Financial Gravity Companies, Inc.: Form 10-Q for the period ended Jun 30, 2019

Forward-Looking Statements

The following Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) is intended to help you understand our historical results of operations during the periods presented and our financial condition. This MD&A should be read in conjunction with our financial statements and the accompanying notes and contains forward-looking statements that involve risks and uncertainties and assumptions that could cause our actual results to differ materially from management’s expectations. See the sections entitled “Risk Factors” below.

Plan of Operations

Financial Gravity Companies, Inc. (“Financial Gravity”, “We” or the “Company”), based in Allen, Texas, was formed specifically to be the parent company of several subsidiaries that provide integrated tax, business, and financial solutions. Financial Gravity’s clients include small businesses, small business owners and high net worth individuals. The Company’s services are focused on helping clients make more money and build wealth, most often with tax savings, lowering costs and improving efficiency. In addition to expanding through client procurement and organic growth, Financial Gravity intends to make a number of acquisitions. The primary acquisition targets currently include accounting, bookkeeping, and financial advisory firms. In fiscal year 2015 the Company acquired two firms: Cloud9 Holdings Company (and its subsidiary Cloud9b2b) which was renamed Financial Gravity Business and Sash Corporation, doing business as Metro Data Processing (a Tulsa, OK payroll processor). In fiscal year 2016 the Company acquired Tax Coach Software LLC. The Company is actively identifying additional potential acquisition candidates to fuel more rapid growth.

Financial Gravity’s Subsidiaries:

Financial Gravity Holdings, Inc.

This entity was created to engage in the acquisition and integration of financial and other businesses which will deliver a wide range of accounting, tax planning and management services to high net worth individuals and businesses in the Dallas/Fort Worth region, with further expansion into other markets in accordance with its long-term growth rate and strategic business plan. Financial Gravity Holdings was merged into Financial Gravity Companies February 13, 2019 and dissolved as of that date.

Financial Gravity Operations, Inc.

This entity was created to raise capital to take the company public and will be eliminated now that the public transaction is complete. This entity integrates the delivery of Financial Gravity Tax, Business, and Wealth Solutions to its growing customer base around the country. This integration, impossible to do for the small business marketplace until now, is what sets Financial Gravity apart from its peers. This integration is handled by Financial Gravity Companies, Inc. Financial Gravity Operations was merged into Financial Gravity Holdings February 12, 2019 and dissolved as of that date.

Financial Gravity Tax, Inc.

Financial Gravity has developed a precise procedure that has proven to be very successful in delivering lower taxes, higher profit, and greater wealth for small business owners.

The process begins with an extensive and comprehensive review of the client’s needs. This assessment sets the requirements for the program that is subsequently developed. Next, Financial Gravity designs a unique "Tax Blueprint®" which identifies several strategies for lowering the client's taxes.

The second step is to use the client’s custom Tax Blueprint® to build that business entity and documentation that captures the identified savings. This is called the Tax Operating System® (TOS). This process is repeated as required and tuned for optimal efficiency thus ensuring that the client receives the best service and optimal solutions in the phases of the business cycle during the year. Clients continue to pay a monthly or weekly subscription fee as part of their TOS service for ongoing tax planning, tax return preparation, payroll and bookkeeping services.

This business unit promises clients they’ll pay the lowest legal, moral and ethical taxes possible. Tax savings is the “tip of the spear” in all its offerings. No company has ever successfully married tax, wealth and business solutions together for Small Business Owners (SBOs) and high net worth individuals. Powered by its no-risk “2x Promise” (the Company guarantees to find double its initial fee in tax savings), clients are quick to sign up for proactive tax planning. Lowering their personal taxes then fuels insurance, wealth and business services sales. These multi-tiered sales provide a 4-8 times multiple to a typical accounting or bookkeeping practice.

SBO’s look for two things from a typical CPA and bookkeeping firm, (1). Lower personal income taxes; and (2). Numbers that help them run/grow their business better. There is no national firm that provides these two services at any level. Its tax planning sets us apart from typical accounting and tax preparation firms. The Company looks forward to setting up a client’s business to be tax efficient. The typical service model employed by CPA firms is oriented more toward compliance, which is the recording of historical data. These providers work on historical records instead of looking forward to proactively plan. SBOs are growing more and more frustrated with accountants who “put numbers in boxes” when what’s truly needed is a partner to help advise them in how to be more efficient in their business. Many SBOs can’t read a P/L or Balance Sheet and even when they can, the data is often too old to act on. As technology speeds up the pace of business real time data is becoming more important. Most CPAs don’t even calculate tax savings for their clients, as asking CPA’s to produce unique data to each client is outside the factory mentality of the profession. The average tax savings is over $20,000 per year per business owner. Financial Gravity Tax is pursuing several M&A and/or partnership opportunities to deliver on the product Bookkeeping with Purpose®, that will help deliver the promised tax savings and producer actionable real time data.

Financial Gravity Wealth, Inc.

After saving thousands in taxes, clients are happy to trust us with the management of their wealth, especially when treated to a different wealth management experience. Financial Gravity Wealth is a Registered Investment Advisory (RIA) firm. An RIA is an advisor or firm engaged in financial planning and wealth management business and is registered either with the Securities and Exchange Commission (SEC) or state securities authorities. An RIA has a fiduciary duty to his or her clients, which means that he or she has a fundamental obligation to provide suitable investment advice and always act in the clients' best interests.

The Department of labor's fiduciary rule is officially dead. The fiduciary rule, also known officially as the “Conflict of Interest” rule, states advisers have to give conflict-free advice on retirement accounts, putting their clients' needs ahead of their own potential compensation. Although the Department of labor’s Fiduciary Rule was struck down by the Fifth Circuit Court, we will still maintain the fiduciary standard as a company, because we think it is best for the client.

Only 5% of all financial planners are RIAs. The advantage of the RIA model is lower cost to the client. Also, since RIAs are not compensated by commissions on financial products, their advice is considered less biased and more accurate. Coupled with tax savings, its status as an RIA makes the Company very attractive to the most profitable clients.

Financial Gravity Business, LLC

The complexity of Advanced Tax Planning next fuels Financial Gravity Business services. The first product that was developed with a partner is Advisor Architect. This product is designed to help financial advisors and accountants run their businesses better. The Company intends to test the service offering / coaching program with the first two markets where it has the most experience and then roll out the service offering to other industries at a later date. Clients spend some of their tax savings from Financial Gravity Tax planning for these services, rendering them “cost neutral”.

The Company has also developed its Partner Programs that teach financial advisors how to serve an underserved community, the Small Business Owner. Financial Gravity Business is the only non-product centric business system for financial advisors that helps them serve the needs of the small business owner without needing to sell a financial services product like a life insurance policy or a 401(k) plan.

To broaden the skillset of CPAs, the Company has created the Certified Tax Master® designation and partner program for CPA’s and Enrolled Agents (“EA’s”). To its knowledge, there is no program offering like this of its kind available elsewhere. This program was created in Financial Gravity Business but will be sold and build revenue in the Tax Coach Software platform.

Financial Gravity Ventures, LLC

This entity in the Company’s corporate family employs its M&A strategy to acquire talent and build wealth for Financial Gravity Companies, Inc. and acquired companies. As mentioned earlier, Financial Gravity is pursuing several acquisition opportunities.

Tax Master Network, LLC formerly Tax Coach Software, LLC

Tax Master Network (TMN) was a key acquisition in fiscal year 2016. TMN supports over 550 CPA and Enrolled Agent professionals, training them to add crucial tax planning services to support clients. Not only did this acquisition bring high-end tax planning to Financial Gravity, but the TMN customer base adds significant business development opportunities for Financial Gravity Wealth. The Company developed the Certified Tax Master® for this group and rolled out new client systems in mid-2016.

Results of Operations for the three and nine months ended June 30, 2019 compared to the three and nine months ended June 30, 2018

Revenues

For the three months ended June 30, 2019, revenues decreased $162,428 to $926,541 from $1,088,969 for the three months ended June 30, 2018. The decrease is principally driven by elimination of intercompany management fees. For the nine months ended June 30, 2019, revenues decreased $245,934 to $3,087,063 from $3,332,997 for to the nine months ended June 30, 2018. The decrease is principally driven by elimination of intercompany management fees.

Operating Expenses

Cost of services increased by $1,903 to $15,473 for the three months ended June 30, 2019 from $13,570 for the three months ended June 30, 2018, and decreased by $20,454, to $44,783 from $65,237 for the nine months ended June 30, 2019 and June 30, 2018, respectively. The changes are related to credit card processing fees.

Professional services expenses include legal expense, professional fees, contract labor, business consulting and computer and internet expense. Professional services expenses decreased $26,514 to $119,205 for the three months ended June 30, 2019 from $145,719 for the three months ended June 30, 2018. This decrease is primarily due to the termination of consulting agreements, resulting in savings of $45,618 in three months ended June 30, 2019, offset by increases in other professional services. For the nine months ended June 30, 2019 and 2018, professional services decreased $346,708, to $278,998 at June 30, 2019, from $625,706 at June 30, 2018. This consists primarily of a cessation of the consulting fee arrangements, resulting in savings of $264,275, and a decrease in legal fees of $70,680.

Depreciation and amortization expenses include depreciation on fixed assets and amortization of definite lived intangibles. In the three months ended March 31, 2019, the investment in Trade Name was deemed fully impaired, and a charge of $69,300 was recorded to amortization for this asset. Depreciation and amortization expenses increased $1,432 for the three months ended June 30, 2019, to $30,235, from $28,803. Depreciation and amortization expenses increased $76,594 to $158,835 for the nine months ended June 30, 2019 from $82,241 for the nine months ended June 30, 2018.. The increases are due to additional purchases of fixed assets and leasehold improvements purchased in the last twelve months, and the aforementioned, one-time charge to amortization of the Trade Name asset.

General and administrative expenses decreased $435,957 to $139,220 for the three months ended June 30, 2019 from $575,177 for the three months ended June 30, 2018 and decreased $1,298,078 to $410,863 from $1,708,941 for the nine months ended June 30, 2019 and 2018. The decrease is primarily due to regular reevaluation of costs, aimed at eliminating unnecessary costs, and reducing them by elimination, consolidation or renegotiation.

Management fees decreased $12,750 to $43,500 for the three months ended June 30, 2019 from $56,250 for the three months ended June 30, 2018, and decreased by $16,750 to $130,500 for the nine months ended June 30, 2019 from $147,250 for the nine months ended June 30, 2018. These are related party fees.

Marketing expenses decreased $19,453 to $48,330 for the three months ended June 30, 2019 from $67,783 for the three months ended June 30, 2018 and decreased $96,073, to $109,945 from $206,018 for the nine months ended those dates. The decrease is primarily due to the Company bringing more of the marketing in-house instead of outsourcing.

Salaries and wages expenses increased $224,511 to $503,224 for the three months ended June 30, 2019 from $278,713 for the three months ended June 30, 2018 and increased $853,043 to $2,351,991 for the nine months ended June 30, 2019, from $1,498,948 for the nine months ended June 30, 2018. The major drivers of this are increases in payroll expenses $60,933 and $166,023 for the three and nine months ended June 30, 2019 respectively, and compensation for stock grants awarded to an officer, $78,750 for the three months ended June 30, 2019, and $183,750 for the nine months ended June 30,2019. Additionally, there were staff increases, period over period.

The Company experienced an increase in its bottom line of $87,137 to a net loss of $16,941 for the three months ended June 30, 2019 from a net loss of $104,078 for the three months ended June 30, 2018, primarily attributable to the reasons noted above, offset by an increase in interest expense of $17,263. Likewise, for the nine months ended June 30, 2019 and 2018, the Net Loss improved by $514,603, to a loss of $536,538, from a loss of $1,051,141 for the same period in 2018.

Significant Accounting Policies

Certain critical accounting policies affect the more significant judgments and estimates used in the preparation of Financial Gravity’s consolidated financial statements. These policies are contained in Note 1 to the consolidated financial statements.

Use of Estimates and Assumptions.

The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reported period. Actual results could differ from those estimates.

Revenue Recognition and Accounts Receivable.

Investment management fees are recognized as services are provided by the Company. Investment management fees include fees earned from assets under management by providing professional services to manage clients’ investments.

Services income is recognized as consulting and other professional services are performed by the Company.

Commission revenue is derived from the sale of premiums on life insurance policies held by third parties. The revenue is recognized at the time the policy is issued.

Revenue represents gross billings less discounts, net of sales tax, as applicable. Amounts invoiced for work not yet completed are shown as deferred revenue in the accompanying consolidated balance sheets.

Tax Master Network Software has 5 types of services that are charged and collected on a month to month subscription basis (Tax Master basic, advance, and elite membership, all-stars coaching, and networker). None of these programs come with a long-term commitment or contract, and there is no up-front payment beyond the monthly subscription fee. Cancellations are processed within the month requested and memberships are closed at the end of the period for which the most recent payment was made. Members are not entitled to refunds for unused memberships.

Trade accounts receivable are carried at the invoiced amount less estimate made for doubtful accounts based on management’s review of outstanding balances. The collectability of the Company’s accounts receivable is reviewed on an ongoing basis, using historical payment trends and review of specific accounts. Accounts receivable are written off after all reasonable collection efforts have been exhausted and when management determines the amounts to be uncollectible. Recoveries of receivables previously written off are recorded when received.

In the normal course of business, the Company extends credit on an unsecured basis to its customers, substantially all of whom are located in the United States of America. The Company does not believe that it is exposed to any significant risk of loss on accounts receivable.

Stock-Based Compensation

The Company recognizes the fair value of stock-based compensation awards as wages in the accompanying statements of operations on a straight-line basis over the vesting period, using the Black-Scholes option pricing model, which is based on risk-free rates of 2.89% in 2019 and 1.49% to 2.55% in 2018, dividend yield of 0%, expected life of 2 years and volatility of 35% to 40%.

Liquidity and Capital Resources

As of June 30, 2019, the Company had cash and cash equivalents of $35,876. The increase of $3,656 in cash and cash equivalents during the nine months ended June 30, 2019 was due to net cash used in operating activities of $964, net cash used by investing activities of $32,582, and net cash provided by financing activities of $37,201.

Net cash used by operating activities was $964 for the nine months ended June 30, 2019. The net cash used in operating activities was due to net loss of $536,538 adjusted primarily by the following: (1) depreciation of $27,943, amortization of $61,592, stock based compensation of $317,464, stock issued for services of $38,660, impairment of an intangible of $69,300, decrease in accounts receivable of $4,823, decrease in accounts receivable related party of $ 1,791, increase in accounts payable – trade of $84,194, a decrease in prepaid expenses of $10,577, and a decrease in accrued expenses of $80,770.

Net cash used by investing activities of $32,582 was comprised of purchases of PP&E of $28,352 and purchases of trademarks $4,230.

Net cash provided by financing activities was $37,201 for the nine months ended June 30, 2019. Cash provided by financing activities consists of borrowings on a line of credit $14,100 and via notes payable of $202,205. Cash used in financing activities consists of payments on the line of credit $6,742 and payments on notes payable $172,362.

As shown below, at June 30, 2019, our contractual cash obligations totaled approximately $697,225, all of which consisted of operating lease obligations and debt principal.

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The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern, which contemplates the Company will need additional financing to fund additional material capital expenditures and to fully implement its business plan. In mitigation of this concern, on May 23, 2017, the Company and GHS Investments, LLC (“GHS Investments”) entered into an Equity Financing Agreement (the “Agreement”). The Agreement was filed as an exhibit to a registration statement on Form S-1, filed with the Securities and Exchange Commission (“SEC”) on September 18, 2017. The agreement was approved by the SEC November 13, 2018. The Agreement contemplates a series of transactions, pursuant to which the Company will “put” shares of its common stock to GHS in consideration of the payment to the Company of eighty percent (80%) of the “Market Price” of such shares. “Market Price” shall mean the average of the two lowest trading prices of the Company’s Common Stock during the ten (10) consecutive trading days preceding the receipt of the applicable put notice. Accordingly, on each instance the Company exercises a put option, the Company will know in advance, both the number of shares issuable upon exercise of the put option, and the dollar amount of the purchase price for such shares. The maximum purchase price for shares to be purchased by GHS Investments under the Agreement is $11,000,000. To facilitate the sale of the shares so purchased by GHS Investments, the Company agreed to file a registration statement with the Securities and Exchange Commission. The Company also entered into a Registration Rights Agreement with GHS Investments, pursuant to which the Company has agreed to provide certain registration rights under the Securities Act of 1933, the rules and regulations promulgated thereunder, and applicable state securities laws. The Agreement will terminate (i) when GHS Investments has purchased an aggregate of $11,000,000 of the common stock of the Company, or (ii) 36 months after the effective date of the Agreement, or (iii) at such time that the registration statement is no longer in effect.

The Company has a backlog of fees under contract in addition to the Company’s accounts receivable balance. The failure to adequately fund its capital requirements could have a material adverse effect on our business, financial condition and results of operations. Moreover, the sale of additional equity securities to raise financing will result in additional dilution to the Company’s stockholders and incurring additional indebtedness could involve the imposition of covenants that restrict our operations. Management is trying to raise additional capital through sales of common stock as well as seeking financing from third parties, via both debt and equity, to balance the Company’s cash requirements and to finance specific capital projects.

Off Balance Sheet Transactions and Related Matters

Other than operating leases discussed in Note 8 to the consolidated financial statements, there are no off-balance sheet transactions, arrangements, obligations (including contingent obligations), or other relationships with unconsolidated entities or other persons that have, or may have, a material effect on financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources of the Company.

Interest Rate Risk. Our business is leveraged and, accordingly, is sensitive to fluctuations in interest rates. Any significant increase in interest rates could have a material adverse effect on our financial condition and ability to continue as a going concern.

As of the end of the period covered by this report, our principal executive officer and principal financial officer, evaluated the effectiveness of our “disclosure controls and procedures,” as defined in Rule 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934. Based on that evaluation, we concluded that, as of the date of the evaluation, our disclosure controls and procedures were not effective to provide reasonable assurance that information required to be disclosed in our periodic filings under the Securities Exchange Act of 1934 is accumulated and communicated to management, including the officers, to allow timely decisions regarding required disclosures. It should be noted that a control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that it will detect or uncover failures within the Company to disclose material information otherwise required to be set forth in the Company’s periodic reports.

During the period covered by this report, there were no changes in our internal control over financial reporting that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

The Company’s limited operating history may not serve as an adequate basis to judge its future prospects and results of operations. Financial Gravity has a relatively limited operating history. Its limited operating history and the unpredictability of the wealth management industry make it difficult for investors to evaluate its business. An investor in its securities must consider the risks, uncertainties and difficulties frequently encountered by companies in rapidly evolving markets.

The Company will need additional financing to implement its business plan. The Company will need additional financing to fully implement its business plan in a manner that not only continues to expand an already established direct-to-consumer approach, but also allows the Company to establish a stronger brand name in all the areas in which it operates. In particular, the Company will need additional financing to:

• Effectuate its business plan and further develop its product and service lines;
• Expand its facilities, human resources, and infrastructure; and
• Increase its marketing efforts and lead generation.

There are no assurances that additional financing will be available on favorable terms, or at all. If additional financing is not available, the Company will need to reduce, defer or cancel development programs, planned initiatives and overhead expenditures. The failure to adequately fund its capital requirements could have a material adverse effect on the Company’s business, financial condition and results of operations. Moreover, the sale of additional equity securities to raise financing will result in additional dilution to the Company’s stockholders and incurring additional indebtedness could involve the imposition of covenants that restrict the Company’s operations.

The Company’s products and services are subject to changes in applicable laws and regulations. The Company’s business is particularly subject to changing federal and state laws and regulations related to the provision of financial services to consumers. The Company’s continued success depends in part on its ability to anticipate and respond to these changes, and the Company may not be able to respond in a timely or commercially appropriate manner. If the Company fails to adjust its products and services in response to changing legal and/or regulatory requirements, the ability to deliver its products and services may be hindered, which in turn could have an adverse effect on the Company’s business, financial condition and results of operations.

The Company may continue to encounter substantial competition in its business. The Company believes that existing and new competitors will continue to improve their products and services, as well as introduce new products and services with competitive price and performance characteristics. The Company expects that it must continue to innovate, and to invest in product development and productivity improvements, to compete effectively in the several markets in which the Company participates. The Company’s competitors could develop a more efficient product or service or undertake more aggressive and costly marketing campaigns than those implemented by the Company, which could adversely affect the Company’s marketing strategies and have an adverse effect on the Company's business, financial condition and results of operations.

Important factors affecting the Company's current ability to compete successfully include:

• lead generation and marketing costs;
• service delivery protocols;
• branded name advertising; and
• product and service pricing.

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In periods of reduced demand for the Company's products and services, the Company can either choose to maintain market share by reducing product and service pricing to meet the competition, or maintain its product and service pricing, which would likely sacrifice market share. Sales and overall profitability may be reduced in either case. In addition, there can be no assurance that additional competitors will not enter the Company's existing markets, or that the Company will be able to continue to compete successfully against its competition.

The Company may not successfully manage its growth. The Company’s success will depend upon the expansion of its operations and the effective management of its growth, which will place a significant strain on its management and on its administrative, operational and financial resources. To manage this growth, it must expand its facilities, augment its operational, financial and management systems, and hire and train additional qualified personnel. If it is unable to manage its growth effectively, its business would be harmed.

The Company relies on key executive officers, and their knowledge of its business and technical expertise would be difficult to replace. The Company is highly dependent on its executive officers. If one or more of the Company's senior executives or other key personnel are unable or unwilling to continue in their present positions, the Company may not be able to replace them easily or at all, and the Company’s business may be disrupted. Competition for senior management personnel is intense, the pool of qualified candidates is very limited, and it may not be able to retain the services of its senior executives or attract and retain high-quality senior executives in the future. Such failure could have a material adverse effect on the Company's business, financial condition and results of operations.

The Company may never pay dividends to its common stockholders. The Company currently intends to retain its future earnings to support operations and to finance expansion; accordingly, the Company does not anticipate paying any cash dividends in the foreseeable future.

The declaration, payment and amount of any future dividends on common stock will be at the discretion of the Company's Board of Directors, and will depend upon, among other things, earnings, financial condition, capital requirements, level of indebtedness and other considerations the Board of Directors considers relevant. There is no assurance that future dividends will be paid on common stock or, if dividends are paid, the amount thereof.

The Company’s common stock is quoted through the OTC Markets, which may have an unfavorable impact on its stock price and liquidity. The Company’s common stock is quoted on the OTC Markets, which is a significantly more limited market than the New York Stock Exchange or NASDAQ. The trading volume may be limited by the fact that many major institutional investment funds, including mutual funds, follow a policy of not investing in OTC Markets stocks and certain major brokerage firms restrict their brokers from recommending OTC Markets stocks because they are considered speculative and volatile.

The trading volume of the Company’s common stock has been and may continue to be limited and sporadic. As a result, the quoted price for the Company’s common stock on the OTC Markets may not necessarily be a reliable indicator of its fair market value.

Additionally, the securities of small capitalization companies may trade less frequently and in more limited volume than those of more established companies. The market for small capitalization companies is generally volatile, with wide price fluctuations not necessarily related to the operating performance of such companies.

The Company’s common stock is subject to price volatility unrelated to its operations. The market price of the Company’s common stock could fluctuate substantially due to a variety of factors, including market perception of the Company’s ability to achieve its planned growth, operating results of the Company and of other companies in the same industry, trading volume in the Company’s common stock, changes in general conditions in the economy and the financial markets or other developments affecting the Company or its competitors.

The Company’s common stock is classified as a “penny stock.” Rule 3a51-1 of the Securities Exchange Act of 1934 establishes the definition of a “penny stock,” for purposes relevant to us, as any equity security that has a minimum bid price of less than $5.00 per share or with an exercise price of less than $5.00 per share, subject to a limited number of exceptions which are not available to us. It is likely that the Company’s common stock will be considered to be a penny stock for the immediately foreseeable future.

For any transaction involving a penny stock, unless exempt, the penny stock rules require that a broker or dealer approve a person’s account for transactions in penny stocks and the broker or dealer receive from the investor a written agreement to the transaction, setting forth the identity and quantity of the penny stock to be purchased. In order to approve a person’s account for transactions in penny stocks, the broker or dealer must obtain financial information and investment experience and objectives of the investor, make a reasonable determination that transactions in penny stocks are suitable for that person, and make a reasonable determination that that person has sufficient knowledge and experience in financial matters to be capable of evaluating the risks of transactions in penny stocks.

The broker or dealer must also provide disclosure to its customers, prior to executing trades, about the risks of investing in penny stocks in both public offerings and in secondary trading, the commissions payable to both the broker-dealer and the registered representative, and the rights and remedies available to an investor in cases of fraud in penny stock transactions.

Because of these regulations, broker-dealers may not wish to furnish the necessary paperwork and disclosures and/or may encounter difficulties in their attempt to buy or sell shares of the Company’s common stock, which may in turn affect the ability of Company stockholders to sell their shares.

Accordingly, the penny stock classification adversely affects any market liquidity for the Company’s common stock and subjects the shares to certain risks associated with trading in penny stocks. These risks include difficulty for investors in purchasing or disposing of shares, difficulty in obtaining accurate bid and ask quotations, difficulty in establishing the market value of the shares, and a lack of securities analyst coverage.