;
 
Issued 10,000 Common Shares valued at $0.10 per share for settlement of $1,000 owing to a related party as a result of the production costs of advertising;
 
Issued 92,500 Common Shares valued at $0.19 per share for settlement of $17,500 in consulting fees owing to an unrelated party;
 
Issued 500,000 Common Shares valued at $0.11 per share for the acquisition of Drinan Marketing Ltd.;
 
Issued 55,000 Common Shares valued at $0.25 per share for settlement of $13,750 in consulting fees owing to an unrelated party;
 
Issued 2,734,667 Common Shares valued at $0.15 per share for cash proceeds of $410,200;
 
Issued 300,000 Common Shares valued at $0.18 per share as a prepayment of $54,000 in consulting fees to an unrelated party;
 
Issued 10,919 Common Shares valued at $0.15 per share for settlement of $1,638 of shareholder loans;
 
Issued 182,749 Common Shares valued at $0.15 per share for settlement at $27,412 in consulting fees owing to an unrelated party;
 
Issued 63,559 Common Shares at $0.236 per share as compensation for $15,000 in consulting fees to an unrelated party;
 
Issued 100,000 Common Shares at $0.16 per share as compensation for $16,000 in consulting fees to an unrelated party;
 
Issued 10,357,143 Common Shares at $0.07 per share as a result of the conversion of $725,000 of Convertible Debentures;
 
Issued 5,714,286 Common Shares at $0.07 per share to related parties as a result of the conversion of $400,000 of Convertible Debentures;
 
Issued 638,978 Common Shares at $0.15 per share for settlement of $102,291 in interest payable to unrelated parties;
 
Issued 277,370 Common Shares at $0.15 per share for settlement of $35,162 in interest payable to related parties;
 
Issued 717,840 Common Shares at $0.15 per share for settlement of $107,676 in consulting fees payable to related parties;
 
Issued 800,000 Common Shares at a fair value of $0.15 per share as compensation for consulting fees to an unrelated party in the amount of $120,000;
 
Issued 500,000 Common Shares at $0.15 per share for settlement of $75,000 in consulting fees to a related party; and
 
Issued 490,000 Common Shares at $0.15 per share for cash proceeds of $73,500.
 
During the year ended December 31, 2013 the Company:
 
 
Issued 276,485 Common Shares valued at $0.035 per share for cash proceeds of $9,677;
 
Issued 942,784 Common Shares at an average price of $0.053 per share for 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 for 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 for 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 per share for cash proceeds of $2,500;
 
Issued 400,000 Common Shares valued at $0.05 per share for settlement of $20,000 in consulting fees owing to unrelated parties; and
 
Issued 300,000 Common Shares valued at $0.0583 per share for settlement of $17,500 in consulting fees owing to unrelated parties.
 
F-18

 
 
 
14. WARRANTS
 
 
The following schedule summarizes the outstanding warrants at December 31, 2014 and 2013:
 
 
   
December 31,
2014
   
December 31,
2013
   
Warrants
Outstanding
   
Weighted Average Exercise Price
   
Warrants Outstanding
   
Weighted Average Exercise Price
 
Beginning of year
   
-
   
$
-
     
1,516,667
   
$
0.10
 
Issued
   
1,510,640
     
0.25
     
-
     
-
 
Expired
   
-
     
-
     
(1,516,667)
     
(0.10)
 
End of year
   
1,510,640
   
$
0.25
     
-
   
$
-
 

(a) On February 28, 2014, as part of the acquisition of DML, the Company issued Warrants to acquire 1,000,000 Common Shares of the Company. 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. No value has been assigned as the Company has since placed DML into voluntary liquidation, and as a result, there is 0% probability of achieving the vesting provision.

(b) On July 25, 2014, and in connection to the private placement, the Company issued 10,640 warrants to purchase Common Shares of the Company exercisable over one year with an exercise price of $0.15 per Common Share.

The fair value of these issued warrants of $2,615 was determined using the Black Scholes option-pricing model with the following weighted average assumptions:

Risk-free interest rate
 
0.32
%
Expected life
 
1 year
 
Estimated volatility in the market price of the Common Shares
 
247
%
Dividend yield
 
Nil
 

The Company fully expensed the value of the warrants in stock based compensation which has been recorded as an administrative expense.

(c) On August 1, 2014, and in connection to the Credit Facility, the Company issued 250,000 warrants to purchase Common Shares of the Company exercisable over two years with an exercise price of $0.30 per Common Share.

The fair value of these issued warrants of $59,240 was determined using the Black Scholes option-pricing model with the following weighted average assumptions:

Risk-free interest rate
 
0.69
%
Expected life
 
2 years
 
Estimated volatility in the market price of the Common Shares
 
357
%
Dividend yield
 
Nil
 
 
 
The Company booked the value of the warrants as prepaid to be expensed over the life of the Credit Facility. During the year ended December 31, 2014, the Company expensed $24,683 in stock based compensation which has been recorded as an administrative expense.

(d) On November 10, 2014, and in connection to the Secured Note and Secured Note No. 2 (together, the “Secured Notes”), the Company issued 250,000 warrants to purchase Common Shares of the Company exercisable over 14 months with an exercise price of $0.20 per Common Share.
 
 
F-19

 

The fair value of these issued warrants of $41,991 was determined using the Black Scholes option-pricing model with the following weighted average assumptions:

Risk-free interest rate
 
0.34
%
Expected life
 
1.14 years
 
Estimated volatility in the market price of the Common Shares
 
237
%
Dividend yield
 
Nil
 
 
 
The Company booked the value of the warrants as prepaid to be expensed over the life of the Secured Notes. During the year ended December 31, 2014, the Company expensed $5,136 in stock based compensation which has been recorded as an administrative expense.
 
 
(e) During fiscal 2012, the Company issued warrants to acquire 1,516,667 Common Shares. These 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 entitled 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