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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D. C. 20549

 

FORM 10-Q

 

(Mark One)

 

QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the fiscal quarter ended June 30, 2023

 

TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE EXCHANGE ACT

 

For the transition period from      to                

 

STEM HOLDINGS, INC.

(Exact name of small business issuer as specified in its charter)

 

Nevada   000-55751   61-1794883

(State of

Incorporation)

 

(Commission

File Number)

 

(IRS Employer

Identification No.)

 

2201 NW Corporate Blvd, Suite 205, Boca Raton, FL 33431

(Address of principal executive offices) (Zip code)

 

Issuer’s telephone number: (561) 948-5410

 

Securities registered pursuant to Section 12(b) of the Act:

 

Title of each class   Trading Symbol   Name of exchange on which registered
Common Stock par value $0.001   STMH   OTCQB

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. 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 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 filer, or a smaller reporting company. See the definitions of “large, accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large Accelerated Filer ☐ Accelerated Filer ☐
Non-accelerated Filer Smaller Reporting Company
  Emerging Growth Company

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

 

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

 

There were 280,544,294 shares outstanding of registrant’s common stock, par value $0.001 per share, as of August 21, 2023.

 

Transitional Small Business Disclosure Format (check one): Yes ☐ No ☒

 

 

 

 
 

 

TABLE OF CONTENTS

 

    Page
  PART I  
     
Item 1. Financial Statements 3
     
  Condensed Consolidated Balance Sheets as of June 30, 2023 (unaudited) and September 30, 2022 3
     
  Unaudited Condensed Consolidated Statements of Operations for the three and nine months ended June 30, 2023, and June 30, 2022 4
     
  Unaudited Consolidated Statement of Changes in Stockholders’ Equity for the three months ended June 30, 2023, and June 30, 2022 5
     
  Unaudited Condensed Consolidated Statements of Cash Flows for the nine months ended June 30, 2023, and June 30, 2022 6
     
  Notes to Unaudited Condensed Consolidated Financial Statements 7
     
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operation 35
     
Item 3. Quantitative and Qualitative Disclosures About Market Risk 41
     
Item 4. Controls and Procedures 41
     
  PART II  
     
Item 1. Legal Proceedings 43
     
Item 1A. Risk Factors 43
     
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 43
     
Item 3. Defaults Upon Senior Securities 43
     
Item 4. Mine Safety Disclosures 43
     
Item 5. Other Information 43
     
Item 6. Exhibits 43
     
SIGNATURES 44

 

2
 

 

PART I

 

ITEM 1. FINANCIAL STATEMENTS

 

STEM HOLDINGS, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(UNAUDITED)

(in thousands, except share and per share amounts)

 

   June 30, 2023   September 30, 2022 
   (unaudited)   * 
ASSETS          
Current assets          
Cash and cash equivalents  $1,704   $1,524 
Accounts receivable, net of allowance for doubtful accounts   267    313 
Note receivable   182    - 
Inventory   1,303    2,675 
Prepaid expenses and other current assets   596    929 
Assets held for sale   -    - 
Total current assets   4,052    5,441 
           
Property and equipment, net   5,449    9,089 
Deposits and other assets   13    13 
Right of use asset   7,819    6,874 
Intangible assets, net   6,801    8,014 
Goodwill   1,522    1,522 
Due from related party   28    28 
Total assets  $25,684   $30,981 
           
LIABILITIES AND SHAREHOLDERS’ EQUITY          
Current liabilities          
Accounts payable and accrued expenses   2,739    2,310 
Convertible notes, net   2,258    1,477 
Current maturities of long-term debt   400    1,000 
Short term notes and advances   223    451 
Derivative liability   31    370 
Lease liability   442    580 
Warrant liability   71    55 
Total current liabilities   6,164    6,243 
           
Lease liability - long term   7,626    6,476 
Long-term debt, mortgages   675    1,225 
Total liabilities   14,465    13,944 
           
Commitments and contingencies (Note 17)   -    - 
           
Shareholders’ equity          
Preferred stock, Series A; $0.001 par value; 50,000,000 shares authorized, none outstanding as of June 30, 2023, and September 30, 2022   -    - 
Preferred stock, Series B; $0.001 par value; 50,000,000 shares authorized, none outstanding as of June 30, 2023, and September 30, 2022   -    - 
Common stock, $0.001 par value; 750,000,000 shares authorized; 271,184,534 and 227,013,967 shares issued, issuable and outstanding as of June 30, 2023, and September 30, 2022, respectively   271    227 
Additional paid-in capital   150,009    148,450 
Distribution   (32)   - 
Accumulated deficit   (140,527)   (133,118)
Total Stem Holdings stockholder’s equity   9,721    15,559 
Noncontrolling interest   1,498    1,478 
Total shareholders’ equity   11,219    17,037 
Total liabilities and shareholders’ equity  $25,684   $30,981 

 

*Derived from audited information

 

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

 

3
 

 

STEM HOLDINGS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(UNAUDITED)

(in thousands, except share and per share amounts)

 

   2023   2022   2023   2022 
  

For the Three Months Ended June 30,

  

For the Nine Months Ended June 30,

 
   2023   2022   2023   2022 
                 
Revenues  $3,830   $4,171   $11,783   $12,517 
Cost of goods sold   2,787    3,500    10,103    10,691 
Gross Profit   1,043    671    1,680    1,826 
                     
Operating expenses:                    
Consulting fees   123    104    231    633 
Professional fees   258    551    743    2,543 
General and administration   2,094    2,555    6,602    8,745 
Impairment of intangible assets   471    -    471    795 
Total operating expenses   2,946    3,210    8,047    12,716 
Loss from operations   (1,903)   (2,539)   (6,367)   (10,890)
                     
Other income (expenses), net                    
Interest expense   (253)   (247)   (1,132)   (605)
Change in fair value of derivative liability   131    -    340    - 
Change in fair value of warrant liability   (28)   357    (16)   2,287 
Foreign currency exchange gain (loss)   188    89    (54)   62 
Other income   2    2,009    18    2,110 
Gain on extinguishment of debt   -    803    -    803 
Other gain (loss)   -    -    -    (30)
Gain from disposal of subsidiary   -    -    -    831 
Loss from sale of long-lived assets   786    -    (178)   - 
Total other income   826    3,011    (1,022)   5,458 
                     
Loss from continuing operations   (1,077)   472    (7,389)   (5,432)
Loss from discontinued operations, net of tax and gain on disposal of $831   -    -    -    (1,745)
Net income (loss)  $(1,077)  $472   $(7,389)  $(7,177)
                     
Net income (loss) attributable to non-controlling interest   33    (68)   20    (180)
                     
Net income loss attributable to Stem Holdings  $(1,110)  $540   $(7,409)  $(6,997)
                     
Net income (loss) per share:                    
Basic and diluted net income (loss) from continuing operations, per share  $(0.00)  $0.00   $(0.03)  $(0.02)
Basic and diluted net income (loss) from discontinued operations, per share  $(0.00)  $0.00   $(0.00)  $(0.01)
Basic and diluted net income (loss), per share  $(0.00)  $0.00   $(0.03)  $(0.03)
Weighted-average shares outstanding                    
Basic   260,338,380    224,607,322    244,212,631    226,199,289 
Diluted   260,338,380    224,607,322    244,212,631    226,199,289 

 

The accompanying notes are an integral part of these unaudited consolidated financial statements.

 

4
 

 

STEM HOLDINGS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY (DEFICIT)

(UNAUDITED)

(in thousands, except share amounts)

 

                                 
                       Total Stem         
   Common Stock   Additional Paid-in       Accumulated   Holdings Shareholders’   Non-Controlling   Total Shareholders’ 
   Shares   Amount   Capital   Distribution   Deficit   Equity   Interest   Equity 
Balance as of September 30, 2022   227,013,967   $227   $148,450   $-   $(133,118)  $15,559   $1,478   $17,037 
Issuance of common stock in connection with consulting agreement   350,000    -    9    -    -    9    -    9 
Stock based compensation   1,137,500    1    22    -    -    23    -    23 
Issuance of common stock in connection with convertible debt   7,352,941    7    117    -    -    124    -    125 
Issuance of options in connection with employment agreement   -    -    87    -    -    87    -    87 
Distribution related to YMY   -    -    -    (24)   -    (24)   -    (24)
Net loss   -    -    -    -    (3,066)   (3,066)   (13)   (3,079)
Balance as of December 31, 2022   235,854,408    235    148,685    (24)   (136,184)   12,712    1,465    14,177 
Issuance of common stock in connection with convertible debt   5,434,782    6    120    -    -    126    -    126 
Issuance of common stock related to interest expense and rent expense   6,895,344    7    138    -    -    145    -    145 
Issuance of options in connection with consulting agreement   -    -    18    -    -    18    -    18 
Issuance of warrants stock in connection with convertible debt   -    -    9    -    -    9    -    9 
Distribution related to YMY   -    -    -    (4)   -    (4)   -    (4)
Beneficial conversion for debt discount   -    -    400    -    -    400    -    400 
Net loss   -    -    -    -    (3,233)   (3,233)   -    (3,233)
Balance as of March 31, 2023   248,184,534   $248   $149,370   $(28)  $(139,417)  $10,173   $1,465   $11,638 
Issuance of common stock in connection with employment agreement   10,000,000    10    90    -    -    100    -    100 
Debt discount related convertible debt   -    -    416    -    -    416         416 
Issuance of shares in connection with advisory agreement and finder’s fee   3,000,000    3    27    -    -    30    -    30 
Issuance of common stock in connection with board member agreement   10,000,000    10    90    -    -    100    -    100 
Issuance of options in connection with consulting agreement   -    -    16    -    -    16    -    16 
Distribution related to YMY   -    -    -    (4)   -    (4)   -    (4)
Net loss   -    -    -    -    (1,110)   (1,110)   33    (1,077)
Balance as of June 30, 2023     271,184,534   $271   $150,009   $(32)  $(140,527)  $9,721   $1,498   $11,219 
                                         
Balance as of September 30, 2021   229,988,620   $230   $148,249   $(135)  $(115,750)  $32,594   $1,640   $34,234 
Common stock issued for cash   3,223,611    3    282    -    -    285    -    285 
Issuance of common stock in connection with consulting agreement   130,000    -    30    -    -    30    -    30 
Stock based compensation   1,000,000    1    219    -    -    220    -    220 
Issuance of common stock related to interest expense   555,953    1    66    -    -    67    -    67 
Common stock cancelled related to discontinued operations   (11,506,700)   (12)   (1,169)   135    -    (1,046)   -    (1,046)
Issuance of options in connection with employment agreement   -    -    292    -    -    292    -    292 
Net loss   -    -    -    -    (4,064)   (4,064)  $(123)   (4,187)
Balance as of December 31, 2021   223,391,484   $223   $147,969   $-   $(119,814)  $28,378   $1,517   $29,895 
Issuance of common stock in connection with employment agreement   1,000,000    1    67    -    -    68    -    68 
Issuance of warrants in connection with consulting agreement   -    -    158    -    -    158    -    158 
Issuance of options in connection with employment agreement   -    -    19    -    -    19    -    19 
Net loss   -    -    -    -    (3,472)   (3,472)   11    (3,461)
Balance as of March 31, 2022   224,391,484   $224   $148,213   $-   $(123,286)  $25,151   $1,528   $26,679 
Issuance of common stock related to interest expense   15,372    -    1    -    -    1    -    1 
Issuance of options in connection with employment agreement   -    -    94    -    -    94    -    94 
Issuance of warrants in connection with extension of debenture maturity   -    -    12    -    -    12    -    12 
Net gain (loss)   -    -    -    -    540    540    (68)   472 
Balance as of June 30, 2022   224,406,856   $224   $148,320   $-   $(122,746)  $25,798   $1,460   $27,258 

 

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

 

5
 

 

STEM HOLDINGS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(UNAUDITED)

(in thousands)

 

   2023   2022 
   For the Nine Months Ended June 30, 
   2023   2022 
Cash flows from operating activities          
Net loss  $(7,389)  $(7,177)
Loss from discontinued operations, net of tax   -    1,745 
Adjustments to reconcile net loss to net cash used in operating activities:          
Stock-based compensation expense   349    691 
Issuance of common stock in connection with consulting agreements   33    188 
Issuance of common stock related to rent and interest expense   146    1 
Impairment of investments   -    288 
Depreciation and amortization   821    1,247 
Amortization of intangible assets   529    655 
Amortization of debt discount   1,007    13 
Impairment of intangible assets   471    - 
Gain on extinguishment of debt   -    (803)
Change in fair value of warrant liability and derivative liability   (322)   (2,183)
Foreign currency adjustment   53    (62)
Loss from sale of long-lived assets   178    - 
Gain on disposal of subsidiary   -    (831)
Gain on sale of property   -    (1,155)
Other   367    103 
Changes in operating assets and liabilities:          
Accounts receivable, net of allowance for doubtful accounts   46    - 
Prepaid expenses and other current assets   333    217 
Inventory   1,372    21 
Other assets   -    1,402 
Accounts payable and accrued expenses   426    (124)
Net cash used in continuing operating activities   (1,580)   (5,764)
Net cash provided by discontinued operating activities   -    340 
Net cash used in operating activities   (1,580)   (5,424)
           
Cash flows from investing activities          
Purchase of property and equipment   (24)   (206)
Sale of property   973    2,173 
Investments   -    (288)
Cash received related to sale of equity method investment   -    1,651 
Related party payments   -    (1)
Net cash provided by investing activities   949    3,329 
           
Cash flows from financing activities          
Proceeds from the issuance of common stock   -    285 
Notes payable and advanced proceeds   1,470    625 
Distribution   (32)   - 
Repayments of notes payable   (627)   (879)
Net cash provided by financing activities from continuing operations   811    31 
           
Net increase (decrease) in cash and cash equivalents   180    (2,064)
Cash and cash equivalents at the beginning of the period   1,524    5,464 
Cash and cash equivalents at the end of the period  $1,704   $3,400 
           
Supplemental disclosure of cash flow information:          
Cash paid for interest  $220   $308 
Cash paid for taxes  $-   $- 
Supplemental disclosure of noncash activities:          
Non-cash repayment of finance liability  $-   $1,092 
Non-cash repayment of mortgages  $1,150    - 
Financed Insurance  $-   $449 
Interest paid in the form of common stock  $-   $67 
Beneficial conversion of debt discount  $817   $- 
Conversion of debt to equity  $249   $- 

 

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

 

6
 

 

STEM HOLDINGS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

1. Incorporation and Operations and Going Concern

 

Stem Holdings, Inc. (“Stem” or the “Company”) is a Nevada corporation incorporated on June 7, 2016, and is a leading omnichannel, vertically-integrated cannabis branded products and technology company with state-of-the-art cultivation, processing, extraction, retail, distribution, and delivery-as-a-service (DaaS) operations throughout the United States. Stem’s family of award-winning brands includes TJ’s Gardens™, TravisxJames™, and Yerba Buena™ flower and extracts; Cannavore™ edible confections; and e-commerce delivery platforms provide direct-to consumer proprietary logistics and an omnichannel UX (user experience)/CX (customer experience).

 

The Company leases and operates in properties for use in the production, distribution and sales of cannabis and cannabis-infused products licensed under the laws of the states of Oregon, Nevada, and California. As of June 30, 2023, Stem had ownership interests in 21 state issued cannabis licenses including nine (9) licenses for cannabis cultivation, two (2) licenses for cannabis processing, one (1) license for cannabis wholesale distribution, three (3) licenses for hemp production and (6) cannabis dispensary licenses.

 

The Company has eight wholly-owned subsidiaries, including Stem Holdings Oregon, Inc., Stem Holdings IP, Inc., Opco, LLC, Stem Oregon Acquisitions 1, Corp., Stem Oregon Acquisitions 2, Corp., Stem Oregon Acquisitions 3, Corp., Stem Oregon Acquisitions 4 Corp., 2336034 Alberta Ltd. Stem, through its subsidiaries, is currently in the process of seeking to be acquired by entities directly in the production and sale of cannabis. Driven Deliveries, Inc., a former wholly-owned subsidiary, was sold during the quarter ended December 31, 2021 (see Note 3).

 

The Company’s stock is publicly traded and is listed on the Canadian Securities Exchange under the symbol “STEM” and the OTCQB exchange under the symbol “STMH”.

 

In June 2021, the Company’s shareholders approved a proposal to amend the Company’s Articles of Incorporation to increase the number of authorized common shares from 300,000,000 shares to 750,000,000 shares.

 

Going Concern

 

On June 30, 2023, the Company had approximate balances of cash and cash equivalents of $1.7 million, negative working capital of approximately $2.1 million, and an accumulated deficit of $140.5 million.

 

These unaudited condensed consolidated financial statements have been prepared on a going concern basis, which assumes that the Company will be able to realize its assets and discharge its liabilities in the normal course of business.

 

While the recreational use of cannabis is legal under the laws of certain States, the use and possession of cannabis is illegal under United States Federal Law for any purpose, by way of Title II of the Comprehensive Drug Abuse Prevention and Control Act of 1970, otherwise known as the Controlled Substances Act of 1970 (the “ACT”). Cannabis is currently included under Schedule 1 of the Act, making it illegal to cultivate, sell or otherwise possess in the United States.

 

On January 4, 2018, the office of the Attorney General published a memo regarding cannabis enforcement that rescinds directives promulgated under former President Obama that eased federal enforcement. In a January 8, 2018 memo, Jefferson B. Sessions, then Attorney General of the United States, indicated enforcement decisions will be left up to the U.S. Attorney’s in their respective states clearly indicating that the burden is with “federal prosecutors deciding which cases to prosecute by weighing all relevant considerations, including federal law enforcement priorities set by the Attorney General, the seriousness of the crime, the deterrent effect of federal prosecution, and the cumulative impact of particular crimes on the community.” Subsequently, in April 2018, former President Trump promised to support congressional efforts to protect states that have legalized the cultivation, sale, and possession of cannabis; however, a bill has not yet been finalized in order to implement legislation that would, in effect, make clear the federal government cannot interfere with states that have voted to legalize cannabis. Further in December 2018, the U.S. Congress passed legislation, which the President signed on December 20, 2018, removing hemp from being included with Cannabis in Schedule I of the Act.

 

7
 

 

In December 2019, an outbreak of a novel strain of coronavirus (COVID-19) originated in Wuhan, China, and has since spread to several other countries, including the United States. On June 11, 2020, the World Health Organization characterized COVID-19 as a pandemic. In addition, as of the time of the filing of this Annual Report on Form 10-K, several states in the United States have declared states of emergency, and several countries around the world, including the United States, have taken steps to restrict travel. The existence of a worldwide pandemic, the fear associated with COVID-19, or any, pandemic, and the reactions of governments in response to COVID-19, or any, pandemic, to regulate the flow of labor and products and impede the travel of personnel, may impact our ability to conduct normal business operations, which could adversely affect our results of operations and liquidity. Disruptions to our supply chain and business operations disruptions to our retail operations and our ability to collect rent from the properties which we own, personnel absences, or restrictions on the shipment of our or our suppliers’ or customers’ products, any of which could have adverse ripple effects throughout our business. If we need to close any of our facilities or a critical number of our employees become too ill to work, our production ability could be materially adversely affected in a rapid manner. Similarly, if our customers experience adverse consequences due to COVID-19, or any other, pandemic, demand for our products could also be materially adversely affected in a rapid manner. Global health concerns, such as COVID-19, could also result in social, economic, and labor instability in the markets in which we operate. Any of these uncertainties could have a material adverse effect on our business, financial condition, or results of operations.

 

These conditions raise substantial doubt as to the Company’s ability to continue as a going concern. Should the United States Federal Government choose to begin enforcement of the provisions under the “ACT”, the Company through its wholly owned subsidiaries could be prosecuted under the “ACT” and the Company may have to immediately cease operations and/or be liquidated upon its closing of the acquisition or investment in entities that engage directly in the production and or sale of cannabis.

 

Management believes that the Company has access to capital resources through potential public or private issuances of debt or equity securities. However, if the Company is unable to raise additional capital, it may be required to curtail operations and take additional measures to reduce costs, including reducing its workforce, eliminating outside consultants, and reducing legal fees to conserve its cash in amounts sufficient to sustain operations and meet its obligations. The Company is also in the process of seeking business combinations by entities directly in the production and sale of cannabis. These matters raise substantial doubt about the Company’s ability to continue as a going concern. The accompanying consolidated financial statements do not include any adjustments that might become necessary should the Company be unable to continue as a going concern.

 

2. Summary of Significant Accounting Policies

 

Basis of Presentation

 

The Company’s consolidated financial statements been prepared in accordance with accounting principles generally accepted in the United States (“GAAP”). The consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. All material intercompany accounts and transactions have been eliminated during the consolidation process. The Company manages its operations as a single segment for the purposes of assessing performance and making operating decisions.

 

The accompanying interim condensed consolidated financial statements are unaudited. In the opinion of management, the accompanying unaudited condensed consolidated financial statements contain all the normal recurring adjustments necessary to present fairly the financial position and results of operations as of and for the periods presented. The interim results are not necessarily indicative of the results to be expected for the full year or any future period.

 

Certain information and footnote disclosures normally included in the consolidated financial statements prepared in accordance with accounting principles generally accepted in the United States have been condensed or omitted pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”). The Company believes that the disclosures are adequate to make the interim information presented not misleading. These consolidated financial statements should be read in conjunction with the Company’s audited consolidated financial statements and the notes thereto included in the Company’s Report on Form 10-K filed on January 13, 2023, for the year ended September 30, 2022.

 

Use of Estimates

 

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the application of accounting policies and the reported amounts of assets, liabilities, income, and expenses. The most significant estimates included in these consolidated financial statements are those associated with the assumptions used to value equity instruments, valuation of its long live assets for impairment testing, valuation of intangible assets, and the valuation of inventory. These estimates and assumptions are based on current facts, historical experience and various other factors believed to be reasonable given the circumstances that exist at the time the financial statements are prepared. Actual results may differ materially and adversely from these estimates. To the extent there are material differences between the estimates and actual results, the Company’s future results of operations will be affected.

 

Reclassifications

 

Certain amounts in the Company’s consolidated financial statements for prior periods have been reclassified to conform to the current period presentation. These reclassifications have not changed the results of operations of prior periods.

 

8
 

 

Principles of Consolidation

 

The Company’s policy is to consolidate all entities that it controls by ownership of a majority of the outstanding voting stock. In addition, the Company consolidates entities that meet the definition of a variable interest entity (“VIE”) for which it is the primary beneficiary. The primary beneficiary is the party who has the power to direct the activities of a VIE that most significantly impact the entity’s economic performance and who has an obligation to absorb losses of the entity or a right to receive benefits from the entity that could potentially be significant to the entity. For consolidated entities that are less than wholly owned, the third party’s holding of equity interest is presented as noncontrolling interests in the Company’s Consolidated Balance Sheets and Consolidated Statements of Changes in Stockholders’ Equity. The portion of net loss attributable to the noncontrolling interests is presented as net loss attributable to noncontrolling interests in the Company’s Consolidated Statements of Operations.

 

The accompanying consolidated financial statements include the accounts of Stem Holdings, Inc. and its wholly owned subsidiaries, Stem Holdings Oregon, Inc., Stem Holdings IP, Inc., Opco, LLC, Stem Oregon Acquisitions 2 Corp., Stem Oregon Acquisitions 3 Corp., Stem Oregon Acquisitions 4 Corp., 7LV USA Corporation, and Stem Oregon Acquisitions 1 Corp., which was subsequently divested. In addition, the Company has consolidated YMY Ventures, WCV, LLC and NVD RE, Inc. under the variable interest requirements.

 

Cash and Cash Equivalents

 

The Company considers all highly liquid investments with a maturity of three months or less at the time of purchase to be cash equivalents. Financial instruments that potentially subject the Company to a concentration of credit risk consist of cash and cash equivalents. The Company’s cash is primarily maintained in checking accounts. These balances may, at times, exceed the U.S. Federal Deposit Insurance Corporation insurance limits. As of June 30, 2023, and September 30, 2022, the Company had no cash equivalents or short-term investments. In accordance with certain secured debentures received this quarter in the amount of $545,000, the Company set up and deposited this amount into a IOLTA trust account held in escrow to securitize these instruments (see Note 12). The Company has not experienced any losses on deposits of cash and cash equivalents to date.

 

Accounts Receivable

 

Accounts receivable is shown on the face of the consolidated balance sheets, net of an allowance for doubtful accounts. The Company analyzes the aging of accounts receivable, historical bad debts, customer creditworthiness and current economic trends, in determining the allowance for doubtful accounts. The Company does not accrue interest receivable on past due accounts receivable. As of June 30, 2023, and September 30, 2022, the reserve for doubtful accounts was $79 for both periods.

 

Inventory

 

Inventory is comprised of raw materials, finished goods and work-in-progress such as pre-harvested cannabis plants and by-products to be extracted. The costs of growing cannabis including but not limited to labor, utilities, nutrition, and irrigation, are capitalized into inventory until the time of harvest.

 

Inventory is stated at the lower of cost or net realizable value, determined using weighted average cost. Cost includes expenditures directly related to manufacturing and distribution of the products. Primary costs include raw materials, packaging, direct labor, overhead, shipping and the depreciation of manufacturing equipment and production facilities determined at normal capacity. Manufacturing overhead and related expenses include salaries, wages, employee benefits, utilities, maintenance, and property taxes.

 

Net realizable value is defined as the estimated selling price in the ordinary course of business, less reasonably predictable costs of completion, disposal, and transportation. At the end of each reporting period, the Company performs an assessment of inventory obsolescence to measure inventory at the lower of cost or net realizable value. Factors considered in the determination of obsolescence include slow-moving or non-marketable items.

 

9
 

 

Prepaid Expenses and Other Current Assets

 

Prepaid expenses consist of various payments that the Company has made in advance for goods or services to be received in the future. These prepaid expenses include consulting, advertising, insurance, and service or other contracts requiring up-front payments.

 

Property and Equipment

 

Property, equipment, and leasehold improvements are stated at cost less accumulated depreciation. Depreciation is calculated using the straight-line method over the estimated useful lives of the assets. Repairs and maintenance expenditures that do not extend the useful lives of related assets are expensed as incurred.

 

Expenditures for major renewals and improvements are capitalized, while minor replacements, maintenance, and repairs, which do not extend the asset lives, are charged to operations as incurred. Upon sale or disposition, the cost and related accumulated depreciation are removed from the accounts and any gain or loss is included in operations. The Company continually monitors events and changes in circumstances that could indicate that the carrying balances of its property, equipment and leasehold improvements may not be recoverable in accordance with the provisions of ASC 360, “Property, Plant, and Equipment.” When such events or changes in circumstances are present, the Company assesses the recoverability of long-lived assets by determining whether the carrying value of such assets will be recovered through undiscounted expected future cash flows. If the total of the future cash flows is less than the carrying amount of those assets, the Company recognizes an impairment loss based on the excess of the carrying amount over the fair value of the assets. See “Note 3 – Property, Equipment and Leasehold Improvements”.

 

Property and equipment are stated at cost less accumulated depreciation. Depreciation is provided on a straight-line method over the estimated useful lives of the assets. The Company estimates useful lives as follows:

 

Buildings 20 years
Leasehold improvements Shorter of term of lease or economic life of improvement*
Furniture and equipment 5 years
Signage 5 years
Software and related 5 years

 

  * Unless the relevant lease is classified as a sales-type lease, under which the assets are depreciated over the estimated useful life.

 

Impairment of Long-Lived Assets

 

The Company reviews the carrying value of its long-lived assets, which include property and equipment, for indicators of impairment whenever events or changes in circumstances indicate that the carrying value of an asset or asset group may not be recoverable. The Company considers the following to be some examples of important indicators that may trigger an impairment review: (i) significant under-performance or losses of assets relative to expected historical or projected future operating results; (ii) significant changes in the manner or use of assets or in the Company’s overall strategy with respect to the manner or use of the acquired assets or changes in the Company’s overall business strategy; (iii) significant negative industry or economic trends; (iv) increased competitive pressures; (v) a significant decline in the Company’s stock price for a sustained period of time; and (vi) regulatory changes. The Company evaluates assets for potential impairment indicators at least annually and more frequently upon the occurrence of such events. The Company does not test for impairment in the year of acquisition of properties, as long as those properties are acquired from unrelated third parties.

 

The Company assesses the recoverability of its long-lived assets by comparing the projected undiscounted net cash flows associated with the related long-lived asset or group of long-lived assets over their remaining estimated useful lives against their respective carrying amounts. In cases where estimated future net undiscounted cash flows are less than the carrying value, an impairment loss is recognized equal to an amount by which the carrying value exceeds the fair value of the asset or asset group. Fair value is generally determined using the assets expected future discounted cash flows or market value, if readily determinable. If long-lived assets are determined to be recoverable, but the newly determined remaining estimated useful lives are shorter than originally estimated, the net book values of the long-lived assets are depreciated and amortized prospectively over the newly determined remaining estimated useful lives.

 

10
 

 

Equity Method Investments

 

Investments in unconsolidated affiliates are accounted for under the equity method of accounting, as appropriate. The Company accounts for investments in limited partnerships or limited liability corporations, whereby the Company owns a minimum of 5.0% of the investee’s outstanding voting stock, under the equity method of accounting. These investments are recorded at the amount of the Company’s investment and adjusted each period for the Company’s share of the investee’s income or loss, and dividends paid.

 

During the nine months ended June 30, 2023, the Company recorded $0 of investee losses.

 

Asset Acquisitions

 

The Company has adopted ASU 2017-01, which clarifies the definition of a business with the objective of adding guidance to assist entities with evaluating whether transactions should be accounted for as businesses acquisitions. As a result of adopting ASU 2017-01, acquisitions of real estate and cannabis licenses do not meet the definition of a business combination and were deemed asset acquisitions, and the Company therefore capitalized these acquisitions, including its costs associated with these acquisitions.

 

Goodwill and Intangible Assets

 

Goodwill. Goodwill represents the excess acquisition cost over the fair value of net tangible and intangible assets acquired. Goodwill is not amortized and is subject to annual impairment testing on or between annual tests if an event or change in circumstance occurs that would more likely than not reduce the fair value of a reporting unit below its carrying value. In testing for goodwill impairment, the Company has the option to first assess qualitative factors to determine whether the existence of events or circumstances lead to a determination that it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If, after assessing the totality of events and circumstances, the Company concludes that it is not more likely than not that the fair value of a reporting unit is less than its carrying amount, then performing the two-step impairment test is not required. If the Company concludes otherwise, the Company is required to perform the two-step impairment test. The goodwill impairment test is performed at the reporting unit level by comparing the estimated fair value of a reporting unit with its respective carrying value. If the estimated fair value exceeds the carrying value, goodwill at the reporting unit level is not impaired. If the estimated fair value is less than the carrying value, further analysis is necessary to determine the amount of impairment, if any, by comparing the implied fair value of the reporting unit’s goodwill to the carrying value of the reporting unit’s goodwill. No goodwill impairment expense was incurred for the nine months ended June 30, 2023, and 2022, respectively.

 

Intangible Assets. Intangible assets deemed to have finite lives are amortized on a straight-line basis over their estimated useful lives, where the useful life is the period over which the asset is expected to contribute directly, or indirectly, to our future cash flows. Intangible assets are reviewed for impairment on an interim basis when certain events or circumstances exist. For amortizable intangible assets, impairment exists when the carrying amount of the intangible asset exceeds its fair value. At least annually, the remaining useful life is evaluated. During the nine months ended June 30, 2023, the Company entered into an asset purchase agreement which included the sale of intangible assets of approximately $222,000. Intangible assets of $471,000 and 0 were impaired for the nine months ended June 30, 2023, and 2022, respectively.

 

An intangible asset with an indefinite useful life is not amortized but assessed for impairment annually, or more frequently, when events or changes in circumstances occur indicating that it is more likely than not that the indefinite-lived asset is impaired. Impairment exists when the carrying amount exceeds its fair value. In testing for impairment, the Company has the option to first perform a qualitative assessment to determine whether it is more likely than not that an impairment exists. If it is determined that it is not more likely than not that an impairment exists, a quantitative impairment test is not necessary. If the Company concludes otherwise, it is required to perform a quantitative impairment test. To the extent an impairment loss is recognized, the loss establishes the new cost basis of the asset that is amortized over the remaining useful life of that asset, if any. Subsequent reversal of impairment losses is not permitted.

 

11
 

 

Business Combinations

 

The Company applies the provisions of ASC 805 in the accounting for acquisitions. ASC 805 requires the Company to recognize separately from goodwill the assets acquired, and the liabilities assumed at their acquisition date fair values. Goodwill as of the acquisition date is measured as the excess of consideration transferred over the net of the acquisition date fair values of the assets acquired and the liabilities assumed. While the Company uses its best estimates and assumptions to accurately apply preliminary value to assets acquired and liabilities assumed at the acquisition date as well as contingent consideration, where applicable, these estimates are inherently uncertain and subject to refinement. As a result, during the measurement period, which may be up to one year from the acquisition date, the Company records adjustments in the current period, rather than a revision to a prior period. Upon the conclusion of the measurement period or final determination of the values of the assets acquired or liabilities assumed, whichever comes first, any subsequent adjustments are recorded in the consolidated statements of operations. Accounting for business combinations requires management to make significant estimates and assumptions, especially at the acquisition date, including estimates for intangible assets, contractual obligations assumed, restructuring liabilities, pre-acquisition contingencies, and contingent consideration, where applicable. Although the Company believes the assumptions and estimates made have been reasonable and appropriate, they are based in part on historical experience and information obtained from management of the acquired companies and are inherently uncertain. Unanticipated events and circumstances may occur that may affect the accuracy or validity of such assumptions, estimates, or actual results.

 

Contingent Consideration

 

The Company accounts for “contingent consideration” according to FASB ASC 805, “Business Combinations” (“FASB ASC 805”). Contingent consideration typically represents the acquirer’s obligation to transfer additional assets or equity interests to the former owners of the acquiree if specified future events occur or conditions are met. FASB ASC 805 requires that contingent consideration be recognized at the acquisition-date fair value as part of the consideration transferred in the transaction. FASB ASC 805 uses the fair value definition in Fair Value Measurements, which defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. As defined in FASB ASC 805, contingent consideration is (i) an obligation of the acquirer to transfer additional assets or equity interests to the former owners of an acquiree as part of the exchange for control of the acquiree, if specified future events occur or conditions are met or (ii) the right of the acquirer to the return of previously transferred consideration if specified conditions are met.

 

Warrant Liability

 

The Company accounts for certain common stock warrants outstanding as a liability at fair value and adjusts the instruments to fair value at each reporting period. This liability is subject to re-measurement at each balance sheet date until exercised, and any change in fair value is recognized in the Company’s consolidated statements of operations. The fair value of the warrants issued by the Company has been estimated using a Black Scholes model.

 

Embedded Conversion Features

 

The Company evaluates embedded conversion features within convertible debt to determine whether the embedded conversion feature(s) should be bifurcated from the host instrument and accounted for as a derivative at fair value with changes in fair value recorded in the statement of operations. If the conversion feature does not require recognition of a bifurcated derivative, the convertible debt instrument is evaluated for consideration of any beneficial conversion feature (“BCF”) requiring separate recognition. When the Company records a BCF, the intrinsic value of the BCF is recorded as a debt discount against the face amount of the respective debt instrument (offset to additional paid-in capital) and amortized to interest expense over the life of the debt.

 

Income Taxes

 

The provision for income taxes is determined in accordance with ASC 740, “Income Taxes”. The Company files a consolidated United States federal income tax return. The Company provides for income taxes based on enacted tax law and statutory tax rates at which items of income and expense are expected to be settled in our income tax return. Certain items of revenue and expense are reported for Federal income tax purposes in different periods than for financial reporting purposes, thereby resulting in deferred income taxes. Deferred taxes are also recognized for operating losses that are available to offset future taxable income. Valuation allowances are established when necessary to reduce deferred tax assets to the amount expected to be realized. The Company has incurred net operating losses for financial-reporting and tax-reporting purposes. As of June 30, 2023, and September 30, 2022, such net operating losses were offset entirely by a valuation allowance.

 

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The Company recognizes uncertain tax positions based on a benefit recognition model. Provided that the tax position is deemed more likely than not of being sustained, the Company recognizes the largest amount of tax benefit that is greater than 50.0% likely of being ultimately realized upon settlement. The tax position is derecognized when it is no longer more likely than not of being sustained. The Company classifies income tax related interest and penalties as interest expense and selling, general and administrative expense, respectively, on the consolidated statements of operations.

 

In December 2017, the Tax Cuts and Jobs Act (TCJA or the Act) was enacted, which significantly changes U.S. tax law. In accordance with ASC 740, “Income Taxes”, the Company is required to account for the new requirements in the period that includes the date of enactment. The Act reduced the overall corporate income tax rate to 21.0%, created a territorial tax system (with a one-time mandatory transition tax on previously deferred foreign earnings), broadened the tax base and allowed for the immediate capital expensing of certain qualified property.

 

Revenue Recognition

 

The Company recognizes revenue when its customer obtains control of promised goods or services, in an amount that reflects the consideration which the entity expects to receive in exchange for those goods or services. To determine revenue recognition for arrangements that an entity determines are within the scope of Accounting Standards Codification (ASC) Topic 606, Revenue from Contracts with Customers (Topic 606), the entity performs the following five steps: (i) identify the contract(s) with a customer; (ii) identify the performance obligations in the contract; (iii) determine the transaction price; (iv) allocate the transaction price to the performance obligations in the contract; and (v) recognize revenue when (or as) the entity satisfies a performance obligation. The Company only applies the five-step model to contracts when it is probable that the entity will collect the consideration it is entitled to in exchange for the goods or services it transfers to the customer. At contract inception, once the contract is determined to be within the scope of Topic 606, the Company assesses the goods or services promised within each contract and determines those that are performance obligations and assesses whether each promised good or service is distinct. The Company then recognizes as revenue the amount of the transaction price that is allocated to the respective performance obligation when (or as) the performance obligation is satisfied.

 

Revenue for the Company’s product sales has not been adjusted for the effects of a financing component as the Company expects, at contract inception, that the period between when the Company’s transfers control of the product and when the Company receives payment will be one year or less. Product shipping and handling costs are included in cost of product sales.

 

The following policies reflect specific criteria for the various revenue streams of the Company:

 

Cannabis Dispensary, Cultivation and Production

 

Revenue is recognized upon transfer of retail merchandise to the customer upon sale transaction, at which time its performance obligation is complete. Revenue is recognized upon delivery of product to the wholesale customer, at which time the Company’s performance obligation is complete. Terms are generally between cash on delivery to 30 days for the Company’s wholesale customers.

 

The Company’s sales environment is somewhat unique, in that once the product is sold to the customer (retail) or delivered (wholesale) there are essentially no returns allowed or warranty available to the customer under the various state laws.

 

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Delivery

 

1) Identify the contract with a customer

 

The Company sells retail products directly to customers. In these sales there is no formal contract with the customer. These sales have commercial substance and there are no issues with collectability as the customer pays the cost of the goods at the time of purchase or delivery.

 

2) Identify the performance obligations in the contract

 

The Company sells its products directly to consumers. In this case these sales represent a performance obligation with the sales and any necessary deliveries of those products.

 

3) Determine the transaction price

 

The sales that are done directly to the customer have no variable consideration or financing component. The transaction price is the cost that those goods are being sold for plus any additional delivery costs.

 

4) Allocate the transaction price to performance obligations in the contract

 

For the goods that the Company sells directly to customers, the transaction price is allocated between the cost of the goods and any delivery fees that may be incurred to deliver to the customer.

 

5) Recognize revenue when or as the Company satisfies a performance obligation

 

For the sales of the Company’s own goods the performance obligation is complete once the customer has received the product.

 

Leases

 

On October 1, 2020, the Company adopted ASC 842 and elected to apply the new standard at the adoption date and recognize a cumulative effect as an adjustment to retained earnings. Upon calculation the effect on retained earnings was immaterial and no adjustment was deemed necessary. Leases with an initial term of twelve months or less are not recorded on the balance sheet. For lease agreements entered into or reassessed after the adoption of Topic 842, we combine the lease and non-lease components in determining the lease liabilities and right of use (“ROU”) assets.

 

Our lease agreements generally do not provide an implicit borrowing rate; therefore, an internal incremental borrowing rate is determined based on information available at lease commencement date for purposes of determining the present value of lease payments. We used the incremental borrowing rate on June 30, 2023, for all leases that commenced prior to that date. In determining this rate, which is used to determine the present value of future lease payments, we estimate the rate of interest we would pay on a collateralized basis, with similar payment terms as the lease and in a similar economic environment.

 

Under Topic 842, operating lease expense is generally recognized evenly over the term of the lease. Lease costs were approximately $323,000 and $1,010,000, respectively for the three and nine months ended June 30, 2023, and approximately $331,000 and $763,000, respectively for the three and nine months ended June 30, 2022. The Company has nine operating leases consisting with remaining lease terms ranging from 7 months to 167 months.

 

Lease Costs 

 

   Nine Months Ended   Nine Months Ended 
   June 30, 2023   June 30, 2022 
Components of total lease costs:          
Operating lease expense  $1,010   $763 
Total lease costs  $1,010   $763 

 

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Lease positions as of June 30, 2023

 

ROU lease assets and lease liabilities for our operating leases were recorded in the consolidated condensed balance sheet as follows:

 

   June 30, 2023 
Assets     
Right of use asset  $7,819 
Total assets  $7,819 
      
Liabilities     
Operating lease liabilities – short term  $442 
Operating lease liabilities – long term   7,626 
Total lease liability  $8,068 

 

Lease Terms and Discount Rate

 

Weighted average remaining lease term (in years) – operating lease   11.80 
Weighted average discount rate – operating lease   10.74%

 

Cash Flows

 

   Nine Months Ended 
   June 30, 2023 
Cash paid for amounts included in the measurement of lease liabilities:     
ROU amortization  $1,010 
Cash paydowns of operating liability  $(1,010)

 

The future minimum lease payments under the leases are as follows:

 

      
2023  $331 
2024   1,272 
2025   1,252 
2026   1,271 
2027   1,080 
Thereafter   9,828 
Total future minimum lease payments   15,034 
Less: Lease imputed interest   (6,966)
Total  $8,068 

 

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Disaggregation of Revenue

 

In the nine months ended June 30, 2023, revenue reported was primarily from the sale of cannabis and related products accounted for under ASC 606.

 

The following table illustrates our revenue by type related to the three months ended June 30, 2023, and 2022 respectively:

 

Three Months Ended June 30,  2023   2022 
Revenue          
Wholesale  $841   $1,126 
Retail   3,774    3,630 
Rental   -    - 
Other   13    66 
Total revenue   4,628    4,822 
Discounts and returns   (798)   (651)
Net Revenue  $3,830   $4,171 

 

The following table illustrates our revenue by type related to the nine months ended June 30, 2023, and 2022 respectively:

 

Nine Months Ended June 30,  2023   2022 
Revenue          
Wholesale  $2,639   $3,256 
Retail   11,431    11,217 
Other   47    106 
Total revenue   14,117    14,579 
Discounts and returns   (2,334)   (2,062)
Net Revenue  $11,783   $12,517 

 

Geographical Concentrations

 

As of June 30, 2023, the Company is primarily engaged in the production and sale of cannabis, which is only legal for recreational use in 19 states and D.C., with lesser legalization, such as for medical use in an additional 18, as of the time of these consolidated financial statements. In addition, the United States Congress has passed legislation, specifically the Agriculture Improvement Act of 2018 (also known as the “Farm Bill”) that has removed production and consumption of hemp and associated products from Schedule 1 of the Controlled Substances Act.

 

Cost of Goods Sold

 

Cost of sales represents costs directly related to manufacturing and distribution of the Company’s products. Primary costs include raw materials, packaging, direct labor, overhead, shipping and handling and the depreciation of manufacturing equipment and production facilities. Manufacturing overhead and related expenses include salaries, wages, employee benefits, utilities, maintenance, and property taxes. The Company recognizes the cost of sales as the associated revenues are recognized.

 

Fair Value of Financial Instruments

 

As defined in the authoritative guidance, 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.

 

To estimate fair value, 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 authoritative guidance 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” measurements) and the lowest priority to unobservable inputs (“Level 3” measurements). The three levels of the fair value hierarchy are as follows:

 

Level 1 — Observable inputs such as quoted prices in active markets at the measurement date for identical, unrestricted assets or liabilities.

 

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Level 2 — Other inputs that are observable, directly, or indirectly, such as quoted prices in markets that are not active, or inputs which are observable, either directly or indirectly, for substantially the full term of the asset or liability.

 

Level 3 — Unobservable inputs for which there is little or no market data and which the Company makes its own assumptions about how market participants would price the assets and liabilities.

 

In instances in which multiple levels of inputs are used to measure fair value, hierarchy classification is based on the lowest level input that is significant to the fair value measurement in its entirety. The Company’s assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment and considers factors specific to the asset or liability.

 

Stock-based Compensation

 

The Company accounts for share-based payment awards exchanged for services at the estimated grant date fair value of the award. Stock options issued under the Company’s long-term incentive plans are granted with an exercise price equal to no less than the market price of the Company’s stock at the date of grant and expire up to ten years from the date of grant. These options generally vest on the grant date or over a one-year period.

 

The Company estimates the fair value of stock option grants using the Black-Scholes option pricing model and the assumptions used in calculating the fair value of stock-based awards represent management’s best estimates and involve inherent uncertainties and the application of management’s judgment.

 

Expected Term - The expected term of options represents the period that the Company’s stock-based awards are expected to be outstanding based on the simplified method, which is the half-life from vesting to the end of its contractual term.

 

Expected Volatility - The Company computes stock price volatility over expected terms based on its historical common stock trading prices.

 

Risk-Free Interest Rate - The Company bases the risk-free interest rate on the implied yield available on U. S. Treasury zero-coupon issues with an equivalent remaining term.

 

Expected Dividend - The Company has never declared or paid any cash dividends on its common shares and does not plan to pay cash dividends in the foreseeable future, and, therefore, uses an expected dividend yield of zero in its valuation models.

 

Effective January 1, 2017, the Company elected to account for forfeited awards as they occur, as permitted by Accounting Standards Update (“ASU”) 2016-09. Ultimately, the actual expenses recognized over the vesting period will be for those shares that vested. Prior to making this election, the Company estimated a forfeiture rate for awards at 0%, as the Company did not have a significant history of forfeitures.

 

Earnings (Loss) per Share

 

ASC 260, Earnings Per Share, requires dual presentation of basic and diluted earnings per share (“EPS”) with a reconciliation of the numerator and denominator of the basic EPS computation to the numerator and denominator of the diluted EPS computation. Basic EPS excludes dilution. Diluted EPS reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that then shared in the earnings of the entity.

 

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Basic net loss per share of common stock excludes dilution and is computed by dividing net loss by the weighted average number of shares of common stock outstanding during the period. Diluted net loss per share of common stock reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that then shared in the earnings of the entity unless inclusion of such shares would be anti-dilutive. Since the Company has only incurred losses, basic and diluted net loss per share is the same. Securities that could potentially dilute loss per share in the future that were not included in the computation of diluted loss per share as of June 30, 2023, and September 30, 2022, are as follows:

 

Potentially dilutive share-based instruments:  June 30, 2023   September 30, 2022 
Convertible notes   124,237,230    34,736,220 
Options to purchase common stock   9,030,685    5,518,185 
Unvested restricted stock awards   -    - 
Warrants to purchase common stock   20,818,536    65,783,059 
Anti-dilutive Securities   154,086,451    106,037,464 

 

The company has determined that the amount of interest expense and gains and losses for the derivative liabilities associated with the Company’s convertible notes is immaterial and inclusion would be anti-dilutive and has therefore not included an Earnings Per Share table recording the diluted earnings.

 

Advertising Costs

 

The Company follows the policy of charging the cost of advertising to expense as incurred. Advertising expense was approximately $25,000 and $47,000 three months ended June 30, 2023, and 2022, respectively. Advertising expense was approximately $95,000 thousand and $217,000 for nine months ended June 30, 2023, and 2022, respectively.

 

Related parties

 

Parties are related to the Company if the parties, directly or indirectly, through one or more intermediaries, control, are controlled by, or are 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 with 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.

 

Segment reporting

 

Operating segments are defined as components of an enterprise about which separate financial information is available that is evaluated regularly by the chief operating decision maker, or decision–making group in deciding how to allocate resources and in assessing performance. The Company’s chief operating decision–maker is its chief executive officer. The Company currently operates in one segment.

 

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Recent Accounting Guidance

 

In June 2016, the FASB issued ASU 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments (“ASU 2016-13”). ASU 2016-13 provides guidance for recognizing credit losses on financial instruments based on an estimate of current expected credit losses model. The amendments are effective for fiscal years beginning after December 15, 2019. Recently, the FASB issued the final ASU to delay adoption for smaller reporting companies to calendar year 2023. The Company is currently assessing the impact of the adoption of this ASU on its financial statements.

 

In January 2020, the FASB issued ASU 2020-01, Investments - Equity Securities (Topic 321), Investments - Equity Method and Joint Ventures (Topic 323), and Derivative and Hedging (Topic 815), which clarifies the interaction of rules for equity securities, the equity method of accounting, and forward contracts and purchase options on certain types of securities. The guidance clarifies how to account for the transition into and out of the equity method of accounting when considering observable transactions under the measurement alternative. The ASU is effective for annual reporting periods beginning after December 15, 2020, including interim reporting periods within those annual periods, with early adoption permitted. The adoption of this standard did not have a material impact on the Company’s consolidated financial statements and related disclosures.

 

In August 2020, the FASB issued ASU 2020-06, Debt—Debt with Conversion and Other Options (Subtopic 470-20) and Derivatives and Hedging—Contracts in Entity’s Own Equity (Subtopic 815-40): Accounting for Convertible Instruments and Contracts in an Entity’s Own Equity. This ASU amends the guidance on convertible instruments and the derivatives scope exception for contracts in an entity’s own equity, and also improves and amends the related EPS guidance for both Subtopics. The ASU will be effective for smaller reporting companies for annual reporting periods beginning after December 15, 2022, and interim periods within those annual periods and early adoption is permitted. We are currently evaluating the impact of the new guidance on our consolidated financial statements.

 

3. Property, Plant & Equipment

 

Property and equipment consist of the following (in thousands):

 

   June 30, 2023   September 30, 2022 
         
Land  $-   $1,151 
Automobiles   -    93 
Signage   -    19 
Furniture and equipment   1,541    2,590 
Leasehold improvements   3,342    3,532 
Buildings and property improvements   5,062    7,460 
Computer software   57    59 
Property and equipment, gross   10,002    14,904 
Accumulated depreciation   (4,553)   (5,815)
Property and equipment, net  $5,449   $9,089 

 

Depreciation expense was approximately $256,000 and $400,000 for the three months ended June 30, 2023, and 2022, respectively. Depreciation expense was approximately $917,000 and $1.3 million for the nine months ended June 30, 2023, and 2022, respectively. Depreciation expense is included in general and administrative expense.

 

4. Inventory

 

Inventory consists of the following (in thousands):

 

   June 30, 2023   September 30, 2022 
         
Raw materials  $198   $569 
Work-in-progress   151    450 
Finished goods   954    1,656 
Total Inventory  $1,303   $2,675 

 

Raw materials and work-in-progress include the costs incurred for cultivation materials and live plants. Finished goods consists of cannabis products sent to retail locations or ready to be sold. No inventory reserve was recorded for the nine months ended June 30, 2023, and the year ended September 30, 2022, due to management’s assessment of the inventory on hand.

 

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5. Prepaid expenses and other current assets

 

Prepaid expenses and other current assets are assets and payments previously made, that benefit future periods. The balance as of June 30, 2023, includes the Employee Retention Tax Credit (“ERTC”) program from the U.S Treasury, as part of the COVID-19 stimulus package. During the fiscal year ended September 30, 2021, the Company applied for certain ERTC credits in the approximate amount of $5.1 million, which is reflected within the Statement of Operations as a reduction to general and administration expense. The remaining balance of the ERTC receivable was $201 thousand as of June 30, 2023.

 

Prepaid and other current assets comprised of the following:

 

   June 30, 2023   September 30, 2022 
         
Prepaid expenses  $213   $538 
ERTC credits   201    201 
Deposits and other current assets   182    190 
           
Total prepaid expenses and other current assets  $596   $929 

 

6. Non-Controlling Interests

 

Non-controlling interests in consolidated entities are as follows (in thousands):

 

   As of September 30, 2022 
   NCI Equity Share   Net Loss Attributable to NCI   NCI in Consolidated Entities   Non-Controlling Ownership % 
NVD RE Corp.  $553   $(37)  $516    36.2%
Western Coast Ventures, Inc.   842   $(3)   839    49.0%
YMY Ventures, Inc.   299   $30    329    50.0%
Michigan RE 1, Inc.   (54)  $(152)   (206)   49.0%
   $1,640   $(162)  $1,478      

 

   As of June 30, 2023 
   NCI Equity Share   Net Loss Attributable to NCI   NCI in Consolidated Entities   Non-Controlling Ownership % 
NVD RE Corp.  $516   $(28)  $488    36.2%
Western Coast Ventures, Inc.   839   $-    839    49.0%
YMY Ventures, Inc.   329   $48    377    50.0%
Michigan RE 1, Inc.   (206)  $-    (206)   49.0%
   $1,478   $20   $1,498      

 

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7. Discontinued Operations, Assets and Liabilities Held for Sale

 

Discontinued Operations

 

On December 15, 2021, pursuant to a Share Exchange Agreement, the Company sold Driven Deliveries and its subsidiaries to the shareholders of Budee, Inc. in a transaction which the Company fully divested all of its interests in Driven Deliveries and all of its subsidiaries. Included in the terms of the Share Exchange Agreement, the shareholder of Budee, Inc., and prior officer of Driven Deliveries returned approximately 11.5 million shares of the Company’s common stock and assumed approximately $7.9 million of the Companies liabilities. Notwithstanding, the Company will continue to be responsible for $210 thousand of accounts payable assumed in the acquisition of Driven Deliveries.

 

The following table presents the assets and liabilities associated with the divestiture of Driven Deliveries, Inc. as of December 15, 2021, the date Driven was divested (in thousands):

 

   December 15, 2021 
     
ASSETS     
Current assets     
Cash and cash equivalents  $47 
Inventory   509 
Prepaid expenses and other current assets   242 
Total current assets   798 
      
Property and equipment, net   4 
Right of use asset   327 
Intangible assets, net   7,049 
Total assets  $8,178 
      
LIABILITIES AND SHAREHOLDERS’ EQUITY     
Current liabilities     
Accounts payable and accrued expenses   7,551 
Short term notes and advances   3 
Lease liability   218 
Total current liabilities   7,772 
      
Lease liability - long term   108 
Total liabilities  $7,880 

 

The following table presents the operating results related to the divestiture of Driven Deliveries; Inc. (in thousands):

 

  

Three Months Ended

December 31, 2021

 
     
Revenues  $3,805 
Cost of goods sold   3,772 
Gross Profit   33 
      
Operating expenses:     
Consulting fees   4 
Professional fees   24 
General and administration   1,749 
Total operating expenses   1,777 
Loss from operations   (1,744)
      
Other expenses     
Interest expense   1 
Total other expense   1 
Loss from discontinued operations  $(1,745)

 

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In April 2023, the Company entered into a mutual settlement and release agreement with the landlord of one its indoor grow facilities in Oregon. The mutual consideration between the parties was to sell and transfer certain property and equipment to the landlord in exchange for complete termination of the existing lease and all of its obligations.

 

8. Assets Sale

 

On January 3, 2023, pursuant to an Oregon Real Estate Agreement, the Company sold its ownership interest in Never Again 2, LLC. The purchase price for this land and its leasehold improvements was $275,000 and excluding the cultivation license. At the closing the Company received $56,055 net of a $200,000 mortgage that was paid off along with broker fees. The Company recorded a loss on sale of approximately $1 million.

 

On March 15, 2023, the Company executed as Asset Purchase Agreement in which certain assets were sold for $200,000. In the terms of the agreement the buyer purchased one Marijuana Processor License, one Marijuana Wholesaler license, assumed certain liabilities. The licenses had a recorded value of $222,427 and accumulated amortization of $