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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

____________________________

FORM 10-Q

 

☒ QUARTERLY REPORT UNDER SECTION 13 OR 15(D) OF THE SECURITIES

EXCHANGE ACT OF 1934

For the Quarterly Period Ended June 30, 2017

OR

☐ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

                               FOR THE TRANSITION PERIOD FROM _______________________ TO _______________________

 

Commission File # 000-55208

 

KONARED CORPORATION

 (Exact name of registrant as specified in its charter)

 

NEVADA

(State or other jurisdiction of incorporation or organization)

 

99-0366971

(IRS Employer Identification Number)

 

1101 Via Callejon #200

San Clemente, California 92673-4230
(Address of principal executive offices)    (Zip Code)

 

Tel. (808) 212-1553

 (Registrant's telephone no., including area code)

Indicate by check mark whether the registrant (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 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.   Yes ☒   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 (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).   Yes ☒   No ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated file, or a smaller reporting company.

 

	Large accelerated filer	☐	Accelerated filer	☐
	Non-accelerated filer	☐	Smaller reporting company	☒

 

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

 

The issuer had 186,984,979 shares of common stock issued and outstanding as of August 17, 2017.

 

 

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KONARED CORPORATION

Table of Contents

 

 

 

PART I – FINANCIAL INFORMATION

 

ITEM 1.  FINANCIAL STATEMENTS (unaudited)

KONARED CORPORATION

BALANCE SHEETS

 

 

The accompanying notes to financial statements are an integral part of these financial statements

 

KONARED CORPORATION

STATEMENTS OF OPERATIONS

(Unaudited)

 

 

The accompanying notes to financial statements are an integral part of these financial statements

 

KONARED CORPORATION

STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (DEFICIT)

(Unaudited)

 

The accompanying notes to financial statements are an integral part of these financial statements

 

KONARED CORPORATION

STATEMENTS OF CASH FLOWS

(Unaudited)

 

 

The accompanying notes to financial statements are an integral part of these financial statements

 

KONARED CORPORATION

 

SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION

(Unaudited)

NON CASH INVESTING AND FINANCING ACTIVITIES

(Unaudited)

 

The accompanying notes to financial statements are an integral part of these financial statements

 

KONARED CORPORATION

NOTES TO FINANCIAL STATEMENTS

(Unaudited)

NOTE 1 – Nature of Organization

KonaRed Corporation ("KonaRed", "KonaRed Corporation", "us", "we", the "Registrant", or the "Company") was incorporated in the State of Nevada on October 4, 2010 as TeamUpSport Inc. Prior to, and in anticipation of, closing of an asset purchase agreement (the "Asset Agreement") with Sandwich Isles Trading Co, Inc., on September 9, 2013 our company effected a name change by merging with our wholly-owned Nevada subsidiary named "KonaRed Corporation" with our company as the surviving corporation under the new name "KonaRed Corporation". On October 4, 2013 pursuant to the terms the Asset Agreement, we acquired substantially all of the assets, property and undertaking of the health beverage and food business (the "Business") operated under the name "KonaRed" from Sandwich Isles Trading Co., Inc. ("SITC") which was a private company incorporated in Hawaii on August 22, 2008 and dissolved on May 23, 2014. As a result of October 4, 2013 acquisition of the Business from Sandwich Isles Trading Co., Inc. ("SITC") we ceased to be a "shell company" as defined in Rule 12b-2 of the Securities Exchange Act of 1934 (the "Exchange Act").

NOTE 2 – Basis of Presentation and Summary of Significant Accounting Policies

These financial statements have been presented by the Company in accordance with accounting principles generally accepted in the United States and are expressed in U.S. dollars. The Company's fiscal year-end is December 31st.

The preparation of these financial statements in accordance with United States generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses in the reporting period. The Company regularly evaluates estimates and assumptions related to recoverability of long-lived assets, and deferred income tax asset valuations. The Company bases its estimates and assumptions on current facts, historical experience and various other factors that it believes to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities and the accrual of costs and expenses that are not readily apparent from other sources. The actual results experienced by the Company may differ materially and adversely from the Company's estimates. To the extent there are material differences between estimates and the actual results, future results of operations will be affected.

The Company's financial instruments consist principally of cash, accounts receivable, inventory, accounts payable, notes payable and related party debt. The Company believes that the recorded values of all of these financial instruments approximate their current fair values because of the short term nature and respective maturity dates or durations.

The Company considers all highly liquid instruments with maturity of three months or less at the time of issuance to be cash equivalents. There were no cash equivalents recorded for the periods ended June 30, 2017 and December 31, 2016.

 

KONARED CORPORATION

NOTES TO FINANCIAL STATEMENTS

(Unaudited)

NOTE 2 – Basis of Presentation and Summary of Significant Accounting Policies (continued)

Revenue from customer purchase agreements is recorded as unearned revenue and amortized over the term of the agreements. At June 30, 2017 and December 31, 2016, unearned revenues were $172,986 and $193,020 respectively. Unearned revenue is comprised of the unamortized portion of a $200,000 cash payment we received during the year ended December 31, 2016 for a non-refundable signing fee from a strategic supplier partnership arrangement; and for online subscriptions wherein we ship a scheduled amount of product to online retail subscribers each month.

Trade accounts receivable are periodically evaluated for collectability based on past credit history with customers and their current financial condition. Bad debts expense or write offs of receivables are determined on the basis of loss experience, known and inherent risks in the receivable portfolio and current economic conditions. During the periods ended June 30, 2017 and June 30, 2016, the Company wrote off accounts receivable totaling $0 and $172, respectively. There were no allowances for doubtful accounts recorded for the period ended June 30, 2017 or the year ended December 31, 2016.

 

Inventories are composed of raw materials and finished goods. Our raw materials inventory is comprised of dried coffee fruit and other input components, such as labels, caps, and packaging materials. Our finished goods inventory process begins when we take possession of dried coffee fruit from coffee growers in Hawaii. We then ship the raw material to our California warehouse for storage and then send required quantities to subcontractors for value-added processing; or we ship the raw materials directly from Hawaii to the processors. For our beverage products which include coffee fruit, value-added processing then occurs whereby the dried coffee fruit is converted to liquid extract through water based extraction. The extracts are then shipped from the raw materials processors to our California warehouse or directly to our bottling contractors. The bottling contractors then add our proprietary extract to other ingredients to produce our finished goods. Our cold brew coffee is manufactured using a comparable process. Finished goods are shipped back to either our Company's warehouse or third party transit agents and subsequently disseminated to either distributors or shipped directly to retailers. The process for production of our nutritional wellness products follows a similar manufacturing chain, but does not involve a bottling process.

Inventories are valued at the lower of cost, as determined on an average basis, or market. Market value is determined by reference to selling prices at, or around, balance sheet date or by management's estimates based on prevailing market conditions. Management writes down the inventories to market value if it is below cost. Management also regularly evaluates the composition of its inventories to identify slow-moving and obsolete inventories to determine if a valuation allowance is required. If a valuation allowance is required, an offsetting entry is made which expenses the reserved inventory to cost of goods sold during the period in which the valuation was required. Subsequently, if this reserved inventory is used in future periods, an offset is entered to cost of goods sold which decreases cost of goods sold during that subsequent period. Costs of raw material and finished goods inventories include purchase and related costs incurred in bringing the products to their present location and condition. Labor, direct and indirect overhead, and the processing, bottling and shipping costs incurred during 3^rd party manufacturing are factored into the costs of our inventories.

 

KONARED CORPORATION

NOTES TO FINANCIAL STATEMENTS

(Unaudited)

NOTE 2 – Basis of Presentation and Summary of Significant Accounting Policies (continued)

Sales revenue consists of amounts earned from customers through the sales of its finished products via wholesale and direct online retail channels. The Company also operates a branded ingredients division that sells raw material fruit powder and extracts to wholesale customers. Sales revenue is recognized when persuasive evidence of an arrangement exists, price is fixed or determinable, title to and risk of loss for the product has passed, which is generally when the products are received by the customers, and collectability is reasonably assured. Customers accept goods FOB shipping point. Goods are sold on a final sale basis and in the normal course of business the Company does not accept sales returns. In circumstances where returns are negotiated, sales returns which are accepted are returned to inventory and deducted from sales revenue.

Cost of goods sold ('COGS') primarily consist of raw materials purchases and third party processing costs. COGS also include: warehousing and distribution costs for inbound freight charges; shipping and handling costs; purchasing and receiving costs; costs for our labor; direct and indirect overhead costs; and the processing, bottling and shipping costs charged by 3^rd party manufacturers.

In accordance with guidance provided in EITF Abstracts Issue No. 00-10 'Accounting for Shipping and Handling Fees and Costs', the Company records costs for products shipped to customers within general and administrative expenses, rather than within COGS. Prior to the year ended December 31, 2016, these costs were included within COGS and COGS for the period ended June 30, 2016 shown in these financial statements were adjusted to reflect the change in accounting policy for fiscal 2016. During the periods ended June 30, 2017 and June 30, 2016, customer shipping expenses totaled $136,773 and $0 respectively.

In accordance with ASC 740 - Income Taxes, the provision for income taxes is computed using the asset and liability method. Under the asset and liability method, deferred income tax assets and liabilities are determined based on the differences between the financial reporting and tax bases of assets and liabilities and are measured using the currently enacted tax rates and laws. A valuation allowance is provided for the amount of deferred tax assets that, based on available evidence, are not expected to be realized.

The Company also follows the guidance related to accounting for income tax uncertainties. In accounting for uncertainty in income taxes, the Company recognizes the financial statement benefit of a tax position only after determining that the relevant tax authority would more likely than not sustain the position following an audit. For tax positions meeting the more likely than not threshold, the amount recognized in these financial statements is the benefit that has a greater than 50% likelihood of being realized upon ultimate settlement with the relevant tax authority.

No liability for unrecognized tax benefits was recorded as of June 30, 2017 and December 31, 2016.

We account for share-based awards to employees in accordance with ASC 718 "Stock Compensation". Under this guidance, stock compensation expense is measured at the grant date, based on the fair value of the award, and is recognized as an expense over the estimated service period (generally the vesting period) on the straight-line attribute method. Share-based awards to non-employees are accounted for in accordance with ASC 505-50 "Equity", wherein such awards are expensed over the period in which the related services are rendered.

 

 

KONARED CORPORATION

NOTES TO FINANCIAL STATEMENTS

(Unaudited)

NOTE 2 – Basis of Presentation and Summary of Significant Accounting Policies (continued)

In accordance with ASC 820–10–35–37 Fair Value in Financial Instruments; ASC 815 Accounting for

Derivative Instruments and Hedging Activities; and ASC 815–40 (formerly Emerging Issues Task Force ("EITF") Issue No. 00–19 and EITF 07–05), the Company evaluates its financial instruments to determine if such instruments are derivatives or contain features that qualify as embedded derivatives. For derivative financial instruments that are accounted for as liabilities, the derivative instrument is initially recorded at its fair value and is then re-valued at each reporting date, with changes in the fair value reported in the statements of operations.

As of June 30, 2017, the Company had outstanding a senior convertible note (the "VDF Note") with a balance of $1,088,265, net of a discount of $16,786. At June 30, 2017 the VDF Note had an embedded derivative valued at $11,649. As of December 31, 2016, the VDF Note had a balance of $869,674 net of a discount of $16,786 and the embedded derivative liability was valued at $11,649. During the period ended June 30, 2017, $237,072 of principal was accrued to the VDF Note. This was comprised of a patent license fee of $200,000 and accrued interest of $37,072. The net amount of the Change in Fair Value of Derivatives for the period ended June 30, 2017 was $nil.

There are no embedded derivatives in any other notes issued by the Company.

Costs incurred in developing the ability to create and manufacture products for sale are included in research and development. Once a product is commercially feasible and starts to sell to third party customers, the classification of such costs as development costs stops and such costs are recorded as costs of production, which are included in cost of goods sold. Research and development costs are expensed when incurred.

The Company computes loss per share in accordance with ASC 260, Earnings per Share. ASC 260 requires presentation of both basic and diluted earnings per share ("EPS") on the face of the income statement. Basic EPS is computed by dividing net loss available to common shareholders (numerator) by the weighted average number of common shares outstanding (denominator) during the period. Diluted EPS gives effect to all dilutive potential common shares outstanding during the period including stock warrants and options, using the treasury stock method; and convertible preferred stock and convertible debt using the if-converted method. In computing diluted EPS, the average stock price for the period is used in determining the number of shares assumed to be purchased from the exercise of stock options or warrants. Diluted EPS excludes all dilutive potential common shares if their effect is anti-dilutive. The Company currently has options, warrants and convertible debt outstanding, and no convertible preferred stock has been issued. Common stock equivalents pertaining to the options, warrants and convertible debt were not included in the computation of diluted net loss per common share in these financial statements because the effect would have been anti-dilutive due to the net losses for the periods ended June 30, 2017 and June 30, 2016.

 

 

KONARED CORPORATION

NOTES TO FINANCIAL STATEMENTS

(Unaudited)

NOTE 2 – Basis of Presentation and Summary of Significant Accounting Policies (continued)

Financial instruments which potentially subject the Company to concentrations of credit risk consist of cash and trade receivables. The Company places its cash with high credit quality financial institutions. At times, such cash may be in excess of the FDIC limit. With respect to trade receivables, the Company routinely assesses the financial strength of its customers and, as a consequence, believes that the receivable credit risk exposure is limited.

A party is considered to be related to the Company if the party directly or indirectly or through one or more intermediaries, controls, is controlled by, or is under common control with the Company. Related parties also include principal owners of the Company, its management, members of the immediate families of principal owners of the Company and its management and other parties with which the Company may deal if one party controls or can significantly influence the management or operating policies of the other to an extent that one of the transacting parties might be prevented from fully pursuing its own separate interests. A party which can significantly influence the management or operating policies of the transacting parties or if it has an ownership interest in one of the transacting parties and can significantly influence the other to an extent that one or more of the transacting parties might be prevented from fully pursuing its own separate interests is also a related party.

As defined in ASC 820 "Fair Value Measurements", fair value is 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 (exit price). The Company utilizes market data or assumptions that market participants would use in pricing the asset or liability, including assumptions about risk and the risks inherent in the inputs to the valuation technique. These inputs can be readily observable, market corroborated, or generally unobservable. The Company classifies fair value balances based on the observability of those inputs. ASC 820 establishes a fair value hierarchy that prioritizes the inputs used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (level 1 measurement) and the lowest priority to unobservable inputs (level 3 measurement).

The three levels of the fair value hierarchy defined by ASC 820 are as follows:

Level 1 – Quoted prices are available in active markets for identical assets or liabilities as of the reporting date. Active markets are those in which transactions for the asset or liability occur in sufficient frequency and volume to provide pricing information on an ongoing basis. Level 1 primarily consists of financial instruments such as exchange-traded derivatives, marketable securities and listed equities.

Level 2 – Pricing inputs are other than quoted prices in active markets included in level 1, which are either directly or indirectly observable as of the reported date. Level 2 includes those financial instruments that are valued using models or other valuation methodologies. These models are primarily industry standard models that consider various assumptions, including quoted forward prices for commodities, time value, volatility factors, and current market and contractual prices for the underlying instruments, as well as other relevant economic measures. Substantially all of these assumptions are observable in the marketplace throughout the full term of the instrument, can be derived from observable data or are supported by observable levels at which transactions are executed in the marketplace. Instruments in this category generally include non-exchange-traded derivatives such as commodity swaps, interest rate swaps, options and collars.

 

KONARED CORPORATION

NOTES TO FINANCIAL STATEMENTS

(Unaudited)

NOTE 2 – Basis of Presentation and Summary of Significant Accounting Policies (continued)

 

Level 3 – Pricing inputs include significant inputs that are generally less observable from objective sources. These inputs may be used with internally developed methodologies that result in management's best estimate of fair value.

The Company's Level 1 assets and liabilities consist of cash, accounts receivable, accounts receivable - related party, inventories net, of any inventory allowance, accounts payable and accrued liabilities, short term debt, net of discounts, long term convertible note, net of discount, and unearned revenue. Pursuant to ASC 820, the fair value of these assets and liabilities is determined based on Level 1 inputs, which consist of quoted prices in active markets for identical assets. Level 2 assets and liabilities consist of a derivative liability arising from a convertible note payable. Pursuant to ASC 820, the fair value of this liability is determined based on Level 2 inputs, which consisted of a valuation by an accredited third party expert. We do not currently have any assets or liabilities which are classified under the criterion of Level 3.

It is management's opinion that the Company is not exposed to significant interest, currency or credit risks arising from the financial instruments which it holds.

 

KONARED CORPORATION

NOTES TO FINANCIAL STATEMENTS

(Unaudited)

NOTE 2 – Basis of Presentation and Summary of Significant Accounting Policies (continued)

Costs for advertising are expensed when incurred. Advertising and marketing costs totaled $244,497 and $157,673 for the six months ended June 30, 2017 and June 30, 2016, respectively. Costs for product promotion and investor relations are included with advertising to form advertising and marketing expenses. When these other costs are excluded, advertising comprised $171,177 and $137,568 for the periods ended June 30, 2017 and June 30, 2016, respectively.

Fixed assets are recorded at cost. Depreciation is calculated on a straight line method over the estimated useful lives of the various assets as follows:

During the six month periods ended June 30, 2017 and June 30, 2016: (a) depreciation for furniture and equipment of $1,048 and $1,048 was respectively recorded; and (b) depreciation for warehouse fixtures of $174 and $174 was respectively recorded. Accumulated depreciation for all fixed assets totaled $8,093 at June 30, 2017.

Maintenance and repairs are expensed as incurred while renewals and betterments are capitalized.

Maintenance and repairs will be expensed as incurred while renewals and betterments will be capitalized.

In April 2016, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ('ASU') No. 2016-15 ' Statement of Cash Flows (Topic 230) - Classification of Certain Cash Receipts and Cash Payments because stakeholders had indicated that there is diversity in practice in how certain cash

receipts and cash payments are presented and classified in the statement of cash flows under Topic 230, Statement of Cash Flows, and other Topics. This Update addresses eight specific cash flow issues with the objective of reducing the existing diversity in practice. The amendments in this Update apply to all entities, including both business entities and not-for-profit entities that are required to present a statement of cash flows under Topic 230. Among the eight issues, there were two which appeared germane to the Company: (i) Debt Prepayment or Debt Extinguishment Costs, which provided guidance that Cash payments for debt prepayment or debt extinguishment costs should be classified as cash outflows for financing activities; and (ii) Separately Identifiable Cash Flows and Application of the Predominance Principle, which provided guidance that the classification of cash receipts and payments that have aspects of more than one class of cash flows should be determined first by applying specific guidance in generally accepted accounting principles (GAAP). In the absence of specific guidance, an entity should determine each separately identifiable source or use within the cash receipts and cash payments on the basis of the nature of the underlying cash flows. An entity should then classify each separately identifiable source or use within the cash receipts and payments on the basis of their nature in financing, investing, or operating activities. In situations in which cash receipts and payments have aspects of more than one class of cash flows and cannot be separated by source or use, the appropriate classification should depend on the activity that is likely to be the predominant source or use of cash flows for the item.

 

 

 

KONARED CORPORATION

NOTES TO FINANCIAL STATEMENTS

(Unaudited)

NOTE 2 – Basis of Presentation and Summary of Significant Accounting Policies (continued)

The amendments in this Update are effective for public business entities for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years. For all other entities, the amendments are effective for fiscal years beginning after December 15, 2018, and interim periods within fiscal years beginning after December 15, 2019. Early adoption is permitted, including adoption in an interim period. If an entity early adopts the amendments in an interim period, any adjustments should be reflected as of the beginning of the fiscal year that includes that interim period. An entity that elects early adoption must adopt all of the amendments in the same period. This ASU conforms with the Company's current protocols and the Company expects to adopt this ASU once it becomes effective. The Company does not expect the adoption of the ASU to have a significant impact on our consolidated financial statements.

In April 2016, FASB issued ASU No. 2016-10 'Revenue from Contracts with Customers (Topic 606). This follows the May 28, 2014, FASB and the International Accounting Standards Board (IASB) issuance of a converged standard on recognition of revenue from contracts with customers. The amendments in this Update affect entities with transactions included within the scope of Topic 606. The scope of that Topic includes entities that enter into contracts with customers to transfer goods or services (that are an output of the entity's ordinary activities) in exchange for consideration. The core principle of the guidance in Topic 606 is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The amendments in this Update affect the guidance in Accounting Standards Update 2014-09, Revenue from Contracts with Customers (Topic 606), which is not yet effective. The effective date and transition requirements for the amendments in this Update are the same as the effective date and transition requirements in Topic 606 (and any other Topic amended by Update 2014-09). Accounting Standards Update 2015-14, Revenue from Contracts with Customers (Topic 606): Deferral of the Effective Date, defers the effective date of Update 2014-09 by one year. The Company will evaluate this standard and may implement adoption of once the standard becomes effective. The Company does not expect the adoption of the standard to have a significant impact on our financial statements.

Management does not anticipate that the adoption of these standards will have a material impact on the financial statements.

The Company has implemented all new accounting pronouncements that are in effect and that may impact its financial statements and does not believe that there are any other new pronouncements that have been issued that might have a material impact on its financial position or results of operations.

 

 

KONARED CORPORATION

NOTES TO FINANCIAL STATEMENTS

(Unaudited)

NOTE 3 – Going Concern

The accompanying financial statements have been prepared on a going concern basis, which contemplates the realization of assets and satisfaction of liabilities in the normal course of business. Since inception, the Company has incurred losses totaling $25,741,455 as of June 30, 2017 and has a incurred a net loss for the three months ended June 30, 2017 of $1,248,625. These factors, among others, raise substantial doubt about the Company's ability to continue as a going concern for a reasonable period of time. As needed, the Company will pursue additional equity and/or debt financing while managing cash flows from operations in an effort to provide funds to meet its obligations on a timely basis and to support future business development. The financial statements do not contain any adjustments to reflect the possible future effects on the classification of assets or the amounts and classification of liabilities that may result should the Company be unable to continue as a going concern. To address these issues, during the six months ended June 30, 2017, the Company raised $748,968 from private placement equity offerings, and benefited from conversion of $410,896 of debt into equity. We anticipate we will continue to raise funds through private placement equity sales in the near future.

NOTE 4 – Inventory

 

Inventory includes raw materials and finished goods. Finished goods contain direct materials and other manufacturing costs charged directly by third party manufacturing vendors. Inventory consists of the following:

During the period ended June 30, 2017 and the year ended December 31, 2016, the Company wrote down inventory by $17,351 and $24,769, respectively, to account for expired inventory which had been written-off and disposed of, and for minor manufacturing process shrinkages. The Company recognized $nil and $nil recovery in inventory allowance respectively for the period ended June 30, 2017 and the year ended December 31, 2016. At June 30, 2017 the Company had $nil of reserved inventory and all inventory was valued at full cost.

NOTE 5 – Fixed Assets

Fixed assets at June 30, 2017 and December 31, 2016 respectively comprised: (a) furniture and equipment totaling $4,495 and $5,543, net of accumulated depreciation of $6,707 and $5,659; and (b) warehouse fixtures totaling $2,086 and $2,260, net of accumulated depreciation of $1,386 and $1,212.

 

KONARED CORPORATION

NOTES TO FINANCIAL STATEMENTS

(Unaudited)

NOTE 6 – Amortization of License Fee

During the year ended December 31, 2016, unearned revenue included a cash payment we received for a non-refundable signing fee of $200,000 from a strategic supplier partnership arrangement (the "FP Agreement"). The FP Agreement was executed on October 28, 2016 and because this was included in a license fee agreement, to conform with generally accepted accounting principles it is recorded as unearned revenue which is to be amortized over the five year life of the agreement.

Revenue amortizations under the FP License agreement have been, and will be, recorded as income based on the following schedule:

NOTE 7 – Short Term Debt, Short Term Debt - Related Party & Short Term Convertible Notes

September 2015 Notes:

At June 30, 2017, the balances on the September 2015 Notes were $nil and both notes were fully repaid.

On September 30, 2015, we issued two subordinated promissory notes ("September 2015 Note One" and "September 2015 Note Two", collectively, the "September 2015 Notes") to two lenders (the "September 2015 Lenders"). The September 2015 Notes included customary default provisions, were not secured and were subordinated to senior notes issued by the Company. September 2015 Note One had a face value of $100,000 and September 2015 Note Two had a face value of $150,000. The interest rate on each note was 8% per annum and this amount fully accrued upon issuance and added $8,000 to September 2015 Note One and $12,000 to September 2015 Note Two to bring the total balances due on each note to $108,000 and $162,000, respectively. The September 2015 Notes each included a 10% original issuance discount ("OID") which resulted in total net proceeds to the Company of $225,000. As an inducement for the loans, on September 30, 2015 the September 2015 Lenders received five‑year warrants, with cashless exercise rights, to purchase restricted shares of our common stock at an exercise price of $0.08 per share. September 2015 Note One Lender received 1,250,000 warrants which was valued using a Black-Scholes model at $67,115; and September 2015 Note Two Lender received 1,875,000 warrants which were valued using a Black-Scholes model at non-cash cost of $100,673.

 

KONARED CORPORATION

NOTES TO FINANCIAL STATEMENTS

(Unaudited)

NOTE 7 – Short Term Debt, Short Term Debt - Related Party & Short Term Convertible Notes (continued)

During the six months ended June 30, 2017, the holder of September 2015 Note Two converted the remaining balance of $65,000 due on the note into 1,625,000 shares valued at $128,463 based on a market close prices on dates of issuance. The conversions resulted in a $63,463 difference between the cash redemption balance and the value of the shares redemption which was treated as a conversion loss and recorded as an additional non-cash interest expense. Concurrent with the conversions, the remaining $16,527 of the warrant discount on September 2015 Note Two was recorded as an amortization expense and the remaining $8,062 OID was recorded as interest expense.

During the year ended December 31, 2016, the Company timely met a series of scheduled cash payments on September 2015 Note One totaling $49,000 and on August 30, 2016 redeemed the balance of $59,000 due through issuance of 1,475,000 shares valued at $95,875 based on a market close price on date of issuance. The $36,875 difference between the cash redemption balance and the value of the shares redemption was treated as a conversion loss and recorded as an additional non-cash interest expense. At time of redemption on August 30, 2016 the remaining $50,245 of the warrant discount on September 2015 Note One was recorded as an amortization expense and the remaining $7,486 OID was recorded as interest expense.

December 2015 Note:

At June 30, 2017, the balance on the December 2015 Note was $nil and the note was fully repaid.

On December 3, 2015, we issued a subordinated promissory note (the "December 2015 Note") to one lender (the "December 2015 Lender") in the aggregate amount of $110,000 (the "Original Principal"). The December 2015 Note bears interest at 8% per annum and this amount fully accrued upon execution of the loan and added $8,800 to the balance due at issuance date. The principal and interest was due and payable in full on December 3, 2016 ("Maturity Date") and had a re-payment schedule which required payments of $39,600 respectively on sixth, ninth and twelfth month anniversary dates of issuance. The December 2015 Notes included an aggregate $10,000 original issuance discount ("OID") which resulted in net proceeds of $100,000. The December 2015 Note provides for customary events of default was not secured, and was subordinated to senior notes issued by the Company and ranked equally with other debt issued by the Company. As an inducement for the loan, the Company issued the December 2015 Lender 500,000 restricted common shares valued at a non-cash cost of $30,050. During the six months ended June 30, 2017, the holder of December 2015 Note converted the remaining balance of $39,600 due on the note into 990,000 shares valued at $61,578 based on a market close price on date of issuance. The conversion resulted in a $21,978 difference between the cash redemption balance and the value of the shares redemption which was treated as a conversion loss and recorded as an additional non-cash interest expense. Concurrent with the conversion, the remaining $6,340 of the BCF discount on the December 2015 Note was recorded as an amortization expense and the remaining $1,179 OID was recorded as interest expense.

At December 31, 2016, the balance on the December 2015 Note was $32,081. This included the remaining face value and accrued interest totaling $39,600, net of an unamortized BCF discount of $6,340 and an unamortized OID discount of $1,179. During the year ended December 31, 2016, the Company timely met two scheduled cash payments totaling $79,200 and, prior to scheduled redemption date, on December 2, 2016 the lender extended the maturity date of the note to March 7, 2016 in exchange for 300,000 shares of the Company and the right to convert the balance of $39,600 into common shares of the Company at a price of $0.04 per share. On December 2, 2016, the Company's closing share price was $0.05 which created a BCF valued at $9,405 and a non-cash cost for the shares issuance of $15,000.

 

 

 

KONARED CORPORATION

NOTES TO FINANCIAL STATEMENTS

(Unaudited)

NOTE 7 – Short Term Debt, Short Term Debt - Related Party & Short Term Convertible Notes (continued)

LPC Note One:

On August 18, 2015, we issued a Senior Convertible Note ("LPC Note One") to a third party ("LPC") in the amount of $250,000. LPC Note One was issued pursuant to the terms of a Securities Purchase Agreement and bears interest at the rate of 5% per annum (or 18% upon the occurrence of an event of default). Principal and interest was originally due and payable in full on December 31, 2016 and LPC Note One. Interest may be paid via issuance of the Company's common stock if the Company meets certain conditions that would allow the issuance of the Company's common stock without any trading restrictions. LPC Note One has a $25,000 original issuance discount ("OID") which resulted in net proceeds of $225,000. The Company has the right to prepay LPC Note One, pursuant to the terms thereof, at any time, provided it pays a prepayment amount of 120% of the then outstanding balance, accrued interest and interest payable from the date of prepayment to the Maturity Date. LPC Note One provides for customary events of default such as failing to timely make payments and the occurrence of certain fundamental defaults, as described in LPC Note One. LPC Note One is not secured and is subordinated to the VDF Note, ranks equally with LPC Note Two, and ranks above other debt issued by the Company. The principal amount of LPC Note One and all accrued interest is convertible at the option of LPC into shares of our common stock at any time at a fixed Conversion Price of $0.07 per share, subject to adjustments for stock splits, stock dividends, stock combinations or other similar transactions as provided in LPC Note One. At no time may LPC Note One be converted into shares of our common stock if such conversion would result in LPC and its affiliates owning an aggregate of shares of our common stock in excess of 4.99% of the then outstanding shares of our common stock, provided such percentage may increase to 9.99% upon not less than 61 days prior written notice. As an inducement for the loan, on August 18, 2015 the Company granted LPC 3,750,000 six year warrants, which includes a cashless exercise provision, to purchase 3,750,000 restricted shares of our common stock at an exercise price of $0.10 per share which was valued using a Black-Scholes model at a non-cash cost of $277,014. At August 18, 2015, LPC Note One also included a BCF of $107,143 because the exercise price of LPC Note One was set below the market price of our stock when the note was executed. Since the combined warrant discount and BCF exceeded the face value of the note less OID, the warrant discount for LPC Note One was capped at $117,857, resulting in a total discount of $225,000. On December 16, 2016, prior to the scheduled redemption dates, LPC extended the maturities of each of its two notes from December 31, 2016 to December 31, 2017 in return for issuance by the Company of 7,000,000 six year warrants, with cashless exercise rights, to purchase 7,000,000 restricted shares of our common stock at an exercise price of $0.05 per share. The warrants were valued using a Black-Scholes model at a non-cash cost of $315,658, of which $143,481 was ascribed as an increase to the discount of LPC Note One and $172,177 was ascribed as an increase to the discount of LPC Note Two.

At June 30, 2017, the recorded balance on LPC Note One was $161,455 which included the remaining face value of $250,000 plus $3,160 accrued interest for the three months ended June 30, 2017, net of unamortized warrant and BCF discounts totaling $89,482 and an unamortized OID discount of $2,223. At December 31, 2016, the recorded balance on LPC Note One was $68,086 which included the remaining face value of 250,000, net of an unamortized warrant and BCF discounts totaling $177,505 and an unamortized OID discount of $4,409. During the six month periods ended June 30, 2017 and June 30, 2016, $88,023 and $81,736, respectively, of the BCF and warrant discounts were recorded as amortization expenses, and $2,186 and $9,082, respectively, of the OID amortization was recorded as interest expenses.

 

 

KONARED CORPORATION

NOTES TO FINANCIAL STATEMENTS

(Unaudited)

NOTE 7 – Short Term Debt, Short Term Debt - Related Party & Short Term Convertible Notes (continued)

LPC Note Two:

On November 23, 2015, we issued a Senior Convertible Note ("LPC Note Two") to LPC in the amount of $300,000. LPC Note Two was issued pursuant to the terms of a Securities Purchase Agreement and bears interest at the rate of 5% per annum (or 18% upon the occurrence of an event of default). Principal and interest was originally due and payable in full on December 31, 2016. Interest may be paid via issuance of the Company's common stock if the Company meets certain conditions that would allow the issuance of the Company's common stock without any trading restrictions. LPC Note Two has a $30,000 OID which resulted in net proceeds of $270,000. The Company has the right to prepay LPC Note Two, pursuant to the terms thereof, at any time, provided it pays a prepayment amount of 120% of the then outstanding balance, accrued interest and interest payable from the date of prepayment to the Maturity Date. LPC Note Two provides for customary events of default such as failing to timely make payments and the occurrence of certain fundamental defaults, as described in LPC Note Two. LPC Note Two is not secured and is subordinated to the VDF Note, ranked equally with LPC Note One, and ranks above other debt issued by the Company. The principal amount of LPC Note Two and all accrued interest is convertible at the option of LPC into shares of our common stock at any time at a fixed Conversion Price of $0.05 per share, subject to adjustments for stock splits, stock dividends, stock combinations or other similar transactions as provided in LPC Note Two. At no time may LPC Note Two be converted into shares of our common stock if such conversion would result in LPC and its affiliates owning an aggregate of shares of our common stock in excess of 4.99% of the then outstanding shares of our common stock, provided such percentage may increase to 9.99% upon not less than 61 days prior written notice. On November 23, 2015, as an inducement for the loan the Company granted LPC 5,000,000 six year warrants, which includes a cashless exercise provision, to purchase 5,000,000 shares of our restricted common stock at an exercise price of $0.07 per share which was valued using a Black-Scholes model at a cost of $253,098. At November 23, 2015, LPC Note Two also included a BCF of $102,600 because the exercise price of LPC Note Two was set below the market price of our stock when the note was executed. Since the combined warrant discount and BCF exceeded the face value of the note less OID, the warrant discount for LPC Note Two was capped at $167,400, resulting in a total discount of $270,000. On December 16, 2016, prior to the scheduled redemption dates, LPC extended the maturities of each of its two notes from December 31, 2016 to December 31, 2017 in return for issuance by the Company of 7,000,000 six year warrants, with cashless exercise rights, to purchase 7,000,000 restricted shares of our common stock at an exercise price of $0.05 per share. The warrants were valued using a Black-Scholes model at a non-cash cost of $315,658, of which $143,481 was ascribed as an increase to the discount of LPC Note One and $172,177 was ascribed as an increase to the discount of LPC Note Two.

During the six month period ended June 30, 2017, LPC converted $300,000 principal and $3,060 accrued interest due on the note into 6,105,843 shares valued at $405,361 based on market close prices on dates of issuance. The conversions resulted in a $99,064 difference between the cash redemption balance and the value of the shares redemption which was treated as a conversion loss and recorded as an additional non-cash interest expense. Concurrent with the conversions, $210,745 of the warrant discount was recorded as an amortization expense and $6,162 OID was recorded as interest expense. For the six month period ended June 30, 2017, excluding the conversion amortization adjustments, $13,693 of the remaining warrant discount was recorded as amortization expense and $400 of the remaining OID was recorded as interest expense. For the six month period ended June 30, 2016, $121,634 of the warrant discount was recorded as amortization expense and $13,514 of the OID was recorded as interest expense.

 

 

KONARED CORPORATION

NOTES TO FINANCIAL STATEMENTS

(Unaudited)

NOTE 7 – Short Term Debt, Short Term Debt - Related Party & Short Term Convertible Notes (continued)

At June 30, 2017, the recorded balance on LPC Note Two was $nil and the note was fully repaid. At December 31, 2016, the recorded balance on LPC Note Two was $69,000. This included the remaining face value of $300,000, net of an unamortized discount of $224,438 and an unamortized OID of $6,562.

RP Note:

On July 31, 2016, the Company issued a $100,000 note (the "RP Note") to a director of the Company for a loan. The RP Note had an original maturity date of January 27, 2017 and is classified as short term related party debt. The RP Note bears interest at 8% per annum due at maturity and may be prepaid in whole, or in part, at any time before each maturity date without prepayment penalty. As an inducement for the loan, the Company issued 340,000 restricted common shares to the lender at a non-cash cost of $15,504 valued at market close price on date of issue. At December 31, 2016, the balance due on the RP Note was $103,353 including $3,353 of accrued interest for the year ended December 31, 2016. On January 27, 2017, the lender extended the maturity of the RP Note to July 27, 2017 in return for 340,000 restricted common shares valued at $16,592 at market close price on date of issue. At June 30, 2017, the balance due on the RP Note was $103,968, which included $3,968 of accrued interest for the six month period ended June 30, 2017.

SFC Note:

On February 14, 2017, the Company issued a $100,000 note (the "SFC Note") to a long term shareholder of the Company for a loan. The SFC Note has maturity date of August 14, 2017 and bears interest at 8% per annum due at maturity and may be prepaid in whole, or in part, at any time before each maturity date without prepayment penalty. As an inducement for the loan, the Company issued 340,000 restricted common shares to the lender at a non-cash cost of $23,800 valued at market close price on date of issue. At June 30, 2017, the balance due on the SFC Note was $102,981 including $2,981 of accrued interest for the six month period ended June 30, 2017.

NOTE 8 – Convertible Long Term Note Payable

VDF Note:

On January 28, 2014, we entered into a patent settlement with VDF FutureCeuticals, Inc. ("VDF") at which time a senior convertible note (the "VDF Note") was issued to VDF, whereby we agreed to pay principal equal to the sum of aggregate accrued and unpaid patent license fee payments plus accrued interest. The maturity of the VDF Note is December 31, 2018 unless accelerated pursuant to an event of default or the License Agreement is terminated and all accrued and unpaid obligations under the VDF Note have been paid. Due to its term the VDF Note is classified as long term debt. Interest on the note is 7% per annum, subject to an adjustment to 12% for events of default and we have the right, subject to certain limitations, to prepay principal at any time and from time to time. At any time VDF has the option to convert any principal outstanding on the VDF Note into shares of our common stock at a conversion price determined by the terms of the VDF Note, which is subject to adjustment based on our issuance of stock and other securities and is currently $0.2157 per share. The VDF Note provides that we may, at our option, roll-over to the VDF Note quarterly License fee payments and accrued interest and ranks senior to any other debt issued by the Company unless written consent of VDF is obtained to amend the ranking.

 

KONARED CORPORATION

NOTES TO FINANCIAL STATEMENTS

(Unaudited)

NOTE 8 – Convertible Long Term Note Payable (continued)

At June 30, 2017, the VDF Note had an outstanding balance $1,088,265. This included the principal due of $1,105,051, net of a discount of $16,786 resulting from the embedded derivative. During the six month period ended June 30, 2017, a roll-over of a License fee of $200,000 was accrued to the VDF Note. At December 31, 2016, the VDF Note had an outstanding balance $869,674. This included the principal due of $886,460, net of a discount of $16,786 resulting from the embedded derivative. During the year ended December 31, 2016, License fee payments accrued to the VDF Note totaled $375,000 and accrued interest of $42,188 was added for a total addition to the VDF Note of $417,188.

NOTE 9 – Derivatives

In connection with the issuance of debt or equity instruments, the Company may sell options or warrants to purchase our common stock. In certain circumstances, the convertible debt, options or warrants may be classified as derivative liabilities, rather than as equity. Additionally, the debt or equity instruments may contain embedded derivative instruments, such as embedded derivative features which in certain circumstances may be required to be bifurcated from the associated host instrument and accounted for separately as a derivative instrument liability. The Company's derivative instrument liabilities are re-valued at the end of each reporting period, with changes in the fair value of the derivative liability recorded as charges or credits to income in the period in which the changes occur. For options, warrants and bifurcated embedded derivative features that are accounted for as derivative instrument liabilities, the Company estimates fair value using either quoted market prices of financial instruments with similar characteristics or other valuation techniques. The valuation techniques require assumptions related to the remaining term of the instruments and risk-free rates of return, our current common stock price and expected dividend yield, and the expected volatility of our common stock price over the life of the option.

The following table summarizes the derivative activity for the year ended December 31, 2016 and during the six month period ended June 30, 2017:

 

 

 

KONARED CORPORATION

NOTES TO FINANCIAL STATEMENTS

(Unaudited)

NOTE 10 – Related Party Transactions

During the six month period ended June 30, 2017 Retiring Director resigned from the Board at which time the Company: (i) re-priced 1,000,000 options Retiring Director held from an exercise price of $0.17 per share to an exercise price of $0.05 per share.  The Black-Scholes options pricing model cost of the transaction was $14,303; and (ii) issuance of 150,000 restricted common shares at a non-cash cost of $0.0722 per share for aggregate deemed compensation of $10,830.

 

During the six month period ended June 30, 2017 Retiring Director resigned from the Board at which time the Company re-priced 750,000 options he held from an exercise price of $0.17 per share to an exercise price of $0.05 per share and issued him an additional 150,000 options with the same three year remaining maturity. The exercise price of the new options was set on date of grant and these options vested immediately. The combined Black-Scholes options pricing model cost of the transactions was $14,528.

KONARED CORPORATION

NOTES TO FINANCIAL STATEMENTS

(Unaudited)

NOTE 10 – Related Party Transactions (continued)

At June 30, 2017 and December 31, 2016, the Company had related party accounts payable of $nil and $nil, respectively; and shareholder loans of $nil and $nil, respectively.

NOTE 11 – Equity

Our authorized capital stock consists of 877,500,000 shares of common stock, with a par value of $0.001 per share; and 10,000 shares of preferred stock at a par value of 0.001. The holders of common stock have dividend rights, liquidation rights and voting rights of one vote for each share of common stock. There are no preferred shares issued and outstanding and the terms of any future preferred shares issuances will be as determined by the Board of Directors. As of June 30, 2017, there were 186,984,979 shares of our common stock issued and outstanding.

On January 23, 2017, we issued 250,000 restricted common shares at $0.0484 per share to a new director at market close price on date of grant as an inducement fee for joining our Board for a deemed non-cash cost of $12,100. These shares were issued to one Accredited Investor (as that term is defined in Rule 501 of Regulation D under the Securities Act of 1933, as amended) or qualified under the terms Rule 506 Regulation D, and in issuing these shares we relied on the exemptions from the registration requirements provided for in Rule 506 Regulation D and/or Section 4(a)(2) of the Securities Act of 1933, as amended.

On January 26, 2017, we issued 340,000 restricted common shares at $0.0488 per share to an Accredited Investor related party at market close price on date of grant as an inducement fee extension of the maturity of a promissory note for a deemed non-cash cost of $16,592. These shares were issued to one non-U.S. person (as that term is defined in Regulation S of the Securities Act of 1933, as amended) in offshore transactions in which we relied on the exemptions from the registration requirements provided for in Regulation S and/or Section 4(2) of the Securities Act of 1933, as amended.

On  February 14, 2017, we remedially executed a private placement related to Unit Offer #3 which raised $15,000 through the sale of 375,000 units. Each unit was priced at $0.04 per unit and comprised of one restricted common share price plus one five year warrant exercisable to purchase one restricted common share at $0.055 per share. The fair market value of the shares and embedded value of the warrants is based on the valuations done for Unit Offer #3. These shares were issued to one non-U.S. person (as that term is defined in Regulation S of the Securities Act of 1933, as amended) in offshore transactions in which we relied on the exemptions from the registration requirements provided for in Regulation S and/or Section 4(2) of the Securities Act of 1933, as amended. The warrants were valued using a Black-Scholes model at a non-cash cost of $16,463. At June 30, 2017, none of these warrants had been exercised.

 

KONARED CORPORATION

NOTES TO FINANCIAL STATEMENTS

(Unaudited)

NOTE 11 – Equity (continued)

On February 22, 2017, we issued 990,000 common shares at $0.04 per share for conversion by December 2015 Lender of the remaining $39,600 due on the December 2015 Note. The value of the shares was $61,578 based on a market close price on date of issuance. The conversion resulted in a $21,978 difference between the cash redemption balance and the value of the shares redemption which was treated as a conversion loss and recorded as an additional non-cash interest expense. This conversion fully paid the note and no further payments are due. These shares were issued to one Accredited Investor with reliance on the exemptions from registration requirements provided in the Securities Act of 1933, as amended, Section 4(1) and Rule 144.

During the period ended June 30, 2017 in six transactions, LPC converted $300,000 principal and $3,060 accrued interest due on LPC Note Two at a conversion price of $0.05 per share into 6,105,843 shares valued at $405,361 based on market close prices on dates of issuance. The conversions resulted in a $99,064 difference between the cash redemption balance and the value of the shares redemption which was treated as a conversion loss and recorded as an additional non-cash interest expense. These shares were issued to one Accredited Investor with reliance on the exemptions from registration requirements provided in the Securities Act of 1933, as amended, Section 4(1) and Rule 144.  These conversions fully paid all amounts due on LPC Note Two and the note is extinguished.

On March 1, 2017, we issued 1,100,000 restricted common shares at $0.0548 per share at market close price on date of grant for consultant services rendered for a deemed cost of $60,280. These shares were issued to one Accredited Investor (as that term is defined in Rule 501 of Regulation D under the Securities Act of 1933, as amended) or qualified under the terms Rule 506 Regulation D, and in issuing these shares we relied on the exemptions from the registration requirements provided for in Rule 506 Regulation D and/or Section 4(a)(2) of the Securities Act of 1933, as amended.

KONARED CORPORATION

NOTES TO FINANCIAL STATEMENTS

(Unaudited)

NOTE 11 – Equity (continued)

On March 6, 2017, we issued 653,842 restricted common shares to a company wholly owned by our CFO at a price of $0.0559 on date of grant as compensation for a deemed cost of $36,615. These shares were issued to one non-U.S. person (as that term is defined in Regulation S of the Securities Act of 1933, as amended) in offshore transactions in which we relied on the exemptions from the registration requirements provided for in Regulation S and/or Section 4(2) of the Securities Act of 1933, as amended.

On May 31, 2017, we issued 150,000 restricted common shares at $0.0722 per share market close price on date of grant to a Director for deemed compensation of $10,830. These shares were issued to one US person with reliance on the exemptions from the registration requirements provided for in Rule 506 Regulation D and/or Section 4(a)(2) of the Securities Act of 1933, as amended.

On June 8, 2017, we issued 250,000 restricted common shares at $0.0692 per share market close price on date of grant to a Director for deemed compensation of $17,300. These shares were issued to one US person with reliance on the exemptions from the registration requirements provided for in Rule 506 Regulation D and/or Section 4(a)(2) of the Securities Act of 1933, as amended.

KONARED CORPORATION

NOTES TO FINANCIAL STATEMENTS

(Unaudited)

NOTE 11 – Equity (continued)

During the six month period ended June 30, 2017, we raised $429,468 through a private placement stock offering which sold 7,808,510 restricted common shares at $0.055 per share. These shares were issued to sixteen Accredited Investors (as that term is defined in Rule 501 of Regulation D under the Securities Act of 1933, as amended) or qualified under the terms Rule 506 Regulation D, and in issuing these shares we relied on the exemptions from the registration requirements provided for in Rule 506 Regulation D and/or Section 4(a)(2) of the Securities Act of 1933, as amended.  As part of this private placement stock offering, we raised an additional $220,000 in return for 4,000,000 restricted common shares at $0.055 per share, however as of June 30, 2017, these shares have not been issued pending receipt of information from purchaser required by stock registrar.  These funds have been recorded as Stock Payable in the Equity section of the company's balance sheet as of June 30, 2017.

On January 1, 2016 we issued 600 restricted common shares at $0.0614 per share at market close price on date of grant to an employee for deemed compensation of $37. These shares were issued to one US person with reliance on the exemptions from the registration requirements provided for in Rule 506 Regulation D and/or Section 4(a)(2) of the Securities Act of 1933, as amended.

On January 11, 2016 we issued 5,000 restricted common shares at $0.064 per share to an employee at market close price on date of grant for deemed compensation of $320.  These shares were issued to one US person with reliance on the exemptions from the registration requirements provided for in Rule 506 Regulation D and/or Section 4(a)(2) of the Securities Act of 1933, as amended.

In February 2016, we executed a private placement unit offering which raised $171,000 through the sale of 4,275,000 units priced at $0.04 per unit with each unit being comprised of one restricted common share price plus one five year warrant exercisable to purchase one restricted common share at $0.055 per share. The fair market value of the shares based on closing market prices on dates of sale was $227,160 and the embedded value of the warrants based on a Black-Scholes option pricing model was $182,910. These shares were issued to four US persons who are Accredited Investors (as that term is defined in Rule 501 of Regulation D under the Securities Act of 1933, as amended) or qualified under the terms Rule 506 Regulation D, and in issuing these shares we relied on the exemptions from the registration requirements provided for in Rule 506 Regulation D and/or Section 4(a)(2) of the Securities Act of 1933, as amended.

KONARED CORPORATION

NOTES TO FINANCIAL STATEMENTS

(Unaudited)

NOTE 11 – Equity (continued)

On March 31, 2016 we issued 150,366 restricted common shares at $0.051 per share at market close price on date of grant to our CEO for deemed compensation totaling $7,669. These shares were issued to one US person with reliance on the exemptions from the registration requirements provided for in Rule 506 Regulation D and/or Section 4(a)(2) of the Securities Act of 1933, as amended.

On March 31, 2016 we issued 318,081 restricted common shares at $0.051 per share at market close price on date of grant to our President & COO for deemed compensation totaling $16,222. These shares were issued to one US person with reliance on the exemptions from the registration requirements provided for in Rule 506 Regulation D and/or Section 4(a)(2) of the Securities Act of 1933, as amended.

On March 31, 2016 we issued 462,663 restricted common shares at $0.051 per share at market close price on date of grant to a company wholly owned by our CFO for deemed compensation totaling $23,596.  These shares were issued to one non-U.S. person (as that term is defined in Regulation S of the Securities Act of 1933, as amended) in offshore transactions in which we relied on the exemptions from the registration requirements provided for in Regulation S and/or Section 4(2) of the Securities Act of 1933, as amended.

From April to May 2016, we executed a private placement unit offering which raised $394,000 through the sale of 9,850,000 units priced at $0.04 per unit with each unit being comprised of one restricted common share price plus one five year warrant exercisable to purchase one restricted common share at $0.055 per share. The fair market value of the shares based on closing market prices on dates of sale was $532,443 and the embedded value of these warrants based on a Black-Scholes option pricing model was $426,730. These shares were issued to nine US persons who are Accredited Investors (as that term is defined in Rule 501 of Regulation D under the Securities Act of 1933, as amended) or qualified under the terms Rule 506 Regulation D, and in issuing these shares we relied on the exemptions from the registration requirements provided for in Rule 506 Regulation D and/or Section 4(a)(2) of the Securities Act of 1933, as amended.

On May 20, 2016 we issued 10,000 restricted common shares at $0.054 per share at market close price on date of grant to an employee for deemed compensation of $540. These shares were issued to one US person with reliance on the exemptions from the registration requirements provided for in Rule 506 Regulation D and/or Section 4(a)(2) of the Securities Act of 1933, as amended.

 

KONARED CORPORATION

NOTES TO FINANCIAL STATEMENTS

(Unaudited)

NOTE 11 – Equity (continued)

On June 6, 2016, we issued 5,000 restricted common shares at $0.0518 per share at market close price on date of grant to a health care professional for endorsement services for deemed compensation of $259. These shares were issued to US persons with reliance on the exemptions from the registration requirements provided for in Rule 506 Regulation D and/or Section 4(a)(2) of the Securities Act of 1933, as amended.

For the period ended June 30, 2016 we issued 164,841 restricted common shares at $0.052483 per share at market close price on date of grant to our CEO for deemed compensation totaling $8,651. These shares were issued to one US person with reliance on the exemptions from the registration requirements provided for in Rule 506 Regulation D and/or Section 4(a)(2) of the Securities Act of 1933, as amended.

 

KONARED CORPORATION

NOTES TO FINANCIAL STATEMENTS

(Unaudited)

NOTE 11 – Equity (continued)

For the period ended June 30, 2016 we issued 348,702 restricted common shares at $0.052483 per share at market close price on date of grant to our President & COO for deemed compensation totaling $18,301. These shares were issued to one US person with reliance on the exemptions from the registration requirements provided for in Rule 506 Regulation D and/or Section 4(a)(2) of the Securities Act of 1933, as amended.

For the period ended June 30, 2016 we issued 507,202 restricted common shares at $0.052483 per share at market close price on date of grant to a company wholly owned by our CFO for deemed compensation totaling $26,619. These shares were issued to one non-U.S. person (as that term is defined in Regulation S of the Securities Act of 1933, as amended) in offshore transactions in which we relied on the exemptions from the registration requirements provided for in Regulation S and/or Section 4(2) of the Securities Act of 1933, as amended.

On June 30, 2016 we issued 1,200 restricted common shares at $0.0497 per share at market close price on date of grant to an employee for deemed compensation of $60. These shares were issued to one US person with reliance on the exemptions from the registration requirements provided for in Rule 506 Regulation D and/or Section 4(a)(2) of the Securities Act of 1933, as amended.

On June 30, 2016, we issued 1,500,000 restricted common shares at $0.0497 per share at market close price on date of grant for consultant services rendered for a deemed cost of $74,550. These shares were issued to three US persons with reliance on the exemptions from the registration requirements provided for in Rule 506 Regulation D and/or Section 4(a)(2) of the Securities Act of 1933, as amended.

On August 1, 2016, the Company received a loan of $100,000 from a director of the Company and issued 340,000 restricted common shares as an inducement fee at market close price of $0.0456 on date of issue for a deemed cost of $15,504. These shares were issued to one non-U.S. person (as that term is defined in Regulation S of the Securities Act of 1933, as amended) in offshore transactions in which we relied on the exemptions from the registration requirements provided for in Regulation S and/or Section 4(2) of the Securities Act of 1933, as amended.

 

KONARED CORPORATION

NOTES TO FINANCIAL STATEMENTS

(Unaudited)

NOTE 11 – Equity (continued)

On August 8, 2016, we issued 20,000 restricted common shares at $0.0475 per share market close price on date of grant to an employee for deemed compensation of $950. These shares were issued to one US person with reliance on the exemptions from the registration requirements provided for in Rule 506 Regulation D and/or Section 4(a)(2) of the Securities Act of 1933, as amended.

On August 8, 2016, we issued 50,000 restricted common shares at $0.0475 per share market close price on date of grant to an employee for deemed compensation of $2,375. These shares were issued to one US person with reliance on the exemptions from the registration requirements provided for in Rule 506 Regulation D and/or Section 4(a)(2) of the Securities Act of 1933, as amended.

On August 15, 2016, we issued 1,333,333 restricted common shares at $0.049 per share at market close price on date of grant to our President & COO for deemed compensation totaling $65,333. These shares were issued to one US person with reliance on the exemptions from the registration requirements provided for in Rule 506 Regulation D and/or Section 4(a)(2) of the Securities Act of 1933, as amended.

On August 24, 2016, we issued 42,500 restricted common shares at $0.0639 per share market close price on date of grant to an employee for deemed compensation of $2,716. These shares were issued to one US person with reliance on the exemptions from the registration requirements provided for in Rule 506 Regulation D and/or Section 4(a)(2) of the Securities Act of 1933, as amended.

On August 24, 2016, we issued 25,000 restricted common shares at $0.0639 per share market close price on date of grant to an employee for deemed compensation of $1,598. These shares were issued to one US person with reliance on the exemptions from the registration requirements provided for in Rule 506 Regulation D and/or Section 4(a)(2) of the Securities Act of 1933, as amended.

From July to September 2016, we executed a private placement offering which raised $101,000 through the sale of 2,525,000 units priced at $0.04 per unit with each unit being comprised of one restricted common share price plus one five year warrant exercisable to purchase one restricted common share at $0.055 per share. The fair market value of the shares based on closing market prices on dates of sale was $168,525 and the embedded value of the warrants based on a Black-Scholes option pricing model was $132,571. These shares were issued to eight persons who are Accredited Investors (as that term is defined in Rule 501 of Regulation D under the Securities Act of 1933, as amended) or qualified under the terms Rule 506 Regulation D, and in issuing these shares we relied on the exemptions from the registration requirements provided for in Rule 506 Regulation D and/or Section 4(a)(2) of the Securities Act of 1933, as amended.

On August 30, 2016, the Company redeemed the balance due of $59,000 on the September 2015 Note One through issuance of 1,475,000 shares valued at $95,875 based on a market close price of $0.065 per share on date of issuance. This included a loss on conversion of $36,875 based on the difference between the value of the shares issued at market close price on date of issue and the agreed conversion price of $0.04 per share. These shares were issued to one US company, which is an Accredited Investor (as that term is defined in Rule 501 of Regulation D under the Securities Act of 1933, as amended), and in issuing these shares to this person we relied on the exemptions from the registration requirements provided for in Rule 506 Regulation D and/or Section 4(a)(2) of the Securities Act of 1933, as amended.

 

KONARED CORPORATION

NOTES TO FINANCIAL STATEMENTS

(Unaudited)

NOTE 11 – Equity (continued)

 

On September 6, 2016, we issued 10,000 restricted common shares at $0.0599 per share market close price on date of grant to an employee for deemed compensation of $599. These shares were issued to one US person with reliance on the exemptions from the registration requirements provided for in Rule 506 Regulation D and/or Section 4(a)(2) of the Securities Act of 1933, as amended.

On September 8, 2016, we issued 25,000 restricted common shares at $0.06 per share market close price on date of grant to an employee for deemed compensation of $1,500. These shares were issued to one US person with reliance on the exemptions from the registration requirements provided for in Rule 506 Regulation D and/or Section 4(a)(2) of the Securities Act of 1933, as amended.

On September 9, 2016, we issued 10,000 restricted common shares at $0.0581 per share market close price on date of grant to an employee for deemed compensation of $581. These shares were issued to one US person with reliance on the exemptions from the registration requirements provided for in Rule 506 Regulation D and/or Section 4(a)(2) of the Securities Act of 1933, as amended.

On September 23, 2016, a note holder provided an extension of the maturity of the note held in return for the note being amended to provide for conversion into shares at $0.04 per share. This amendment created a beneficial conversion feature which was valued at a cost of $37,669, such amount which was recorded as an increase to Additional Paid in Capital.

On September 27, 2016 we issued 906,634 restricted common shares at $0.05802 per share at market close price on date of grant to our President & COO for deemed compensation totaling $52,603. These shares were issued to one US person with reliance on the exemptions from the registration requirements provided for in Rule 506 Regulation D and/or Section 4(a)(2) of the Securities Act of 1933, as amended.

On September 29, 2016, we issued 129,244 restricted common shares at $0.058 per share market close price on date of grant to a predecessor investor for deemed cost of $7,496 to revise the shares owed to him from our reverse merger share exchange in 2014. These shares were issued to one US person with reliance on the exemptions from the registration requirements provided for in Rule 506 Regulation D and/or Section 4(a)(2) of the Securities Act of 1933, as amended. A value for capital stock of $129 was recorded and the balance of $7,367 for the cost of the shares was offset to additional paid in capital.

 

KONARED CORPORATION

NOTES TO FINANCIAL STATEMENTS

(Unaudited)

NOTE 11 – Equity (continued)

For the three months ended September 30, 2016, we issued to LPC: (a) 45,629 restricted shares at $0.0561 per share for a deemed cost of $2,560 for interest accrued on LPC Note One for the period from July 1, 2016 to September 30, 2016; and (b) 76,660 restricted shares at $0.0561 per share for a deemed cost of $4,301 for interest accrued on LPC Note Two for the period from July 1, 2016 to September 30, 2016. These shares were issued at market close price on date of grant to one US company, which is an Accredited Investor (as that term is defined in Rule 501 of Regulation D under the Securities Act of 1933, as amended), and in issuing these shares to this person we relied on the exemptions from the registration requirements provided for in Rule 506 Regulation D and/or Section 4(a)(2) of the Securities Act of 1933, as amended.

On September 30, 2016, we issued 193,848 restricted common shares at $0.0561 per share at market close price on date of grant to our CEO for deemed compensation totaling $10,875. These shares were issued to one US person with reliance on the exemptions from the registration requirements provided for in Rule 506 Regulation D and/or Section 4(a)(2) of the Securities Act of 1933, as amended.

On September 30, 2016, we issued 1,382,532 restricted common shares at $0.0561 per share at market close price on date of grant to our President & COO for deemed compensation totaling $77,560. These shares were issued to one US person with reliance on the exemptions from the registration requirements provided for in Rule 506 Regulation D and/or Section 4(a)(2) of the Securities Act of 1933, as amended.

On September 30, 2016, we issued 426,040 restricted common shares at $0.0561 per share at market close price on date of grant to a company wholly owned by our CFO for deemed compensation totaling $23,901. These shares were issued to one non-U.S. person (as that term is defined in Regulation S of the Securities Act of 1933, as amended) in offshore transactions in which we relied on the exemptions from the registration requirements provided for in Regulation S and/or Section 4(2) of the Securities Act of 1933, as amended.

From July 1 to September 30, 2016, we raised $120,000 through a private placement stock offering of 3,000,000 restricted common shares at $0.04 per share. These shares were issued to six US persons who are Accredited Investors (as that term is defined in Rule 501 of Regulation D under the Securities Act of 1933, as amended) or qualified under the terms Rule 506 Regulation D, and in issuing these shares we relied on the exemptions from the registration requirements provided for in Rule 506 Regulation D and/or Section 4(a)(2) of the Securities Act of 1933, as amended.

On October 4, 2016, we issued 150,000 restricted common shares at $0.059 per share at market close price on date of grant to a newly appointed director as an inducement for joining our Board for a deemed cost of $8,850. These shares were issued to one US person with reliance on the exemptions from the registration requirements provided for in Rule 506 Regulation D and/or Section 4(a)(2) of the Securities Act of 1933, as amended.

On October 28, 2016, we issued 1,000,000 restricted common shares at $0.0525 per share at market close price on date of grant for consultant services rendered for a deemed cost of $52,500. These shares were issued to three US person with reliance on the exemptions from the registration requirements provided for in Rule 506 Regulation D and/or Section 4(a)(2) of the Securities Act of 1933, as amended.

 

KONARED CORPORATION

NOTES TO FINANCIAL STATEMENTS

(Unaudited)

NOTE 11 – Equity (continued)

On December 2, 2016, we issued 300,000 common shares at $0.0495 per share at market close price on date of grant to a debt holder as part of the compensation for a maturity extension on the note held for a deemed cost of $14,850. These shares were issued to one US person with reliance on the exemptions from registration requirements provided in Rule 144(d)(3)(ii). At this time the underlining note was also amended to provide for conversion of the note to shares at $0.04 per share and this created a beneficial conversion feature which was valued at a cost of $9,405, such amount which was recorded as an increase to Additional Paid in Capital.

On December 6, 2016, LPC provided an extension of the maturity of two notes held in return for the grant of 7,000,000 six year warrants exercisable at $0.05 per share. The warrants were valued using a Black-Scholes model at a non-cash cost of $315,658, such amount which was recorded as an increase to Additional Paid in Capital.

For the three months ended December 31, 2016, we issued to LPC: (a) 45,629 restricted shares at $0.0451 per share for a deemed cost of $2,058 for interest accrued on LPC Note One for the period from October 1, 2016 to December 31, 2016 ; and (b) 76,660 restricted shares at $0.0451 per share for a deemed cost of $3,457 for interest accrued on LPC Note Two for the period from October 1, 2016 to December 31, 2016. These shares were issued at market close price on date of grant to one US company, which is an Accredited Investor (as that term is defined in Rule 501 of Regulation D under the Securities Act of 1933, as amended), and in issuing these shares to this person we relied on the exemptions from the registration requirements provided for in Rule 506 Regulation D and/or Section 4(a)(2) of the Securities Act of 1933, as amended.

On December 6, 2016, the Company entered into a securities purchase agreement (the "Securities Agreement") with PCF Holdings Group, LLC. ("PCF") under which PCF committed to invest, or cause to be invested, $940,000 in three tranches of (i) $300,000, (ii) $500,000 and (iii) $140,000, respectively for the purchase of Stock Units. Under the Securities Agreement, PCF (or its designee) will purchase from the Company up to 28.5 million stock units (each a "Stock Unit" and in the plural, the "Stock Units"), to be paid in three tranches. The series of warrants for each tranche each have the same three exercise prices, include cashless exercise rights, and have the same three expiry terms. The first tranche was priced at $0.024 per Stock Unit and the second and third tranches are priced at $0.04 per Stock Unit. Each Stock Unit consists of one share of restricted common stock of the Company (each a "Share") and three separate warrant classes (each a "Warrant" and the shares underlying the Warrants being the "Warrant Shares" or,

 

KONARED CORPORATION

NOTES TO FINANCIAL STATEMENTS

(Unaudited)

NOTE 11 – Equity (continued)

in the singular a "Warrant Share") respectively have (i) an exercise price of $0.055 per share for a term of five years, (ii) an exercise price of $0.20 per shares for a term of three years and (iii) an exercise price of $0.25 per share for a term of 18 months. The fair market value of the shares based on closing market price on date of sale was $625,000 and the embedded value of the warrants based on a Black-Scholes option pricing model was $1,410,059. These shares were issued to three Accredited Investors (as that term is defined in Rule 501 of Regulation D under the Securities Act of 1933, as amended) or qualified under the terms Rule 506 Regulation D, and in issuing these shares we relied on the exemptions from the registration requirements provided for in Rule 506 Regulation D and/or Section 4(a)(2) of the Securities Act of 1933, as amended. For the second and third tranches, each Stock Unit shall be priced at $0.04 per Stock Unit and shall consist of one Share and three separate warrant classes (each a "Warrant" and the shares underlying the Warrants being the "Warrant Shares", or in the singular a "Warrant Share") that shall respectively have (i) an exercise price of $0.055 per share for a term of five years, (ii) an exercise price of $0.20 per share for a term of three years and (iii) an exercise price of $0.25 per share for a term of 18 months. At the initial Tranche Closing, PCF purchased 12,500,000 Stock Units for a purchase price of $300,000 in cash (the "Initial Tranche"). Subject to the continued accuracy and validity of the representations and warranties of the Company to PCF, the satisfaction by the Company of all its covenants set forth in the Securities Agreement and other considerations, then not later than 120 days from the Initial Tranche Closing (the "Second Tranche Closing"), Purchaser shall purchase 12,500,000 Stock Units (the "Second Tranche) for a purchase price of $500,000; and then not later than 120 days from the Second Tranche Closing (the "Third Tranche Closing"), Purchaser shall purchase 3,500,000 Stock Units (the "Third Tranche) for a purchase price of $140,000. The Securities Agreement includes a Beneficial Ownership Limitation and at no time may PCF exercise warrants or purchase shares if such exercises or purchases would result in PFC and its affiliates owning an aggregate of shares of our common stock in excess of 17.5% of the then outstanding shares of our common stock. PCF and its affiliates may sell or transfer Units, Shares or Warrants that exceed, or might cause PCF to exceed, the Beneficial Ownership Limitation in order for PCF to comply with the Beneficial Ownership Limitation. PCF may at any time request one registration under the Securities Act of 1933, as amended, of all or part of its Shares (including any Warrant Shares issuable upon exercise of any Warrants) (a "Demand Registration"), however the Company will not be obligated to effect any Demand Registration within nine months from the Initial Tranche Closing, or when Purchaser has the ability to freely sell the securities proposed to be registered under Rule 144, without being subject to any volume or manner of sale restrictions thereunder.

On December 8, 2016, we issued 170,000 restricted common shares at $0.048 per share market close price on date of grant to seven employees for deemed compensation of $8,160. These shares were issued to seven US persons with reliance on the exemptions from the registration requirements provided for in Rule 506 Regulation D and/or Section 4(a)(2) of the Securities Act of 1933, as amended.

 

KONARED CORPORATION

NOTES TO FINANCIAL STATEMENTS

(Unaudited)

NOTE 11 – Equity (continued)

On  February 14, 2017, we remedially executed a private placement related to Unit Offer #3 which raised $15,000 through the sale of 375,000 units. Each unit was priced at $0.04 per unit and comprised of one restricted common share price plus one five year warrant exercisable to purchase one restricted common share at $0.055 per share. The fair market value of the shares and embedded value of the warrants is based on the valuations done for Unit Offer #3. These shares were issued to one non-U.S. person (as that term is defined in Regulation S of the Securities Act of 1933, as amended) in offshore transactions in which we relied on the exemptions from the registration requirements provided for in Regulation S and/or Section 4(2) of the Securities Act of 1933, as amended. The warrants were valued using a Black-Scholes model at a non-cash cost of $16,463. At March 31, 2017, none of these warrants had been exercised.

On April 18, 2017, LPC exercised on a cashless basis 5,000,000 warrants it held into 1,264,674 common shares.  These warrants had been issued with LPC Note Two and this effected full exercise of that warrant.

On May 9, 2017, pursuant to a letter agreement, LPC exercised 1,136,364 warrants which it had been issued on January 27, 2014 into 1,136,364 restricted common shares for the exercise price of $0.15 per share to provide the Company with aggregate proceeds of $170,455. At this same time, the Company issued to LPC 5,000,000 six year warrants with an exercise price of $0.05. The warrants were valued using a Black-Scholes model at a non-cash cost of $342,480. At current date, none of these warrants had been exercised. Copies of the letter agreement and warrant are attached to this Report as exhibit 10.1.

During the year ended December 31, 2016, we raised $681,000 through three private placement unit offerings priced at $0.04 per unit which included the issuance of 17,025,000 five year warrants each exercisable to purchase one restricted common share at $0.055 per share. The aggregate embedded value of these warrants based on a Black-Scholes option pricing model was $742,211. At December 31, 2016, none of these warrants had been exercised.

On December 6, 2016, in relation to its first investment tranche we issued PCF a series of three warrants which include cashless exercise rights. These included: Warrant 1 with an exercise price of $0.055 per share and a term of five years, Warrant 2 with an exercise price of $0.20 per shares and a term of three years, and Warrant 3 with an exercise price of $0.25 per share and a term of 18 months. The aggregate embedded value of the warrants based on a Black-Scholes option pricing model was $1,410,059. At December 31, 2016, none of these warrants had been exercised.

 

KONARED CORPORATION

NOTES TO FINANCIAL STATEMENTS

(Unaudited)

NOTE 11 – Equity (continued)

On December 16, 2016, LPC extended the maturities of each of its two notes from December 31, 2016 to December 31, 2017 in return for issuance by the Company of 7,000,000 six year warrants, with cashless exercise rights, to purchase 7,000,000 restricted shares of our common stock at an exercise price of $0.05 per share. The warrants were valued using a Black-Scholes model at a non-cash cost of $315,658, of which $143,481 was ascribed as an increase to the discount of LPC Note One and $172,177 was ascribed as an increase to the discount of LPC Note Two. At December 31, 2016, none of these warrants had been exercised.

 

The fair valuations for warrants were done on date of grant using a Black Scholes option pricing model with the following assumptions:

 

*(based on US Treasury Constant Maturities matching estimated life)

The following table summarizes the Company's warrant activity for the period ended June 30, 2017 and the year ended December 31, 2016:

*  (remaining term as of June 30, 2017)

**(intrinsic value based on the closing share price of $0.0684 on June 30, 2017)

 

KONARED CORPORATION

NOTES TO FINANCIAL STATEMENTS

(Unaudited)

NOTE 11 – Equity (continued)

On January 20, 2017, as compensation to a retiring director we re-priced 750,000 options he held from an exercise price of $0.17 per share to an exercise price of $0.05 per share and issued him an additional 150,000 options with the same three year remaining maturity. The exercise price of the new options was set on date of grant and these options vested immediately. The combined Black-Scholes options pricing model cost of the transactions was $14,528.

On March 6, 2017, we issued 1,063,782 five year options with an exercise price of $0.0559 set on date of grant to our CEO as compensation. These options vested immediately and had a Black-Scholes options pricing model cost of $35,861.

On March 6, 2017, we issued 2,476,377 five year options with an exercise price of $0.0559 set on date of grant to our President & COO as compensation. These options vested immediately and had a Black-Scholes options pricing model cost of $83,481.

The fair valuations for outstanding options were done on date of grant using a Black Scholes option pricing model with the following assumptions:

*(based on US Treasury Constant Maturities matching estimated life)

A summary of changes in outstanding stock options for the period ended June 30, 2017 and the year ended December 31, 2016 is as follows:

*  (remaining term as of June 30, 2017)

**(intrinsic value based on the closing share price of $0.0684 on June 30, 2017)

 

KONARED CORPORATION

NOTES TO FINANCIAL STATEMENTS

(Unaudited)

NOTE 11 – Equity (continued)

The following table summarizes information about the options outstanding at June 30, 2017:

*  (remaining term as of June 30, 2017)

**(intrinsic value based on the closing share price of $0.0684 on June 30, 2017)

The expensing and amortization of all options grants have been credited to Additional Paid-In Capital.

 

 

 

 

 

 

 

 

KONARED CORPORATION

NOTES TO FINANCIAL STATEMENTS

(Unaudited)

NOTE 12 – Commitments and Contingencies

Various lawsuits, claims and other contingencies arise in the ordinary course of the Company's business activities. As of the date of these financial statements, we know of no threatened or pending lawsuits, claims or other similar contingencies.

On January 28, 2014 we entered into a coffee fruit patent license, Coffeeberry® trademark license and raw materials supply agreement with VDF FutureCeuticals, Inc. ("VDF"). This arrangement was structured on a series of agreements to settle claims asserted by and against the parties with respect to an action filed by VDF against our predecessor company SITC; and resolve a petition for cancellation of certain trademark registrations filed by SITC. A summary of each agreement is as follows:

The License Agreement comprises a coffee fruit patent license, Coffeeberry® trademark license and raw materials supply agreement. The key elements include: (a) Patents and Trademark License: In exchange for Alternative Minimum Payments and royalties (and the terms and conditions related to raw materials discussed below), VDF granted us a non-exclusive, non-transferrable, non-sublicensable license to use and practice certain VDF patent rights and a non-exclusive license to use certain VDF trademarks and trademark rights; and (b) Raw Materials: VDF will supply us with raw materials. We are also permitted to have raw materials manufactured by a third party (subject to some limitations) solely for the use in the products that we sell. Additionally, we must share with VDF all details of certain input raw materials. The License Agreement requires us to make quarterly payments, which may be a base amount (an "Alternative Minimum Payment", or "AMP"), or be grossed up to a higher amount subject to our use of rights under the License. We may rollover AMPs to the VDF senior convertible note (the "VDF Note").

The amount and schedule for the remaining AMPs is as follows:

The VDF Note, as amended, is a senior convertible note with a maturity date of December 31, 2018. Payment requirements are accelerated pursuant to an event of default, or if the License Agreement is terminated. Interest on the Senior Convertible Note is 7% per annum, subject to adjustment to 12% for events of default. By maturity, we must pay VDF all principal plus accrued interest and we have the right, subject to certain limitations, to prepay principal at any time and from time to time. No indebtedness shall rank senior to the payments due under the VDF Note unless prior written consent of VDF is obtained and payments under the note are secured by the Security Agreement as described below. At any time and at the option of VDF, principal outstanding on the VDF Note may be converted into restricted common shares of the Company. The conversion price of the VDF Note is presently $0.2157 per share.

 

 

 

KONARED CORPORATION

NOTES TO FINANCIAL STATEMENTS

(Unaudited)

NOTE 12 – Commitments and Contingencies (continued)

Under the Pledge and Security Agreement, as amended, we pledged collaterally assigned and granted to VDF a security interest in all of our right, title and interest, whether now owned or hereafter acquired, in and to our Company's property to secure the prompt and complete payment and performance of obligations existing under any of the agreements.

The VDF Warrant does not yet exist. The VDF Warrant would entitle VDF, from any time after the occurrence of a Warrant Exercise Event until the fifteenth anniversary of the issuance of the VDF Warrant, to purchase from our Company, restricted common shares representing ten percent (10%) of  fully diluted outstanding shares at a purchase price of $0.001 per share. A Warrant Exercise Event comes into being if we: (i) report $25,000,000 or more of gross sales in any fiscal year; (ii) have a class of securities listed for trading on the New York Stock Exchange, the American Stock Exchange or NASDAQ; (iii) maintain an aggregate market capitalization of at least $125,000,000 for twenty (20) consecutive trading days; or (iv) undergo a change of control as defined in the VDF Warrant. No circumstances have yet occurred which qualify as a Warrant Exercise Event and therefore there is no right in place for VDF to exercise the VDF Warrant.

Under the Registration Rights Agreement VDF, or an assignee, have demand registration rights and incidental registration rights with respect to: (i) common shares issued upon conversion of the VDF Note; (ii) common shares issued upon exercise of the VDF Warrant; and (iii) any shares of our common stock acquired by VDF or an assignee from our Company after the date of the Registration Rights Agreement upon exercise or conversion of other convertible securities that are acquired by VDF or an assignee from our Company after the date of the Registration Rights Agreement. Pursuant to VDF's demand registration right, at any time or from time to time, a holder or holders holding a majority of registrable securities then outstanding may require our Company to use our best efforts to effect the registration under the Securities Act of 1933, as amended, of all or part of their respective registrable securities (subject to any limits that may be imposed by the Securities and Exchange Commission pursuant to Rule 415 under the Securities Act), by delivering a written request to our company. In addition to the registration rights granted to VDF, there are restrictions on our granting of registration rights to other parties.

At present VDF holds no ownership interest in the Company and therefore the terms of the Investor Rights Agreement have not come into effect. The Investor Rights Agreement provides VDF the right to designate that number of nominees to our board of directors such that the total number of directors designated by VDF is in proportion to its percentage ownership of the outstanding voting power of the Company. From and after the date of the Investor Rights Agreement and until such time as: (i) the VDF Note has terminated; (ii) the VDF Warrant has terminated or been exercised; and (iii) VDF's percentage interest is less than 1%, if VDF does not have a designee on our board of directors, VDF shall have the right to appoint one individual as a non-voting observer entitled to attend meetings of our board of directors. Also pursuant to the Investor Rights Agreement, for so long as: (i) the VDF Note remains outstanding, (ii) the VDF Warrant remains outstanding, or (iii) VDF owns a percentage interest equal or greater to 10%, we will require VDF's consent before taking certain corporate actions, including, among others: (a) amending our constating documents, (b) making any material change to the nature of our business, (c) incurring indebtedness exceeding $7,500,000 at any one time outstanding; or (d) declaring or paying dividends.

 

KONARED CORPORATION

NOTES TO FINANCIAL STATEMENTS

(Unaudited)

NOTE 13 – Subsequent Events

It was management's assessment that there were no events which should be classified as subsequent events for the period of these financial statements.

 

 

 

 

---

ITEM 2.  MANAGEMENTS' DISCUSSION AND ANALYSIS OR PLAN OF OPERATION  

FORWARD LOOKING STATEMENTS

Certain information included herein contains forward-looking statements that involve risks and uncertainties within the meaning of Sections 27A of the Securities Act, as amended; Section 21E of the Securities Exchange Act of 1934. These sections provide that the safe harbor for forward looking statements does not apply to statements made in initial public offerings. The words, such as "may," "would," "could," "anticipate," "estimate," "plans," "potential," "projects," "continuing," "ongoing," "expects," "believe," "intend" and similar expressions and variations thereof are intended to identify forward-looking statements. These statements appear in a number of places in this Form 10-Q and include all statements that are not statements of historical fact regarding intent, belief or current expectations of the Company, our directors or our officers, with respect to, among other things: (i) our liquidity and capital resources; (ii) our financing opportunities and plans; (iii) continued development of business opportunities; (iv) market and other trends affecting our future financial condition; (v) our growth and operating strategy. Investors and prospective investors are cautioned that any such forward-looking statements are not guarantees of future performance and involve risks and uncertainties, and that actual results may differ materially from those projected in the forward-looking statements as a result of various factors. The factors that might cause such differences include, among others, the following: (i) we have incurred significant losses since our inception; (ii) any material inability to successfully develop our business plans; (iii) any adverse effect or limitations caused by government regulations; (iv) any adverse effect on our ability to obtain acceptable financing; (v) competitive factors; and (vi) other risks including those identified in our other filings with the Securities and Exchange Commission.

 

The following discussion and the information provided contain forward-looking statements that reflect our plans, estimates and beliefs. Our actual results could differ materially from those discussed in the forward looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those discussed below and elsewhere in this Report. Our actual results may differ materially from the results anticipated in any forward-looking statements in this Report due to a variety of factors, including, without limitation those set forth as "Risk Factors" in the Post-Effective Amendment to our Form S-1 which became Effective on May 12, 2016. This can be found along with all our filings  to the SEC at www.sec.gov.

Corporate Overview

In this Annual Report on Form 10-K the terms "KonaRed", "we", "us", "our", the "Registrant", and the "Company" mean KonaRed Corporation. Unless otherwise stated, "$" refers to United States dollars. Our fiscal year end is December 31st. We were incorporated in the State of Nevada on October 4, 2010 and our predecessor operating business was incorporated in the State of Hawaii on August 22, 2008. Our head office and distribution center is located at 1101 Via Callejon #200, San Clemente, CA 92673-4230.

The Company's common stock is publicly traded on the OTCQB over-the-counter market ('OTCQB') under the trading symbol: KRED.

Description of Business

Beverage Products

KonaRed® Corporation is a Hawaiian Coffee Company and the pioneer of the USA Grown, Hawaiian Coffee Fruit. The company oversees a vertically integrated supply chain which starts with the world renowned, highest quality Coffee and Coffee Fruit from Kona, Hawaii. The Company produces five award winning Ready to Drink ('RTD') 12oz Cold Brew Coffee varieties, Bag in the Box, Key Kegs, a complete line of whole bean and ground Kona Coffee Beans, plus its well established RTD Antioxidant Juices and Hawaiian Coffee Fruit nutritional supplements. The Company also has an industrial ingredients supply division. KonaRed products are sold throughout the U.S. and can be found in select Vons, Albertsons, Publix, Pavilions, Costco, Ralphs, Fred Meyer, King Soopers, Smiths, Kroger, Safeway, Vitamin Shoppe, Target, Whole Foods, 7-Eleven and many other retail outlets. More information about KonaRed and its products can be found at www.konared.com.

 

 

12oz. Award Winning RTD Cold Brew Coffees

In February 2016 we introduced a new line of Ready-to-Drink ('RTD') Cold Brew Coffees which included the flavors of 'Original', 'Hawaiian Vanilla' and 'Espresso'. In August 2016, consumer demand precipitated the addition of 'Kauai Caramel' and 'Maui Mocha' flavors. Sales of this product have expanded quickly and the line is now being sold in leading retailers throughout the US.  Hawaiian Vanilla has won the BevergeWorld BevStar award and the Original Cold Brew won the Gourmet Retailer Editor's Choice for Best Coffee.  KonaRed RTD Cold Brew Coffees have become one of the leading brands in this fast growing consumer packaged goods sector.  Cold brew coffee continues to grow in popularity as it appeals to premium beverage trends, but also health and wellness ones too.

The evidence of consumer demand for Cold Brewed Coffee is in the numbers. According to SPINS data for the 52 weeks ending October 4^th 2015, Cold Brewed Coffee sales reached $15.3 million in Multi-Outlet and $7.3million in the Natural Channel. With dollar and unit sales in both channels exceeding 100% growth versus the prior year and the top three brands commanding over 85% share of the segment, it's evident that 2015 was just the beginning.  The category is estimated to have grown to $65 million during 2016.  As the category continues to grow, so does KonaRed's sales.  The company will continue to focus on this area of business with continued distribution and new product innovation.

      

 

 

KonaRed's anti-oxidant beverage products consist of the following proprietary formulations:

●

16 oz. KonaRed Original Antioxidant Juice (2 servings)

 

 

 

 

●

10.5 oz. KonaRed Original Antioxidant Juice (1 serving)

 

 

New Product Offerings:

KonaRed® Original Bag in a box – sold primarily at Costco.

Shelf pictures

 

Wellness Products

We also produce wellness nutritional products which are now available at select locations of Vitamin Shoppe nationwide and in several major chains in Hawaii. Primary among these is our antioxidant KonaRed Hawaiian Superfruit Powder Tub and our Wake-up Performance Powder Packets.

 

●

KonaRed Hawaiian Superfruit Powder

100% soluble coffee fruit powder made from coffee fruit from Kona, Hawaii

●

KonaRed Wake Up Performance Powder Packets

1 tub with 30 packets

 

 

Coffee Bean Products

Our line of KonaRed Coffee Beans come in varieties.

 

●

100% Kona Coffee beans

●

10% Kona Blends

●

Both come in Whole Bean or Ground

 

Industrial Ingredient Division Launch

In December of 2015, we executed a supply contract with VDF Futureceuticals Inc, ("VDF"). We now offer an American made U.S.A Hawaiian grown coffee fruit supply to the world with both coffee fruit powders and liquid extracts to other companies B2B.

Use of Patents

An important element of our business is the License we have been provided by VDF which provides us with the use of VDF's coffee fruit patents and Coffeeberry^® trademark license. We developed the necessary processing and manufacturing intellectual property ("IP") for processing and manufacturing our base ingredient - the coffee fruit (and have subsequently merged this with the IP provided by VDF). The License Agreement provides us with access to use of VDF's patents, as existing and/or modified in the future, along with the processes, products, methods, compositions and know-how developed by VDF related to the patented Coffee Cherry related inventions, trade secrets and know-how.

Trademarks

We have filed and received several trademarks that we use in our daily business

KonaRed

Nature's Best Kept Secret

Paradise in a Bottle

Operations, Facilities and Distribution Method for Our Products

Our distribution facility is a 10,000 square foot facility located in San Clemente, California. We use an outsourcing business model based on utilizing third parties for the bulk of our non-core business operations, such as manufacturing and coffee fruit extraction and retail products, while maintaining in-house control of critical marketing, product development and warehousing/shipping functions.

 

Supply and Distribution for Our Product

We have an agreement in place which provides a reliable and trusted source of coffee fruit supply. This is structured based on our commitment to exclusively purchase coffee fruit from the supplier and the supplier is obligated to provide coffee fruit exclusively to our company. Our company's principal supplier of raw coffee fruit is Greenwell Farms, Inc., a Hawaii corporation with a long established history as a major Hawaiian coffee supplier.

We determine the amount of dried coffee fruit to purchase from our suppliers based on our annual sales forecasts and have historically been accurate at estimating supply quantities based on projected sales. Since the fruit surrounding the coffee bean was previously discarded as a byproduct of coffee production, such raw material has also remained readily available from coffee farms located in Hawaii and internationally. Therefore, although we currently have a principal supplier, in the event that we lose this supplier, we are confident that we would be able to secure raw material from other suppliers.

Our production process is based on our company taking possession of the dried coffee fruit from the grower, shipping the dried coffee fruit to our San Clemente warehouse for storage, and then subsequently sending required quantities to subcontractors for value-added processing. For our company's beverage production, our antioxidant beverages are processed by us sending processed coffee fruit to a 3rd party flavor house which makes the KonaRed concentrate and then ships it to our company's bottling vendors. The process for Cold Brew Coffee is similar. Notably, we own the proprietary beverage formulas. Pallets of the ready-to-drink product items (defined as "Stock-keeping Units", or "SKUs") are then shipped back to our company's warehouse, or third party inventory transit service providers, and disseminated to either distributors, or shipped directly to retailers.

 

 

 

Market

We believe our company has established a frontrunner position in the coffee fruit and cold brew coffee categories, boasting numerous retail entrees and continued expansion. We first established our products in the upstart coffee fruit sector on our home turf in Hawaii and then have expanded across the USA by winning placements at Kroger, Publix, Target, Vitamin Shoppe and other major retailers. We have since moved into the large and lucrative market of coffee and have expanded beyond just coffee fruit. Over 50% of Americans over the age of 18 drink coffee daily and it is a huge marketplace. We have positioned ourselves as one of the leading RTD Cold Brew Coffee product lines on the market since our February 2016 launch.

Sales Strategy

Our sales strategy for our Cold Brew Coffee and Antioxidant beverages and nutritional supplement products is to sell and ship directly from our warehouse in San Clemente, California for our Western U.S. and Hawaii business and  then rely on more centrally located warehouses for the Mid-West and East Coast regions.  We have a direct sales team of four individuals, two in Hawaii and two in Southern California whose main job is to secure new customers directly in person. We have also retained manufacturers' sales representatives who work to increase our overall sales efforts in specific regions such as New York, Los Angeles and Florida.

We've learned the importance of supporting our distributor network through "on the ground" sales personnel and will add to our sales force as markets develop. For an emerging product such as ours, merchandising follow-up, dialog with store managers, and coordination of promotions and pricing are critical in maintaining brand momentum. We anticipate adding sales staff to meet demand as we grow.

Although KonaRed was invented as a wellness product, we believe consumer acceptance of our beverage products now places us both within the coffee and 'premium juice' retail categories, as well as on dairy shelves with cold brew coffees, and the coffee aisle with our whole bean coffee line.

In summary, our sales expansion priorities are:

(1) expansion of wholesale distribution

(2) retail chain success

(3) growth of direct to retail sales

(4) growth of direct to consumer sales, and

(5) development of raw material ingredient sales

 

Major Industry Participants

The expansion of leading beverage monoliths within new products in the beverage category has tightened pricing but also created a vibrant mergers and acquisitions environment for emerging brands like KonaRed.

Takeovers and mergers are a hallmark of our industry. Recent beverage industry deals have included:

 

Market Development and Metrics

Our objective is to develop KonaRed into a powerhouse coffee company which supplies consumers with a variety of high quality coffee, beverage and nutritional products. We plan to achieve this using a strategy of expanding our retail footprint through a series of revenue generating distribution channels as well as direct to consumer sales.

Presently, our predominant focus is our beverage and cold brew coffee businesses and we are generating revenues through the following distribution channels:

●

Direct Store Distributors

●

Broadline Distributors

●

Direct to Retail

●

Online Retail

●

Raw Material Ingredient Sales

The specifics of each channel are as follows:

 

 

To develop this strategy we continually evaluate: product line sales, product line specific gross margin, individual products costs and pricing of individual product lines. Growth of our retail footprint will continue to be evaluated through the growth of our client base in each specific distribution channel.

Competition

 

The beverage industry is extremely competitive. The principal areas of competition include pricing, packaging, development of new products and flavors, and marketing campaigns. Our product is competing directly with a wide range of drinks produced by a relatively large number of manufacturers. Most of these brands have enjoyed broad, well-established national recognition for years, through well-funded ad and other marketing campaigns. In addition, companies manufacturing these products generally have far greater financial, marketing, and distribution resources than we do. We compete to secure distributors who will agree to market our product over those of our competitors, provide stable and reliable distribution, and secure adequate shelf space in retail outlets. Our products compete with all liquid refreshments, including numerous specialty beverages, such as: SoBe; Snapple; Arizona; Vitamin Water; Gatorade; and Powerade.

Important factors that affect our ability to compete successfully include taste and flavor of our product, trade and consumer promotions, the development of new, unique and cutting edge products, attractive and unique packaging, branded product advertising, pricing, and the success of our distribution network. We believe our branding is strong and our position as a U.S. coffee supplier is relatively unique. We are committed to ethical production of our source ingredients and our use of a previously discarded by-product of coffee represents our environmentally positive corporate operating philosophy. We are also non-GMO. We believe these factors combine to provide us with a competitive advantage and our products are consistently well received by consumers.

 

 

Intellectual Property

 

KonaRed^® is a registered trademark in the United States and in Japan and we intend to seek a number of trademarks for slogans and product designs. We also hold trademark rights to the "Paradise in a Bottle^®" and "Nature's Best Kept Secret^®" tag lines; and rights to a suite of international CoffeeBerry^® trademarks provided under our License with VDF. We believe we have the rights to use the necessary processing and manufacturing intellectual property relating to processing and manufacturing our base ingredient (the coffee fruit) and our proprietary beverage formulas. However, we do not own the manufacturing process for making the finished beverages. We intend to aggressively assert our rights under trade secret, unfair competition, trademark and copyright laws to protect our intellectual property, including product design, product research and concepts and recognized trademarks. These rights are protected through the acquisition of patents and trademark registrations, the maintenance of trade secrets, the development of trade dress, and, where appropriate, litigation against those who are, in our opinion, infringing these rights.

While there can be no assurance that registered trademarks will protect our proprietary information, we intend to assert our intellectual property rights against any infringer. Although any assertion of our rights could result in a substantial cost to, and diversion of effort by, our Company, management believes that the protection of our intellectual property rights will be a key component of our operating strategy.

Seasonality of Business

 

The sales of our products are influenced to some extent by weather conditions in the markets in which we operate. Unusually cold or rainy weather during the summer months may have a temporary effect on the demand for our product and contribute to lower sales, which could have an adverse effect on our results of operations for such periods.

Government Regulation

 

Our products are considered to be synonymous with coffee for regulatory purposes and are thus sold under the U.S. Food and Drug Administration's ("FDA") "Generally Regarded as Safe" ("GRAS") regulatory umbrella. Accordingly, we are not required to petition for FDA approval of our coffee fruit offerings, which would be typical under standard dietary supplement guidelines. However, our Company has registered all of its supply chain subcontractors with the FDA as required and has met and answered all inquiries by the FDA. We believe we are in full compliance with all FDA regulations.

The advertising, distribution, labeling, production, safety, sale, and transportation in the United States of our product are subject to: the Federal Food, Drug, and Cosmetic Act; the Federal Trade Commission Act; the Lanham Act; state consumer protection laws; competition laws; federal, state and local workplace health and safety laws; various federal, state and local environmental protection laws; and various other federal, state and local statutes and regulations. It will be our policy to comply with any and all legal requirements.

Employees

 

In addition to Shaun Roberts, who is our Chief Executive Officer, Interim Chief Financial Officer,  director, and Board Chair; and Kyle Redfield, who is our President and Chief Operating Officer, director; we currently employ 10 full-time employees who all work in the United States. Our operations are overseen directly by management that engages our employees to carry on our business. Our management oversees all responsibilities in the areas of corporate administration, business development, and research; and as needed we engage the services of other professionals for legal, audit and other technical services. We intend to expand our current management to retain other skilled directors, officers, and employees with experience relevant to our business focus. Our management's relationships will provide the foundation through which we expect to grow our business in the future. We believe that the skill-set of our management team will be a primary asset in the development of our brands and trademarks.

 

Description of Property

Our principal office and warehouse is located at 1101 Via Callejon #200, San Clemente, California 92673-4230. During the period ended June 30, 2017 and the year ended December 31, 2016 we shared our warehouse premises with a sublessee whose occupancy ended on April 7, 2017, at which time we assumed all lease payments. We also utilize offices provided by our CEO and CFO. The current distribution facility lease has a term of June 1, 2016 to May 31, 2018 and presently requires lease payments of $10,466 per month. On February 25, 2016, the lease was extended for an additional 24 month term based on lease payments of $10,466 for June 1, 2016 to May 31, 2017 and $10,793 for June 1, 2017 to May 31, 2018. We believe that the condition of our principal office and warehouse are satisfactory, suitable and adequate for our current needs.

Fixed assets currently shown on our balance sheet are comprised of furniture and warehouse fixtures and at present the Company has no material property balances which are classified as assets under generally accepted accounting principles.

Critical Accounting Policies

 

Basis of presentation

 

The financial statements of the company have been prepared in accordance with the accounting principles generally accepted in the United States of America ('GAAP').

Inventories

 

Inventories are primarily raw materials and finished goods. Inventories are valued at the lower of, cost as determined on an average basis, or market. Market value is determined by reference to selling prices at, or around, balance sheet date or by management's estimates based on prevailing market conditions. Management writes down the inventories to market value if it is below cost. Management also regularly evaluates the composition of its inventories to identify slow-moving and obsolete inventories to determine if valuation allowance is required. Costs of raw material and finish goods inventories include purchase and related costs incurred in bringing the products to their present location and condition.

 

Revenue recognition

 

Sales revenue consists of amounts earned from customers through the sale of its consumer and industrial products and from delivery fees. Sales revenue is recognized when persuasive evidence of an arrangement exists, price is fixed or determinable, title to and risk of loss for the product has passed, which is generally when the products are received by the customers, and collectability is reasonably assured. Customers accept good FOB shipping point. Goods are sold on a final sale basis and in the normal course of business the Company does not accept sales returns.

 

Cost of goods sold

 

Cost of goods sold consists primarily of selling of raw materials and finished goods purchased from vendors as well as warehousing and distribution costs such as inbound freight charges, shipping and handling costs, purchasing and receiving costs.

Customer shipping expenses

Costs for products shipped to customers are recorded as general and administrative expenses.

 

Stock Based Payments

 

We account for share-based awards to employees in accordance with ASC 718 "Stock Compensation". Under this guidance, stock compensation expense is measured at the grant date, based on the fair value of the award, and is recognized as an expense over the estimated service period (generally the vesting period) on the straight-line attribute method. Share-based awards to non-employees are accounted for in accordance with ASC 505-50 "Equity", wherein such awards are expensed over the period in which the related services are rendered.

Deferred Revenue

Revenue from customer purchase agreements is recorded as unearned revenue and amortized over the term of the agreements. At June 30, 2017 and December 31, 2016, unearned revenues were $172,986 and $193,020, respectively. Historically, unearned revenue comprised of amortization of online subscriptions wherein we ship a scheduled amount of product to online retail subscribers each month and during the year ended December 31, 2016, unearned revenue was increased based on a cash payment we received for a non-refundable signing fee of $200,000 from a strategic supplier license (the "FP Agreement"). The FP license fee will be amortized over the term of the license, which translates to addition of $40,000 per year to our Other Income.

 

 

RESULTS OF OPERATIONS

The following discussion and analysis covers material changes in the financial condition of our Company for the three and six month periods ended June 30, 2017 and June 30, 2016. A summary is as follows:

Sales

Total sales are comprised of product sales and shipping and delivery fees. During the three and six month periods ended June 30, 2017 we recorded total sales of $955,030 and $1,545,095 compared with total sales of $229,662 and $384,925 for the three and six month periods ended June 30, 2016, representing an increase of 316% and 301%, respectively. Comparative product sales for the three and six month periods ended June 30, 2017 and June 30, 2016 were $954,114 and $1,545,094 versus $228,393 and $374,184, respectively, representing an increases of 318% and 311% respectively; and comparative shipping and delivery fees were $916 and $5,763 versus $1,269 and $10,741 respectively.

We are now benefiting from our efforts during 2016 to build a distribution network for our new Cold Brew Coffee product line. We attribute the growth in revenue during the period ended June 30, 2017 to continuing acquisition of new customers for KonaRed Cold Brew Coffees and orders from repeat customers. Cold Brew is now KonaRed's major marketing focus and accounted for 81% and 81% of our sales during the three and six month periods ended June 30, 2017.

 

 

Overall, Cold Brew Coffee is a booming new market sector and KonaRed has emerged early as a leader in this new category. The Cold Brewed Coffee industry earned total revenues of approximately $65 million in 2016. Its growth is expected to mark one of the top food and beverage trends of the last few years and this growth trend continues. KonaRed's Cold Brew Coffees have won multiple industry and consumer awards and now appear on major retail shelves throughout the Western US, Florida and New York.

Cost of Goods Sold

For the three and six month periods ended June 30, 2017 and June 30, 2016, Cost of Goods Sold ('COGS') were $721,037 and $1,118,265 compared to $130,689 and $325,337 respectively, which represents 75% and 72% of sales compared with 57% and 85% of sales, respectively.

Gross Margin was 25% and 28% versus 43% and 15% for the three and six month periods ended June 30, 2017 and June 30, 2016.  We attribute the decrease in Gross Margin to our increased distribution among national retailers at reduced margins in return for higher sales volume.  In addition, many of the national chains purchase our products through distributors.

COGS components for the three and six month periods ended June 30, 2017 and June 30, 2016 were: manufacturing costs, which include both in-house and outsourced manufacturing costs, totaling  $1,010,080  versus $248,074 respectively; inventory delivery costs of $61,839 versus $11,942, respectively; and packaging, inventory write-offs, term discounts, and other costs of $46,346 versus $65,321, respectively.

Operating Expenses

Our operating expenses are classified into three categories:

-  Research and development

-  Advertising and marketing

-  General and administrative expenses

Research and Development

Research and development costs were minimal for both three and six month periods ended June 30, 2017 and June 30, 2016. We project R&D costs will remain near current levels during the balance of fiscal 2017.

Advertising and Marketing

Advertising and marketing costs were $202,904 and $244,497 versus $91,376 and $157,673, respectively for the three and six month periods ended June 30, 2017 and June 30, 2016, representing an increase of 122% and 55%. This increase was attributable to coop advertising credits charged by national retailers. Primary components of advertising and marketing expenses for the six month periods ended June 30, 2017 and June 30, 2016 were: (i) advertising and graphic art costs of $152,369 versus $20,667, respectively; (ii) cost of free samples and demos was $39,035 versus $95,599, respectively; and (iii) other marketing expenses, sponsorships and public relations initiatives totaled $53,093 and $41,407, respectively. We project advertising and marketing costs will increase during the balance of fiscal 2017.

 

 

General and Administrative

General and administrative ('G&A') costs were $783,979 and $1,631,485 for the three and six month periods ended June 30, 2017 compared to $618,657 and $1,151,013 for the three and six month periods ended June 30, 2016, representing an increase of 41% and 48%. Major components of G&A for the six month periods were: (i) payroll of $609,669 versus $444,164, respectively, representing an increase of 37%; (ii) non-cash stock and options issuance costs for compensation and services of $358,072 versus $244,757, respectively, representing an increase of 46%; (iii) professional and consultant fees of $44,807 versus $91,343, respectively, representing a decrease of 51%; and (iv) VDF License fees of $200,000 versus $175,000, respectively, representing an increase of 14%. We project general and administrative expenses will grow moderately during the balance of fiscal 2017.

Interest Expense

Interest expense, including amortizations of original issuance discounts related to debt issuances and amortization of derivatives created by issuance of convertible securities, totaled $71,102 and $251,417 for the three and six month periods ended June 30, 2017 versus $37,136 and $73,532 for the three and six month periods ended June 30, 2016. We project that interest expenses will decrease during the balance of fiscal 2017.

Other Income (Expense)

During the three and six month periods ended June 30, 2017 and June 30, 2016, we recorded license fee revenue amortization of $10,000 and $20,000 versus $nil and $nil, respectively; and non-cash charges for changes in fair market value of derivative liabilities which arose from our issuance of convertible debt instruments and non-cash amortizations of discounts on notes payable which respectively totaled $434,291 and $677,808 versus $142,342 and $285,175, respectively.

Net Loss

Our net losses for the three and six month periods ended June 30, 2017 and June 30, 2016 were $1,248,625 or $0.01 per share and $2,359,237 or $0.01 per share, versus $794,468 or $0.01 per share and $1,612,490 or $0.01 per share, respectively.

Liquidity and Capital Resources

Our financial position at June 30, 2017 and December 31, 2016 was as follows:

 

Net Working Capital

As of June 30, 2017 we had cash on hand of $101,588, accounts receivable  totaling $264,397, inventory of $547,532, compared with cash of $68,546, accounts receivable plus accounts receivable - related party totaling $122,365, and inventory of $267,830 as of December 31, 2016. Our net working capital increased to a negative balance of $182,774 at June 30, 2017, from a negative balance of $198,866 at December 31, 2016. At present, we estimate we will need to raise capital during the coming twelve months to fund our strategic plans.

 

Cash Flows

Key elements comprising the comparative figures for Net cash (used) by Operating Activities for the six month periods ended June 30, 2017 and June 30, 2016 include: (i) net losses of $2,359,237 and $1,612,490, respectively; (ii) non-cash expenses for stock issued for services and compensation of $677,277 and $244,757, respectively; (iii) net non-cash amortization option grant and notes payable discount amortizations totaling $481,937 and $329,439, respectively; (iv) an increase in inventory of $279,702 versus a decrease in inventory of $80,836; and (v) increases of $440,138 and $31,296, respectively in accounts payable and accrued liabilities.

During the period ended June 30, 2017 we raised a total of $748,968 through sales of equity. This was comprised of: (a) $431,468 raised from private placement sales of 7,844,874 restricted common shares at $0.055 per share; (b) $15,000 through a private placement remedial Unit Offer #3 sale of 375,000 units priced at $0.04 per unit which included one restricted common share and one five year warrant exercisable at $0.055 per share; (c) $82,500 from issuance of 1,500,000 restricted common shares at $0.055 per share to two prior unit offering subscribers for exercises of 1,500,000 warrants they held; and (d) $220,000 raised from the sale of 4,000,000 restricted common shares which had not yet been issued and recorded as Stock Payable on the Balance Sheet as of June 30, 2017.

The Company has no securities outstanding which have conversion prices which vary based on the trading price of the Company's common shares.

During the six month period ended June 30, 2017, the Company raised $100,000 from issuance of a short term non-convertible promissory note and rolled over $200,000 of a license fee to the VDF Note.

 

 

During the six month period ended June 30, 2017, $410,896 of debt was converted by holders into equity.

These included: (a) two transactions in which we issued at total of 1,625,000 common shares at $0.04 per share for conversion by September 2015 Note Two Purchaser of the remaining $65,000 due on September 2015 Note Two. The market values of the shares totaled $128,463 based on a market close prices on dates of issuance. The conversions resulted in a $63,463 difference between the cash redemption balance and the value of the shares redemption which was treated as a conversion loss and recorded as an additional non-cash interest expense. These conversions fully paid the note and no further payments are due; (b) issuance of 990,000 common shares at $0.04 per share for conversion by December 2015 Lender of the remaining $39,600 due on the December 2015 Note. The value of the shares was $61,578 based on a market close price on date of issuance. The conversion resulted in a $21,978 difference between the cash redemption balance and the value of the shares redemption which was treated as a conversion loss and recorded as an additional non-cash interest expense. This conversion fully paid the note and no further payments are due; and (c) five transactions in which LPC converted at total of $300,000 principal and $3,060 accrued interest due on LPC Note Two at a conversion price of $0.05 per share into 6,105,843 shares valued at $405,361 based on market close prices on dates of issuance. The conversions resulted in a $99,064 difference between the cash redemption balance and the value of the shares redemption which was treated as a conversion loss and recorded as an additional non-cash interest expense.  This conversion fully paid all amounts due on LPC Note Two and the note is extinguished.

Off-Balance Sheet Arrangements

We had no significant off-balance sheet arrangements at June 30, 2017 or December 31, 2016 that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that is material to stockholders.

 

 

 

ITEM 3.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

EXCHANGE RATE FLUCTUATION RISK

Our reporting currency is United States Dollars. Our transactions are primarily conducted in US$ but may also include transactions in other currencies. Foreign currency rate fluctuations may have a material impact on the Company's financial reporting. These fluctuations may have positive or negative impacts on the results of operations of the Company.

We have not entered into derivative contracts either to hedge existing risk or for speculative purposes.

ITEM 4.  CONTROLS AND PROCEDURES

A.   Disclosure Controls and Procedures.

As required by Rule 13a-15(b) under the Securities Exchange Act of 1934, as amended, (the "Exchange Act") our management conducted an evaluation (under the supervision and with the participation of our President, Chief Executive Officer and interim Chief Financial Officer, Shaun Roberts) as of the end of the period covered by this Quarterly Report on Form 10-Q, of the effectiveness of our disclosure controls and procedures as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act. Based on that evaluation, Mr. Roberts concluded that our disclosure controls and procedures are not effective to provide reasonable assurance that information required to be disclosed in the reports that we file or submit under the Exchange Act, (i) is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission's rules and forms and (ii) is accumulated and communicated to our management, including Mr. Roberts, as appropriate to allow timely decisions regarding required disclosure.

 

B.   Management's Report on Internal Control Over Financial Reporting.

Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rules 13a-15(f) and 15d-15(f). Our internal control system is designed to provide reasonable assurance to our management and Board of Directors regarding the reliability of financial reporting and the preparation and fair presentation of financial statements for external purposes in accordance with generally accepted accounting principles. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

 

Management has assessed the effectiveness of our internal control over financial reporting as of December 31, 2016. Management's assessment was based on criteria set forth in Internal Control - Integrated Framework (2013), issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Based upon this assessment, management concluded that, as of June 30, 2017, our internal control over financial reporting was not effective, based upon those criteria, as a result of the identification of the material weaknesses described below.

 

A material weakness is a deficiency or combination of deficiencies in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the annual or interim financial statements will not be prevented or detected on a timely basis.

 

Specifically, management identified the following control weaknesses: (i) the Company has not implemented measures that would prevent one individual from overriding the internal control system. The Company does not believe that this control weakness has resulted in deficient financial reporting because the Chief Financial Officer is aware of his responsibilities under the SEC's reporting requirements and personally certifies the financial reports; and (ii) The Company utilizes accounting software that does not prevent erroneous or unauthorized changes to previous reporting periods and/or can be adjusted so as not to provide an adequate audit trail of entries made in the accounting software.

 

Accordingly, while the Company has identified certain material weaknesses in its system of internal control over financial reporting, it believes that it has taken reasonable steps to ascertain that the financial information contained in this report is in accordance with generally accepted accounting principles. Management has determined that current resources would be appropriately applied elsewhere and when resources permit, they will alleviate material weaknesses through various steps.

C.   Changes in Internal Control Over Financial Reporting.

There have been no changes in our internal control over financial reporting identified in connection with the evaluation required by Rule 13a-15(d) of the Exchange Act that occurred during the quarter ended June 30, 2017 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

 

 

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PART II – OTHER INFORMATION

ITEM 1.  LEGAL PROCEEDINGS

 

Various lawsuits, claims and other contingencies arise in the ordinary course of the Company's business activities. There are no material, active, or pending legal proceedings against us, nor are we involved as a plaintiff in any material proceedings or pending litigation. There are no proceedings in which any of our officer and director, or any registered or beneficial shareholders are an adverse party or has a material interest adverse to us.

ITEM 1A.  RISK FACTORS

Not required for smaller reporting companies.

ITEM 2.  UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

On January 23, 2017, we issued 250,000 restricted common shares at $0.0484 per share to a new director at market close price on date of grant as an inducement fee for joining our Board for a deemed non-cash cost of $12,100. These shares were issued to one Accredited Investor (as that term is defined in Rule 501 of Regulation D under the Securities Act of 1933, as amended) or qualified under the terms Rule 506 Regulation D, and in issuing these shares we relied on the exemptions from the registration requirements provided for in Rule 506 Regulation D and/or Section 4(a)(2) of the Securities Act of 1933, as amended.

On  February 14, 2017, we remedially executed a private placement related to Unit Offer #3 which raised $15,000 through the sale of 375,000 units. Each unit was priced at $0.04 per unit and comprised of one restricted common share price plus one five year warrant exercisable to purchase one restricted common share at $0.055 per share. The fair market value of the shares and embedded value of the warrants is based on the valuations done for Unit Offer #3. These shares were issued to one non-U.S. person (as that term is defined in Regulation S of the Securities Act of 1933, as amended) in offshore transactions in which we relied on the exemptions from the registration requirements provided for in Regulation S and/or Section 4(2) of the Securities Act of 1933, as amended. The warrants were valued using a Black-Scholes model at a non-cash cost of $16,463. At June 30, 2017, none of these warrants had been exercised.

During February, 2017, we issued 1,500,000 restricted common shares to two prior unit offering subscribers for exercises of 1,500,000 warrants they held at the exercise price $0.055 per share for proceeds of $82,500. These subscribers are Accredited Investors (as that term is defined in Rule 501 of Regulation D under the Securities Act of 1933, as amended) or qualified under the terms Rule 506 Regulation D, and in issuing these shares we relied on the exemptions from the registration requirements provided for in Rule 506 Regulation D and/or Section 4(a)(2) of the Securities Act of 1933, as amended.

On February 22, 2017, we issued 990,000 common shares at $0.04 per share for conversion by December 2015 Lender of the remaining $39,600 due on the December 2015 Note. The value of the shares was $61,578 based on a market close price on date of issuance. The conversion resulted in a $21,978 difference between the cash redemption balance and the value of the shares redemption which was treated as a conversion loss and recorded as an additional non-cash interest expense. This conversion fully paid the note and no further payments are due. These shares were issued to one Accredited Investor with reliance on the exemptions from registration requirements provided in the Securities Act of 1933, as amended, Section 4(1) and Rule 144.

On March 1, 2017, we issued 1,100,000 restricted common shares at $0.0548 per share at market close price on date of grant for consultant services rendered for a deemed cost of $60,280. These shares were issued to one Accredited Investor (as that term is defined in Rule 501 of Regulation D under the Securities Act of 1933, as amended) or qualified under the terms Rule 506 Regulation D, and in issuing these shares we relied on the exemptions from the registration requirements provided for in Rule 506 Regulation D and/or Section 4(a)(2) of the Securities Act of 1933, as amended.

On March 2, 2017, we issued 15,500 restricted common shares at $0.0518 per share to a professional athlete for endorsement services rendered. These shares were issued at market close price on issue date for deemed compensation of $803. These shares were issued to US persons with reliance on the exemptions from the registration requirements provided for in Rule 506 Regulation D and/or Section 4(a)(2) of the Securities Act of 1933, as amended.

On March 6, 2017, we issued 653,842 restricted common shares to a company wholly owned by our CFO at a price of $0.0559 on date of grant as compensation for a deemed cost of $36,615. These shares were issued to one non-U.S. person (as that term is defined in Regulation S of the Securities Act of 1933, as amended) in offshore transactions in which we relied on the exemptions from the registration requirements provided for in Regulation S and/or Section 4(2) of the Securities Act of 1933, as amended.

On March 7, 2017, we issued 50,000 restricted common shares at $0.0604 per share to a professional athlete for endorsement services rendered. These shares were issued at market close price on issue date for deemed compensation of $3,020. These shares were issued to US persons with reliance on the exemptions from the registration requirements provided for in Rule 506 Regulation D and/or Section 4(a)(2) of the Securities Act of 1933, as amended.

On April 3, 2017, we issued 11,000 restricted common shares at $0.0720 per share to a professional athlete for endorsement services rendered. These shares were issued at market close price on issue date for deemed compensation of $792. These shares were issued to US persons with reliance on the exemptions from the registration requirements provided for in Rule 506 Regulation D and/or Section 4(a)(2) of the Securities Act of 1933, as amended.

 

On April 11, 2017 we issued 50,000 restricted common shares at $0.0709 per share at market close price on date of grant to an employee for deemed compensation of $3,545. These shares were issued to one US person with reliance on the exemptions from the registration requirements provided for in Rule 506 Regulation D and/or Section 4(a)(2) of the Securities Act of 1933, as amended.

On May 31, 2017, we issued 150,000 restricted common shares at $0.0722 per share market close price on date of grant to a Director for deemed compensation of $10,830. These shares were issued to one US person with reliance on the exemptions from the registration requirements provided for in Rule 506 Regulation D and/or Section 4(a)(2) of the Securities Act of 1933, as amended.

On June 8, 2017, we issued 250,000 restricted common shares at $0.0692 per share market close price on date of grant to a Director for deemed compensation of $17,300. These shares were issued to one US person with reliance on the exemptions from the registration requirements provided for in Rule 506 Regulation D and/or Section 4(a)(2) of the Securities Act of 1933, as amended.

During the six month period ended June 30, 2017, we raised $429,468 through a private placement stock offering which sold 7,808,510 restricted common shares at $0.055 per share. These shares were issued to sixteen Accredited Investors (as that term is defined in Rule 501 of Regulation D under the Securities Act of 1933, as amended) or qualified under the terms Rule 506 Regulation D, and in issuing these shares we relied on the exemptions from the registration requirements provided for in Rule 506 Regulation D and/or Section 4(a)(2) of the Securities Act of 1933, as amended.  As part of this private placement stock offering, we raised an additional $220,000 in return for 4,000,000 restricted common shares at $0.055 per share, however as of June 30, 2017, these shares have not been issued pending receipt of information from purchaser required by stock registrar.  These funds have been recorded as Stock Payable in the Equity section of the company's balance sheet as of June 30, 2017.

ITEM 3.  DEFAULTS UPON SENIOR SECURITIES

None.

ITEM 4.  MINE SAFETY DISCLOSURES

Not applicable.

ITEM 5.  OTHER INFORMATION

None.

 

 

ITEM 6.  EXHIBITS

 

 

SIGNATURES

 

In accordance with the requirements of the Securities Exchange Act of 1934, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

KONARED CORPORATION

 

 

/s/ Shaun Roberts		Dated:	August 17, 2017
Shaun Roberts
Chief Executive Officer,
Chief Financial Officer

 

 

 

 

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