Notes to Condensed Consolidated Financial Statements

1. Organization, Nature of Operations, and Principles of Consolidation

Real Goods Solar, Inc. (the “Company” or “RGS”) is a residential and small business commercial solar energy engineering, procurement, and construction firm.

These consolidated financial statements have been prepared on the going concern basis, which presumes the realization of assets and the settlement of liabilities in the normal course of operations. The application of the going concern basis is dependent upon the Company achieving profitable operations to generate sufficient cash flows to fund continued operations, or, in the absence of adequate cash flows from operations, obtaining additional financing. The Company has reported losses from operations for the three months and six months ended June 30, 2018 and 2017 and has an accumulated deficit of $213 million at June 30, 2018. These factors raise substantial doubt about the Company's ability to continue as a going concern. The financial statements do not include any adjustments relating to the recoverability and classification of recorded asset amounts or amounts and classification of liabilities that might be necessary should the Company be unable to continue as a going concern.

The Company is the licensee of POWERHOUSE™, an in-roof solar shingle using technology developed by the Dow Chemical Company that it believes will improve results of operations and generate cash flow. The Company anticipates receiving UL approval during October 2018 to manufacture and sell the shingles. To commercialize POWERHOUSE™, the Company has raised approximately $10 million since July 1, 2018.

Principles of Consolidation

We have prepared our unaudited interim condensed consolidated financial statements included herein pursuant to the rules and regulations of the SEC. Certain information and note disclosures normally included in annual financial statements prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) have been condensed or omitted pursuant to these rules and regulations, although we believe that the disclosures made are adequate to make the information not misleading. In our opinion, the unaudited interim financial statements contain all adjustments (consisting of only normal recurring adjustments) necessary to present fairly, in all material respects, our condensed consolidated financial position as of June 30, 2018, the interim results of operations for the three months and six months ended June 30, 2018 and 2017, and cash flows for the six months ended June 30, 2018 and 2017. These interim statements have not been audited. The balance sheet as of December 31, 2017 was derived from our audited consolidated financial statements included in our 2017 10-K. The interim condensed consolidated financial statements contained herein should be read in conjunction with our audited financial statements, including the notes thereto, for the year ended December 31, 2017.

Discontinued Operations

During 2014, we committed to a plan to sell certain contracts and rights comprising our large commercial installations business, otherwise known as our former Commercial segment. At the same time, we determined not to enter into further large commercial installation contracts in the mainland United States. Most contracts in process at December 31, 2014 were substantially completed during 2015 and remaining work was completed during 2016. We report this business as a discontinued operation, separate from our continuing operations. See Note 12. Discontinued Operations.

Liquidity and Financial Resources Update

The Company has experienced recurring operating losses and negative cash flow from operations which have necessitated: (i) developing plans to grow revenue to generate positive cash flow and (ii) raising additional capital. No assurances can be given that the Company will be successful with its plans to grow revenue for profitable operations or, if necessary, raise additional capital. See Note 6. Shareholders’ Equity and Note 7. Convertible Debt for transactions raising capital during the first half of 2018.

The Company’s plans to grow revenue are:

Until the Company is successful in implementing its plans to increase revenue for profitable operations, the Company expects to have a cash outflow from operating activities. The Company expects to obtain UL certification for POWERHOUSE™ 3.0 in October 2018 and proceed with the commercialization of POWERHOUSE™ 3.0. The Company initially expects to have cash outflow from operating activities for commercialization of POWERHOUSE™ 3.0 and prepayments with supply chain manufacturers as sales of the product commence. Additionally, the Company will be required to make the remaining “Initial License” payment of $2 million, which will be recorded as a cash outflow in investing activities.

To provide funds to commercialize POWERHOUSE™ 3.0, on March 30, 2018, the Company entered into the Securities Purchase Agreement for the 2018 Note Offering (as defined and further discussed in Note 7. Convertible Debt). Cash proceeds received by the Company including hypothetical cash receipts related specifically to the 2018 Note Offering are summarized below:

The expected activity above reflects:

* The Company receiving cash of $3.3 million from the Investor Notes (Note 7).

* The noteholders converting shares represented by Additional Amount (Note 7) into Class A common stock at the reset price of $0.3223

The Company has access to hypothetical cash from exercise of other common stock warrants. The hypothetical maximum cash from exercise of other common stock warrants is the mathematical result of the number of warrant shares times the respective exercise price per share. The hypothetical results are premised upon an increase in the future trading value of the company’s common stock resulting in the exercise of common stock warrants. It further assumes all investors elect cash exercises (not cashless exercises) and warrant exercise prices are not reduced or reset to a lower amount. The majority of common stock warrants have exercise prices at or below $3.10 per share and could result in cash receipts of approximately $19 million. No assurances can be given that the investors will exercise their remaining common stock warrants.

The Company believes it has arranged for the capital to commercialize POWERHOUSE™ 3.0. No assurances can be given that the Company will successfully commercialize POWERHOUSE™ 3.0.

2. Significant Accounting Policies

The Company made no changes to its significant accounting policies during the six months ended June 30, 2018 with the exception of the adoption of ASC 606 as discussed in Note 3. Revenue and recognition of derivative liabilities and warrant liabilities related to the 2018 Note Offering as discussed in Note 7. Convertible Debt.

Common Stock Warrants

The Company accounts for common stock warrants in accordance with applicable accounting guidance provided in Financial Accounting Standards Board (“FASB”) ASC 480, Liabilities – Distinguishing Liabilities from Equity , as either liabilities or as equity instruments depending on the specific terms of the warrant agreement. Certain of the Company’s warrants are accounted for as liabilities due to provisions either allowing the warrant holder to request redemption, at the intrinsic value of the warrant, upon a change of control, event of default or failure to deliver shares. The Company classifies these warrant liabilities with maturities of five years on the Condensed Consolidated Balance Sheet as long-term liabilities. They are revalued at each balance sheet date after their initial issuance with changes in the value recorded in earnings. The Company used a Monte Carlo pricing model to value these warrant liabilities.

Derivatives

The 2018 Notes contain conversion features which have been accounted for in accordance with FASB ASC 815, Derivatives and Hedging. The conversion options are embedded within the 2018 Notes but have been separated as (i) their economic characteristics and risks do not clearly and closely relate to the 2018 Notes (ii) the 2018 Notes are not remeasured at fair value and (iii) a separate instrument with the same terms as the conversion options would be considered a derivative. Additionally, the conversion options meet all the criteria of a derivative in that they have an underlying (conversion price) and notional amount (potential shares), the conversion options do not require an initial net investment and the conversion options provide for net settlement. The conversion options have been initially measured at fair value and are revalued at each balance sheet date after their initial issuance with changes in the value recorded in earnings. The Company used a Lattice pricing model to value these derivative liabilities. The Lattice pricing model, which is based, in part, upon unobservable inputs for which there is little or no market data, requires the Company to develop its own assumptions. The Company classifies these derivative liabilities with maturities of one year on the Condensed Consolidated Balance Sheet as short-term liabilities. When the conversion option has been exercised, for accounting purposes both liabilities (i.e., the debt host and the separated derivative liability) will be subject to extinguishment accounting. As such, a gain or loss upon extinguishment of the two liabilities equal to the difference between the recorded value of the liabilities and the fair value of the consideration issued to extinguish them will be recorded.

Reclassification of Prior Year Presentation

Certain prior year amounts have been reclassified for consistency with the current period presentation. These reclassifications had no effect on the reported results of operations. During the second quarter of 2017, the Company concluded that it was appropriate to classify items in the statement of operations to conform with operating metrics reported to investors and the manner in which management evaluates financial performance and to classify warranty liability separately as current and non-current liabilities. Accordingly, the Company revised the classification of certain items to report items in the statement of operations and balance sheet. These changes in classification did not change the previously reported operating income (loss) in the statement of operations, or cash generated (used) from operations in the statement of cash flows, or operating income (loss) for any business segment.

Recently Issued Accounting Standards

ASU 2018-11

In July 2018, FASB issued Accounting Standards Update No. 2018-11 (“ASU 2018-11”), Leases (Topic 842): Targeted Improvements . The amendments in this Update provide entities with an additional (and optional) transition method to adopt the new leases standard. Additionally, the amendments in this Update provide lessors with a practical expedient, by class of underlying asset, to not separate nonlease components from the associated lease component and, instead, to account for those components as a single component if the nonlease components otherwise would be accounted for under the new revenue guidance (Topic 606). The Company will assess the impact of ASU 2018-11in preparation for the adoption of ASU 2016-02.

ASU 2018-10

In July 2018, FASB issued Accounting Standards Update No. 2018-10 (“ASU 2018-10”), Codification Improvements to Topic 842, Leases . The amendments in this update narrow aspects of the guidance issued in the amendments in Update 2016-02. The Company has previously disclosed that upon adoption of ASU 2016-02, right-of-use assets and lease liabilities will be recognized on the balance sheet in amounts that will be material. The Company will assess the impact of ASU 2018-10 in preparation for the adoption of ASU 2016-02.

ASU 2018-07

In June 2018, FASB issued Accounting Standards Update No. 2018-07 (“ASU 2018-07”), Compensation – Stock Compensation (Topic 718) – Improvement to Nonemployee Share-Based Payment Accounting. The amendments in this Update expand the scope of Topic 718 to include share-based payment transactions for acquiring goods and services from nonemployees. Nonemployee share-based payment awards within the scope of Topic 718 are measured at grant-date fair value of the equity instruments that an entity is obligated to issue when the good has been delivered or the service has been rendered. The definition of the term grant date is amended to generally state the date at which a grantor and a grantee reach a mutual understanding of the key terms and conditions. Consistent with the accounting for employee share-based payment awards, an entity will consider the probability of satisfying performance conditions when nonemployee share-based payment awards contain such conditions. Generally, the classification of equity-classified nonemployee share-based payment awards will continue to be subject to the requirements of Topic 718 unless modified after the good has been delivered, the service has been rendered, any other conditions necessary to earn the right to benefit from the instruments have been satisfied, and the nonemployee is no longer providing goods or services. This eliminates the requirement to reassess classification of such awards upon vesting. This amendment is effective for public entities for fiscal years beginning after December 15, 2018 including interim periods within that fiscal year. The Company will assess the impact of ASU 2018-07 on any nonemployee share-based payments entered in the future.

ASU 2018-05

On March 13, 2018, the FASB issued Accounting Standards Update No. 2018-05 (“ASU 2018-05”), Income Taxes (Topic 740) – Amendments to SEC Paragraphs Pursuant to SEC Staff Accounting Bulletin No. 118 , which was issued to state the income tax accounting implications of the Tax Cuts and Jobs Act (“TCJA”). The guidance clarifies the measurement period timeframe, changes in subsequent reporting periods and reporting requirements as a result of the TCJA. The measurement period begins in the period that includes the TCJA’s enactment date which was December 22, 2017 and as a result the Company has reflected the impact of this ASU on the tax provision and deferred tax calculation as of December 31, 2017.

ASU 2017-11

On July 13, 2017, the FASB issued Accounting Standards Update No. 2017-11 (“ASU 2017-11”), Earnings Per Share (Topic 260); Distinguishing Liabilities from Equity (Topic 480); Derivatives and Hedging (Topic 815): (Part I) Accounting for Certain Financial Instruments with Down Round Features, (Part II) Replacement of the Indefinite Deferral for Mandatorily Redeemable Financial Instruments of Certain Nonpublic Entities and Certain Mandatorily Redeemable Noncontrolling Interests with a Scope Exception. The amendments in Part I of this Update change the classification analysis of certain equity-linked financial instruments (or embedded features) with down round features. When determining whether certain financial instruments should be classified as liabilities or equity instruments, a down round feature no longer precludes equity classification when assessing whether the instrument is indexed to an entity’s own stock. The amendments also clarify existing disclosure requirements for equity-classified instruments. The amendments in Part II of this Update recharacterize the indefinite deferral of certain provisions of Topic 480 that now are presented as pending content in the Codification, to a scope exception. Those amendments do not have an accounting effect. For public business entities, the amendments in Part I of this Update are effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018. The amendments in Part II of this Update do not require any transition guidance because those amendments do not have an accounting effect. The Company will assess the impact of ASU 2017-11 on any derivative instruments entered into in the future.

ASU 2016-09

In March 2016, the FASB issued ASU 2016-09, Improvements to Employee Share-Based Payment Accounting, which amends ASC 718 and includes provisions intended to simplify various provisions related to how share-based payments are accounted for and presented in the financial statements. ASU 2016-09 eliminates the previous requirement to gross up the statement of cash flows between financing and operating to reflect the impact of windfall tax benefits has been eliminated. Instead, all tax related cash flows resulting from share-based payments will be reported as operating activities in the statement of cash flows. Additionally, the previous practice of classifying cash outflows related to an employee’s minimum statutory tax withholding as operating is no longer available. Instead, all such payments should be classified as financing. ASU 2016-09 is effective for public business entities for annual reporting periods beginning after December 15, 2016, and interim periods within those reporting periods. Due to the 2018 Incentive Plan (defined in Note 8. Share-Based Compensation), this guidance is effective for the current period however, there is no impact to the statement of cash flows.

ASU 2016-02

On February 25, 2016, the FASB issued Accounting Standards Update No. 2016-02 (“ASU 2016-02”), Leases (Topic 842), which sets out the principles for the recognition, measurement, presentation and disclosure of leases for both parties to a contract (i.e. lessees and lessors). The new standard requires lessees to apply a dual approach, classifying leases as either finance or operating leases based on the principle of whether the lease is effectively a financed purchase by the lessee. This classification will determine whether lease expense is recognized based on an effective interest method or on a straight-line basis over the term of the lease, respectively. A lessee is also required to record a right-of-use asset and a lease liability for all leases with a term of greater than 12 months regardless of their classification. Leases with a term of 12 months or less will be accounted for similar to existing guidance for operating leases today. The new standard requires lessors to account for leases using an approach that is substantially equivalent to existing guidance for sales-type leases, direct financing leases and operating leases. The standard is effective for financial statements issued for fiscal years beginning after December 15, 2018, and interim periods therein. The Company currently expects that upon adoption of ASU 2016-02, right-of-use assets and lease liabilities will be recognized on the balance sheet in amounts that will be material.

3. Revenue

Effective January 1, 2018, the Company has adopted “ASC 606 – Revenue From Contracts with Customers ” related to revenue recognition. Under the standard, revenue is recognized 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 using a five-step model to achieve that principle. In addition, the standard requires disclosures to understand the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers. The Company has elected to adopt the modified retrospective method for transitioning this accounting standard which requires that the cumulative effect of applying the revenue standard to existing contracts be recorded as an adjustment to retained earnings. Per our analysis performed as of the prior year ended December 31, 2017 no adjustments were required. For the six months ended June 30, 2018, the adoption of ASC 606 has resulted in the following changes in significant accounting policies:

Deferred Revenue

When we receive consideration, or such consideration is unconditionally due, from a customer prior to transferring goods or services to the customer under the terms of a sales contract, we record deferred revenue, which represents a contract liability. We recognize deferred revenue as net sales after we have satisfied our performance obligations to the customer and all revenue recognition criteria are met.

Revenue Recognition – Installation of photovoltaic modules (“PV”) solar systems

We generally recognize revenue for installation of PV solar systems at a point in time (“performance obligation”) following the transfer of control to the customer which typically occurs when installers have completed an installation of the PV solar system. Although ASC 606 is generally applied to a single contract with a customer, a portfolio approach may be acceptable if an entity reasonably expects that the effect of applying a portfolio approach to a group of contracts or group of performance obligations would not differ materially from considering each contract or performance obligation separately. The Company uses standard contract templates to initiate sales with customers which may vary based on customer type. As such, applying the portfolio approach to each type of customer contract would not differ materially from considering each contract on a standalone basis. The Company has used the portfolio approach in their analysis and determined that each project started during the six months ended June 30, 2018 contains one performance obligation.

Each project’s transaction price is included within the contract and although there is only one performance obligation, certain complexities could exist which impact the transaction price. Specific to solarized programs, wherein the Company has a scalable price per watt to the homeowner based on the number of participating homes in the community, the Company may credit homeowners of previously executed contract. Any credits to homeowners on previously executed contracts are treated as adjustments to the transaction price via change order forms. For solarized program incentives, the Company uses the “most likely amount” method in determining any adjustments to the transaction price due to certainty of the credit amount prior to completion of the project. The Company has also considered financing components on projects started during the six months ended June 30, 2018 and elected the use of a practical expedient where an entity need not adjust the promised amount of consideration for the effects of a significant financing component if the entity expects, at contract inception, that the period between when the entity transfers a promised service to the customer and when the customer pays for that good or service will be one year or less. All receivables from projects entered into during the current quarter are expected to be received within one year from project completion and no adjustments to the transactions prices were made.

Under ASC 606, the Company is required to recognize as an asset the incremental costs of obtaining a contract with a customer if those costs are expected to be recovered. The Company does incur selling and marketing costs and sales commissions that otherwise would not have been incurred if the contract had not been obtained however, these costs are not recoverable from the customer and are expensed as incurred.

The Company may enter into contracts/projects in which control of the PV solar systems transfers to the customer over time. As of June 30, 2018, only one contract satisfied the requirement of control transferring over time.

Since control transfers over time, revenue is recognized based on the extent of progress towards the completion of the performance obligation. The method utilized by the Company to measure the progress towards completion requires judgment and is based on the products and services provided. The Company utilizes the input method to measure the progress of our contracts because it best depicts the transfer of assets to the customer which incurs as materials are consumed by the project. The input method measures the progress towards completion based on the ratio of costs incurred to date (“actual cost”) to the total estimated costs (“budget”) at completion of performance obligation. Revenues, including estimated fees, are recorded proportionally as costs are incurred. Costs to fulfill include materials, labor and/or subcontractors’ costs, and other direct costs. Indirect costs and costs to procure the panels, inverters, and other system miscellaneous costs needed to satisfy the performance obligation are excluded since the customer does not gain control of those items until delivered to the site. Including the costs of those items would overstate the extent of our performance.

If a contract is separated into multiple performance obligations, the Company allocates the total transaction price to each performance obligation based on a budget vs actual ratio at each performance obligation. The Company does not sell contracts that have multiple performance obligations as PV systems are not functionable until completely installed. More frequently, the Company sells a customized customer specific solution, which use the expected cost plus a profit margin to calculate the selling price at each performance obligation.

Revenue Recognition – Operations & Maintenance

We generally recognize revenue for standard, recurring commercial operations and maintenance services over time as customers receive and consume the benefits of such services, which typically include corrective maintenance, data hosting or energy/deck monitoring services for a period. These services are treated as stand-ready performance obligations and satisfied evenly over the length of the agreement, so the Company has elected a time-based method to measure progress and recorded revenue using a straight-line method.

Revenue Recognition – Service & Warranty

Warranties for workmanship and roof penetration are included within each contract. These warranties cannot be purchased separately from the related services, are intended to safeguard the customer against workmanship and does not provide any incremental service to the customer. It is necessary for the Company to perform the specified tasks to provide assurance that the final product complies with agreed-upon specifications and likely do not give rise to a separate performance obligation. The Company will continue to account for any related warranties in accordance with ASC 460-10 and record an accrual for potential warranty costs at the completion of a project. Any services provided to a customer outside of warranties such as system inspections are recognized upon completion of the service.

Adoption of the standards related to revenue recognition had no impact to cash from or used in operating, financing, or investing on our consolidated cash flows statements. Refer to Note 12. Segment Information for further information, including revenue by segment.

4. Property and Equipment

Property and equipment, stated at lower of cost or estimated fair value, consists of the following as of June 30 and December 31, respectively:

5. Commitments and Contingencies

The Company leases office and warehouse space through operating leases. Some of the leases have renewal clauses, which range from one month to five years.

The Company leases vehicles for certain field personnel through operating leases. Leases range up to four years with varying termination dates through 2021.

The following schedule represents the annual future minimum payments of all leases as of June 30, 2018:

The Company incurred office and warehouse rent expense of $0.2 million and automobile lease expense of $0.06 million for the three months ended June 30, 2018 and $0.3 million and $0.1 million for the six months ended June 30, 2018.

The Company is subject to risks and uncertainties in the normal course of business, including legal proceedings; governmental regulation, such as the interpretation of tax and labor laws; and the seasonal nature of its business due to weather-related factors. The Company has accrued for probable and estimable costs incurred with respect to identified risks and uncertainties based upon the facts and circumstances currently available.

In August 2018, the Company resolved a dispute with a customer of the former Commercial segment wherein the customer alleged that the Company had not completed agreed-upon remedial work to remedy alleged deficiencies. To avoid the costs of arbitration, obtain a release of the funds held in escrow related to this matter, and receive a release of all future obligation or liability, whether based on warranty, contract, or otherwise, the Company agreed to a complete settlement with all parties and increased its liability for this matter by approximately $0.1 million during the first quarter of 2018.

On June 29, 2015, the Company received a subpoena from the U.S. Securities and Exchange Commission requesting the production of documents, records and information related to the July 2014 Offering (the “Subpoena”). The Company had incurred significant legal expenses related to the Subpoena for which it requested coverage from RGS’s Directors’ & Officers’ liability insurance provider. Initially coverage had been denied but the provider paid $1.5 million of legal expense while reserving its right to be reimbursed by the Company. Accordingly, the $1.5 million paid by the insurance provider was accrued for as a long-term liability until a settlement could be reached. On June 30, 2018 the Company and the insurance provider agreed upon a settlement proposal whereby the Company will pay the insurance provider $0.6 million in monthly installments of $25,000 per month beginning September 2018 up to a maximum of $0.6 in full settlement of the obligation. The defeasance of the obligation has been recorded as other income in the accompanying Condensed Consolidated Statement of Operation with the remaining balance split between current and noncurrent liabilities in the accompanying Condensed Consolidated Balance Sheet.

6. Shareholders’ Equity

January 2018 Offering

On January 4, 2018, the Company closed a registered offering and concurrent private placement (“January 2018 Offering”) with one institutional and accredited investor in which the Company issued and sold to the Investor (i) 800,000 shares of Class A common stock, (ii) a prepaid Series P Warrant to purchase 800,000 shares of Class A common stock, and (iii) a Series O Warrant to purchase 1,600,000 shares of Class A common stock pursuant to the terms of the Securities Purchase Agreement, dated as of January 2, 2018, between the Company and the investor. The investor paid $1.15 per share of Class A common stock and $1.14 per share of Class A common stock underlying the Series P Warrant for aggregate gross proceeds of approximately $1.8 million. The Company received net proceeds of approximately $1.5 million at the closing.

The Series O Warrant is exercisable at any time starting six months after issuance and will remain exercisable for a period of five years thereafter at an initial exercise price of $1.47 per share, subject to adjustments for stock splits and similar events. The Series P Warrant is exercisable immediately after issuance and for a period of five years thereafter at an initial exercise price of $1.15 per share, of which $1.14 was paid at the closing with $0.01 per share payable upon exercise. On January 4, 2018, the investor paid $0.01 per share of Class A common stock to exercise the Series P Warrant.

2018 Convertible Note Offering

In connection with the issuance of the 2018 Note Offering, described in Note 7. Convertible Debt, the Company issued $10.75 million in principal and original issue discount of the 2018 Notes and Series Q Warrants exercisable into 9,126,984 shares of Class A common stock. At the closing of that transaction, the Company also sold warrants to the Placement Agents to purchase 730,159 shares of Class A common stock. During the three months ended June 30, 2018, $6.4 million of the 2018 Notes were converted and 0.2 million of the Series Q Warrants were exercised.

Option Exercises, 2018 Convertible Note Conversions and Warrant Exercises

During the three and six months ended June 30, 2018 and 2017, the Company issued stock options as further discussed in Note 8. Share Based Compensation however, none of these options were exercised during the period. During the six months ended June 30, 2018, the Company issued 800,000 shares of its Class A common stock upon the exercise of prepaid Series P warrants attributable to the January 2018 Offering and 5,309,553 shares upon the conversion of the 2018 Notes and exercise of Series Q Warrants.

At June 30, 2018, the Company had the following shares of Class A common stock reserved for future issuance:

7. Convertible Debt

2018 Convertible Note Offering

On March 30, 2018, the Company entered into a Securities Purchase Agreement with two unaffiliated institutional and accredited investors for a private placement (the "2018 Note Offering") of up to $10.75 million in principal amount and $10 million funding amount (reflecting $0.75 million of original issue discount) of Senior Convertible Notes (the "2018 Notes"), and Series Q Warrants (the “Series Q Warrants”) to purchase 9,126,984 shares of Class A Common Stock. On April 9, 2018, the Company closed the 2018 Note Offering. At the closing on April 9, 2018, the Company received $5 million of the gross proceeds and two secured promissory notes from each investor, in a combined aggregate amount of $5 million (each, an “Investor Note”), secured by cash and/or securities held in investor accounts. The Securities Purchase Agreement required the Company to hold a shareholders’ meeting before June 30, 2018 to seek approval of the issuance of shares of Class A Common Stock upon conversion of the 2018 Notes and exercise of the Series Q Warrants at conversion and exercise prices below the market price of its Class A common stock at the time of entering into the Securities Purchase Agreement, in compliance with Nasdaq Marketplace Rules. On June 21, 2018 the Company held its 2018 annual shareholder meeting at which time the shareholders approved the 2018 Note Offering and thereby initiating a reset period which enabled the note holders to earn additional amounts, effectively a make-whole for amounts previously converted. As a result of the shareholder approval, the conversion price of the 2018 Notes and the exercise price of the Series Q Warrants were reset to $0.3223 on July 9, 2018.  

Activity with respect to the 2018 Note Offering is presented below:

The 2018 Notes are convertible at any time, at the option of the holder, into shares of Class A common stock at a conversion price. The initial fixed conversion price was $1.26 per share (which was above the closing bid price of our Class A common stock immediately before executing the Securities Purchase Agreement; the conversion price was increased from $1.2405 to $1.26 in the Amendments) and the initial exercise price of the Series Q Warrants was $1.12, subject to reduction under certain circumstances as well as adjustment for stock splits, stock dividends and similar events. The Company will not be required to amortize the 2018 Notes. All amounts owed under the 2018 Notes not previously converted into shares of Class A common stock will mature and come due on April 9, 2019. As discussed above, the conversion price of the 2018 Notes and the exercise price of the Series Q Warrants were reset to $0.3223 on July 9, 2018.

The 2018 Notes contain negative and affirmative covenants, including a requirement that the Company on a quarterly basis has available cash of at least $0.75 million.

At the closing of the 2018 Note Offering, the Company entered into a Registration Rights Agreement with the purchaser of the 2018 Notes under which it is required to file an initial registration statement with the SEC covering the resale of the shares of Class A common stock issuable pursuant to the 2018 Notes and the Series Q Warrants and to use the Company’s reasonable best efforts to have that initial registration statement declared effective within specified deadlines. The Company will be subject to certain monetary penalties, as set forth in the Registration Rights Agreement, if it fails to meet specified filing deadlines, effectiveness deadlines, maintenance requirements, and/or current public information requirements under the Registration Rights Agreement. The Company filed the required registration statement with the SEC on April 27, 2018, and the SEC declared the registration statement effective on May 4, 2018. As a result of the conversion price and exercise price reset, and in accordance with the provisions of the 2018 Note offering, the Company expects to file a Form S-3 Registration Statement with the SEC to register additional shares of the Company’s Class A common stock covering future conversions.

The Company determined that based on the terms set forth in the 2018 Notes, the 2018 Notes contained embedded derivatives namely the conversion options. These conversion options were incorporated into the Notes to incentivize the Holders to provide the company with short term funding for POWERHOUSE™. The embedded derivatives do not meet the criteria for equity classification and have been recorded at their fair value on the Condensed Consolidated Balance Sheets as a short-term liability due to the 2018 Notes maturing in one year. Any changes in the fair value of the conversion options have been recorded as a gain or loss directly on the Condensed Consolidated Statement of Operations. See Note 9. Fair Value Measurements for information about the techniques we use to measure the fair value of our derivative instruments.

The following tables present the fair values of derivative instruments included in our consolidated balance sheets as of June 30, 2018 and 2017 (in thousands):

In addition to the derivative liabilities, the Company accounts for the Series Q warrants in accordance with ASC 480. The Series Q Warrants are accounted for as liabilities due to provisions allowing the warrant holder to request redemption, upon a change of control, failure to timely deliver shares of Class A common stock upon exercise or default. The Company classifies these warrant liabilities on the Condensed Consolidated Balance Sheet as long-term liabilities, which are revalued at each balance sheet date subsequent to their initial issuance. The Company used a Monte Carlo pricing model to value these warrant liabilities. The Monte Carlo pricing model, which is based, in part, upon unobservable inputs for which there is little or no market data, requires the Company to develop its own assumptions. See Note 9. Fair Value Measurements for information about the techniques we use to measure the fair value of our Series Q Warrants.

8. Share-Based Compensation

On June 21, 2018, the shareholders approved the Real Goods Solar 2018 Long-Term Incentive Plan (“2018 Incentive Plan”) which allows the Company to issue up to 1,300,000 Class A Common Stock shares. Employees or individuals who perform services for the Company are eligible to participate in the 2018 Incentive Plan, which terminates upon the earlier of a board resolution terminating the 2018 Incentive Plan or ten years after the effective date of June 21, 2018 (“Effective Date”). All outstanding options are non-qualified and are generally granted with an exercise price equal to the closing market price of the Company’s stock on the date of the grant. Under the 2018 Incentive Plan, the Company granted non-qualified stock options (“2018 Options”) with an explicit requisite service period of 2.78 years and a maximum contractual term of seven years from the Effective Date. On the last day of each calendar quarter occurring after the Effective Date, the 2018 Options will vest at 8.3% contingent on continuous employment. The 2018 Options are classified as equity and measured using the “fair-value-based method” with share-based compensation expense recognized in the income statement on a straight-line basis over the requisite service for the entire award. The Company uses a Black-Scholes pricing model to estimate the value of the 2018 Options as of the effective date and will account for forfeitures when they occur.

The table below presents a summary of the Company’s option activity as of June 30, 2018 and changes during the quarter then ended:

During the six months ended June 30, 2018, the Company granted 1,120,000 stock options and cancelled four stock options versus zero grants of stock options and zero cancellations of stock options during the six months ended June 30, 2017. Total share-based compensation expense recognized was $0.09 million and $0.05 million during both the three months ended June 30, 2018 and 2017 and $0.09 million and $0.2 million during the six months ended June 30, 2018 and 2017, respectively.

9. Fair Value Measurements

The following tables summarize the basis used to measure certain financial assets and liabilities at fair value on a recurring basis in the consolidated balance sheets:

For the Company’s Level 3 measures, which represent Series Q Warrants and the 2018 Notes Conversion Options, fair value is based on a Monte Carlo model and Lattice pricing model, respectively. The models are based, in part, upon unobservable inputs for which there is little or no market data, requiring the Company to develop its own assumptions. The Company used a market approach to value these liabilities.

The following table shows the reconciliation from the beginning to the ending balance for the Company’s common stock warrant liability and embedded derivative liability measured at fair value on a recurring basis using significant unobservable inputs (i.e. Level 3) for the period ended June 30, 2018:

2018 Notes Derivative Liability

The fair value of the 2018 Notes Derivative Liabilities was derived using a Lattice pricing model, which is based, in part, upon unobservable inputs for which there is little or no market data, requiring the Company to develop its own assumptions. The assumptions used on April 9, 2018 and June 30, 2018 to value the Derivative Liabilities are as follows:

Common Stock Warrants

The fair value of the Series Q Warrants was derived using a Monte Carlo pricing model, which is based, in part, upon unobservable inputs for which there is little or no market data, requiring the Company to develop its own assumptions. The assumptions used on April 9, 2018 and June 30, 2018 to value the common stock warrant liabilities are as follows:

2018 Options

The determination of the estimated fair value of the 2018 Options using the Black-Scholes option-pricing model is affected by the Company’s stock price as well as assumptions regarding a number of complex and subjective variables. Expected volatilities are based on a value calculated using the historical stock price volatility. Expected life is based on the specific vesting terms of the option and anticipated changes to market value and expected employee exercise behavior. The risk-free interest rate used in the option valuation model is based on U.S. Treasury zero-coupon securities with remaining terms similar to the expected term on the options. RGS does not anticipate paying any cash dividends on its Class A common stock in the foreseeable future and, therefore, an expected dividend yield of zero is used in the option valuation model. The assumptions used to value to 2018 Options on June 21, 2018 are as follows:

10. Goodwill Impairment

The Company performed its annual test of goodwill and based on the results of this test, the Company determined that the fair value of the goodwill no longer exceeded the carrying amount. The fair value was determined using a discounted cash flow valuation technique and resulted in an impairment of goodwill of $1.3 million for the quarter ended June 30, 2018.

11. Net Income (Loss) Per Share

Basic net income (loss) per share excludes any dilutive effects of options, warrants or our senior secured convertible notes due on April 1, 2019 (the “2016 Notes”). The Company computes basic net income (loss) per share using the weighted average number of shares of its Class A common stock outstanding during the period. The Company computes diluted net income (loss) per share using the weighted average number of shares of its Class A common stock and common stock equivalents outstanding during the period. The Company excluded common stock equivalents of 29.4 million and 6.5 million for the three months ended June 30, 2018 and 2017, respectively, and 29.4 million and 6.5 million for the six months ended June 30, 2018 and 2017, respectively from the computation of diluted net loss per share because their effect was antidilutive.

12. Segment Information

The Company operates as four reportable segments: (1) Residential – the installation of solar energy systems for homeowners, including lease financing thereof, and small business commercial in the continental U.S.; (2) Sunetric – the installation of solar energy systems for both homeowners and business owners (commercial) in Hawaii; (3) POWERHOUSE™ – the manufacturing and sale of solar shingles; and (4) Other – corporate operations. The Company discontinued its former large commercial segment and it is presented as discontinued operations.

Financial information for the Company’s segments and a reconciliation of the total of the reportable segments’ loss from operations to the Company’s consolidated net loss are as follows: 

The following is a reconciliation of reportable segments’ assets to the Company’s consolidated total assets. The Other segment includes certain unallocated corporate amounts.

13. Discontinued Operations

The following is a reconciliation of the major line items constituting pretax income of discontinued operations to the after-tax gain on discontinued operations that are presented in the condensed consolidated statements of operations as indicated:

The following is a reconciliation of the carrying amounts of major classes of assets and liabilities of the discontinued operations to the total assets and liabilities of the discontinued operations presented separately in the condensed consolidated balance sheets as indicated:

14. Subsequent Events

See Note 7. Convertible Debt for information on activity after the period. The Company has evaluated events up to the filing date of these interim financial statements and determined that, other than what has been disclosed above, no further subsequent event activity required disclosure.