VAPOR HUB INTERNATIONAL INC.

The Company adopted ASU 2015-03 during the quarter ended September 30, 2016, which requires debt issuance costs to be presented in the balance sheet as a direct deduction from the associated debt liability. The Company’s adoption of this ASU did not have a significant impact on the Company’s financial position, results of operations or cash flows. The adoption resulted in a reclassification of deferred finance costs of $100,302 and $133,166 from current assets to offset against convertible notes payable in current liabilities as of September 30, 2016 and June 30, 2016, respectively.

The Company evaluated modifications of debt instruments under ASC 470-50-40 “Extinguishments of Debt” (“ASC 470”). ASC 470 requires modifications to debt instruments to be evaluated to assess whether the modifications are considered “substantial modifications”. A substantial modification of terms shall be accounted for like an extinguishment. For extinguished debt, a difference between the re-acquisition price and the net carrying amount of the extinguished debt shall be recognized currently in income of the period of extinguishment as losses or gains.

The Company recorded an original valuation for the Iliad Note of $29,475 for the derivative liability. As of June 30, 2016, the Company had a derivative liability for the Iliad Note of $111,940.  On July 15, 2016, the Iliad Note was extinguished in exchange for a new Note.  The Company recorded an original valuation for the July 15, 2016 Iliad Note of $74,112 for the derivative liability. As of September 30, 2016, the Company had a derivative liability for the new Iliad Note of $65,478.

On January 28, 2016, Darin Dyroff, an individual, filed a lawsuit in the Superior Court of the State of California, County of San Luis Obispo, Case Number 16CV-0047 against Vip Vapor Shop & Lounge, Kennedy Enterprises, and Does 1-100.  Vapor Hub was served with the Complaint by Dyroff on July 18, 2016.   The Complaint asserts causes of action for strict products liability and negligent products liability and the defendant is seeking damages for pain and suffering, mental and emotional distress, future medical care, loss of earnings, lost earnings capacity, property damage, punitive damages, and costs of suit.  On September 23, 2016, Steam Distribution, LLC, a defendant in the case, filed a Cross-Complaint against Vapor Hub.   The case has been remitted to the Company’s product liability insurance carrier and is being handled by them.  The insurance company agreed to defend Vapor Hub under its insurance policy subject to the satisfaction of the policy’s $10,000 deductible. The company does not know the potential exposure on the claim, but believes its exposure is immaterial.

Revenues: Revenues are comprised of royalties and gross sales less returns and discounts.  During the three months ended September 30, 2016, we generated $70,000 in royalty income and merchandise sales of $2,425,222 (net of returns adjustments and discounts of $5,820).  For the three months ended September 30, 2015, we generated merchandise sales of $1,962,345 (net of returns adjustments and discounts of $8,752). The increase in revenues compared to the prior year period primarily results from growth of our wholesale distribution and direct distribution to retail store sales.  We anticipate that revenues will significantly decline in the second quarter as a result of a dispute with one of our Mod manufacturers which has resulted in inventory not being readily available for sale.

Other income (expense): Other income of $96,656 for the three months ended September 30, 2016 consists of a positive change in fair value of derivative liability of $366,194 associated with our credit facilities offset by interest expense of $33,273 incurred in connection with our credit facilities, amortization of finance fees of $35,364, interest expense-amortization of debt discount of $126,031 and loss on extinguishment of debt related to a retired Typenex Co-Investment, LLC and Iliad Research & Trading, L.P. loans of $74,870.  During the comparable period in 2015, we had other expense of $130,115 consisting of $32,686 in interest expense, amortization of finance fees of $9,765, interest expense-amortization of debt discount of $42,181 and a change in fair value of derivative liability of $45,483.