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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 December 31, 2021

 

  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   OTCQX

 

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 221,452,741 shares outstanding of registrant’s common stock, par value $0.001 per share, as of February 22, 2022.

 

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 December 31, 2021 (unaudited) and September 30, 2021 3
     
  Unaudited Condensed Consolidated Statements of Operations for the three months ended December 31, 2021 and December 31, 2020 4
     
  Unaudited Consolidated Statement of Changes in Stockholders’ Equity for the three months ended December 31, 2021 and December 31, 2020 5
     
  Unaudited Condensed Consolidated Statements of Cash Flows for the three months ended December 31, 2021 and December 31, 2020 6
     
  Notes to Unaudited Condensed Consolidated Financial Statements 7
     
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operation 37
     
Item 3. Quantitative and Qualitative Disclosures About Market Risk 43
     
Item 4. Controls and Procedures 43
     
  PART II  
     
Item 1. Legal Proceedings 44
     
Item 1A. Risk Factors 45
     
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 46
     
Item 3. Defaults Upon Senior Securities 46
     
Item 4. Mine Safety Disclosures 46
     
Item 5. Other Information 46
     
Item 6. Exhibits 46
     
SIGNATURES 47

 

2

 

 

PART I

 

ITEM 1. FINANCIAL STATEMENTS

 

STEM HOLDINGS, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands except for share and per share amounts)

 

   December 31,   September 30, 
   2021   2021 
    (unaudited)   * 
ASSETS          
Current assets          
Cash and cash equivalents  $3,260   $5,464 
Accounts receivable, net of allowance for doubtful accounts   232    260 
Note receivable   437    430 
Inventory   3,548    3,126 
Prepaid expenses and other current assets   855    2,187 
Assets held for sale   -    9,324 
Total current assets   8,332    20,791 
           
Property and equipment, net   12,294    12,598 
Investment in equity method investees   720    1,008 
Investments in affiliates   230    230 
Deposits and other assets   13    13 
Right of use asset   4,114    4,235 
Intangible assets, net   10,640    10,856 
Goodwill   7,429    7,429 
Due from related party   28    28 
Total assets  $43,800   $57,188 
           
LIABILITIES AND SHAREHOLDERS’ EQUITY          
Current liabilities          
Accounts payable and accrued expenses   2,730    2,547 
Convertible notes, net   2,899    2,940 
Convertible notes, net related party   -    223 
Short term notes and advances   329    650 
Due to related party   -    1 
Lease liability   489    467 
Warrant liability   538    2,277 
Liabilities held for sale   -    6,801 
Total current liabilities   6,985    15,906 
           
Lease liability - long term   3,726    3,855 
Finance liability   1,094    1,093 
Long-term debt, mortgages   2,100    2,100 
Total liabilities   13,905    22,954 
           
Commitments and contingencies (Note 17)   -    - 
           
Shareholders’ equity          
Preferred stock, Series A; $0.001 par value; 50,000,000 shares authorized, none outstanding as of December 31, 2021 and September 30, 2021   -    - 
Preferred stock, Series B; $0.001 par value; 50,000,000 shares authorized, none outstanding as of December 31, 2021 and September 30, 2021   -    - 
Common stock, $0.001 par value; 750,000,000 shares authorized; 223,391,484 and 230,738,620  shares issued, issuable and outstanding as of December 31, 2021 and September 30, 2021, respectively   223    230 
Additional paid-in capital   147,969    148,249 
Stock subscription receivable   -    (135)
Accumulated deficit   (119,814)   (115,750)
Total Stem Holdings stockholder’s equity   28,378    32,594 
Noncontrolling interest   1,517    1,640 
Total shareholders’ equity   29,895    34,234 
Total liabilities and shareholders’ equity  $43,800   $57,188 

 

* Derived from audited information

 

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

 

3

 

 

STEM HOLDINGS, INC.

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands except for share and per share amounts)

 

   2021   2020 
   For the Three Months Ended December 31, 
   2021   2020 
         
Revenues  $4,211   $5,269 
Cost of goods sold   3,395    3,459 
Gross Profit   816    1,810 
           
Operating expenses:          
Consulting fees   188    744 
Professional fees   1,277    914 
General and administration   3,440    3,062 
Impairment expense   795    - 
Total operating expenses   5,700    4,720 
Loss from operations   (4,884)   (2,910)
           
Other income (expenses), net          
Interest expense   (178)   (710)
Change in fair value of derivative liability   -    208 
Change in fair value of warrant liability   1,738    90 
Foreign currency exchange gain (loss)   41   (43)
Other income   10    200 
Gain from disposal of subsidiary   831    - 
Total other income (expense)   2,442    (255)
           
 Loss from continuing operations     (2,442 )     (3,165 )
 Loss from discontinued operations, net of tax     (1,745 )     (114 )
Net loss  $(4,187)  $(3,279)
           
Net loss attributable to non-controlling interest   (123)   (91)
           
Net loss attributable to Stem Holdings  $(4,064)  $(3,188)
                 
 Loss from continuing operations, per share     (0.01 )     (0.05 )
 Loss from discontinued operations, per share     (0.01 )     (0.00 )
           
Net loss per share, basic and diluted  $(0.02)  $(0.05)
Weighted-average shares outstanding, basic and diluted   230,231,560    69,680,137 

 

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

 

4

 

 

STEM HOLDINGS, INC.

UNAUDITED CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS’ EQUITY

(in thousands, except for share and per share amounts)

 

   Shares   Amount    Capital   Receivable   Deficit   Equity   Interest   Equity 
                       Total Stem         
   Common Stock  

Additional

Paid-in

  

  Subscription   Accumulated   Holdings Shareholders’  

Non-

Controlling

   Total Shareholders’ 
   Shares   Amount    Capital   Receivable   Deficit   Equity   Interest   Equity 
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 
                                         
Balance as of September 30, 2020   68,258,745   $68   $76,310   $-   $(51,386)  $24,992   $1,840   $26,832 
Issuance of common stock in connection with consulting agreement   1,569,570    2    587    -    -    589    -    589 
Common stock to be issued   6,833,069    7    2,863    -    -    2,870    -    2,870 
Stock based compensation   1,868,750    2    560    -    -    562    -    562 
Cancellation of common stock related to convertible notes   (525,400)   (1)   1    -    -    -    -    - 
Issuance of common stock related to rent and interest expense   501,561    1    208    -    -    209    -    209 
Issuance of subscription receivable   -    -    600    (600)   -    -    -    - 
Issuance of warrants in connection with employment agreement   -    -    132    -    -    132    -    132 
Issuance of options in connection with employment agreement   -    -    61    -    -    61    -    61 
Acquisition of Driven Deliveries, Inc.   101,968,944    101    43,224    (135)   -    43,190         43,190 
Net loss   -    -    -         (3,188)   (3,188)   (91)   (3,279)
Balance as of December 31, 2020   180,475,239    180    124,546    (735)   (54,574)   69,417    1,749   $71,166 

 

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

 

5

 

 

STEM HOLDINGS, INC.

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

 

   2021   2020 
   For the Three Months Ended 
   December 31, 
   2021   2020 
Cash flows from operating activities          
Net loss  $(4,187)  $(3,279)
Loss from discontinued operations, net of tax   

1,745

    

114

 
Adjustments to reconcile net loss to net cash used in operating activities:          
Stock-based compensation expense   512    756 
Issuance of common stock in connection with consulting agreements   30    589 
Issuance of common stock related to rent and interest expense   -    209 
Impairment of investments   288    - 
Depreciation and amortization   434    488 
Amortization of intangible assets   216    245 
Amortization of debt discount   7    464 
Gain on sale of equity method investments   -    (200)
Change in fair value of derivative liability   -    (208)
Change in fair value of warrant liability   (1,738)   (79)
Foreign currency adjustment   (41)   (24)

Gain from disposal of subsidiary

   (831)   - 
Other   14     
Changes in operating assets and liabilities:          
Accounts receivable, net of allowance for doubtful accounts   28    (65)
Prepaid expenses and other current assets   217    17 
Inventory   (422)   (192)
Other assets   1,172    61 
Accounts payable and accrued expenses   250    229 
Net cash used in continuing operating activities   

(2,306

)   

(875

)
Net cash provided by discontinued operating activities   

340

    

(114

)
Net cash used in operating activities   (1,966)   (989)
           
Cash flows from investing activities          
Proceeds related to sale of SOK Management, LLC   -    200 
Purchase of property and equipment   (129)   (165)
Investment in equity method investees   -   (91)
Investments   -    (100)
Cash acquired in acquisition, net of cash transferred   

-

    

-

 
Related party payments   (1)   - 
Net cash used in continuing investing activities   (130)   (156)
Net cash used in discontinued investing activities   

-

    

-

 
Net used in investing activities   

(130

)   (156)
           
Cash flows from financing activities          
Proceeds from the issuance of common stock   285    2,869 
Proceeds from notes payable and advances   

-

    

-

 
Repayments of notes payable   (393)   (6)
Net cash provided by (used in) provided by financing activities from continuing operations   (108)   2,863 
Net cash provided by financing activities from discontinued operations   

-

    

-

 
Net cash provided by (used in) provided by financing activities   

(108

)   

2,863

 
           
Net (decrease) increase in cash and cash equivalents   (2,204)   1,718 
Cash and cash equivalents at the beginning of the period   5,464    2,129 
Cash and cash equivalents at the end of the period  $3,260   $3,847 
           
Supplemental disclosure of cash flow information:          
Cash paid for interest  $106   $655 
Supplemental disclosure of noncash activities:          
Financed Insurance  $65   $17 
Interest paid in the form of common stock  $66   $- 
Acquisition of Driven Deliveries, Inc.  $-   $43,325 
Refinancing of mortgage  $-   $1,100 

 

The accompanying notes are an integral part of these unaudited 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.

 

The Company purchases, improves, leases, operates, and invests 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, California, Massachusetts, and New York. As of December 31, 2021, Stem had ownership interests in 24 state issued cannabis licenses including nine (9) licenses for cannabis cultivation, three (3) licenses for cannabis processing, two (2) licenses for cannabis wholesale distribution, three (3) licenses for hemp production and (7) cannabis dispensary licenses.

 

The Company has nine wholly-owned subsidiaries, including Stem Holdings Oregon, Inc., Stem Holdings IP, Inc., Opco, LLC, Stem Agri, Inc., Stem Holdings Oregon Acquisitions 1, Corp., Stem Holdings Oregon Acquisitions 2, Corp., Stem Holdings Oregon Acquisitions 3, Corp., Stem Holdings Oregon Acquisitions 4 Corp., 2336034 Alberta Ltd., Stem, through its subsidiaries, is currently in the process of the acquisition of entities or 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 OTCQX 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 December 31, 2021, the Company had approximate balances of cash and cash equivalents of $3.3 million, positive working capital of approximately $1.3 million, and an accumulated deficit of $119.8 million.

 

These audited 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, where the Company has and is working towards further finalizing the acquisition of entities or investment in entities that directly produce or sell cannabis, 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. 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.

 

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-lived 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.

 

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.

 

8

 

 

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 Holdings Agri, Inc., Stem Oregon Acquisitions 2 Corp., Stem Oregon Acquisitions 3 Corp., Stem Oregon Acquisitions 4 Corp., 7LV USA Corporation, and Stem Oregon Acquisitions 1 Corp., and Driven Deliveries, Inc., which was divested during the quarter ended December 31, 2021. 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 December 31, 2021, and 2020, the Company had no cash equivalents or short-term investments. The Company has not experienced any losses on deposits of cash and cash equivalents.

 

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 December 31, 2021, the reserve for doubtful accounts was $43 thousand.

 

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.

 

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.

 

9

 

 

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

 

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.

 

An impairment expense of $795 thousand was recorded for the three months ended December 31, 2021. During the three months ended December 31, 2020, the Company determined that no impairment was required.

 

Capitalization of Project Costs

 

The Company’s policy is to capitalize all costs that are directly identifiable with a specific property, would be capitalized if the Company had already acquired the property, and when the property, or an option to acquire the property, is being actively sought after, and either funds are available or will likely become available to exercise their option. All amounts shown capitalized prior to acquisition of a property are included under the caption of Project Costs within the “Prepaid expenses and other current assets” line item in the consolidated balance sheet.

 

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 quarter ended December 31, 2021, the Company recorded $0 of investee losses.

 

10

 

 

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.

 

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.

 

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.

 

During the quarter ended December 31, 2021, and 2020, the Company determined that there were $0 and $0 losses related to the impairment of goodwill and intangible assets, respectively.

 

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.

 

11

 

 

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 September 30, 2021, and 2020, such net operating losses were offset entirely by a valuation allowance.

 

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.

  

12

 

 

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.

 

Effective October 1, 2019, the Company adopted the requirements of ASU 2014-09 (ASC 606) and related amendments, using the modified retrospective method. The adoption of ASC 606 did not have a significant impact on the Company’s revenue recognition policy as revenues related to wholesale and retail revenue are recorded upon transfer of merchandise to the customer, which was the effective policy under ASC 605 previously.

 

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.

 

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.

 

13

 

 

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

 

The Company recognizes rental revenue from tenants, including rental abatements, lease incentives and contractual fixed increases attributable to operating leases, on a straight-line basis over the term of the related leases when collectability is reasonably assured.

 

The Company makes estimates of the collectability of its tenant receivables related to base rents, straight-line rent, and other revenues. In the current fiscal year, the Company began significant rental operations. The Company considers such things as historical bad debts, tenant creditworthiness, current economic trends, facility operating performance, lease structure, developments relevant to a tenant’s business, and changes in tenants’ payment patterns in its analysis of accounts receivable and its evaluation of the adequacy of the allowance for doubtful accounts. Specifically, for straight-line rent receivables, the Company’s assessment includes an estimation of a tenant’s ability to fulfill its rental obligations over the remaining lease term.

 

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 December 31, 2021, 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 $327 thousand for the quarter ended December 31, 2021. The Company has nine operating leases consisting with remaining lease terms ranging from 13 months to 173 months.

 

Lease Costs

 

   Three Months Ended 

 

Three Months

Ended

   December 31,    December 31,
   2021    2020
Components of total lease costs:             
Operating lease expense  $327    $ 169  
Total lease costs  $327    $ 169  

 

14

 

 

Lease positions as of December 31, 2021

 

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

 

   December 31, 
   2021 
Assets     
Right of use asset  $4,114 
Total assets  $4,114 
      
Liabilities     
Operating lease liabilities – short term  $489 
Operating lease liabilities – long term   3,726 
Total lease liability  $4,215 

 

Lease Terms and Discount Rate

 

Weighted average remaining lease term (in years) – operating lease   10 
Weighted average discount rate – operating lease   12.52%

 

Cash Flows

 

  

Three Months

Ended

   

Three Months

Ended

   December 31,    December 31,
   2021    2020
Cash paid for amounts included in the measurement of lease liabilities:             
ROU amortization  $327    $ 169  
Cash paydowns of operating liability  $(327)   $ (169 )

 

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

 

      
2022  $745 
2023   985 
2024   788 
2025   687 
2026   659 
Thereafter   4,670 
Total future minimum lease payments   8,534 
Less: Lease imputed interest   (4,319)
Total  $4,215 

 

15

 

 

Disaggregation of Revenue

 

In the quarter ended December 31, 2021, 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 quarters ended December 31, 2021, and 2020 respectively:

 

Three Months Ended December 31,  2021   2020 
Revenue          
Wholesale  $554   $1,120 
Retail   4,366    4,727 
Rental   -    4 
Other   21    347 
Total revenue   4,941    6,198 
Discounts and returns   (730)   (929)
Net Revenue  $4,211   $5,269 

 

Geographical Concentrations

 

As of December 31, 2021, the Company is primarily engaged in the production and sale of cannabis, which is only legal for recreational use in 15 states and D.C., with lesser legalization, such as for medical use in an additional 21 states and D.C., 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.

 

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.

 

16

 

 

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.

 

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 December 31, 2021, and September 30, 2021, are as follows:

 

  December 31,   September 30, 
Potentially dilutive share-based instruments:  2021   2021 
Convertible notes   3,246,440    3,696,311 
Options to purchase common stock   5,980,060    7,140,447 
Unvested restricted stock awards   -    - 
Warrants to purchase common stock   61,965,834    62,965,833 
    71,192,334    73,802,591 

 

Advertising Costs

 

The Company follows the policy of charging the cost of advertising to expense as incurred. Advertising expense was $122 thousand and $54 thousand for the quarters ended December 31, 2021, and 2020, respectively.

 

17

 

 

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.

 

Recent Accounting Guidance

 

In January 2017, the FASB issued ASU 2017-04, Intangibles—Goodwill and Other (Topic 350)—Simplifying the Test for Goodwill Impairment. ASU 2017-04 simplifies the accounting for goodwill impairments by eliminating the requirement to compare the implied fair value of goodwill with its carrying amount as part of step two of the goodwill impairment test referenced in Accounting Standards Codification (“ASC”) 350, Intangibles - Goodwill and Other (“ASC 350”). As a result, an entity should perform its annual, or interim, goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount. An impairment charge should be recognized for the amount by which the carrying amount exceeds the reporting unit’s fair value. However, the impairment loss recognized should not exceed the total amount of goodwill allocated to that reporting unit. ASU 2017-04 is effective for annual reporting periods beginning after December 15, 2019. The adoption of this standard did not have a material impact on the Company’s consolidated financial statements and related disclosures.

 

In August 2018, the FASB issued ASU 2018-13, “Fair Value Measurement (Topic 820): Disclosure Framework - Changes to the Disclosure Requirements for Fair Value Measurement” (“ASU 2018-13”). ASU 2018-13 removes, modifies and adds certain disclosure requirements in Topic 820 “Fair Value Measurement”. ASU 2018-13 eliminates certain disclosures related to transfers and the valuations process, modifies disclosures for investments that are valued based on net asset value, clarifies the measurement uncertainty disclosure, and requires additional disclosures for Level 3 fair value measurements. ASU 2018-13 is effective for the Company for annual and interim reporting periods beginning January 1, 2020. The adoption of this standard did not have a material impact on the Company’s consolidated financial statements and related disclosures.

 

In February 2016, the FASB issued ASU No. 2016-02, Leases. The standard amends the existing lease accounting guidance and requires lessees to recognize a lease liability and a right-of-use asset for all leases (except for short-term leases that have a duration of one year or less) on their balance sheets. Lessees will continue to recognize lease expense in a manner similar to current accounting. For lessors, accounting for leases under the new guidance is substantially the same as in prior periods but eliminates current real estate-specific provisions and changes the treatment of initial direct costs. Entities are required to use a modified retrospective approach for leases that exist or are entered into after the beginning of the earliest comparable period presented, with an option to elect certain transition relief. Full retrospective application is prohibited. The standard was adopted as of October 1, 2020. As of December 31, 2021, the Company recognized additional operating liabilities of approximately $4,215 million, with corresponding ROU assets of approximately $4,114 million.

 

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. We are currently evaluating the impact of the new guidance on our consolidated financial statements.

 

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 annual reporting periods beginning after December 15, 2021 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.

 

18

 

 

3. 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, and September 30, 2021 (in thousands):

 

   December 15,   September 30, 
   2021   2021 
         
ASSETS          
Current assets          
Cash and cash equivalents  $47   $106 
Inventory   509    382 
Prepaid expenses and other current assets   242    887 
Total current assets   798    1,375 
           
Property and equipment, net   4    12 
Right of use asset   327    328 
Intangible assets, net   7,049    7,609 
Total assets  $8,178   $9,324 
           
LIABILITIES AND SHAREHOLDERS’ EQUITY          
Current liabilities          
Accounts payable and accrued expenses   7,551    5,967 
Short term notes and advances   3    7 
Settlement payable   -    92 
Acquisition notes payable   -    409 
Lease liability   218    218 
Total current liabilities   7,772    6,693 
           
Lease liability - long term   108    108 
Total liabilities  $7,880   $6,801 

 

The total assets and total liabilities in the above table for the year ended September 30, 2021, are presented in the balance sheet as of September 30, 2021, as Assets held for sale and Liabilities held for sale.

 

19

 

 

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

 

   2021   2020 
  

Three Months Ended

December 31,

 
   2021   2020 
         
Revenues  $3,805   $191 
Cost of goods sold   3,772    14 
Gross Profit   33    177 
           
Operating expenses:          
Consulting fees   4    - 
Professional fees   24    8 
General and administration   1,749    282 
Total operating expenses   1,777    290 
Loss from operations   (1,744)   (113)
           
Other expenses          
Interest expense   1    1 
Total other expense   1    1 
Loss from discontinued operations   $(1,745)   $(114)

 

20

 

 

4. Property, Plant & Equipment

 

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

 

   2021   2021 
   December 31,   September 30, 
   2021   2021 
         
Land  $1,451   $1,451 
Automobiles   93    74 
Signage   19    19 
Furniture and equipment   3,114    3,033 
Leasehold improvements   3,499    3,474 
Buildings and property improvements   10,127    10,126 
Computer software   59    56 
Property and equipment, gross   18,362    18,233 
Accumulated depreciation   (6,068)   (5,635)
Property and equipment, net  $12,294   $12,598 

 

Depreciation expense was approximately $409 thousand and $487 thousand for the quarters ended December 31, 2021, and 2020, respectively. Depreciation expense is included in general and administrative expense.

 

5. Inventory

 

Inventory consists of the following (in thousands):

 

   December 31,    September 30, 
   2021   2021 
         
Raw materials  $682   $866 
Work-in-progress   823    543 
Finished goods   2,043    1,717 
Total Inventory  $3,548   $3,126 

 

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 quarters ended December 31, 2021, and September 30, 2021, due to management’s assessment of the inventory on hand.

 

6. 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 December 31, 2021, 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 December 31, 2021.

 

21

 

 

Prepaid and other current assets comprised of the following:

 

   December 31,   September 30, 
   2021   2021 
         
Prepaid expenses  $526   $732 
ERTC credits   201    605 
Deposits and other current assets   128    850 
           
Total prepaid expenses and other current assets  $855   $2,187 

 

7. Equity method investments

 

Tilstar Medical, LLC

 

In April 2019, the Company entered into an agreement to acquire 48% of the membership interest of Tilstar Medical, LLC (“TIL”). TIL is a startup operation located in Laurel, Maryland and owns a project management company which assists in procuring licenses for the production and sale of cannabis. The purchase price for the 48% interest was $550,000 to capitalize TIL which under the operating agreement occurs upon the execution of the agreement. As of September 30, 2019, the Company had funded the $550,000 and accounted for its investment using the equity method of accounting. The Company was not made aware at time of its investment in the type and magnitude of expenses that would be funded with its investment capital and is currently in the process of renegotiating the terms of the operating agreement. During the year ended September 30, 2019, Tilstar Medical along with its partner, Stem Holdings, Inc. received a letter from the Maryland Medical Cannabis commission with notification that we received stage one pre-approval for a processor license. The Companies application ranked amongst the top nine highest scoring applications for a medical cannabis processor license. Final awards will be issued during calendar year 2021. During the quarter ended December 31, 2020 the Company did not recognize a loss on investment related to TIL. During the quarter ended December 31, 2021, the Company recorded impairment expense of $288 thousand related to its investment in TIL.

 

Community Growth Partners, Inc

 

On January 6, 2020, the Company issued a convertible promissory note to Community Growth Partners Holdings, Inc., (“CGS”) which will act as a line of credit. Subject to the terms and conditions of the note, CGS promises to pay the Company all of the outstanding principal together with interest on the unpaid principal balance upon the date that is twelve months after the effective date and shall be payable as follows: (a)The Company agrees to make several loans to CGS from time to time upon request of CGS in amounts not to exceed the principal sum of $2,000,000, (b) Payment of principal and interest shall be immediately available funds, (c) This note may be prepaid in whole or in part at any time without premium or penalty. Any partial prepayment shall be applied against the principal amount outstanding, (d) The unpaid principal amount outstanding under this note shall bear interest commencing upon the first advance at the rate of 10% per annum through the maturity date, calculated on the basis of a 365-day, until the entire indebtedness is fully paid, (e) Upon the closing of a $2,000,000 financing by the Company, all of the principal and interest shall automatically convert into equity shares of CGS at the price obtained by the qualified financing. As of September 30, 2020, a portion of the note was converted into 7% equity. In March 2021, the balance of a note receivable was converted into an additional 6% equity leaving an equity investment of 13%. As of December 31, 2021, and September 30, 2021, the Company recorded an investment of $0.7 million.

 

8. Note Receivable

 

On January 4, 2020, the Company issued a $355,000 promissory note to Community Growth Partners Holdings, Inc., (“CGS”). CGS is a cannabis license holder in Massachusetts. Subject to the terms and conditions of the note, CGS promises to pay the Company all of the outstanding balance together with interest the date that is six months after the opening of the Great Barrington Dispensary which was opened September 2020. As of December 31, 2021, the note is in default and the Company is negotiating modification terms. As of December 31, 2021, and September 30, 2021, 2020, the principal and interest balance of the note is $432,474 and $422,204, respectively.

 

On January 6, 2020, the Company issued a convertible non-negotiable revolving credit promissory note up to $2,500,000 with a four-year term to CGS. Subject to the terms and conditions of the note, CGS promises to pay the Company the lesser of $2,500,000 or the aggregate unpaid principal amount of the loan. In the period of January 2020 through August 2020 the Company advanced $899,700 related to the note. In September 2020, the Company converted $480,182 of the balance into approximately 7% ownership in CGS. In March 2021, the Company converted the remaining balance plus accrued interest of $30,000 into an additional 6% ownership interest in CGS. As of December 31, 2021, and September 30, 2021, the principal and interest balance of the note was $0.

 

22

 

 

In September 2020 a former employee received funds on behalf of the Company. On October 1, 2020, the Company executed a $14,382 promissory note to memorialize and structure a plan to receive the funds from the individual. The note is non-interest bearing and is to be paid in equal monthly installments of $799 over an eighteen-month term with a maturity date of March 1, 2022. As of December 31, 2021, and September 30, 2021, the principal balance of the note was $4,794 and $7,990, respectively.

 

9. Consolidated Asset Acquisitions

 

YMY Ventures LLC

 

In September 2018, the Company entered into an agreement to acquire 50% of the membership interest of YMY Ventures LLC (“YMY”). YMY is a startup operation located near Las Vegas, Nevada and owns licenses for the production and sale of cannabis. The purchase price for the 50% interest was $750,000, with the first $375,000 paid into escrow upon signing, with the final $375,000 due upon closing, which under the agreement occurs when the license is transferred by the Nevada Department of Taxation and receipt of approval in transfer of ownership by the Division of Public and Behavioral Health of the City of North Las Vegas. As of June 30, 2019, the Company had funded the $375,000 into escrow and had provided the joint venture with additional funds primarily in the form of payments for work performed to acquire four licenses from the Nevada Department of Taxation in the amount of approximately $690,238. As of February 28, 2019, the Nevada Department of Taxation approved the change of ownership for four medical and recreational cultivation and production licenses held by YMY Ventures now owned by Stem Holdings, Inc. Pursuant to the agreement, the escrowed amount of $375,000 was released and an additional payment of $67,500 was issued in August 2019. The balance of $307,500 was being held and negotiated with the partners due to the additional funds over and above the original obligation to provide tenant improvements of $650,000. As of December 31, 2021, the balance has been paid in full including interest and attorney’s fees.

 

NVD RE Corp.

 

In April 2018, the Company received a 37.5% interest in NVD RE Corp. (“NVD”) upon its issuance to NVD of a commitment to contribute $1.275 million to NVD, which included the purchase price of $600,000 and an additional commitment to pay tenant improvement costs of $675,000. As of September 30, 2019, the Company paid $600,000 in cash for the real estate and not only fully funded its commitment but invested an additional $377,000 in capital over and above its original obligation. NVD used the funds provided to date by the Company to construct a cannabis indoor grow building and processing plant located near Las Vegas, Nevada and to continue the buildout of the property. The Company has no further commitment to fund the entity beyond its initial equity purchase commitment. NVD leases its facilities to YMY Ventures, LLC.

 

In the fiscal year ended September 30, 2019, NVD obtained $300,000 in proceeds from a mortgage on its property. The funds from this mortgage were advanced to the Company. During the fiscal year ended September 30, 2021, this obligation was paid in its entirety, and $400,000 in additional proceeds were received on new mortgage.

 

In May 2020, the Company acquired an additional 26.25% interest in NVD by issuing 386,035 common shares at par value of $0.001 which resulted in a total investment of 63.75%.

 

Michigan RE 1

 

On January 4, 2021, the Company entered into a Securities Purchase Agreement (“SPA”) with Michigan RE 1, Inc. (“MRE1”) pursuant to a private placement offering of up to an aggregate amount of $510 comprising up to 510 shares of MRE1’s common stock which represents 51% ownership by the Company. On January 5, 2021, the Company was party to an Asset Purchase Agreement between Leoni Wellness, LLC (“Seller”) and Organic Guyz, LLC (“Purchaser”) whereas the Seller is engaged in the recreational cannabis business and the Purchaser desires to purchase the local municipal license to operate an adult use retailer in the City of Kalamazoo, Michigan. The purchase price to be paid by the Purchaser is $400,000. A non-refundable deposit of $250,000, except in the event of a material breach of the SPA, is due within three days of the executed SPA. The deposit will be acknowledged by an execution of a joint escrow agreement. At closing the Purchaser will pay $250,000 to the Seller by cashiers check or wire transfer. The remaining $150,000 shall be paid by the Purchaser to the Seller in accordance with a promissory note to be executed at closing. The promissory note shall be paid in full on the earlier of the date the Purchaser purchases the real property located at 3928 Portage Street, Kalamazoo, Michigan or eighteen months from the closing date. The promissory note shall be secured by an escrow agent whereby three hundred thousand (300,000) shares (“Shares”) of Stem Holdings shall be held in the benefit of Seller and a Collateral Assignment of Licenses and Permits whereby upon default on the promissory note, the Purchaser shall assign the marijuana business permit back to the Seller. Upon the maturity date of the promissory note, in the event that the borrower has not paid the principal balance of the note in full, Seller shall have the option to receive the Shares as payment or $150,000 by wire transfer. During the quarter ended December 31, 2021, the Department of Zoning and Planning has indicated that it will not issue a license due to related religious reasons. As a result, the Company recorded an impairment expense of $272 thousand during the quarter ended December 31, 2021.

 

Kaya Holdings, Corp.

 

On April 13, 2021, the Company executed an Investors’ Rights Agreement in conjunction with a Subscription Agreement with Kaya Holdings, Corp. The Company purchased 2,875,000 shares of Class B common stock of Kaya Holdings, Corp for a total investment of $230,000. In addition to the purchased Class B shares, the Company received 500,000 founder Class B shares resulting in a total of 3,375,000 Class B shares. Subsequent to December 31, 2021, the Company, pursuant to a securities purchase agreement sold all of these shares to a third party for $200,000, recognizing a loss of $30,000.

 

23

 

 

10. Non-Controlling Interests

 

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

 

   As of September 30, 2021 
  

NCI

Equity

Share

  

Net Loss Attributable

to NCI

   NCI in Consolidated Entities  

Non-

Controlling Ownership %

 
NVD RE Corp.  $587   $(34)  $553    36.2%
Western Coast Ventures, Inc.   1,052    (210)   842    49.0%
YMY Ventures, Inc.   243    56    299    50.0%
Michigan RE 1, Inc.   -    (54)   (54)   49.0%
   $1,882   $(242)  $1,640      

 

   As of December 31, 2021 
  

NCI

Equity

Share

  

Net Loss Attributable

to NCI

   NCI in Consolidated Entities  

Non-

Controlling Ownership %

 
NVD RE Corp.  $553   $(9)  $544    36.2%
Western Coast Ventures, Inc.   842   $(3   839    49.0%
YMY Ventures, Inc.   299   $41   340   50.0%
Michigan RE 1, Inc.   (54)  $(152)   (206)   49.0%
   $1,640   $(123)  $1,517      

 

11. Business Combination

 

Artifact

 

On September 17, 2021, pursuant to an Agreement and Plan of Reorganization (“Agreement”) the Company acquired a marijuana processor business and a marijuana retailer business located in Eugene, Oregon; a marijuana retailer business located in Salem, Oregon; and certain intellectual property assets, including but not limited to the “ARTIFACT EXTRACTS” trademark that is used by the retail businesses acquired in connection with the Agreement. In connection with the Agreement, the Company acquired fixed assets and intangible assets in exchange for 8,209,178 common shares of the Company valued at $2,380,661 or $0.29 per share.

 

24

 

 

Purchase Price Allocation

 

As of September 17, 2021, the Company allocated the purchase consideration to the fair value of the assets acquired and liabilities assumed as summarized in the table below (in thousands):

 

Purchase Consideration 
     
Stock Consideration  $2,381 
      
Total Purchase Consideration  $2,381 

 

Allocation of Purchase Consideration
     
Working Capital  $189 
      
Fixed Assets   14 
      
Customer Relationships   3 
      
License   1,762 
      
Tradename   206 
      
Goodwill   207 
      
Total Purchase Consideration  $2,381 

 

The goodwill of $207,000 is not expected to be deductible for income tax expenses.

 

The following unaudited proforma condensed consolidated results of operations have been prepared as if the acquisition above occurred October 1, 2020 (in thousands):

 

       
    Three Months Ended 
    December 31, 2020 
Revenue   $1,813 
Net loss   $(3,330)

 

The unaudited proforma condensed consolidated results of operations are not necessarily indicative of results that would have occurred had the acquisitions occurred as of October 1, 2020, nor are they necessarily indicative of the results that may occur in the future.

 

12. Intangible Assets, net

 

Intangible assets as of December 2021, and September 2021 (in thousands):

 

   Estimated Useful Life   Cannabis Licenses   Tradename   Customer Relationship   Non-compete   Technology   Accumulated Amortization   Net Carrying Amount 
Balance as September 30, 2021       $20,092   $951   $645   $220   $418   $(3,861)  $18,465 
YMY Ventures   15    -    -    -    -    -    (13)   (13)
Western Coast Ventures, Inc.   15    -    -    -    -    -    -    - 
Yerba Buena   3-15 years    -    -    -    -    -    (43)   (43)
Foothill (7LV)   15    -    -    -    -    -    (131)   (131)
Driven Deliveries   10-15 years    (9,315)   (413)   -    -    (413)   2,533    (7,608)
JV Retail 3   3-15 years    -    -    -    -    -    (9)   (9)
JV Retail 4   3-15 years    -    -    -    -    -    (8)   (8)
JV Extraction   10-15 years    -    -    -    -    -    (13)   (13)
Other   5    -    -    -    -    -    -    - 
Balance as December 31, 2021       $10,777   $538   $645   $220   $5   $(1,545)  $10,640 

 

Actual amortization expense to be reported in future periods could differ from these estimates as a result of new intangible asset acquisitions, changes in useful lives or other relevant factors or changes. Amortization expense for the quarters ended December 31, 2021, and 2020 was $217,698 and $245,000, respectively.