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EX-32.2 - CERTIFICATION - GILLA INC.glla_ex322.htm
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EX-32.1 - CERTIFICATION - GILLA INC.glla_ex321.htm


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
 
FORM 10-Q
 
þ
 
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the quarterly period ended March 31, 2016
 
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)
     
475 Fentress Blvd., Unit L,
Daytona Beach, Florida
 
32114
(Address of Principal Executive Offices)
 
(Zip Code)

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

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

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

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

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
 
99,560,923 Common Shares, $0.0002 Par Value, were issued and outstanding as of May 13, 2016.


 
 
 
 
 
 GILLA, INC.
 
INDEX TO UNAUDITED CONDENSED CONSOLIDATED INTERIM FINANCIAL STATEMENTS
 
     
Page
 
PART I - Financial Information
     
         
Item 1.
Interim Financial Statements (unaudited)
     
         
 
Condensed Consolidated Interim Balance Sheets as of March 31, 2016 (Unaudited) and December 31, 2015 (Audited)
   
3
 
           
 
Unaudited Condensed Consolidated Interim Statements of Operations and Comprehensive Loss for the Three Months Ended March 31, 2016 and March 31, 2015
   
4
 
           
 
Unaudited Condensed Consolidated Interim Statement of Changes in Shareholders’ Deficiency for the Three Months Ended March 31, 2016
   
5
 
           
 
Unaudited Condensed Consolidated Interim Statements of Cash Flows for the Three Months Ended March 31, 2016 and March 31, 2015
   
6
 
           
 
Notes to Unaudited Condensed Consolidated Interim Financial Statements
   
7
 
           
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operation
   
27
 
           
Item 3.
Quantitative and Qualitative Disclosures About Market Risk
   
36
 
           
Item 4.
Disclosure Controls and Procedures
   
36
 
           
PART II - Other Information
       
           
Item 1.
Legal Proceedings
   
37
 
           
Item 1A.
Risk Factors
   
37
 
           
Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
   
37
 
           
Item 3.
Defaults Upon Senior Securities
   
37
 
           
Item 4.
Mine Safety Disclosures
   
37
 
           
Item 5.
Other Information
   
37
 
           
Item 6.
Exhibits
   
38
 
           
SIGNATURES
   
39
 

 
2

 
 
Gilla Inc.
Condensed Consolidated Interim Balance Sheets
 (Amounts expressed in US Dollars)

   
March 31,
2016
   
December 31,
2015
 
   
(unaudited)
   
(audited)
 
ASSETS
 
Current assets
           
Cash and cash equivalents
 
$
33,741
   
$
81,696
 
Trade receivables (net of allowance for doubtful accounts $20,108 (December 31, 2015: $20,370))
   
494,573
     
45,534
 
Inventory (note 6)
   
195,190
     
154,700
 
Other current assets (note 5)
   
309,005
     
322,326
 
Total current assets
   
1,032,509
     
604,256
 
Long term assets
               
Property and equipment (note 7)
   
179,680
     
150,349
 
Website development (note 8)
   
8,583
     
9,083
 
Intangibles (notes 4 and 8)
   
204,283
     
215,283
 
Goodwill (note 4)
   
1,252,084
     
1,252,084
 
Total long term assets
   
1,644,630
     
1,626,799
 
                 
Total assets
 
$
2,677,139
   
$
2,231,055
 
LIABILITIES
               
Current liabilities
               
Accounts payable
 
$
1,223,534
   
$
687,767
 
Accrued liabilities (note 9)
   
265,774
     
251,517
 
Accrued interest - related parties (note 16)
   
161,853
     
131,755
 
Customer deposits
   
1,500
     
372,500
 
Loans from shareholders (note 9)
   
157,984
     
27,528
 
Due to related parties (note 16)
   
1,146,741
     
996,939
 
Promissory notes (note 4a)
   
779,128
     
495,193
 
Amounts owing on acquisition (note 4d)
   
190,549
     
150,549
 
Convertible debentures (note 12)
   
50,000
     
80,658
 
Credit facility (note 10)
   
-
     
212,415
 
Term loan (note 11)
   
770,000
     
-
 
Total current liabilities
   
4,747,063
     
3,406,821
 
                 
Long term liabilities
               
Loans from shareholders (note 9)
   
613,975
     
461,250
 
Due to related parties (note 16)
   
635,271
     
662,140
 
Amounts owing on acquisitions (note 4d)
   
165,710
     
196,127
 
Promissory notes (note 4a)
   
-
     
267,857
 
Convertible debentures (note 12)
   
11,296
     
6,500
 
Total long term liabilities
   
1,426,252
     
1,593,874
 
                 
Total liabilities
   
6,173,315
     
5,000,695
 
                 
Going concern (note 2)
               
Related party transactions (note 16)
               
Commitments and contingencies (note 17)
               
Subsequent events (note 20)
               
 
STOCKHOLDERS’ DEFICIENCY                
Common stock (note 13)
 
 $
19,913
   
 $
19,913
 
Additional paid-in capital
   
5,784,215
     
5,581,585
 
Shares to be issued (note 15)
   
121,000
     
20,000
 
Accumulated deficit
   
(9,656,556)
     
(8,750,688)
 
Accumulated other comprehensive income
   
235,252
     
359,550
 
Total shareholders’ deficiency
   
(3,496,176)
     
(2,769,640)
 
Total liabilities and stockholders’ deficiency
 
$
2,677,139
   
$
2,231,055
 
 
The accompanying notes are an integral part of these unaudited condensed consolidated interim financial statements
 
 
3

 

Gilla Inc.
Unaudited Condensed Consolidated Interim Statements of Operations and Comprehensive Loss
 (Amounts expressed in US Dollars)

   
For the Three Months Ended March 31, 2016
   
For the Three Months Ended
March 31, 2015
 
             
Sales revenue
  $ 1,356,933     $ 3,804  
Cost of goods sold
    860,946       2,231  
Gross profit
    495,987       1,573  
                 
Operating expenses
               
Administrative
    1,047,026       365,639  
Consulting fees - related parties (note 16)
    108,229       176,994  
Depreciation
    13,495       450  
Amortization
    11,500       4,999  
Total operating expenses
    1,180,250       548,082  
                 
Loss from operations
    (684,263 )     (546,509 )
                 
Other income (expenses):
               
Foreign exchange gain (loss)
    (77,483 )     10,084  
Amortization of debt discount
    (22,138 )     (61,777 )
Interest expense, net
    (121,984 )     (72,187 )
                 
Total other expenses
    (221,605 )     (123,880 )
                 
Net loss before income taxes
    (905,868 )     (670,389 )
Income taxes
    -       -  
Net loss
  $ (905,868 )   $ (670,389 )
                 
Loss per weighted average number of shares outstanding (basic and diluted)
  $ (0.009 )   $ (0.007 )
                 
Weighted average number of shares outstanding (basic and diluted)
    99,560,923       92,698,018  
                 
                 
Comprehensive loss:
               
Net loss
  $ (905,868 )   $ (670,389 )
                 
Foreign exchange translation adjustment
    (124,298 )     93,729  
                 
Comprehensive loss
  $ (1,030,166 )   $ (576,660 )

The accompanying notes are an integral part of these unaudited condensed consolidated interim financial statements 
 
 
4

 

Gilla Inc.
Unaudited Condensed Consolidated Interim Statement of Changes in Stockholders’ Deficiency
 (Amounts expressed in US Dollars)
 
   
Common Stock
   
Additional
Paid-In
   
Shares To Be
   
Accumulated
   
Accumulated
Other Comprehensive
   
Total Stockholders’
 
   
Shares
   
Amount
   
Capital
   
Issued
   
Deficit
   
Income
   
Deficiency
 
Balance, December 31, 2015
    99,560,923     $ 19,913     $ 5,581,585     $ 20,000     $ (8,750,688 )   $ 359,550     $ (2,769,640 )
                                                         
Shares to be issued on the conversion of convertible debentures
    -       -       -       23,000       -       -       23,000  
                                                         
Shares to be issued for settlement of deferred fees owing to a related party
    -       -       -       48,000       -       -       48,000  
                                                         
Shares to be issued for settlement of consulting fees
    -       -       -       30,000       -       -       30,000  
                                                         
Issuance of warrants
    -       -       202,630       -       -       -       202,630  
                                                         
Foreign currency translation gain
    -       -       -       -       -       (124,298 )     (124,298 )
                                                         
Net loss
    -       -       -       -       (905,868 )     -       (905,868 )
                                                         
Balance, March 31, 2016
    99,560,923     $ 19,913     $ 5,784,215     $ 121,000     $ (9,656,556 )   $ 235,252     $ (3,496,176 )
 
The accompanying notes are an integral part of these unaudited condensed consolidated interim financial statements
 
 
5

 

Gilla Inc.
Unaudited Condensed Consolidated Interim Statements of Cash Flows
 (Amounts Expressed in US Dollars)
 
   
For the Three Months Ended March 31, 2016
   
For the Three
Months Ended
March 31, 2015
 
CASH FLOWS FROM OPERATING ACTIVITIES:
           
Net loss
  $ (905,868 )   $ (670,389 )
Items not requiring an outlay of cash
               
Depreciation
    13,495       450  
Amortization
    11,500       4,999  
Stock based compensation
    50,508       38,719  
Amortization of debt discount
    22,138       61,777  
Interest on amounts owing on acquisition
    9,582       -  
Interest on promissory notes
    16,078       -  
Common shares to be issued for settlement of interest
    -       1,096  
Common shares to be issued for services
    30,000       -  
Changes in operating assets and liabilities
               
Trade receivable
    (448,732 )     -  
Other current assets
    166,495       93,305  
Inventory
    (38,908 )     2,231  
Accounts payable
    530,527       101,498  
Accrued liabilities
    14,257       (17,269 )
Customer deposits
    (371,000 )     -  
Due to related parties
    131,885       138,177  
Accrued interest-related parties
    30,098       18,687  
  Net cash used in operating activities
    (737,945 )     (226,719 )
                 
CASH FLOWS FROM INVESTING ACTIVITIES:
               
Disposal (addition) of capital assets
    (42,677 )     -  
  Net cash used in investing activities
    (42,677 )     -  
                 
CASH FLOWS FROM FINANCING ACTIVITIES:
               
Proceeds from term loan
    397,396       -  
Repayments to credit facility
    -       (387,110 )
Shareholder loans received
    249,877       7,106  
Proceeds from related parties
    139,474       71,443  
Repayments to related parties
    (46,277 )     -  
Repayment of convertible debentures
    (25,000 )     -  
  Net cash provided by financing activities
    715,470       (308,561 )
Effect of exchange rate changes on cash
    17,197       39,790  
Net increase (decrease) in cash
    (47,955 )     (495,490 )
                 
Cash at beginning of year
    81,696       496,724  
                 
Cash at end of year
  $ 33,741     $ 1,234  
                 
Supplemental Schedule of Cash Flow Information:
               
Cash paid for interest
  $ 14,813     $ 6,934  
Cash paid for income taxes
  $ -     $ -  
                 
Non cash financing activities:
               
Common stock to be issued in settlement of deferred related party fees
  $ 48,000     $ -  
 
The accompanying notes are an integral part of these unaudited condensed consolidated interim financial statements

 
6

 
 
  Gilla Inc.
Notes to Unaudited Condensed Consolidated Interim Financial Statements
March 31, 2016
 (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.

On July 1, 2015, the Company closed the acquisition of all the issued and outstanding shares of E Vapor Labs Inc. (formerly, E Liquid Wholesale, Inc.) (“E Vapor Labs”), a Florida based E-liquid manufacturer. Pursuant to the share purchase agreement, dated June 25, 2015, the Company paid a total purchase price of $1,125,000 payable as (i) $225,000 in cash on closing and (ii) $900,000 in unsecured promissory notes issued on closing, such promissory notes issued in three equal tranches of $300,000 due four, nine and eighteen months respectfully from the closing date.

On July 14, 2015, the Company closed the acquisition of all the issued and outstanding shares of E-Liq World, LLC (“VaporLiq”), an E-liquid subscription based online retailer. Pursuant to the share purchase agreement, dated July 14, 2015, the Company issued 500,000 Common Shares and warrants for the purchase of 500,000 Common Shares of the Company exercisable over eighteen months with an exercise price of $0.20 per Common Share.

On November 2, 2015, the Company closed the acquisition of all of the assets of 901 Vaping Company LLC (“901 Vaping”), an E-liquid manufacturer, including all of the rights and title to own and operate the Craft Vapes, Craft Clouds and Miss Pennysworth’s Elixirs E-liquid brands (the “CV Brands”). Pursuant to the asset purchase agreement, dated October 21, 2015, the Company (i) issued to the vendor 1,000,000 Common Shares of the Company valued at $0.15 per share for a total value of $150,000; (ii) paid cash consideration equal to 901 Vaping’s inventory and equipment of $23,207; and (iii) agreed to a quarterly-earn out based on the gross profit stream derived from product sales of the CV Brands commencing on the closing date up to a maximum of 25% of the gross profit stream.

On December 2, 2015, the Company closed the acquisition of all of the assets of The Mad Alchemist, LLC ( “TMA”), an E-liquid manufacturer, including the assets, rights and title to own and operate The Mad Alchemist and Replicant E-liquid brands (the “TMA Brands”), pursuant to an asset purchase agreement dated November 30, 2015. The total purchase price for the assets was $500,000 including the issuance of (i) 819,672 Common Shares valued at $0.122 per share for a total value of $100,000; (ii) $400,000 in cash payable in 10 equal payments of $20,000 in cash and $20,000 in Common Shares every 3 months following the closing date; and (iii) agreed to a quarterly-earn out based on the gross profit stream derived from product sales of the TMA Brands commencing on the closing date up to a maximum of 25% of the gross profit stream.

The current business of the Company consists of the manufacturing, marketing and distribution of generic and premium branded E-liquid, which is the liquid used in vaporizers, E-cigarettes, and other vaping hardware and accessories. E-liquid is heated by the atomizer to deliver the sensation of smoking. Gilla’s product portfolio includes Craft Vapes, Craft Clouds, Vape Warriors, Miss Pennysworth’s Elixirs, The Mad Alchemist, Replicant and Coil Glaze E-liquid brands.

2. GOING CONCERN

These unaudited condensed consolidated interim financial statements have been prepared on a going concern basis, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. As shown in these unaudited condensed consolidated interim financial statements, at March 31, 2016, the Company has an accumulated deficit of $9,656,556 and a working capital deficiency of $3,714,554 as well as negative cash flows from operating activities of $737,945 for the three month period ended March 31, 2016. These conditions represent material uncertainty that cast significant doubt about the Company's ability to continue as a going concern. The ability of the Company to continue as a going concern is 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.
 
 
7

 
 
These unaudited condensed consolidated interim 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.

3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

The accompanying unaudited condensed consolidated interim financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and with the instructions to Form 10-Q. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete consolidated financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Interim results are not necessarily indicative of the results that may be expected for a full year. These condensed consolidated interim financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto included in the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2015, as filed with the U.S. Securities and Exchange Commission.
 
The accounting policies of the Company are in accordance with accounting principles generally accepted in the United States of America. Outlined below are those policies considered particularly significant:
 
(a)  
Basis of Consolidation

These condensed consolidated interim financial statements include the accounts of the Company and its wholly owned subsidiaries; Gilla Operations, LLC (“Gilla Operations”); E Vapor Labs Inc.; E-Liq World, LLC; Charlie’s Club, Inc. (“Charlie’s Club”); Gilla Enterprises Inc. and its wholly owned subsidiary Gilla Europe Kft.; Gilla Operations Worldwide Limited (“Gilla Worldwide”); Gilla Franchises, LLC and its wholly owned subsidiary Legion of Vape, LLC.; and Snoke Distribution Canada Ltd. and its wholly owned subsidiary Snoke Distribution USA, LLC. All inter-company accounts and transactions have been eliminated in preparing these condensed consolidated interim financial statements.
 
(b)  
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’s Hungarian subsidiary maintains its books in the Hungarian Forint (HUF) 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 period. 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 accumulated other comprehensive income in stockholders' equity. The Company has not, to the date of these condensed consolidated interim financial statements, entered into derivative instruments to offset the impact of foreign currency fluctuations.

(c)  
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 and cash equivalents, trade receivables, accounts payable, accrued interest, due to related parties, accrued liabilities, customer deposits, promissory notes, convertible debentures, loans from  shareholders,  and credit facility and term loan. 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:
 
 
8

 
 
Level 1
 -
Unadjusted quoted prices in active markets for identical assets or liabilities;
Level 2
 -
Observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets with insufficient volume or infrequent transactions (less active markets); or model-derived valuations in which all significant inputs are observable or can be derived principally from or corroborated by observable market data for substantially the full term of the assets or liabilities; and
Level 3
 -
Inputs that are not based on observable market data.
 
 
Cash and cash equivalents is 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.

(d)  
Advertising Costs

In accordance with ASC 720, the Company expenses the production costs of advertising the first time the advertising takes place. The Company expenses all advertising costs as incurred. During the three month period ended March 31, 2016, the Company expensed $45,110 (March 31, 2015: $46,782) as corporate promotions, these amounts have been recorded as administrative expense.
 
 
(e)  
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 and impairment of property and equipment, impairment of goodwill, accruals, 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.

(f)  
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 May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2014-09, Revenue from Contracts with Customers (“ASU 2014-09”), requiring an entity to recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled to in exchange for those goods or services. ASU 2014-09 will supersede nearly all existing revenue recognition guidance under U.S. GAAP when it becomes effective. In August 2015, the FASB issued ASU No. 2015-14, Revenue from Contracts with Customers, deferring the effective date for ASU 2014-09 by one year, and thus, the new standard will be effective for us beginning on February 1, 2018 with early adoption permitted on or after February 1, 2017. This standard may be adopted using either the full or modified retrospective methods. Management of the Company is currently evaluating adoption methods and the impact of this standard on the consolidated financial statements.

In November 2015, the FASB issued ASU No. 2015-17, Income Taxes (Topic 740): Balance Sheet Classification of Deferred Taxes (“ASU 2015-17”). ASU 2015-17 simplifies the presentation of deferred income taxes by eliminating the separate classification of deferred income tax liabilities and assets into current and noncurrent amounts in the consolidated balance sheet statement of financial position. The amendments in the update require that all deferred tax liabilities and assets be classified as noncurrent in the consolidated balance sheet. The amendments in this update are effective for annual periods beginning after December 15, 2016, and interim periods therein and may be applied either prospectively or retrospectively to all periods presented. Early adoption is permitted. Management of the Company is currently evaluating adoption methods and the impact of this standard on the consolidated financial statements.
 
 
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In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842) (“ASU 2016-02”). ASU 2016-02 requires lessees to recognize all leases with terms in excess of one year on their balance sheet as a right-of-use asset and a lease liability at the commencement date. The new standard also simplifies the accounting for sale and leaseback transactions. The amendments in this update are effective for annual periods beginning after December 15, 2018, and interim periods therein and must be adopted using a modified retrospective method for leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements. Early adoption is permitted. Management of the Company is currently evaluating adoption methods and the impact of this standard on the consolidated financial statements.

4. BUSINESS COMBINATIONS

(a) On July 1, 2015, the Company closed the acquisition of all the issued and outstanding shares of E Vapor Labs, a Florida based E-liquid manufacturer. The Company purchased E Vapor Labs in order to procure an E-liquid manufacturing platform allowing the Company to secure large private label contracts as well as manufacture its own brands going forward. The following summarizes the fair value of the assets acquired, liabilities assumed and the consideration transferred at the acquisition date:

Assets acquired:
     
Cash
 
$
22,942
 
Receivables
   
48,356
 
Other current assets
   
21,195
 
Inventory
   
122,309
 
Fixed assets
   
118,867
 
Unallocated purchase price
   
847,265
 
Total assets acquired
 
$
1,180,934
 
         
 Liabilities assumed:
       
Accounts payable
 
$
206,252
 
Loan payable
   
25,000
 
Total liabilities assumed
 
231,252
 
         
Consideration:
       
Cash
 
$
225,000
 
Promissory Notes A, unsecured and non-interest bearing, due November 1, 2015
   
196,026
 
Promissory Notes B, unsecured and non-interest bearing, due April 1, 2016
   
275,555
 
Promissory Notes C, unsecured and non-interest bearing, due January 1, 2017
   
253,101
 
Total consideration
 
$
949,682
 

In consideration for the acquisition, the Company paid to the vendors, $225,000 in cash on closing and $900,000 in unsecured promissory notes issued on the closing (collectively, the “Promissory Notes”). The Promissory Notes were issued in three equal tranches of $300,000 due four (4), nine (9) and eighteen (18) months respectfully from the closing (individually, “Promissory Notes A”, “Promissory Notes B”, and “Promissory Notes C” respectively). The Promissory Notes are all unsecured, non-interest bearing, and on the maturity date, at the option of the vendors, up to one third (1/3) of each tranche of the Promissory Notes can be repaid in Common Shares of the Company, calculated using the 5 day weighted average closing market price of the Company prior to the maturity of the Promissory Notes. The Promissory Notes, are all and each subject to adjustments as outlined in the share purchase agreement (the “SPA”), dated June 25, 2015.

At December 31, 2015, the Company adjusted the Promissory Notes A for the known difference in the working capital balance at closing of the acquisition from the amount specified in the SPA. Further, a 12% discount rate has been used to calculate the present value of the Promissory Notes based on the Company’s estimate of cost of financing for comparable notes with similar term and risk profiles. Over the term of the respective Promissory Notes, interest will be accrued at 12% per annum to accrete the Promissory Notes to their respective principal amounts. During the three month period ended March 31, 2016, the Company recorded $16,078 in interest expense related to the accretion of the Promissory Notes.
 
 
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The Promissory Notes A were due on November 1, 2015. The Company provided notice to the Promissory Note holders on October 30, 2015 indicating its intention to repay such Promissory Notes, however, such inability to accurately determine the required adjustments pursuant to the SPA has forced the Company to defer repayment of such Promissory Notes until such time where the principal amount of the Promissory Notes can be accurately determined (note 17).

The Company is not able to complete the purchase price allocation as the Company has disputed the consideration amount and is currently undergoing negotiations (note 17).

The results of operations of E Vapor Labs have been included in the consolidated statements of operations from the acquisition date. The following table presents pro forma results of operations of the Company and E Vapor Labs as if the companies had been combined as of January 1, 2015. The pro forma condensed combined financial information is presented for informational purposes only. The unaudited pro forma results of operations are not necessarily indicative of results that would have occurred had the acquisition taken place at the beginning of the earliest period presented, or of future results.

   
March 31,
2016
   
March 31,
2015
 
Pro forma revenue
  $ 1,356,933     $ 244,692  
Pro forma loss from operations
  $ (684,263 )   $ (552,088 )
Pro forma net loss
  $ (905,868 )   $ (675,968 )
                 

(b) On July 14, 2015, the Company closed the acquisition of all the issued and outstanding shares of VaporLiq, a private E-liquid subscription based online retailer. The Company purchased VaporLiq mainly to access industry relationships and knowhow of various E-liquid brands that VaporLiq transacts with. The following summarizes the fair value of the assets acquired, liabilities assumed and the consideration transferred at the acquisition date:

Assets acquired:
     
Cash
 
$
5,381
 
Website
   
10,000
 
Inventory
   
2,150
 
Goodwill
   
109,444
 
Total assets acquired
 
$
126,975
 
         
Total liabilities assumed
 
$
-
 
         
Consideration:
       
500,000 Common Shares at $0.17 per share
 
$
85,000
 
500,000 warrants
   
41,975
 
Total consideration
 
$
126,975
 

The warrants are exercisable over eighteen (18) months with an exercise price of $0.20 per Common Share.

The goodwill is attributable to business acumen and access to key E-liquid brands that the Company may leverage for further acquisitions.

The results of operations of VaporLiq have been included in the consolidated statements of operations from the acquisition date, though revenue and net income from VaporLiq were not material for the three month period ended March 31, 2016. Pro forma results of operations have not been presented because the acquisition was not material to the results of operations.

(c) On November 2, 2015, the Company closed the acquisition of all of the assets of 901 Vaping, an E-liquid manufacturer, including all of the rights and title to own and operate the Craft Vapes, Craft Clouds and Miss Pennysworth’s Elixirs E-liquid brands. The following summarizes the fair value of the assets acquired and the consideration transferred at the acquisition date:
 
 
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Assets acquired:
     
Inventory
 
 $
11,335
 
Equipment
   
11,872
 
Intangibles
   
63,000
 
Goodwill
   
87,000
 
Total assets acquired
 
$
173,207
 
         
Consideration:
       
Cash
 
$
23,207
 
1,000,000 Common Shares at $0.15 per share
   
150,000
 
Total consideration
 
$
173,207
 

In consideration for the acquisition, the Company issued 1,000,000 Common Shares of the Company valued at $0.15 per share, paid cash consideration of $23,207 and agreed to a quarterly earn-out based on the gross profit stream derived from product sales of the acquired brands. The earn-out commences on the closing date and pays up to a maximum of 25% of the gross profit stream. As of March 31, 2016, no amounts have been accrued or paid in relation to the quarterly earn-out.
 
Intangible assets consist primarily of customer relationships and brands. Brand intangibles represents the estimated fair value of the trade names acquired. Customer relationship intangibles relates to the ability to sell existing and future products to 901 Vaping’s existing and potential customers. The preliminary estimated useful life and fair values of the identifiable intangible assets are as follows:
 
   
Estimated Useful Life (in years)
   
Amount
 
Brands
    5     $ 30,000  
Customer relationships
    5       33,000  
            $ 63,000  

The results of operations of 901 Vaping have been included in the consolidated statements of operations from the acquisition date, though revenue and net income from 901 Vaping were not material for the three month period ended March 31, 2016. Pro forma results of operations have not been presented because the acquisition was not material to the results of operations.

(d) On December 2, 2015, the Company acquired all of the assets of TMA, an E-liquid manufacturer, including the assets, rights and title to own and operate The Mad Alchemist and Replicant E-liquid brands. The following summarizes the fair value of the assets acquired and the consideration transferred at the acquisition date:

Assets acquired:
     
Inventory
 
$
41,462
 
Equipment
   
36,579
 
Intangibles
   
157,000
 
Goodwill
   
208,376
 
Total assets acquired
 
$
443,417
 
         
Consideration:
       
819,672 Common Shares at $0.122 per share
 
$
100,000
 
Deferred payments
   
343,417
 
Total consideration
 
$
443,417
 

On the closing date, the Company issued 819,672 Common Shares valued at $0.122 per share for a total value of $100,000; agreed to pay a total of $400,000 in deferred payments (the “Amounts Owing on Acquisition”), payable in ten (10) equal payments of $20,000 in cash and $20,000 in common stock every three (3) months following the closing date, and agreed to a quarterly earn-out based on the gross profit stream derived from product sales of the acquired brands. The earn-out commences on the closing date and pays up to a maximum of 25% of the gross profit stream. The number of Common Shares issuable will be calculated and priced using the weighted average closing market price of the Company, as quoted by the OTC Markets Group, for the five trading days prior to each issuance date. Further, a 12% discount rate has been used to calculate the present value of the Amounts Owing on Acquisition. Over the term of the respective deferred payments, interest will be accrued at 12% per annum to accrete the payments to their respective principal amounts. During the three month period ended March 31, 2016, the Company recorded $9,582 in interest expense related to the accretion of the Amounts Owing on Acquisition. At March 31, 2016, the Company owed a total of $356,259 in Amounts Owing on Acquisition, $190,549 of this amount has been recorded as a current liability and the remaining $165,710 has been recorded as a long term liability. The Amounts Owing on Acquisition were fully settled subsequent to March 31, 2016 (note 20).
 
 
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Intangible assets consist primarily of customer relationships and brands. Brand intangibles represents the estimated fair value of the trade names acquired. Customer relationship intangibles relates to the ability to sell existing and future products to TMA’s existing and potential customers. The preliminary estimated useful life and fair values of the identifiable intangible assets are as follows:
 
   
Estimated Useful Life (in years)
   
Amount
 
Brands
    5     $ 60,000  
Customer relationships
    5       97,000  
            $ 157,000  

The results of operations of TMA have been included in the consolidated statements of operations from the acquisition date, though revenue and net income from TMA were not material for the three month period ended March 31, 2016. Pro forma results of operations have not been presented because the acquisition was not material to the results of operations.
 
5. OTHER CURRENT ASSETS

Other current assets consist of the following:

   
March 31,
2016
   
December 31,
2015
 
Vendor deposits
  $ 6,094     $ 175,700  
Prepaid expenses
    216,829       88,274  
Trade currency
    45,000       45,000  
Other receivables
    41,082       13,352  
    $ 309,005     $ 322,326  

Other receivables include VAT receivable, HST receivable and holdback amounts related to the Company’s merchant services account.

6. INVENTORY

Inventory consists of the following:
 
   
March 31,
2016
   
December 31,
2015
 
E-liquid bottles - finished goods
  $ 57,301     $ 65,247  
E-liquid components
    65,362       57,988  
Hardware
    39,370       -  
Bottles and packaging
    33,157       31,465  
    $ 195,190     $ 154,700  
 
During the year ended December 31, 2015, the Company wrote off $75,964 in obsolete E-cigarette inventory recorded in Charlie’s Club, an e-commerce website of the Company, and Gilla Operations, the Company’s primary operating subsidiary in the United States.

At March 31, 2016, the full amount of the Company’s inventory serves as collateral for the Company’s secured borrowings.
 
 
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7. PROPERTY AND EQUIPMENT
 
Property and equipment consists of the following:

   
March 31,
2016
   
December 31,
2015
 
   
Cost
   
Accumulated Depreciation
   
Net
   
Net
 
Furniture and equipment
 
$
37,806
   
$
4,419
   
$
33,387
   
$
1,156
 
Computer hardware
   
18,832
     
5,712
     
13,120
     
5,525
 
Manufacturing equipment
   
161,785
     
28,612
     
133,173
     
143,668
 
   
$
218,423
   
$
38,743
   
$
179,680
   
$
150,349
 

Depreciation expense for the three month periods ended March 31, 2016 and 2015 amounted to $13,495 and $450 respectively. At March 31, 2016, the full amount of the Company’s property and equipment serves as collateral for the Company’s secured borrowings.
 
8. INTANGIBLE ASSETS AND WEBSITE DEVELOPMENT

Website development consists of the following:

   
March 31,
2016
   
December 31,
2015
 
   
Cost
   
Accumulated Amortization
   
Net
   
Net
 
VaporLiq website
  $ 10,000     $ 1,417     $ 8,583     $ 9,083  

Amortization expense on website development for the three month periods ended March 31, 2016 and 2015 amounted to $500 and $4,999 respectively. During the year ended December 31, 2015, the Company impaired the Charlie’s Club website as it was determined to be obsolete due to the shift in direction the Company has pursued from the sale of E-cigarettes to the manufacturing and sale of E-liquid.

The estimated amortization expense for the next 4 years ending December 31, 2016, 2017, 2018 and 2019 approximates $2,000 per year. For the year ending December 31, 2020 it approximates $1,083.

Intangible assets consist of the following:

   
March 31,
2016
   
December 31,
2015
 
   
Cost
   
Accumulated Amortization
   
Net
   
Net
 
Brands
  $ 90,000     $ 6,500     $ 83,500     $ 88,000  
Customer relationships
    130,000       9,217       120,783       127,283  
    $ 220,000     $ 15,717     $ 204,283     $ 215,283  

Amortization expense on intangible assets for the three month periods ended March 31, 2016 and 2015 amounted to $11,000 and nil respectively. The estimated amortization expense for the next 4 years ending December 31, 2016, 2017, 2018 and 2019 approximates $44,000 per year. For the year ending December 31, 2020 it approximates $39,283.

9. LOANS FROM SHAREHOLDERS
 
The Company has outstanding current loans from shareholders as follows:
 
   
March 31,
2016
   
December 31,
2015
 
Non-interest bearing, unsecured, no specific terms of repayment
 
$
5,000
   
$
5,000
 
Bears interest of 1.5% per month on a cumulative basis, unsecured, no specific terms of repayment
   
24,009
     
22,528
 
Bears interest of 6% per annum on a cumulative basis, secured by the assets of the Company, matures on March 2, 2018 (iii)
   
128,975
     
-
 
   
$
157,984
   
$
27,528
 
 
 
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During the three month period ended March 31, 2016, the Company accrued interest of $1,345 on the above current shareholder loan (March 31, 2015: $1,300). Total accrued interest owing on the current shareholder loans at March 31, 2016 is $8,548 (December 31, 2015: $6,686) which is included in accrued liabilities.

The Company has outstanding long term loans from shareholders as follows:
 
   
March 31,
2016
   
December 31,
2015
 
Bears interest of 10% per annum on a cumulative basis, secured by the assets of the Company, matures on July 1, 2017 (i)
 
$
385,000
   
361,250
 
Bears interest of 10% per annum on a cumulative basis, secured by the assets of the Company, matures on July 1, 2017 (ii)
   
100,000
     
100,000
 
Bears interest of 6% per annum on a cumulative basis, secured by the assets of the Company, matures on March 2, 2018 (iii)
   
128,975
     
-
 
   
$
613,975
   
$
461,250
 

(i) 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 $385,000) (December 31, 2015: CAD $500,000; USD $361,250) 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. During the year ended December 31, 2015, the Company and the shareholder extended the maturity date of the Secured Note to July 1, 2017.

The Company accrued interest of $10,386 during the three month period ended March 31, 2016 (March 31, 2015: $8,587) on the Secured Note. Accrued interest owing on the Secured Note at March 31, 2016 is $61,732 (December 31, 2015: $47,617) which is included in accrued liabilities.

(ii) 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. During the year ended December 31, 2015, the Company and the shareholder extended the maturity date of the Secured Note No.2 to July 1, 2017.

The Company accrued interest of $2,856 during the three month period ended March 31, 2016 (March 31, 2015: $2,585) on the Secured Note No.2. Accrued interest owing on the Secured Note No.2 at March 31, 2016 is $16,145 (December 31, 2015: $13,289) which is included in accrued liabilities.

(iii) On March 2, 2016, the Company entered into a loan agreement with a shareholder (the “Loan Agreement”), whereby the shareholder would make available to the Company the aggregate principal amount of CAD $670,000 (the “Shareholder Loan”) for capital expenditures, marketing expenditures and working capital. Under the terms of the Loan Agreement, the Shareholder Loan would be made available to the Company in two equal tranches of CAD $335,000 (USD $257,950) with the first tranche (“Loan Tranche A”) received on the closing date and the second tranche (“Loan Tranche B”) available to the Company at the option of the shareholder on or before May 2, 2016. The Company received Tranche 2 on April 14, 2016. The Shareholder Loan bears interest at a rate of 6% per annum, on the outstanding principal, and shall mature on March 2, 2018, whereby any outstanding principal together with all accrued and unpaid interest thereon shall be due and payable. The Company shall also repay 5% of the initial principal amount of Loan Tranche A and 5% of Loan Tranche B, if made available to the Company, monthly in arrears, with the first principal repayment beginning on June 30, 2016. At March 31, 2016, $128,975 of the amounts owing on the Loan Agreement have been recorded as current liabilities to reflect the monthly principal payments due over the next year. The Company may elect to repay the outstanding principal of the Shareholder Loan together with all accrued and unpaid interest thereon prior to maturity without premium or penalty. The Company also agreed to service the Shareholder Loan during the term prior to making any payments to the Company’s Chief Executive Officer, Chief Financial Officer and Board of Directors. The Shareholder Loan is secured by a general security agreement over the assets of the Company.
 
 
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The Company accrued interest of $1,165 during the three month period ended March 31, 2016 (March 31, 2015: nil) on the Shareholder Loan. Accrued interest owing on the Shareholder Loan at March 31, 2016 is $1,165 (December 31, 2015: nil) which is included in accrued liabilities.
 
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 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. The Credit Facility is secured by all of the Company’s inventory and accounts due relating to any inventory as granted in an intercreditor and subordination agreement by and among the Company, the Secured Note holder and the Lender to establish the relative rights and priorities of the secured parties against the Company and a security agreement by and between the Company and the Lender.

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.

On February 11, 2015, the Company fully repaid the amounts advanced from the Credit Facility.

On April 24, 2015, the Company was advanced $89,590 (CAD $124,000) from the Credit Facility including $17,918 (CAD $24,800) of advances from the Company’s Chief Executive Officer and Chief Financial Officer as their participation in the Credit Facility.

On September 1, 2015, the Company was advanced $122,825 (CAD $170,000) from the Credit Facility including $24,565 (CAD $34,000) of advances from the Company’s Chief Executive Officer and Chief Financial Officer as their participation in the Credit Facility.

During the three month period ended March 31, 2016, the Company expensed $2,189 (March 31, 2014: $6,943) of interest and standby fees as a result of the Credit Facility.

On January 18, 2016, and in connection to the Term Loan (note 11), the Company and the Lender entered into a loan termination agreement whereby the Company and the Lender terminated and retired the Credit Facility. As a result, the CAD $294,000 in amounts advanced from the Credit Facility and the CAD $3,093 in accrued interest owing on the Credit facility were rolled into the Term Loan.

11. TERM LOAN

On January 18, 2016, the Company entered into a term loan (the “Term Loan”) with the Lenders, a consortium of participants that includes two of the Company’s senior executive officers, whereby the Lenders would loan the Company the aggregate principal amount of CAD $1,000,000 for capital expenditures, marketing expenditures and working capital. The agent who arranged the Term Loan was not a related party of the Company. The Term Loan bears interest at a rate of 16% per annum, on the outstanding principal, and shall mature on July 3, 2017, whereby any outstanding principal together with all accrued and unpaid interest thereon shall be due and payable. The Term Loan is subject to a monthly cash sweep, calculated as the total of (i) CAD $0.50 for every E-liquid bottle, smaller than 15ml, sold by the Company within a monthly period; and (ii) CAD $1.00 for every E-liquid bottle, greater than 15ml, sold by the Company within a monthly period (the “Cash Sweep”). The Cash Sweep will be disbursed to the Lenders in the following priority: first, to pay the monthly interest due on the Term Loan; and second, to repay any remaining principal outstanding on the Term Loan. The Company may elect to repay the outstanding principal of the Term Loan together with all accrued and unpaid interest thereon prior to the maturity, subject to an early repayment penalty of the maximum of (i) 3 months interest on the outstanding principal; or (ii) 50% of the interest payable on the outstanding principal until maturity. The Term Loan shall be immediately due and payable at the option of the Lenders if there is a change in key personnel meaning the Company’s current Chief Executive Officer and Chief Financial Officer. On January 18, 2016 and in connection to the Term Loan, the Company issued warrants for the purchase of 250,000 Common Shares of the Company exercisable until December 31, 2017 with an exercise price of $0.20 per Common Share. In addition, the Company also extended the expiration date of the 250,000 warrants issued on August 1, 2014 in connection with the Credit Facility until December 31, 2017, with all other terms of the warrants remaining the same.
 
 
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The Company’s Chief Executive Officer and Chief Financial Officer are both participants of the consortium of participants of the Term Loan, each having committed to provide ten percent of the principal amount of the Term Loan. Neither the Chief Executive Officer nor the Chief Financial Officer will participate in the warrants issued or warrants extended in connection with the Term Loan and both parties have been appropriately abstained from voting on the Board of Directors to approve the Term Loan, where applicable.

During the three month period ended March 31, 2016, the Company was advanced $770,000 (CAD $1,000,000) from the Term Loan including the CAD $294,000 and CAD $3,093 rolled in from the Credit Facility (note 10) as well as CAD $140,581 of advances from the Company’s Chief Executive Officer and Chief Financial Officer. During the three month period ended March 31, 2016, the Company expensed $36,597 (March 31, 2015: nil) in interest as a result of the Term Loan.

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 and $50,000 were issued in settlement of loans from related parties.

On December 31, 2015, the Company issued 650 unsecured subordinated convertible debenture units (the “Convertible Debenture Units”) for proceeds of $650,000. Each Convertible Debenture Unit consisted of an unsecured subordinated convertible debenture having a principal amount of $1,000 (the “Convertible Debentures No.2”) and warrants exercisable for the purchase of 5,000 Common Shares of the Company (note 14). The Convertible Debentures No.2 mature on January 31, 2018 and bear interest at a rate of 8% per annum, which is payable quarterly in arrears. The Convertible Debentures No.2 are convertible into Common Shares of the Company at a fixed conversion rate of $0.10 per share at any time prior to the maturity date. The Company will have the option to force conversion of the Convertible Debentures No.2 at any time after six months from issuance and prior to the maturity date of January 31, 2018. Of the $650,000 Convertible Debentures No.2 issued, $276,000 were issued in settlement of loans from related parties (note 16), $10,000 were issued in settlement of related party consulting fees (note 16), $20,000 were issued in settlement of consulting fees owing to an unrelated party and $227,000 were issued in settlement of loans from shareholders.

The Company evaluated the terms and conditions of the Convertible Debentures and Convertible Debentures No.2 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 and Convertible Debentures No.2 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 results in a debt discount which is accreted over the life of the loan using the effective interest rate. For the three month period ended March 31, 2016, the Company recorded interest expense in the amount of $17,342 (March 31, 2015: $61,777) related to debt discount.
 
 
17

 

For the face value $650,000 Debenture Units, the relative fair value of the warrants included in the Debenture Units of $287,757 was calculated using the Black-Scholes option pricing model. The resulting fair value of the Convertible Debentures No.2 was calculated to be $362,243. The calculation of the effective conversion resulted 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 amount of $133,657 was recorded in additional paid-in capital. The BCF and the fair value of the warrants, which represents debt discount, is accreted over the life of the loan using the effective interest rate. For the three months ended March 31, 2016, the Company recorded interest expense in the amount of $4,796 (March 31, 2015: nil) related to debt discount.

The Company received forms of election whereby holders of the Convertible Debentures elected to convert into Common Shares of the Company at $0.07 per share pursuant to the terms of the Convertible Debentures. As at March 31, 2016, the Company received the following forms of elections from holders of the Convertible Debentures:

Date Form of
Election Received
 
Convertible Debentures Converted
   
Number of
 Common Shares Issued
 
April 15, 2014
  $ 50,000       714,286  
September 30, 2014
    800,000       11,428,572  
November 10, 2014
    275,000       3,928,571  
March 9, 2015
    52,000       742,857  
July 15, 2015
    105,000       1,500,000  
September 1, 2015
    20,000       285,714  
    $ 1,302,000       18,600,000  

On January 25, 2016, the Company received a form of election to convert $23,000 of Convertible Debentures, such Common Shares remain unissued. On March 10, 2016, the Company settled $25,000 in principal of the outstanding Convertible Debentures with a cash payment. The Company is currently in default on the remaining $50,000 of the Convertible Debentures that matured as of January 31, 2016.

During the three month period ended March 31, 2016, the Company recorded interest expense in the amount of $12,964 (March 31, 2015: $7,761) on the Convertible Debentures.

On March 9, 2015, the Company settled interest payable on the Convertible Debentures in the amount of $1,096 with the issuance of Common Shares at $0.15 per share, of which, $358 of interest payable on the Convertible Debentures was settled with a Director of the Company (note 17).
 
13. COMMON STOCK

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

Issued and Outstanding:

   
March 31,
2016
   
December 31,
2015
 
Common Shares 99,560,923 (December 31, 2015: 99,560,923)
  $ 19,913     $ 19,913  

The Company did not issue any Common Shares during the three month periods ended March 31, 2016 and 2015.
 
 
18

 
 
14. WARRANTS
 
The following schedule summarizes the outstanding warrants:
 
   
March 31,
2016
   
December 31,
2015
 
   
Warrants Outstanding
   
Weighted Average Exercise Price
   
Weighted Average Life Remaining (yrs)
   
Warrants Outstanding
   
Weighted Average Exercise Price
   
Weighted Average Life Remaining (yrs)
 
Beginning of year
    8,177,373     $ 0.25       1.39       1,510,640     $ 0.25       1.87  
Issued
    3,050,000       0.23       2.00       6,677,373       0.25       1.73  
Expired
    (250,000 )     0.20       -       (10,640 )     0.15       -  
End of year
    10,977,373     $ 0.25       1.41       8,177,373     $ 0.25       1.39  
 
(a) On January 30, 2015, and in connection to a supply and distribution agreement, the Company issued 250,000 warrants to purchase Common Shares of the Company exercisable over 2 years with an exercise price of $0.30 per Common Share.
 
The fair value of these issued warrants of $38,719 was determined using the Black Scholes option-pricing model with the following weighted average assumptions:
 
Stock price
  $ 0.16  
Risk-free interest rate
    0.71 %
Expected life
 
2 years
 
Estimated volatility in the market price of the Common Shares
    320 %
Dividend yield
 
Nil
 
 
The Company fully expensed the value of the warrants in stock based compensation which has been recorded as an administrative expense.

(b) On May 29, 2015, and in connection to a commission agreement, the Company issued 1,000,000 warrants to purchase Common Shares of the Company exercisable over 2 years. The warrants vest in 4 tranches of 250,000 warrants each. Tranche 1 has an exercise price of $0.40 and vested upon execution of the agreement. Tranche 2 has an exercise price of $0.50 and will vest upon the sales agent delivering $500,001 in sales revenue to Gilla Worldwide. Tranche 3 has an exercise price of $0.60 and will vest upon the sales agent delivering $1,000,001 in sales revenue to Gilla Worldwide. Tranche 4 has an exercise price of $0.70 and will vest upon the sales agent delivering $1,500,001 in sales revenue Gilla Worldwide.

The fair value of these issued warrants of $140,185 was determined using the Black Scholes option-pricing model with the following weighted average assumptions:

Stock price
  $ 0.15  
Risk-free interest rate
    0.85 %
Expected life
 
2 years
 
Estimated volatility in the market price of the Common Shares
    298 %
Dividend yield
 
Nil
 
 
The Company booked the value of the vested warrants in the amount of $35,362 as prepaid to be expensed over the life of the commission agreement. During the three month period ended March 31, 2016, the Company expensed $4,420 in stock based compensation which has been recorded as an administrative expense. No portion of the value of the unvested warrants has been expensed as the sales agent had not yet delivered any sales revenue to Gilla Worldwide.

(c) On July 14, 2015, as part of the consideration for the acquisition of VaporLiq, the Company issued 500,000 warrants to purchase Common shares of the Company exercisable over 18 months with an exercise price of $0.20 per Common Share.

The fair value of these issued warrants of $41,975 was determined using the Black Scholes option-pricing model with the following weighted average assumptions:

Stock price
  $ 0.17  
Risk-free interest rate
    0.51 %
Expected life
 
1.5 years
 
Estimated volatility in the market price of the Common Shares
    219 %
Dividend yield
 
Nil
 
 
 
19

 
 
(d) On December 30, 2015, 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 18 months with an exercise price of $0.20 per Common Share.

The fair value of these issued warrants of $26,822 was determined using the Black Scholes option-pricing model with the following weighted average assumptions:

Stock price
  $ 0.15  
Risk-free interest rate
    0.88 %
Expected life
 
1.5 years
 
Estimated volatility in the market price of the Common Shares
    190 %
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 three month period ended March 31, 2016, the Company expensed $4,446 in financing fees which has been recorded as interest expense.

(e) On December 31, 2015, and in connection to the Debenture Units, the Company issued 3,250,000 warrants to purchase Common Shares of the Company exercisable over 24 months with an exercise price of $0.20 per Common Share.

The fair value of these issued warrants of $516,343 was determined using the Black Scholes option-pricing model with the following weighted average assumptions:

Stock price
  $ 0.17  
Risk-free interest rate
    1.19 %
Expected life
 
2 years
 
Estimated volatility in the market price of the Common Shares
    265 %
Dividend yield
 
Nil
 
 
The value of the warrants along with the BCF represents debt discount on the Convertible Debentures No.2 and is accreted over the life of the loan using the effective interest rate. For the three month period ended March 31, 2016, the Company recorded interest expense in the amount of $4,796 related to debt discount which includes accretion of the BCF (note 13).

(f) On January 18, 2016, and in connection to the Term Loan (note 11), the Company extended the expiration date of the warrants issued on August 1, 2014, for the purchase of 250,000 Common Shares of the Company to be exercisable until December 31, 2017 with an exercise price of $0.30 per Common Share.

The fair value of the extension of these warrants of $30,710 was determined using the Black Scholes option-pricing model with the following weighted average assumptions:

Stock price
  $ 0.18  
Risk-free interest rate
    0.91 %
Expected life
 
1.95 years
 
Estimated volatility in the market price of the Common Shares
    263 %
Dividend yield
 
Nil
 

The Company booked the value of the warrants in the amount of $30,710 as prepaid financing fee to be expensed over the life of the Term Loan. During the three month period ended March 31, 2016, the Company expensed $4,214 of the financing fee which has been recorded as interest expense.

(g) On January 18, 2016 and in connection to the Term Loan (note 11), the Company issued warrants for the purchase of 250,000 Common Shares of the Company exercisable until December 31, 2017 with an exercise price of $0.20 per Common Share.
 
 
20

 

The fair value of these issued warrants of $41,916 was determined using the Black Scholes option-pricing model with the following weighted average assumptions:

Stock price
  $ 0.18  
Risk-free interest rate
    0.91 %
Expected life
 
2 years
 
Estimated volatility in the market price of the Common Shares
    263 %
Dividend yield
 
Nil
 

The Company booked the value of the warrants in the amount of $41,916 as prepaid financing fee to be expensed over the life of the Term Loan. During the three month period ended March 31, 2016, the Company expensed $5,752 of the financing fee which has been recorded as interest expense.

(h) On February 18, 2016 in relation to a consulting agreement, the Company issued warrants for the purchase of 300,000 Common Shares of the Company exercisable until February 17, 2018 with an exercise price of $0.25 per Common Share. The warrants shall vest quarterly in eight equal tranches, with the first tranche vesting immediately and the final tranche vesting on November 18, 2017. If the consulting agreement is terminated prior to the expiration of the warrants, any unexercised fully vested warrants shall expire thirty calendar days following the effective termination date and any unvested warrants shall be automatically canceled.

The fair value of these issued warrants of $30,501 was determined using the Black Scholes option-pricing model with the following weighted average assumptions:

Stock price
  $ 0.11  
Risk-free interest rate
    0.80 %
Expected life
 
2 years
 
Estimated volatility in the market price of the Common Shares
    275 %
Dividend yield
 
Nil
 

During the three month period ended March 31, 2016, the Company expensed $8,418 as stock based compensation in relation to the above warrants which has been recorded as an administrative expense.

(i) On February 18, 2016, in relation to a consulting agreement, the Company issued warrants for the purchase of 1,500,000 Common Shares of the Company exercisable until February 17, 2018 with an exercise price of $0.25 per Common Share. The warrants shall vest quarterly in eight equal tranches, with the first tranche vesting immediately and the final tranche vesting on November 18, 2017. If the consulting agreement is terminated prior to the expiration of the warrants, any unexercised fully vested warrants shall expire thirty calendar days following the effective termination date and any unvested warrants shall be automatically canceled.

The fair value of these issued warrants of $152,503 was determined using the Black Scholes option-pricing model with the following weighted average assumptions:

Stock price
  $ 0.11  
Risk-free interest rate
    0.80 %
Expected life
 
2 years
 
Estimated volatility in the market price of the Common Shares
    275 %
Dividend yield
 
Nil
 

During the three month period ended March 31, 2016, the Company expensed $42,090, as stock based compensation in relation to the above warrants which has been recorded as an administrative expense.

(j) On March 2, 2016 and in connection to the Loan Agreement (note 9), the Company issued warrants for the purchase of 1,000,000 Common Shares of the Company exercisable over 24 months with an exercise price of $0.20 per Common Share, with 500,000 of such purchase warrants vesting upon the close of Loan Tranche A and the remaining 500,000 purchase warrants vesting upon the close of Loan Tranche B, if made available to the Company prior to May 2, 2016. On March 3, 2016, the Company closed Loan Tranche A and 500,000 of the purchase warrants became fully vested and exercisable.
 
 
21

 

The fair value of these issued warrants of $158,995 was determined using the Black Scholes option-pricing model with the following weighted average assumptions:

Stock price
  $ 0.17  
Risk-free interest rate
    0.91 %
Expected life
 
2 years
 
Estimated volatility in the market price of the Common Shares
    271 %
Dividend yield
 
Nil
 

The Company booked the value of the vested warrants in the amount of $79,498 as a prepaid to be expensed over the life of the Loan Agreement. During the three month period ended March 31, 2016, the Company expensed $3,312 which has been recorded as interest expense.
 
15. SHARES TO BE ISSUED

As at March 31, 2016, the Company had $121,000 in shares to be issued consisting of the following:

·
328,571 Common Shares, valued at $0.07 per share, to be issued on conversion of $23,000 of Convertible Debentures;
·
480,000 Common Shares, valued at $0.10 per share, to be issued on the settlement of $48,000 in deferred fees owing to a related party;
·
210,970 Common Shares, valued at $0.142 per share, to be issued on the settlement of $30,000 in consulting fees owing to unrelated parties; and
·
151,745 Common Shares, valued at $0.132 per share, to be issued on the settlement of $20,000 in consulting fees owing to unrelated parties.

The above Common Shares have not yet been issued.

As at December 31, 2015, the Company had $20,000 in shares to be issued consisting of the following:

·
151,745 Common Shares, valued at $0.132 per share, to be issued on settlement of consulting fees owing to unrelated parties.
 
16. RELATED PARTY TRANSACTIONS

Transactions with related parties are incurred in the normal course of business and are measured at the exchange amount, which is the amount of consideration established and agreed to between the related parties.
 
(a)
The Company’s current and former officers and shareholders have advanced funds on an unsecured, non-interest bearing basis to the Company, unless stated otherwise below, for travel related and working capital purposes. The Company has not entered into any agreement on the repayment terms for these advances. 
 
Advances from related parties were as follows:
 
   
March 31,
2016
   
December 31,
2015
 
Advances by and amounts payable to Officers of the Company, two of which are also Directors
  $ 284,781     $ 242,758  
Advances by and consulting fees payable to a corporation owned by two Officers of the Company, one of which is also a Director
    248,920       196,581  
Consulting fees owing to persons related to Officers who are also Directors of the Company
    37,257       37,028  
Advances by Officers of the Company, one of which is also a Director, bears interest at 1.5% per month
    367,441       355,802  
Amounts payable to a corporation formerly related by virtue of a common Officer of the Company
    28,781       30,294  
Amounts payable to a corporation related by virtue of common Officers and a common Director of the Company
    78,061       50,976  
Consulting fees and director fees payable to Directors of the Company
    101,500       83,500  
    $ 1,146,741     $ 996,939  
 
 
22

 
 
At March 31, 2016, the Company had deferred amounts of $635,271 (December 31, 2015: $664,022) owing to related parties. The deferred amounts consist of $250,271 (December 31, 2015: $302,772) owing to Officers of the Company, two of which are also Directors and amounts of $385,000 (CAD $500,000) (December 31, 2015: $361,250; CAD $500,000) owing to a corporation owned by two Officers of the Company, one of which is also a Director. The amounts are non-interest bearing and payable on April 1, 2017. During the three month period ended March 31, 2016, the Company settled $48,000 of the deferred amounts owing to an Officer and Director of the Company with 480,000 Common Shares of the Company which have not yet been issued (note 15).
 
(b)
Interest accrued to related parties were as follows:
 
   
March 31,
2016
   
December 31,
2015
 
             
Interest accrued on advances by Officers of the Company, one of which is also a Director
 
$
154,289
   
$
129,729
 
Advances by and consulting fees payable to a corporation owned by two Officers of the Company, one of which is also a Director
   
7,564
     
2,026
 
   
$
161,853
   
$
131,755
 
 
(c)
 Transactions with related parties were as follows:

During the three month period ended March 31, 2016, the Company expensed $23,271 (March 31, 2015: $9,671) in rent expense payable to a corporation related by virtue of a common Officer and a common Director of the Company. 

During the three month period ended March 31, 2016, the Company expensed $6,178 (March 31, 2015: $3,847) in costs related to a vehicle for the benefit of two Officers who are also Directors of the Company and for the benefit of a person related to an Officer and Director of the Company. The Company also expensed $31,828 (March 31, 2015: $29,187) in travel and entertainment expenses incurred by Officers and Directors of the Company.

On February 2, 2016, the Company settled $48,000 in consulting fees payable to a related party and agreed to issue 480,000 Common Shares at a price of $0.10 per Common Share. These Common Shares remain unissued (note 15).

During the three month period ended March 31, 2015, the Company settled $358 of interest payable on Convertible Debentures with a Director of the Company at $0.15 per share, the Common Shares were issued on April 13, 2015.

During the three month period ended March 31, 2015, the Company issued 228,572 Common Shares at $0.07 per share to a Director of the Company as a result of the conversion of $16,000 of Convertible Debentures, the shares were issued on April 13, 2015.

The Company expensed consulting fees payable to related parties as follows:
 
   
March 31,
2016
   
March 31,
2015
 
Directors
 
$
-
   
$
38,250
 
Officers
   
81,840
     
27,322
 
Corporation owned by two Officers, one of which is also a Director
   
-
     
95,505
 
Persons related to a Director
   
26,389
     
15,917
 
   
$
108,229
   
$
176,994
 

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 and Term Loan (notes 10 and 11).
 
17. COMMITMENTS AND CONTINGENCIES

a) Operating Lease
 
 
23

 

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

Effective January 1, 2015, a subsidiary of the Company entered into an operating lease agreement for a rental premises in Daytona Beach, Florida, USA. The terms of this agreement are to be for a period of 36 months and ending on December 31, 2017 with payments made monthly. Minimum annual lease payments are as follows:

2016
 
$
42,083
 
2017
   
56,110
 
   
$
98,193
 

c) Litigation

The Company is subject to certain legal proceedings and claims, which arise in the ordinary course of its business. Although occasional adverse decisions or settlements may occur, the Company believes that the final disposition of such matters should not have a material adverse effect on its financial position, results of operations or liquidity.

On January 6, 2016, Yaron Elkayam, Pinchas Mamane and Levent Dimen filed a three count complaint against the Company in the Circuit Court of Hillsborough County, Florida alleging (i) breach of contract, (ii) breach of implied covenant of good faith and fair dealing, and (iii) fraud in the inducement seeking damages in the amount of approximately $900,000 of Promissory Notes issued on July 1, 2015 as a result of the acquisition of E Vapor Labs. On February 23, 2015, the Company filed a motion to dismiss the complaint on the basis of failure to allege sufficient jurisdictional facts and failure to satisfy constitutional due process requirements to exercise jurisdiction.

d) Employment Agreements

Pursuant to certain employment agreements with the Company’s management, the Company has agreed to pay termination amounts in the first year of up to twelve months of annual entitlements under such agreements, less any amounts paid during the first year, ending on December 1, 2016.

18. FINANCIAL INSTRUMENTS

(i) Credit Risk

Credit risk is the risk of financial loss to the Company if a customer or counterparty to a financial instrument fails to meet its contractual obligations. The Company’s credit risk is primarily attributable to fluctuations in the realizable values of its cash and trade receivable. Cash accounts are maintained with major international financial institutions of reputable credit and therefore bear minimal credit risk. In the normal course of business, the Company is exposed to credit risk from its customers and the related accounts receivable are subject to normal commercial credit risks. A substantial portion of the Company’s accounts receivable are concentrated with a limited number of large customers all of which the Company believes are subject to normal industry credit risks. At March 31, 2016, the Company booked an allowance of bad debt of $20,108 (December 31, 2015:$20,370) in regards customers with past due amounts. For the three month period ended March 31, 2016, 62% (December 31, 2015: 38%) of the Company’s trade receivables are due from one customer and 91% of the trade receivables are due from two customers. During the three month period ended March 31, 2016, 59% of the Company’s sales were to one customer.

(ii) Liquidity Risk

Liquidity risk is the risk that the Company will not be able to meet its financial obligations as they fall due. The Company’s approach to managing liquidity risk is to ensure, as far as possible, that it will have sufficient liquidity to meet its liabilities when due, under both normal and stressed conditions, without incurring unacceptable losses or risking damage to the Company’s reputation. The Company manages liquidity risk by closely monitoring changing conditions in its investees, participating in the day to day management and by forecasting cash flows from operations and anticipated investing and financing activities. At March 31, 2016, the Company had liabilities due to unrelated parties through its financial obligations over the next five years in the aggregate principal amount of $3,377,345 (December 31, 2015: $1,987,967). Of such amount, the Company has obligations to repay $1,947,660 over the next twelve months with the remaining $1,429,685 becoming due within the following four year period.
 
 
24

 

(iii) Foreign Currency Risk

Currency risk is the risk that the fair value or future cash flows of a financial instrument will fluctuate because of changes in foreign exchange rates. The risks and fluctuations are related to cash and accounts payable and accrued liabilities that are denominated in CAD and HUF.

Analysis by currency in Canadian and Hungarian equivalents is as follows:

March 31, 2016
 
Accounts Payable
   
Accounts Receivable
   
Cash
 
CAD
  $ 193,584     $ -     $ 3,253  
HUF
  $ 221,298     $ 12,231     $ 20,342  

The effect of a 10% strengthening of the United States dollar against the Canadian dollar and Hungarian Forint at the reporting date on the CAD and HUF-denominated trade receivables and payables carried at that date would, had all other variables held constant, have resulted in an increase in profit for the year and increase of net assets of $19,033 and $18,873, respectively. A 10% weakening in the exchange rate would, on the same basis, have decreased profit and decreased net assets by $19,033 and $18,873, respectively. During the three month period ended March 31, 2016, amounts denominated in Euros were minimal and did not subject the Company to significant currency risk.

The Company purchases inventory in a foreign currency, at March 31, 2016, the Company included $62,910 (December 31, 2015: $146) in inventory purchased in a foreign currency on its condensed consolidated interim balance sheet. The Company does not use derivative financial instruments to reduce its exposure to this risk.

(iv) Interest Rate Risk

Interest rate risk is the risk that the fair value or future cash flows of a financial instrument will fluctuate because of changes in market interest rates. The Company is exposed to interest rate risk on its fixed interest rate financial instruments. These fixed-rate instruments subject the Company to a fair value risk. The interest rates on all of the Company’s existing interest bearing debt are fixed. Sensitivity to a plus or minus 25 basis points change in rates would not significantly affect the fair value of this debt.

19. SEGMENTED INFORMATION

The Company currently operates in only one business segment, namely, manufacturing, marketing and distributing of E-liquid, vaporizers, E-cigarettes, and vaping accessories in North America and Europe. Total long-lived assets by geographic location are as follows:

   
March 31,
2016
   
December 31,
2015
Canada
  $ -     $ -  
United States
    1,641,121       1,624,669  
Europe
    3,509       2,130  
    $ 1,644,630     $ 1,626,799  

Total sales by geographic location are as follows:

   
March 31,
2016
   
March 31,
2015
 
Canada
  $ -     $ -  
United States
    1,316,664       3,804  
Europe
    40,269       -  
    $ 1,356,933     $ 3,804  
 
 
25

 
 
20. SUBSEQUENT EVENTS

On April 15, 2016, the Company entered into a settlement agreement (the “Settlement Agreement”) with The Mad Alchemist, LLC (“TMA” or the “TMA Vendor”) and the Pennington family, being Joshua Pennington, Nicole Pennington and Mike Simon (collectively, the “Pennington Family”). Subject to the terms and conditions of the Settlement Agreement, the parties settled: (i) any and all compensation and expenses owing by the Company to the Pennington Family and (ii) all remaining consideration payable by the Company to the TMA Vendor under the SPA totaling $400,000 which was due in cash and common stock in exchange for the Company paying to the TMA Vendor and the Pennington Family a total consideration of $133,163 payable as $100,000 in cash and $33,163 in assets as payments in kind. Of the $100,000 payable in cash, $45,000 was paid upon execution of the Settlement Agreement, $27,500 is payable thirty days following the execution of the Settlement Agreement and the remaining $27,500 payable at the later of (i) sixty days following the execution of the Settlement Agreement, or (ii) the completion of the historical audit of the TMA Vendor. In addition, the employment agreements between the Company and Joshua Pennington and Nicole Pennington were mutually terminated and all amounts were fully settled pursuant to the Settlement Agreement.

On April 13, 2016, the Company entered into a consulting agreement and issued warrants for the purchase of 1,750,000 Common Shares of the Company exercisable until April 12, 2018 with an exercise price of $0.25 per Common Share. Forty percent of the warrants vested immediately with the remaining sixty percent vesting in equal tranches of fifteen percent on September 30, 2016, December 31 2016, June 30, 2017 and December 31, 2017.  If the consulting agreement is terminated prior to the expiration of the warrants, any unexercised fully vested warrants shall expire ninety calendar days following the effective termination date and any unvested warrants shall be automatically cancelled.

On April 14, 2016, under the terms of the Loan Agreement, the Company received Loan Tranche B in the amount CAD $335,000  (note 9). The Company received CAD $100,000 of the amount in cash and the remaining CAD $235,000 is being held in trust to be released on the incurrence of specific expenses.
 
 
26

 
 
ITEM 2.                 MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION
 
The following discussion of the financial condition and results of operations of the Company should be read in conjunction with the financial statements and the related notes thereto included elsewhere in this Quarterly Report on Form 10-Q (this “Report”). This Report contains certain forward-looking statements and the Company's future operating results could differ materially from those discussed herein. Our disclosure and analysis included in this Report concerning our operations, cash flows and financial position include forward-looking statements. Statements that are predictive in nature, that depend upon or refer to future events or conditions, or that include words such as “expect”, “anticipate”, “intend”, “plan”, “believe”, “estimate”, “may”, “project”, “will likely result”, and similar expressions are intended to identify forward-looking statements. Such forward-looking statements include (i) the ability to raise additional capital; and (ii) expectations regarding anticipated growth.  Such forward-looking statements are subject to certain risks, uncertainties and assumptions, and are more fully described under “Part I, Item 1A - Risk Factors” of our Annual Report on Form 10-K for the year ended December 31, 2015. New risks and uncertainties arise from time to time, and it is impossible for us to predict these events or how they may affect us. In any event, these and other important factors, including those set forth in Item 1A – “Risk Factors” of our Annual Report on Form 10-K for the year ended December 31, 2015 may cause actual results to differ materially from those indicated by our forward-looking statements. We assume no obligation to update or revise any forward-looking statements we make in this Report, except as required by applicable securities laws.

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

Overview

Gilla Inc. (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 475 Fentress Blvd., Unit L, Daytona Beach, Florida 32114.

The current business of the Company consists of the manufacturing, marketing and distribution of generic and premium branded E-liquid, which is the liquid used in vaporizers, E-cigarettes, and other vaping hardware and accessories. E-liquid is heated by the atomizer to deliver the sensation of smoking. Gilla’s product portfolio includes Craft Vapes, Craft Clouds, Vape Warriors, Miss Pennysworth’s Elixirs, The Mad Alchemist, Replicant and Coil Glaze E-liquid brands.

Recent Developments
 
On January 18, 2016, the Company entered into a term loan (the “Term Loan”) with a consortium of participants that includes two of the Company’s senior executive officers (the “Lender”), whereby the Lender would loan the Company the aggregate principal amount of CAD $1,000,000 for capital expenditures, marketing expenditures and working capital. The agent who arranged the Term Loan was not a related party of the Company. The Term Loan bears interest at a rate of 16% per annum, on the outstanding principal, and shall mature on July 3, 2017, whereby any outstanding principal together with all accrued and unpaid interest thereon shall be due and payable. The Term Loan is subject to a monthly cash sweep, calculated as the total of (i) CAD $0.50 for every E-liquid bottle, smaller than 15ml, sold by the Company within a monthly period; and (ii) CAD $1.00 for every E-liquid bottle, greater than 15ml, sold by the Company within a monthly period (the “Cash Sweep”). The Cash Sweep will be disbursed to the Lender in the following priority: first, to pay the monthly interest due on the Term Loan; and second, to repay any remaining principal outstanding on the Term Loan. The Company may elect to repay the outstanding principal of the Term Loan together with all accrued and unpaid interest thereon prior to the maturity, subject to an early repayment penalty of the maximum of (i) 3 months interest on the outstanding principal; or (ii) 50% of the interest payable on the outstanding principal until maturity. The Term Loan shall be immediately due and payable at the option of the Lender if there is a change in key personnel meaning the Company’s current Chief Executive Officer and Chief Financial Officer. On January 18, 2016 and in connection to the Term Loan, the Company issued warrants for the purchase of 250,000 Common Shares of the Company exercisable until December 31, 2017 with an exercise price of $0.20 per Common Share. In addition, the Company also extended the expiration date of the 250,000 warrants issued on August 1, 2014 in connection with the credit facility (the “Credit Facility”), entered into on August 1, 2014, until December 31, 2017, with all other terms of the warrants remaining the same. The Company’s Chief Executive Officer and Chief Financial Officer are both participants of the consortium of participants of the Term Loan, each having committed to provide ten percent of the principal amount of the Term Loan. Neither the Chief Executive Officer nor the Chief Financial Officer will participate in the warrants issued or warrants extended in connection with the Term Loan and both parties have been appropriately abstained from voting on the Board of Directors to approve the Term Loan, where applicable.
 
 
27

 

On January 18, 2016 and in connection to the Term Loan, the Company and the Lender entered into a loan termination agreement (the “Loan Termination Agreement”) whereby the Company and the Lender terminated and retired the Credit Facility.

On January 25, 2016, the Company received a form of election whereby a holder of a convertible debenture (the “Convertible Debentures”) elected to convert a total of $23,000 of the Convertible Debentures into Common Shares of the Company pursuant to the terms of the Convertible Debentures. These Common Shares remain unissued.

On February 2, 2016, the Company settled $48,000 in consulting fees payable to a related party and agreed to issue 480,000 Common Shares at a price of $0.10 per Common Share. These Common Shares remain unissued.

On February 18, 2016, the Company entered into a consulting agreement and issued warrants for the purchase of 300,000 Common Shares of the Company exercisable until February 17, 2018 with an exercise price of $0.25 per Common Share. The warrants shall vest quarterly in eight equal tranches, with the first tranche vesting immediately and the final tranche vesting on November 18, 2017. If the consulting agreement is terminated prior to the expiration of the warrants, any unexercised fully vested warrants shall expire thirty calendar days following the effective termination date and any unvested warrants shall be automatically canceled.

On February 18, 2016, the Company entered into a consulting agreement and issued warrants for the purchase of 1,500,000 Common Shares of the Company exercisable until February 17, 2018 with an exercise price of $0.25 per Common Share. The warrants shall vest quarterly in eight equal tranches, with the first tranche vesting immediately and the final tranche vesting on November 18, 2017. If the consulting agreement is terminated prior to the expiration of the warrants, any unexercised fully vested warrants shall expire thirty calendar days following the effective termination date and any unvested warrants shall be automatically canceled.

On March 2, 2016, the Company entered into a loan agreement with a shareholder (the “Loan Agreement”), whereby the shareholder would make available to the Company the aggregate principal amount of CAD $670,000 (the “Shareholder Loan”) for capital expenditures, marketing expenditures and working capital. Under the terms of the Loan Agreement, the Shareholder Loan would be made available to the Company in two equal tranches of CAD $335,000 with the first tranche (“Loan Tranche A”) available on the closing date and the second tranche (“Loan Tranche B”) available to the Company at the option of the shareholder on or before May 2, 2016. The Shareholder Loan bears interest at a rate of 6% per annum, on the outstanding principal, and shall mature on March 2, 2018, whereby any outstanding principal together with all accrued and unpaid interest thereon shall be due and payable. The Company shall also repay 5% of the initial principal amount of Loan Tranche A and 5% of Loan Tranche B, if made available to the Company, monthly in arrears, with the first principal repayment beginning on June 30, 2016. The Company may elect to repay the outstanding principal of the Shareholder Loan together with all accrued and unpaid interest thereon prior to maturity without premium or penalty. The Company also agreed to service the Shareholder Loan during the term prior to making any payments to the Company’s Chief Executive Officer, Chief Financial Officer and Board of Directors. The Shareholder Loan is secured by a general security agreement over the assets of the Company. On March 2, 2016 and in connection to the Loan Agreement, the Company issued warrants for the purchase of 1,000,000 Common Shares of the Company exercisable until March 2, 2018 with an exercise price of $0.20 per Common Share, with 500,000 of such purchase warrants vesting upon the close of Loan Tranche A and the remaining 500,000 purchase warrants vesting upon the close of Loan Tranche B, if made available to the Company prior to May 2, 2016. On March 3, 2016, the Company closed Loan Tranche A and 500,000 of the purchase warrants became fully vested and exercisable.  On April 14, 2016, the Company closed Loan Tranche B and 500,000 of the purchase warrants became fully vested and exercisable.

Subsequent Events

On April 15, 2016, the Company entered into a settlement agreement (the “Settlement Agreement”) with The Mad Alchemist, LLC (“TMA” or the “TMA Vendor”) and the Pennington family, being Joshua Pennington, Nicole Pennington and Mike Simon (collectively, the “Pennington Family”). Subject to the terms and conditions of the Settlement Agreement, the parties settled: (i) any and all compensation and expenses owing by the Company to the Pennington Family and (ii) all remaining consideration payable by the Company to the TMA Vendor under the share purchase agreement totaling $400,000 which was due in cash and common stock in exchange for the Company paying to the TMA Vendor and the Pennington Family a total consideration of $133,163 payable as $100,000 in cash and $33,163 in assets as payments in kind. Of the $100,000 payable in cash, $45,000 was paid upon execution of the Settlement Agreement, $27,500 is payable thirty days following the execution of the Settlement Agreement and the remaining $27,500 payable at the later of (i) sixty days following the execution of the Settlement Agreement, or (ii) the completion of the historical audit of the TMA Vendor. In addition, the employment agreements between the Company and Joshua Pennington and Nicole Pennington were mutually terminated and all amounts were fully settled pursuant to the Settlement Agreement.

On April 13, 2016, the Company entered into a consulting agreement and issued warrants for the purchase of 1,750,000 Common Shares of the Company exercisable until April 12, 2018 with an exercise price of $0.25 per Common Share. Forty percent of the warrants vested immediately with the remaining sixty percent vesting in equal tranches of fifteen percent on September 30, 2016, December 31 2016, June 30, 2017 and December 31, 2017.  If the consulting agreement is terminated prior to the expiration of the warrants, any unexercised fully vested warrants shall expire ninety calendar days following the effective termination date and any unvested warrants shall be automatically cancelled.
 
On May 10, 2016, the U.S. Federal Food & Drug Administration (“FDA”) finalized a new rule, captioned, the “Deeming Tobacco Products To Be Subject to the Federal Food, Drug, and Cosmetic Act”, which extends the FDA’s authority to include the regulation of electronic nicotine delivery systems (such as e-cigarettes and vape pens), all cigars, hookah (waterpipe) tobacco, pipe tobacco and nicotine gels, among others. Going forward, the FDA will be able to review new nicotine products not yet on the market; regulate claims by nicotine product manufacturers and distributers; require evaluation and reporting of the ingredients of nicotine products and how they are made; and require disclosures regarding risks of nicotine products. The final rule goes into effect on August 8, 2016. The Company is assessing the impact of the new FDA rule. Prospective investors are directed to the “Risk Factors” contained in the Company’s Annual Report filed with the U.S. Securities and Exchange Commission for the fiscal year ended December 31, 2015.
 
 
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RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDED MARCH 31, 2016 AND MARCH 31, 2015

Revenue

For the three month period ended March 31, 2016, the Company generated $1,356,933 in sales from E-liquids, vaporizers, E-cigarettes and accessories (collectively, “E-liquids”) as compared to $3,804 in sales for the three month period ended March 31, 2015. For the three month period ended March 31, 2016, E-liquid sales of $1,316,664 were generated in the United States and $40,269 were generated in Europe.

The Company’s cost of goods sold for the three month period ended March 31, 2016 was $860,946 which represents E-liquids, bottles, hardware and the related packaging as compared to $2,231 for the three month period ended March 31, 2015. Gross profit for the three month period ended March 31, 2016 was $495,987 as compared to $1,573 for the comparative period in 2015.

Operating Expenses

For the three month period ended March 31, 2016, the Company incurred an administrative expense of $1,047,026, consulting fees to related parties of $108,229, depreciation expense of $13,495 and an amortization expense of $11,500. Total operating expenses for the three month period ended March 31, 2016 were $1,180,250. For the three month period ended March 31, 2015, the Company incurred an administrative expense of $365,639, consulting fees to related parties of $176,994, depreciation expense of $450 and an amortization expense of $4,999.

Administrative costs were primarily comprised of rent, legal and audit fees, marketing fees, travel expenses, consulting fees and employee wages. The increase in administrative expenses of $681,387 is attributable to increased operations as a result of the acquired businesses and organic growth during the period. The decrease in consulting fees due to related parties of $68,765 is attributable to the effects of foreign exchange translation.

Loss from Operations

For the three month period ended March 31, 2016, the Company incurred a loss from operations of $684,263 as compared to a loss from operations of $546,509 for the three month period ended March 31, 2015 due to the reasons discussed above.

Other Expenses

For the three month period ended March 31, 2016, the Company incurred a foreign exchange loss of $77,483, amortization of debt discount of $22,138, and interest expense of $121,984. For the three month period ended March 31, 2015, the Company incurred a foreign exchange gain of $10,084, amortization of debt discount of $61,777 and interest expense of $72,187. For the three month period ended March 31, 2016, the Company incurred total other expenses of $221,605 as compared to $123,880 for the three month period ended March 31, 2015.

Net Loss and Comprehensive Loss

Net loss amounted to $905,868 for the three month period ended March 31, 2016 compared to a loss of $670,389 for the three month period ended March 31, 2015.

Comprehensive loss amounted to $1,030,166 for the three month period ended March 31, 2016 compared to a comprehensive loss of $576,660 for the three month period ended March 31, 2015. 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, Euros and Hungarian Forints to U.S. dollars.

Liquidity and Capital Resources

As at March 31, 2016, the Company had total assets of $2,677,139 (compared to total assets of $2,231,055 at December 31, 2015) consisting of cash and cash equivalents of $33,741, trade receivables of $494,573, inventory of $195,190, other current assets of $309,005, property and equipment of $179,680, website development of $8,583, intangibles of $204,283 and goodwill of $1,252,084. The assets are primarily the result of the acquisitions of E Vapor Labs (see “Acquisition of E Vapor Labs”), VaporLiq and the assets of the Craft Vapes E-liquid brand (see “Acquisition of CV Brands”) and The Mad Alchemist E-liquid brand (see “Acquisition of TMA Brands”).
 
 
29

 

As at March 31, 2016, the Company had total liabilities of $6,173,315 (compared to total liabilities of $5,000,695 at December 31, 2015) consisting of accounts payable of $1,223,534, accrued liabilities of $265,774, accrued interest due to related parties of $161,853, customer deposits of $1,500, loans from shareholders of $157,984, due to related parties of $1,146,741, promissory notes of $779,128, amounts owing on acquisition of $190,549, convertible debentures of $50,000, term loan of $770,000, long term loans from shareholders of $613,975, long term due to related parties of $635,271, long term amounts owing on acquisitions of $165,710 and long term convertible debentures of $11,296.

At March 31, 2016, the Company had negative working capital of $3,714,554 and an accumulated deficit of $9,656,556.

As at December 31, 2015, the Company had total assets of $2,231,055 consisting of cash and cash equivalents of $81,696, trade receivables of $45,534, inventory of $154,700, other current assets of $322,326, property and equipment of $150,349, website development of $9,083, intangibles of $215,283 and goodwill of $1,252,084.

As at December 31, 2015, the Company had total liabilities of $5,000,695 consisting of accounts payable of $687,767, accrued liabilities of $251,517, accrued interest due to related parties of $131,755, customer deposits of $372,500, loans from shareholders of $27,528, due to related parties of $996,939, promissory notes of $495,193, amounts owing on acquisitions of $150,549, convertible debentures of $80,658, advances on credit facility of $212,415, long term loans from shareholders of $461,250, long term due to related parties of $662,140, long term amounts owing on acquisitions of $196,127, long term promissory notes of $267,857 and long term convertible debentures of $6,500.

At December 31, 2015, the Company had negative working capital of $2,802,565 and an accumulated deficit of $8,750,688.

Net cash used in operating activities

For the three month period ended March 31, 2016, the Company used cash of $737,945 (compared to $226,719 of cash used in operating activities during the three month period ended March 31, 2015) in operating activities to fund administrative, marketing and sales. The increase is attributable to the results of operations and changes in the operating assets and liabilities as discussed above.

Net cash used in investing activities

For the three month period ended March 31, 2016, net cash used in investing activities was $42,677 compared to nil for the three month period ended March 31, 2015.

Net cash flow from financing activities

For the three month period ended March 31, 2016, net cash provided by financing activities was $715,470 (see “Term Loan” and “Shareholder Loan”) compared to net cash used in financing activities of $308,561 for the three month period ended March 31, 2015.

Acquisition of E Vapor Labs

On July 1, 2015, the Company closed the acquisition of all the issued and outstanding shares of E Vapor Labs Inc. (“E Vapor Labs”), a Florida based E-liquid manufacturer. The Company purchased E Vapor Labs in order to procure an E-liquid manufacturing platform allowing the Company to secure large private label contracts as well as manufacture its own brands going forward. The following summarizes the fair value of the assets acquired, liabilities assumed and the consideration transferred at the acquisition date:

Assets acquired:
     
Cash
 
$
22,942
 
Receivables
   
48,356
 
Other current assets
   
21,195
 
Inventory
   
122,309
 
Fixed assets
   
118,867
 
Unallocated purchase price
   
847,265
 
Total assets acquired
 
$
1,180,934
 
         
 Liabilities assumed:
       
Accounts payable
 
$
206,252
 
Loan payable
   
25,000
 
Total liabilities assumed
 
231,252
 
         
Consideration:
       
Cash
 
$
225,000
 
Promissory Notes A, unsecured and non-interest bearing, due November 1, 2015
   
196,026
 
Promissory Notes B, unsecured and non-interest bearing, due April 1, 2016
   
275,555
 
Promissory Notes C, unsecured and non-interest bearing, due January 1, 2017
   
253,101
 
Total consideration
 
$
949,682
 
 
 
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In consideration for the acquisition, the Company paid to the vendors, $225,000 in cash on closing and $900,000 in unsecured promissory notes issued on the closing (collectively, the “Promissory Notes”). The Promissory Notes were issued in three equal tranches of $300,000 due four (4), nine (9) and eighteen (18) months respectfully from the closing (individually, “Promissory Notes A”, “Promissory Notes B”, and “Promissory Notes C” respectively). The Promissory Notes are all unsecured, non-interest bearing, and on the maturity date, at the option of the vendors, up to one third (1/3) of each tranche of the Promissory Notes can be repaid in Common Shares of the Company, calculated using the 5 day weighted average closing market price of the Company prior to the maturity of the Promissory Notes. The Promissory Notes, are all and each subject to adjustments as outlined in the share purchase agreement (the “SPA”), dated June 25, 2015.

At December 31, 2015, the Company adjusted the Promissory Notes A for the known difference in the working capital balance at closing of the acquisition from the amount specified in the SPA. Further, a 12% discount rate has been used to calculate the present value of the Promissory Notes based on the Company’s estimate of cost of financing for comparable notes with similar term and risk profiles. Over the term of the respective Promissory Notes, interest will be accrued at 12% per annum to accrete the Promissory Notes to their respective principal amounts. During the three month period ended March 31, 2016, the Company recorded $16,078 in interest expense related to the accretion of the Promissory Notes.

The Promissory Notes A were due on November 1, 2015. The Company provided notice to the Promissory Note holders on October 30, 2015 indicating its intention to repay such Promissory Notes, however, such inability to accurately determine the required adjustments pursuant to the SPA has forced the Company to defer repayment of such Promissory Notes until such time where the principal amount of the Promissory Notes can be accurately determined.

The Company is not able to complete the purchase price allocation as the Company has disputed the consideration amount and is currently undergoing negotiations.

The results of operations of E Vapor Labs have been included in the consolidated statements of operations from the acquisition date. The following table presents pro forma results of operations of the Company and E Vapor Labs as if the companies had been combined as of January 1, 2015. The pro forma condensed combined financial information is presented for informational purposes only. The unaudited pro forma results of operations are not necessarily indicative of results that would have occurred had the acquisition taken place at the beginning of the earliest period presented, or of future results.

   
March 31,
2016
   
March 31,
2015
 
Pro forma revenue
  $ 1,356,933     $ 244,692  
Pro forma loss from operations
  $ (684,263 )   $ (552,088 )
Pro forma net loss
  $ (905,868 )   $ (675,968 )

Acquisition of CV Brands

On November 2, 2015, the Company closed the acquisition of all of the assets of 901 Vaping Company LLC (“901 Vaping”), an E-liquid manufacturer, including all of the rights and title to own and operate the Craft Vapes, Craft Clouds and Miss Pennysworth’s Elixirs E-liquid brands. The following summarizes the fair value of the assets acquired and the consideration transferred at the acquisition date:

Assets acquired:
     
Inventory
 
 $
11,335
 
Equipment
   
11,872
 
Intangibles
   
63,000
 
Goodwill
   
87,000
 
Total assets acquired
 
$
173,207
 
         
Consideration:
       
Cash
 
$
23,207
 
1,000,000 Common Shares at $0.15 per share
   
150,000
 
Total consideration
 
$
173,207
 
 
 
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In consideration for the acquisition, the Company issued 1,000,000 Common Shares of the Company valued at $0.15 per share, paid cash consideration of $23,207 and agreed to a quarterly earn-out based on the gross profit stream derived from product sales of the acquired brands. The earn-out commences on the closing date and pays up to a maximum of 25% of the gross profit stream. As of March 31, 2016, no amounts have been accrued or paid in relation to the quarterly earn-out.
 
Intangible assets consist primarily of customer relationships and brands. Brand intangibles represents the estimated fair value of the trade names acquired. Customer relationship intangibles relates to the ability to sell existing and future products to 901 Vaping’s existing and potential customers. The preliminary estimated useful life and fair values of the identifiable intangible assets are as follows:

   
Estimated Useful Life (in years)
   
Amount
 
Brands
    5     $ 30,000  
Customer relationships
    5       33,000  
            $ 63,000  

The results of operations of 901 Vaping have been included in the consolidated statements of operations from the acquisition date, though revenue and net income from 901 Vaping were not material for the three month period ended March 31, 2016. Pro forma results of operations have not been presented because the acquisition was not material to the results of operations.

Acquisition of TMA Brands

On December 2, 2015, the Company acquired all of the assets of TMA, an E-liquid manufacturer, including the assets, rights and title to own and operate The Mad Alchemist and Replicant E-liquid brands. The following summarizes the fair value of the assets acquired and the consideration transferred at the acquisition date:

Assets acquired:
     
Inventory
 
 $
41,462
 
Equipment
   
36,579
 
Intangibles
   
157,000
 
Goodwill
   
208,376
 
Total assets acquired
 
$
443,417
 
         
Consideration:
       
819,672 Common Shares at $0.122 per share
 
$
100,000
 
Deferred payments
   
343,417
 
Total consideration
 
$
443,417
 

On the closing date, the Company issued 819,672 Common Shares valued at $0.122 per share for a total value of $100,000; agreed to pay a total of $400,000 in deferred payments (the “Amounts Owing on Acquisition”), payable in ten (10) equal payments of $20,000 in cash and $20,000 in common stock every three (3) months following the closing date, and agreed to a quarterly earn-out based on the gross profit stream derived from product sales of the acquired brands. The earn-out commences on the closing date and pays up to a maximum of 25% of the gross profit stream. The number of Common Shares issuable will be calculated and priced using the weighted average closing market price of the Company, as quoted by the OTC Markets Group, for the five trading days prior to each issuance date. Further, a 12% discount rate has been used to calculate the present value of the Amounts Owing on Acquisition. Over the term of the respective deferred payments, interest will be accrued at 12% per annum to accrete the payments to their respective principal amounts. During the three month period ended March 31, 2016, the Company recorded $9,582 in interest expense related to the accretion of the Amounts Owing on Acquisition. At March 31, 2016, the Company owed a total of $356,259 in Amounts Owing on Acquisition, $190,549 of this amount has been recorded as a current liability and the remaining $165,710 has been recorded as a long term liability. The Amounts Owing on Acquisition were fully settled subsequent to March 31, 2016.
 
 
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Intangible assets consist primarily of customer relationships and brands. Brand intangibles represents the estimated fair value of the trade names acquired. Customer relationship intangibles relates to the ability to sell existing and future products to TMA’s existing and potential customers. The preliminary estimated useful life and fair values of the identifiable intangible assets are as follows:

   
Estimated Useful Life (in years)
   
Amount
 
Brands
    5     $ 60,000  
Customer relationships
    5       97,000  
            $ 157,000  

The results of operations of TMA have been included in the consolidated statements of operations from the acquisition date, though revenue and net income from TMA were not material for the three month period ended March 31, 2016. Pro forma results of operations have not been presented because the acquisition was not material to the results of operations.

Term Loan

On January 18, 2016, the Company entered into a term loan (the “Term Loan”) with the Lenders, a consortium of participants that includes two of the Company’s senior executive officers, whereby the Lenders would loan the Company the aggregate principal amount of CAD $1,000,000 for capital expenditures, marketing expenditures and working capital. The agent who arranged the Term Loan was not a related party of the Company. The Term Loan bears interest at a rate of 16% per annum, on the outstanding principal, and shall mature on July 3, 2017, whereby any outstanding principal together with all accrued and unpaid interest thereon shall be due and payable. The Term Loan is subject to a monthly cash sweep, calculated as the total of (i) CAD $0.50 for every E-liquid bottle, smaller than 15ml, sold by the Company within a monthly period; and (ii) CAD $1.00 for every E-liquid bottle, greater than 15ml, sold by the Company within a monthly period (the “Cash Sweep”). The Cash Sweep will be disbursed to the Lenders in the following priority: first, to pay the monthly interest due on the Term Loan; and second, to repay any remaining principal outstanding on the Term Loan. The Company may elect to repay the outstanding principal of the Term Loan together with all accrued and unpaid interest thereon prior to the maturity, subject to an early repayment penalty of the maximum of (i) 3 months interest on the outstanding principal; or (ii) 50% of the interest payable on the outstanding principal until maturity. The Term Loan shall be immediately due and payable at the option of the Lenders if there is a change in key personnel meaning the Company’s current Chief Executive Officer and Chief Financial Officer. On January 18, 2016 and in connection to the Term Loan, the Company issued warrants for the purchase of 250,000 Common Shares of the Company exercisable until December 31, 2017 with an exercise price of $0.20 per Common Share. In addition, the Company also extended the expiration date of the 250,000 warrants issued on August 1, 2014 in connection with the Credit Facility until December 31, 2017, with all other terms of the warrants remaining the same.

The Company’s Chief Executive Officer and Chief Financial Officer are both participants of the consortium of participants of the Term Loan, each having committed to provide ten percent of the principal amount of the Term Loan. Neither the Chief Executive Officer nor the Chief Financial Officer will participate in the warrants issued or warrants extended in connection with the Term Loan and both parties have been appropriately abstained from voting on the Board of Directors to approve the Term Loan, where applicable.

During the three month period ended March 31, 2016, the Company was advanced $770,000 (CAD $1,000,000) from the Term Loan including the CAD $294,000 and CAD $3,093 rolled in from the Credit Facility as well as CAD $140,581 of advances from the Company’s Chief Executive Officer and Chief Financial Officer. During the three month period ended March 31, 2016, the Company expensed $36,597 (March 31, 2015: nil) in interest as a result of the Term Loan.

Shareholder Loan

On March 2, 2016, the Company entered into a loan agreement with a shareholder (the “Loan Agreement”), whereby the shareholder would make available to the Company the aggregate principal amount of CAD $670,000 (the “Shareholder Loan”) for capital expenditures, marketing expenditures and working capital. Under the terms of the Loan Agreement, the Shareholder Loan would be made available to the Company in two equal tranches of CAD $335,000 (USD $257,950) with the first tranche (“Loan Tranche A”) received on the closing date and the second tranche (“Loan Tranche B”) available to the Company at the option of the shareholder on or before May 2, 2016. The Company received Tranche 2 on April 14, 2016. The Shareholder Loan bears interest at a rate of 6% per annum, on the outstanding principal, and shall mature on March 2, 2018, whereby any outstanding principal together with all accrued and unpaid interest thereon shall be due and payable. The Company shall also repay 5% of the initial principal amount of Loan Tranche A and 5% of Loan Tranche B, if made available to the Company, monthly in arrears, with the first principal repayment beginning on June 30, 2016. At March 31, 2016, $128,975 of the amounts owing on the Loan Agreement have been recorded as current liabilities to reflect the monthly principal payments due over the next year. The Company may elect to repay the outstanding principal of the Shareholder Loan together with all accrued and unpaid interest thereon prior to maturity without premium or penalty. The Company also agreed to service the Shareholder Loan during the term prior to making any payments to the Company’s Chief Executive Officer, Chief Financial Officer and Board of Directors. The Shareholder Loan is secured by a general security agreement over the assets of the Company.
 
 
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The Company accrued interest of $1,165 during the three month period ended March 31, 2016 (March 31, 2015: nil) on the Shareholder Loan. Accrued interest owing on the Shareholder Loan at March 31, 2016 is $1,165 (December 31, 2015: nil) which is included in accrued liabilities.

Satisfaction of Our Cash Obligations for the Next 12 Months

The unaudited condensed consolidated interim financial statements have been prepared on a going concern basis, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. As shown in these unaudited condensed consolidated interim financial statements, at March 31, 2016, the Company has an accumulated deficit of $9,656,556 and a working capital deficiency of $3,714,554 as well as negative cash flows from operating activities of $737,945 for the three month period ended March 31, 2016. These conditions represent material uncertainty that cast significant doubt about the Company's ability to continue as a going concern. The ability of the Company to continue as a going concern is 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.

The unaudited condensed consolidated interim 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

The Company has no off-balance sheet arrangements.
 
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 May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2014-09, Revenue from Contracts with Customers (“ASU 2014-09”), requiring an entity to recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled to in exchange for those goods or services. ASU 2014-09 will supersede nearly all existing revenue recognition guidance under U.S. GAAP when it becomes effective. In August 2015, the FASB issued ASU No. 2015-14, Revenue from Contracts with Customers, deferring the effective date for ASU 2014-09 by one year, and thus, the new standard will be effective for us beginning on February 1, 2018 with early adoption permitted on or after February 1, 2017. This standard may be adopted using either the full or modified retrospective methods. Management of the Company is currently evaluating adoption methods and the impact of this standard on the consolidated financial statements.

In November 2015, the FASB issued ASU No. 2015-17, Income Taxes (Topic 740): Balance Sheet Classification of Deferred Taxes (“ASU 2015-17”). ASU 2015-17 simplifies the presentation of deferred income taxes by eliminating the separate classification of deferred income tax liabilities and assets into current and noncurrent amounts in the consolidated balance sheet statement of financial position. The amendments in the update require that all deferred tax liabilities and assets be classified as noncurrent in the consolidated balance sheet. The amendments in this update are effective for annual periods beginning after December 15, 2016, and interim periods therein and may be applied either prospectively or retrospectively to all periods presented. Early adoption is permitted. Management of the Company is currently evaluating adoption methods and the impact of this standard on the consolidated financial statements.
 
 
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In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842) (“ASU 2016-02”). ASU 2016-02 requires lessees to recognize all leases with terms in excess of one year on their balance sheet as a right-of-use asset and a lease liability at the commencement date. The new standard also simplifies the accounting for sale and leaseback transactions. The amendments in this update are effective for annual periods beginning after December 15, 2018, and interim periods therein and must be adopted using a modified retrospective method for leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements. Early adoption is permitted. Management of the Company is currently evaluating adoption methods and the impact of this standard on the consolidated financial statements.
 
CRITICAL ACCOUNTING POLICIES

The accompanying unaudited condensed consolidated interim financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and with the instructions to Form 10-Q. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete consolidated financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Interim results are not necessarily indicative of the results that may be expected for a full year. These condensed consolidated interim financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto included in the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2015, as filed with the U.S. Securities and Exchange Commission.
 
The accounting policies of the Company are in accordance with accounting principles generally accepted in the United States of America. Outlined below are those policies considered particularly significant:

Basis of Consolidation

These condensed consolidated interim financial statements include the accounts of the Company and its wholly owned subsidiaries; Gilla Operations, LLC (“Gilla Operations”); E Vapor Labs Inc.; E-Liq World, LLC; Charlie’s Club, Inc. (“Charlie’s Club”); Gilla Enterprises Inc. and its wholly owned subsidiary Gilla Europe Kft.; Gilla Operations Worldwide Limited (“Gilla Worldwide”); Gilla Franchises, LLC and its wholly owned subsidiary Legion of Vape, LLC.; and Snoke Distribution Canada Ltd. and its wholly owned subsidiary Snoke Distribution USA, LLC. All inter-company accounts and transactions have been eliminated in preparing these condensed consolidated interim 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’s Hungarian subsidiary maintains its books in the Hungarian Forint (HUF) 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 period. 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 accumulated other comprehensive income in stockholders' equity. The Company has not, to the date of these condensed consolidated interim financial statements, entered into derivative instruments to offset the impact of foreign currency fluctuations.

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 and cash equivalents, trade receivables, accounts payable, accrued interest, due to related parties, accrued liabilities, customer deposits, promissory notes, convertible debentures, loans from shareholders, and credit facility and term loan. 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:.
 
 
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●  Level 1
 -
Unadjusted quoted prices in active markets for identical assets or liabilities;
●  Level 2
 -
Observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets with insufficient volume or infrequent transactions (less active markets); or model-derived valuations in which all significant inputs are observable or can be derived principally from or corroborated by observable market data for substantially the full term of the assets or liabilities; and
●  Level 3
 -
Inputs that are not based on observable market data.

Cash and cash equivalents is 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.

Advertising Costs

In accordance with ASC 720, the Company expenses the production costs of advertising the first time the advertising takes place. The Company expenses all advertising costs as incurred. During the three month period ended March 31, 2016, the Company expensed $45,110 (March 31, 2015: $46,782) as corporate promotions, these amounts have been recorded as administrative expense.

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 and impairment of property and equipment, impairment of goodwill, accruals, 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.

ITEM 3.                 QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
 
This item is not applicable to smaller reporting companies.
 
ITEM 4.                 DISCLOSURE CONTROLS AND PROCEDURES
 
Evaluation of Disclosure Controls and Procedures

We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our filings with the Securities and Exchange Commission (SEC) is recorded, processed, summarized and reported within the time period specified in the SEC’s rules and forms, and that such information is accumulated and communicated to management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure based on the definition of “disclosure controls and procedures” as defined in Rule 13a-15(e) promulgated under the Securities Exchange Act of 1934, as amended (the “Exchange Act”).
 
As of the end of the period covered by this Report, and under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we evaluated the effectiveness of the design and operation of the Company’s disclosure controls and procedures. Based on this evaluation, we believe that disclosure controls and procedures were not effective as of March 31, 2016, due to our limited resources and staff.
 
Limitations on Effectiveness of Controls and Procedures
 
 
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Our management, including our Chief Executive Officer (Principal Executive Officer) and Chief Financial Officer (Principal Financial Officer), does not expect that our disclosure controls and procedures or our internal controls will prevent all errors and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected. These inherent limitations include, but are not limited to, the realities that judgments in decision-making can be faulty and that breakdowns can occur because of simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the control. The design of any system of controls also is based in part upon certain assumptions about the likelihood of future events and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Over time, controls may become inadequate because of changes in conditions, or the degree of compliance with the policies or procedures may deteriorate. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected.
 
Changes in Internal Controls

During the quarter ended March 31, 2016, there have been no changes in our internal control over financial reporting that have materially affected or are reasonably likely to materially affect our internal controls over financial reporting.
 
PART II - OTHER INFORMATION
 
ITEM 1.                 LEGAL PROCEEDINGS
 
On January 5, 2016, Yaron Elkayam, Pinchas Mamane and Levent Dikmen filed a three count complaint against the Company in the Circuit Court of Hillsborough County, Florida alleging (i) breach of contract, (ii) breach of implied covenant of good faith and fair dealing, and (iii) fraud in the inducement seeking damages in the amount of approximately $900,000 of Promissory Notes issued on July 1, 2015 as a result of the acquisition of E Vapor Labs. On February 23, 2016, the Company filed a motion to dismiss the complaint on the basis of failure to allege sufficient jurisdictional facts and failure to satisfy constitutional due process requirements to exercise jurisdiction. There can be no assurance that the outcome of this complaint would not have a material adverse effect on the business, results of operations and financial condition. The legal proceeding has been brought in Circuit Court of the Thirteenth Judicial Circuit in and for Hillsborough County, State of Florida, Civil Division under the following caption: Yaron Elkayam, Pinchas Mamane, Levent Dikmen, Plaintiffs, v. Gilla, Inc., Case No. 16-CA-0047, Division H, filed January 5, 2016.

ITEM 1A.              RISK FACTORS
 
There have been no material changes in the Company’s risk factors from those disclosed in Part I, Item 1A of our Annual Report on Form 10-K for the fiscal year ended December 31, 2015.
 
ITEM 2.                 UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
 
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, (the “Securities Act”) that have not been previously reported in a Form 8-K, Form 10-Q or Form 10-K, except for the following:

On March 31, 2016, the Company agreed to issue 210,970 Common Shares at $0.142 per Common Share, as a settlement of $30,000 in consulting fees owed to unrelated parties, pursuant to the exemption from the registration requirements of the Securities Act provided by Section 4(2) of the Securities Act or to non-U.S. persons pursuant to the exemption from registration requirements of the Securities Act provided by Regulation S of the Securities Act. These Common Shares remain unissued.

ITEM 3.                 DEFAULTS UPON SENIOR SECURITIES
 
None.
 
ITEM 4.                 MINE SAFETY DISCLOSURES
 
Not applicable.
 
ITEM 5.                 OTHER INFORMATION
 
None.
 
 
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ITEM 6.                 EXHIBITS
 
           
Incorporated by Reference
Exhibit
Number
  
Exhibit Description
  
Filed
Herewith
  
Form
 
Exhibit
 
Filing Date
               
31.1
 
Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
 
X
           
                     
31.2
 
Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
 
X
           
                     
32.1
 
Certification of Chief Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.*
 
X
           
                     
32.2
 
Certifications of Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.*
 
X
           
                     
101.INS
 
XBRL Instance Document
 
X
           
                     
101.SCH
 
XBRL Taxonomy Extension Schema
 
X
           
                     
101.CAL
 
XBRL Taxonomy Extension Calculation Linkbase
 
X
           
                     
101.DEF
 
XBRL Taxonomy Definition Linkbase
 
X
           
                     
101.LAB
 
XBRL Taxonomy Extension label Linkbase
 
X
           
                     
101.PRE
 
XBRL Taxonomy Extension Presentation Linkbase
 
X
           

* This certification is deemed not filed for purposes of Section 18 of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), or otherwise subject to the liability of that section, nor shall it be deemed incorporated by reference into any filing under the Securities Act or the Exchange Act.
 
 
38

 

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized.
 
 
 
GILLA INC.
 
(Registrant)
     
May 16, 2016
By:
/s/ J. Graham Simmonds
   
Name:   J. Graham Simmonds
   
Title:     Chief Executive Officer and Director
 
 
 
May 16, 2016
By:
/s/ Ashish Kapoor
   
Name:    Ashish Kapoor
   
Title:      Chief Financial Officer and
               Chief Accounting Officer

 
 
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