CLS HOLDINGS USA, INC. Management report and analysis of the financial situation and operating results. (Form 10-Q)

HISTORY AND PROSPECTS




We were incorporated on March 31, 2011 as Adelt Design, Inc. to manufacture and
market carpet binding art. Production and marketing of carpet binding art never
commenced. On November 20, 2014, we adopted amended and restated articles of
incorporation, thereby changing our name to CLS Holdings USA, Inc. Effective
December 10, 2014, we effected a reverse stock split of our issued and
outstanding common stock at a ratio of 1-for-0.625 (the "Reverse Split"),
wherein 0.625 shares of our common stock were issued in exchange for each share
of common stock issued and outstanding.



On April 29, 2015the company, CLS Laboratories and the Merger Sub consummated Fusion, whereby the Merger Sub merged with and into CLS Laboratorieswith CLS Laboratories
remaining the surviving entity. As a result of the merger, we acquired the business of CLS Laboratories and abandoned our previous cases. Thus, only the financial statements of CLS Laboratories are included here.




CLS Labs was originally incorporated in the state of Nevada on May 1, 2014 under
the name RJF Labs, Inc. before changing its name to CLS Labs, Inc. on October
24, 2014. It was formed to commercialize a proprietary method of extracting
cannabinoids from cannabis plants and converting the resulting cannabinoid
extracts into concentrates such as oils, waxes, edibles and shatter. These
concentrates may be ingested in a number of ways, including through vaporization
via electronic cigarettes ("e-cigarettes"), and used for a variety of
pharmaceutical and other purposes. Testing in conjunction with two Colorado
growers of this extraction method and conversion process has revealed that it
produces a cleaner, higher quality product and a significantly higher yield than
the cannabinoid extraction processes currently existing in the marketplace.



On April 17, 2015, CLS Labs took its first step toward commercializing its
proprietary methods and processes by entering into agreements through its wholly
owned subsidiary, CLS Labs Colorado, with certain Colorado entities. During
2017, we suspended our plans to proceed with the Colorado Arrangement due to
regulatory delays and have not yet determined if or when we will pursue them
again.



We have been issued a U.S. patent with respect to our proprietary method of
extracting cannabinoids from cannabis plants and converting the resulting
cannabinoid extracts into concentrates such as oils, waxes, edibles and shatter.
These concentrates may be ingested in a number of ways, including through
vaporization via electronic cigarettes, and used for a variety of pharmaceutical
and other purposes. Internal testing of this extraction method and conversion
process has revealed that it produces a cleaner, higher quality product and a
significantly higher yield than the cannabinoid extraction processes currently
existing in the marketplace. We have not yet commercialized our proprietary
process. We plan to generate revenues through licensing, fee-for-service and
joint venture arrangements related to our proprietary method of extracting
cannabinoids from cannabis plants and converting the resulting cannabinoid
extracts into saleable concentrates.



We intend to monetize our extraction and conversion method and generate revenues
through (i) the licensing of our patented proprietary methods and processes to
others, (ii) the processing of cannabis for others, and (iii) the purchase of
cannabis (or cultivation through our joint venture) and the processing and sale
of cannabis-related products. We plan to accomplish this through the acquisition
of companies, the creation of joint ventures, through licensing agreements, and
through fee-for-service arrangements with growers and dispensaries of cannabis
products. We believe that we can establish a position as one of the premier
cannabinoid extraction and processing companies in the industry. Assuming we do
so, we then intend to explore the creation of our own brand of concentrates for
consumer use, which we would sell wholesale to cannabis dispensaries. We believe
that we can create a "gold standard" national brand by standardizing the
testing, compliance and labeling of our products in an industry currently
comprised of small, local businesses with erratic and unreliable product
quality, testing practices and labeling. We also plan to offer consulting
services through Cannabis Life Sciences Consulting, LLC, which will generate
revenue by providing consulting services to cannabis-related businesses,
including growers, dispensaries and laboratories, and driving business to our
processing facilities. Finally, we intend to grow through select acquisitions in
secondary and tertiary markets, targeting newly regulated states that we believe
offer a competitive advantage. Our goal at this time is to become a successful
regional cannabis company.



                                       31

————————————————– ——————————

Contents




On December 4, 2017, we entered into the Acquisition Agreement with Alternative
Solutions to acquire the outstanding equity interests in the Oasis LLCs.
Pursuant to the Acquisition Agreement, as amended, we paid a non-refundable
deposit of $250,000 upon signing, which was followed by an additional payment of
$1,800,000 on February 5, 2018, for an initial 10% of Alternative Solutions and
each of the subsidiaries. At the closing of our purchase of the remaining 90% of
the ownership interests in Alternative Solutions and the Oasis LLCs, which
occurred on June 27, 2018, we paid the following consideration: $5,995,543 in
cash, a $4.0 million promissory note due in December 2019, and $6,000,000 in
shares of our common stock. The cash payment of $5,995,543 was less than the
$6,200,000 payment originally contemplated because we assumed an additional
$204,457 of liabilities. The Oasis Note, which was repaid in full in December
2019, was secured by all of the membership interests in Alternative Solutions
and the Oasis LLCs and by the assets of the Oasis LLCs. At that time, we applied
for regulatory approval to own an interest in the Oasis LLCs, which approval was
received on June 21, 2018. Just prior to closing, the parties agreed that we
would instead acquire all of the membership interests in Alternative Solutions,
the parent of the Oasis LLCs, from its members, and the membership interests in
the Oasis LLCs owned by members other than Alternative Solutions. We received
final regulatory approval to own our interest in the Oasis LLCs through
Alternative Solutions under the final structure of the transaction on April 26,
2022.



On October 31, 2018, the Company, CLS Massachusetts, Inc., a Massachusetts
corporation and a wholly-owned subsidiary of the Company ("CLS Massachusetts"),
and In Good Health, Inc., a Massachusetts corporation ("IGH"), entered into an
Option Agreement (the "IGH Option Agreement"). Under the terms of the IGH Option
Agreement, CLS Massachusetts had an exclusive option to acquire all of the
outstanding capital stock of IGH (the "IGH Option") during the period beginning
on the earlier of the date that is one year after the effective date of the
conversion and December 1, 2019 and ending on the date that was 60 days after
such date. If CLS Massachusetts exercised the IGH Option, the Company, a
wholly-owned subsidiary of the Company and IGH would enter into a merger
agreement (the form of which has been agreed to by the parties) (the "IGH Merger
Agreement"). At the effective time of the merger contemplated by the IGH Merger
Agreement, CLS Massachusetts would pay a purchase price of $47,500,000, subject
to reduction as provided in the IGH Merger Agreement, payable as follows: $35
million in cash, $7.5 million in the form of a five-year promissory note, and $5
million in the form of restricted common stock of the Company, plus $2.5 million
as consideration for a non-competition agreement with IGH's President, payable
in the form of a five-year promissory note. IGH and certain IGH stockholders
holding sufficient aggregate voting power to approve the transactions
contemplated by the IGH Merger Agreement had entered into agreements pursuant to
which such stockholders had, among other things, agreed to vote in favor of such
transactions. On October 31, 2018, as consideration for the IGH Option, we made
a loan to IGH, in the principal amount of $5,000,000, subject to the terms and
conditions set forth in that certain loan agreement, dated as of October 31,
2018 between IGH as the borrower and the Company as the lender. The loan was
evidenced by a secured promissory note of IGH, which bore interest at the rate
of 6% per annum and was to mature on October 31, 2021. To secure the obligations
of IGH to us under the loan agreement and the promissory note, the Company and
IGH entered into a security agreement dated as of October 31, 2018, pursuant to
which IGH granted to us a first priority lien on and security interest in all
personal property of IGH. If we did not exercise the Option on or prior to the
date that was 30 days following the end of the option period, the loan amount
was to be reduced to $2,500,000 as a break-up fee, subject to certain exceptions
set forth in the IGH Option Agreement. On August 26, 2019, the parties amended
the IGH Option Agreement to, among other things, delay the closing until January
2020. By letter agreement dated January 31, 2020, the parties extended the IGH
Option Agreement to February 4, 2020. On February 4, 2020, CLS Massachusetts
exercised the IGH Option and IGH subsequently asserted that CLS Massachusetts'
exercise was invalid. By letter dated February 26, 2020, we informed IGH that as
a result of its breaches of the IGH Option, which remained uncured, an event of
default had occurred under the IGH Note. We advised IGH that we were electing to
cause the IGH Note to bear interest at the default rate of 15% per annum
effective February 26, 2020 and to accelerate all amounts due under the IGH
Note. On February 27, 2020, IGH informed CLS Massachusetts that it did not plan
to make further payments under the IGH Note on the theory that the break-up fee
excused additional payments. This dispute, including whether IGH breached the
IGH Option and whether CLS was entitled to collect default interest, was in
litigation. During the twelve months ended May 31, 2021, we impaired the
remaining amounts due under the IGH Note in the amount of $2,498,706, which
included $2,497,884 in principal and $822 in accrued interest. As of November
30, 2021, the principal balance of the IGH Note was $0 and the interest
receivable was $0.



On June 14, 2021, the parties to the IGH lawsuit entered into a confidential
settlement agreement to resolve the action and a secured promissory note dated
and executed by IGH in favor of us and effective June 11, 2021 (the "IGH
Settlement Note"). Pursuant to the IGH Settlement Note, IGH paid us $3,000,000,
$1,000,000 of which was paid on or before July 12, 2021. The remaining
$2,000,000 and accrued interest was paid in 12 equal monthly installments, which
began on August 12, 2021. During the year ended May 31, 2022, we received
$2,740,820 under the IGH Settlement Note, which included $2,666,670 in principal
and $74,150 in accrued interest. During the three months ended August 31, 2022,
we received $348,165 was due under the IGH Settlement Note, which included
$333,333 in principal and $14,382 in accrued interest. As of August 31, 2022,
the IGH Settlement Note has been paid in full. We record amounts paid under the
IGH Settlement Note as gains when payments are received



                                       32

————————————————– ——————————

Contents




On October 20, 2021, we entered into a management services agreement (the "Quinn
River Joint Venture Agreement") through our 50% owned subsidiary, Kealii
Okamalu, LLC ("Kealii Okamalu"), with CSI Health MCD LLC ("CSI") and a
commission established by the authority of the Tribal Council of the Fort
McDermitt Paiute and Shoshone Tribe (the "Tribe"). The purpose of the Quinn
River Joint Venture Agreement is to establish a business (the "Quinn River Joint
Venture") to grow, cultivate, process and sell cannabis and related products.
The Quinn River Joint Venture Agreement has a term of 10 years plus a 10 year
renewal term from the date the first cannabis crop produced is harvested and
sold. Pursuant to the Quinn River Joint Venture Agreement, Kealii Okamalu is
expected to lease approximately 20-30 acres of the Tribe's land located along
the Quinn River at a cost of $3,500 per quarter and manage the design, finance
and construction of a cannabis cultivation facility on such tribal lands (the
"Cultivation Facility"). Kealii Okamalu will also manage the ongoing operations
of the Cultivation Facility and related business, including, but not limited to,
cultivation of cannabis crops, personnel staffing, product packaging, testing,
marketing and sales. Packaged products will be branded as "Quinn River Farms."
We will provide 10,000 square feet of warehouse space at our Las Vegas facility,
and will have preferred vendor status including the right to purchase cannabis
flower and the business's cannabis trim at favorable prices. Kealii Okamalu will
contribute $6 million towards the construction of the Cultivation Facility and
the working capital for the Quinn River Joint Venture. This amount will be
repaid from a portion of the net income of the Quinn River Joint Venture
otherwise payable to CSI and the Tribe at the rate of $750,000 per quarter for
eight quarters. Kealii Okamalu will receive one-third of the net profits of the
Quinn River Joint Venture.



On January 4, 2018, former Attorney General Jeff Sessions rescinded the
memorandum issued by former Deputy Attorney General James Cole on August 29,
2013 (as amended on February 14, 2014, the "Cole Memo"), the Cole Banking
Memorandum, and all other related Obama-era DOJ cannabis enforcement guidance.
While the rescission did not change federal law, as the Cole Memo and other DOJ
guidance documents were not themselves laws, the rescission removed the DOJ's
formal policy that state-regulated cannabis businesses in compliance with the
Cole Memo guidelines should not be a prosecutorial priority. Notably, former
Attorney General Sessions' rescission of the Cole Memo has not affected the
status of the U.S. Department of the Treasury's Financial Crimes Enforcement
Network ("FinCEN") memorandum issued by the Department of Treasury, which
remains in effect. This memorandum outlines Bank Secrecy Act-compliant pathways
for financial institutions to service state-sanctioned cannabis businesses,
which echoed the enforcement priorities outlined in the Cole Memo. In addition
to his rescission of the Cole Memo, Attorney General Sessions issued a one-page
memorandum known as the "Sessions Memorandum". The Sessions Memorandum explains
the DOJ's rationale for rescinding all past DOJ cannabis enforcement guidance,
claiming that Obama-era enforcement policies are "unnecessary" due to existing
general enforcement guidance adopted in the 1980s, in chapter 9.27.230 of the
U.A. Attorneys' Manual ("USAM"). The USAM enforcement priorities, like those of
the Cole Memo, are based on the use of the federal government's limited
resources and include "law enforcement priorities set by the Attorney General,"
the "seriousness" of the alleged crimes, the "deterrent effect of criminal
prosecution," and "the cumulative impact of particular crimes on the community."
Although the Sessions Memorandum emphasizes that cannabis is a federally illegal
Schedule I controlled substance, it does not otherwise instruct U.S. Attorneys
to consider the prosecution of cannabis-related offenses a DOJ priority, and in
practice, most U.S. Attorneys have not changed their prosecutorial approach to
date. However, due to the lack of specific direction in the Sessions Memorandum
as to the priority federal prosecutors should ascribe to such cannabis
activities, there can be no assurance that the federal government will not seek
to prosecute cases involving cannabis businesses that are otherwise compliant
with state law.



William Barr served as United States Attorney General from February 14, 2019 to
December 23, 2020. The DOJ under Mr. Barr did not take a formal position on
federal enforcement of laws relating to cannabis. On March 11, 2021, United
States President Biden's nominee, Merrick Garland was sworn in as the U.S.
Attorney General. During his campaign, President Biden stated a policy goal to
decriminalize possession of cannabis at the federal level, but he has not
publicly supported the full legalization of cannabis. It is unclear what impact,
if any, this administration will have on U.S. federal government enforcement
policy on cannabis. Nonetheless, there is no guarantee that the position of the
Department of Justice will not change.



We incurred a net loss of $1,148,478 attributable to CLS Holdings, Inc. for the
three months ended August 31, 2022, resulting in an accumulated deficit as of
August 31, 2022 of $96,228,295. These conditions raise substantial doubt about
our ability to continue as a going concern.



COVID-19 Update



On March 12, 2020, Governor Steven Sisolak declared a State of Emergency related
to the COVID-19 global pandemic. This State of Emergency was initiated due to
the multiple confirmed and presumptive cases of COVID-19 in the State of Nevada.
On March 17, 2020, pursuant to the Declaration of Emergency, Governor Sisolak
released the Nevada Health Response COVID-19 Risk Mitigation Initiative
("Initiative"). This Initiative provided guidance related to the March 12
Declaration of Emergency, requiring Nevadans to stay home and all nonessential
businesses to temporarily close to the public for thirty (30) days. In the
Initiative, it was declared that licensed cannabis stores and medical
dispensaries could remain open only if employees and consumers strictly adhered
to the social distancing protocols.



                                       33

————————————————– ——————————

Contents




In light of the Initiative, Governor Sisolak issued Declaration of Emergency
Directive 003 on March 20, 2020 which mandated retail cannabis dispensaries to
operate as delivery only. On April 29, 2020, Governor Sisolak issued Declaration
of Emergency Directive 016 which amended the cannabis section of Directive 003
and permitted licensed cannabis dispensaries to engage in retail sales on a
curbside pickup or home delivery basis pursuant to guidance from the Cannabis
Compliance Board. Through Directive 016, licensed cannabis dispensaries were
able to begin curbside pickup on May 1, 2020 so long as the facility adhered to
protocols developed by the Cannabis Compliance Board ("CCB").



In accordance with Directive 016, the CCB released guidelines related to
curbside pickup requiring all facilities wishing to offer curbside pickup to
first submit and receive approval from the CCB. Serenity Wellness Center LLC
developed the required procedures and submitted and received State approval on
April 30, 2020 to conduct curbside pickup sales effective May 1, 2020. Further,
the City of Las Vegas required cannabis facilities to obtain a temporary 30-day
curbside pickup permit. Serenity Wellness Center LLC was issued its first
temporary curbside pickup permit from the City of Las Vegas on May 1, 2020.
Serenity Wellness Center LLC has subsequently received a temporary curbside
permit every thirty (30) days thereafter. Upon expiration every 30 days, the
City of Las Vegas reviews the licensee and determines if a new temporary permit
shall be issued.



On May 7, 2020, Governor Sisolak issued Declaration of Emergency Directive 018.
Directive 018 worked to reopen the State of Nevada as a part of Phase One of the
Nevada United: Roadmap to Recovery Plan introduced by Governor Sisolak on April
30, 2020. Directive 018 provided that, in addition to curbside pickup or home
delivery, licensed cannabis dispensaries could engage in retail sales on an
in-store basis effective May 9, 2020, pursuant to guidance from the CCB. The CCB
required facilities wishing to engage in limited in-store retail sales to submit
Standard Operating Procedures and receive approval of the same. Serenity
Wellness Center LLC developed the required procedures and submitted and received
State approval on May 8, 2020 to conduct limited in-store retail sales effective
May 9, 2020. The City of Las Vegas did not require a separate permit for limited
in-store sales.



On July 31, 2020, Governor Sisolak issued Declaration of Emergency Directive 029
reaffirming The Nevada United: Roadmap to Recovery Plan. Directive 029 stated
that all directives promulgated pursuant to the March 12, 2020 Declaration of
Emergency or subsections thereof set to expire on July 31, 2020, would remain in
effect for the duration of the current state of emergency unless terminated
prior to that date by a subsequent directive or by operation of law associated
with lifting the Declaration of Emergency. Further, Directive 029, having become
effective at 11:59 PM on Friday, July 31, 2020 shall remain in effect until
terminated by a subsequent directive promulgated pursuant to the March 12, 2020
Declaration of Emergency, or dissolution or lifting of the Declaration of
Emergency itself, to facilitate the State's response to the COVID-19 pandemic.



COVID-19 cases increased at a significant rate in November and December 2021
with the arrival of the Omicron variant, but then sharply dropped off as we
started 2022. As a result, our curbside and delivery programs have now returned
to approximately 20% of total dispensary revenue.  In addition, COVID-19
restrictions and mask mandates have ceased.  The number of customers and
transactions at our dispensary have increased by approximately 20%, although the
amount of each transaction has decreased by approximately 18% primarily as a
result of the cessation of special federal unemployment benefits and the impact
of the decline in the overall economy.



Our supply chain remains challenging and delayed with respect to our purchases
on non-cannabis items; the purchase of cannabis-related items has returned to
normal. In recent months the labor market has been very tight for us.  Although
we have been able to employ sufficient staff to maintain operations at a normal
level, wage increases have averaged about 15% annually in order for us to do so.



The gradual return to more normal operations since the COVID-19 pandemic continues to evolve and the ways in which our business may respond to meet the needs of our customers cannot be fully known.

                                       34

————————————————– ——————————

Contents

Results of operations for the three months ended August 31, 2022 and August 31, 2021




The table below sets forth our select expenses as a percentage of revenue for
the applicable periods:



                                                     Three Months Ended        Three Months Ended
                                                      August 31, 2022           August 31, 2021
Revenue                                                              100 %                     100 %
Cost of Goods Sold                                                    50 %                      47 %
Gross Margin                                                          50 %                      53 %
Selling, General, and Administrative Expenses                         53 %                      53 %
Gain on Settlement of Notes Receivable                                (6 )%                    (21 )%
Provision for Income Tax                                               9 %                       6 %




The table below sets forth certain statistical and financial highlights for the
applicable periods:



                                                     Three Months Ended       Three Months Ended
                                                      August 31, 2022          August 31, 2021
Number of Customers Served (Dispensary)                           82,944                   65,092
Revenue                                             $          6,044,927     $          5,500,710
Gross Profit                                        $          3,042,197     $          2,896,243
Gain on Note Receivable                             $           (348,165 )   $         (1,174,082 )
Net (Loss) Income                                   $         (1,332,125 )   $            427,599
EBITDA (1)                                          $            374,212     $          1,351,843



(1) EBITDA is a non-GAAP measure of financial performance and should not be

considered as alternatives to net income or any other derived measure

in accordance with GAAP. This non-GAAP measure has limitations as

analysis tool and should not be considered in isolation or as substitutes

for the analysis of our financial results as presented in accordance with GAAP.

Not all companies use identical calculations, these presentations

may not be comparable to similarly named measures from other companies.

As required by the rules of the SECONDwe provide below a reconciliation of

such non-GAAP financial measure contained herein at most directly

GAAP comparable measure. Management believes that EBITDA provides

relevant and useful information, widely used by analysts, investors

and competitors in our industry and by our management. Providing

this non-GAAP measure of profitability, management intends to provide investors

with a meaningful and consistent comparison of our profitability measures for

      the periods presented.




Reconciliation of net loss for the three months ended August 31, 2022 and 2021
to EBITDA:



                                 Three Months Ended       Three Months Ended
                                  August 31, 2022          August 31, 2021
Net Loss                        $         (1,148,478 )   $            427,599
Add:
Interest expense, net           $            766,670     $            418,592
Provision for income taxes      $            519,085     $            328,340
Depreciation and amortization   $            236,935     $            177,312
EBITDA                          $            374,212     $          1,351,843




                                       35

————————————————– ——————————

  Table of Contents



Revenues



We had revenue of $6,044,927 during the three months ended August 31, 2022, an
increase of $544,217, or 10%, compared to revenue of $5,500,710 during the three
months ended August 31, 2021. Our cannabis dispensary accounted for $3,888,557,
or 64%, of our revenue for the three months ended August 31, 2022, an increase
of $142,982, or 4%, compared to $3,745,575 during the three months ended August
31, 2021. Dispensary revenue increased during the first quarter of fiscal year
2023 because our average sales per day increased from $40,713 during the first
quarter of fiscal year 2022 to $42,267 during the first quarter of fiscal year
2023. Our cannabis production accounted for $2,156,370, or 36%, of our revenue
for the three months ended August 31, 2022, an increase of $401,235 or 23%,
compared to $1,755,135 for the three months ended August 31, 2021. The increase
in production revenues for the first quarter of fiscal year 2023 was primarily
due to an increase in our THC distillate sales of almost $1,000,000, as well as
sales to 10 new dispensaries and significant increases in existing customer
order size and frequency. These improvements occurred as a result of our
addition of a new sales director, an improvement in our product mix, the
introduction of new products, and the procurement of higher quality materials.
The increase was also due to greater revenue from third parties for whom we
manufactured and processed their products.



Cost of Goods Sold



Our cost of goods sold for the three months ended August 31, 2022 was
$3,002,730, an increase of $398,263, or 15%, compared to cost of goods sold of
$2,604,467 for the three months ended August 31, 2021. The increase in cost of
goods sold for the three months ended August 31, 2022 was due primarily to an
increase in revenue and more aggressive competitive discounts. Cost of goods
sold was 50% of sales during the three months ended August 31, 2022 resulting in
a gross margin of 50%. Cost of goods sold was 47% for the three months ended
August 31, 2021 resulting in a gross margin of 53%. Costs of goods sold as a
percentage of revenue increased due to aggressive pricing in response to a very
competitive market. Gross margin exceeded our target of 50% for the first
quarter of fiscal year 2023. Cost of goods sold during the first quarter of the
2023 fiscal year primarily consisted of $2,636,259 of product cost, $198,261 of
state and local fees and taxes, and $151,507 of supplies and materials.



Selling, general and administrative expenses




Selling, general and administrative expenses, or SG&A, increased by $306,508, or
approximately 11%, to $3,202,302 during the three months ended August 31, 2022,
compared to $2,895,794 for the three months ended August 31, 2021. The increase
in SG&A expenses for the three months ended August 31, 2022 was primarily due to
increases in costs associated with operating the Oasis LLCs.



SG&A expense during the three months ended August 31, 2022 was primarily
attributable to an aggregate of $2,686,829 in costs associated with operating
the Oasis LLCs, an increase of $327,633 compared to $2,359,196 during the first
quarter of fiscal 2022. The major components of the $327,633 increase in SG&A
associated with the operation of the Oasis LLCs during the three months ended
August 31, 2022 compared to the three months ended August 31, 2021 were as
follows: payroll and related costs of $1,413,836 compared to $1,001,651; lease,
facilities and office costs of $700,454 compared to $522,217; professional fees
of $150,232 compared to $88,370; depreciation and amortization of $161,556
compared to $101,358; and travel of $106,074 compared to $70,886. Payroll costs
increased during the first quarter of fiscal 2023 primarily due to increases in
salaries of our employees related to the national labor shortage and due to an
increase in the number of employees in our manufacturing division as we planned
for the rollout of our pre-roll division. Payroll costs also increased due to
costs incurred in connection with our response to COVID-19. Lease, facilities
and office costs increased due to our efforts to prepare our facilities for the
new pre-roll division by purchasing equipment and implementing compliance
procedures applicable to this new division. Lease, facilities and office costs
also increased due to costs incurred in connection with our response to
COVID-19. Professional fees increased primarily due to legal fees related to
regulatory compliance issues. Travel increased due to tribal visits in New
Mexico and Northern Nevada. These increases were partially offset by a decrease
in sales and marketing costs of $231,769 due toa concerted effort to reduce
professional outsourced marketing programs.



Finally, SG&A decreased by $21,125 during the three months ended August 31, 2022
as a result of a decrease in the expenses associated with the ongoing
implementation of other aspects of our business plan and our general corporate
overhead to $515,474 from $536,599 during the three months ended August 31,
2021. The major component of this decrease compared to the first quarter of
fiscal 2022 was follows: expenses related to travel increased by $28,467 as
corporate travel returned to more normal levels. Payroll and related costs
increased during the first quarter of fiscal 2023 due to an increase in the
number of administrative employees to support our expanding operations. These
increases were partially offset by a decrease in professional fees of $58,970.



                                       36

————————————————– ——————————

  Table of Contents



Loss on Equity Investment



During the three months ended August 31, 2022, we had a loss on equity
investment in the amount of $234,430 compared to $0 during the first quarter of
fiscal 2022. The Company, through its 50% owned subsidiary Kealii Okamalu, owns
a one-third interest in the Quinn River Joint Venture. The first quarter of
fiscal 2023 loss represents our share of the results of the Quinn River Joint
Venture. The Quinn River Joint Venture had no sales during the first quarter of
fiscal 2023, as it was in the grow stage of the production cycle. The Quinn
River Joint Venture completed its first harvest in August 2022, and we expect it
to commence the generation of revenue in the second quarter of fiscal 2023.



Gain on settlement of note receivable




During the three months ended August 31, 2022, we recorded a gain on the
settlement of the IGH Settlement Note in the amount of $348,165 compared to
$1,174,082 for the first quarter of fiscal 2022. This gain on the settlement
arose after IGH notified us on February 27, 2021, that it did not plan to make
further payments in accordance with the terms of the IGH Note on the theory that
the Break-Up Fee excused such additional payments. We vehemently disagreed and
litigation ensued. On June 14, 2021, the parties to the IGH lawsuit entered into
a confidential settlement agreement to resolve the action and executed the
$3,000,000 IGH Settlement Note. Pursuant to the IGH Settlement Note, IGH paid us
$1,000,000 on or before July 21, 2021. The remaining $2,000,000 and accrued
interest was paid in 12 equal monthly installments, and the final installment
was paid in July 2022.



Interest Expense, Net



Our interest expense was $766,670 for the three months ended August 31, 2022, an
increase of $348,078, or 83%, compared to $418,592 for the three months ended
August 31, 2021. The increase in interest expense was primarily due to the
original issue discount associated with the 2021 Debentures in the amount of
$185,081 which was amortized to interest expense during the three months ended
August 31, 2022. There was no comparable charge during the first quarter of the
prior fiscal year. In addition, the increase in net interest expense for the
first quarter of fiscal 2023 was due to an increase in interest expense of
$174,601 in connection with  the 2021 Debentures in the principal amount of
$2,500,000 (net of original issue discount of $1,875,000), which we issued in
the November 2021 Debenture Offering. The increase in net interest expense for
the first quarter of fiscal 2023 was partially offset by a decrease in the
amortization of discounts on debentures in the amount of $11,604.



Provision for Income Taxes



We recorded a provision for income taxes in the amount of $519,085 during the
three months ended August 31, 2022 compared to $328,340 during the three months
ended August 31, 2021. Although we have net operating losses that we believe are
available to us to offset this entire tax liability, which arises under Section
280E of the Code because we are a cannabis company, as a conservative measure,
we have accrued this liability.



Net Loss


Our net loss for the three months ended August 31, 2022 has been $1,332,125 compared to a net income of $427,599 for the three months ended August 31, 2022a decrease of $1,759,721i.e. 412%.



Non-Controlling Interest



During the three months ended August 31, 2022, the cost of our non-controlling
interest in Kealii Okamalu was $183,647. This amount is composed of our portion
of the operating loss of the Quinn River Joint Venture and our loss on equity
investment. There was no comparable expense during the first quarter of fiscal
2022.


Net loss attributable to CLS Holdings USA, Inc.

Our net loss attributable to CLS Holdings USA, Inc. for the three months ended
August 31, 2022 has been $1,148,478 compared to a net income of $427,599 for the three months ended August 31, 2021a decrease of $1,576,077i.e. 369%.

                                       37

————————————————– ——————————

Contents

Cash and capital resources

The following table summarizes our total assets, liabilities and short-term working capital as of August 31, 2022 and May 31, 2022:



                             August 31,          May 31,
                                2022              2022
Current Assets              $   5,965,967     $   6,883,557

Current liabilities $28,788,597 $28,112,190
Working capital (deficit) ($22,822,630) ($21,228,633)





At August 31, 2022, we had a working capital deficit of $22,822,630, an increase
of $1,593,997 from the working capital deficit of $21,228,633 we had at May 31,
2022. Our working capital decreased primarily due to a reduction in cash as a
result of the Company advancing an additional $805,234 to the Quinn River Joint
Venture through its Kealii Okamalu subsidiary. Our partner in this entity has
not made its required capital contribution so we contributed these funds to
assure the venture's continued operations.  Working capital also decreased due
to an increase in our accrued potential tax liability as a result of the
calculation of our tax liability under 280E, which can change based on the
deductibility of applicable expenses and is not necessarily tied to operating
income.  Our working capital decrease was partially offset due to an increase in
inventory of $798,707 and a decrease of interest payable in the amount of
$107,708, which was the result of the payment of accrued interest on the
November 2021 Debentures.



Our working capital needs are expected to continue to increase, and we will seek
additional debt or equity financing and re-financing to meet them. Over the next
twelve months we will require additional capital to repay certain of our
convertible debt and implement our business plan, including the development of
other revenue sources, such as possible acquisitions and the development of the
Quinn River Joint Venture. Although we recently completed the first harvest of
the Quinn River Joint Venture, due to various start-up delays, we have not yet
been able to sell the bulk of the resulting crop. In addition, our partner in
Kealii Okamalu has not yet contributed its capital contribution and we have
advanced additional amounts to cover this cash need. We believe that once we
sell the initial crop from the Quinn River Joint Venture, which is expected to
occur in the second quarter of fiscal 2023, and once our partner in Kealii
Okamalu makes its required capital contribution, our liquidity will improve;
however, we cannot yet estimate when our partner will make the required capital
contribution. Until these issues are resolved, we have been relying, and likely
will continue to rely, on short-term financing through the 2022 Financing
Agreement and our Short Term Financing Agreement. Although we have been able to
secure such financing so far, there can be no assurance that we will be able to
continue to secure such financing if we continue to need it.



In September 2022, we successfully refinanced all but one of the U.S.
Convertible Debentures and all of the Canaccord Debentures so that 60% of them
were converted into equity and the balance of them mature in equal portions in
December 2023 and December 2024. We are actively seeking to re-finance the
remaining U.S. Convertible Debenture that matures on October 25, 2022 but we
have not yet reached any agreement with respect to such refinancing.



Although our revenues are expected to grow as we expand our operations, we only
achieved net income for the first time during our first quarter of fiscal 2022
and we have experienced net losses since such time. If we are able to re-finance
the balance of our U.S. Convertible Debentures on satisfactory terms and our
partner in Kealii Okamalu makes its required capital contribution, we believe we
will have funds sufficient to sustain our operations at their current level, or
if we require additional cash, we expect to obtain the necessary funds as
described above; however, our prospects must be considered in light of the
risks, expenses and difficulties frequently encountered by companies in their
early stage of operations. To address these risks, we must, among other things,
seek growth opportunities through additional debt and/or equity investments and
acquisitions in our industry, successfully execute our business strategy,
including our planned joint ventures, and successfully navigate the COVID-19
business environment in which we currently operate as well as any changes that
may arise in the cannabis regulatory environment. We cannot assure that we will
be successful in addressing such risks, and the failure to do so could have a
material adverse effect on our business prospects, financial condition and
results of operations.



Cash flows used in operating activities were $1,461,763 during the three months
ended August 31, 2022, an increase of $676,488, or approximately 86%, compared
to $785,275 during the three months ended August 31, 2021. In deriving cash
flows used in operating activities from the net losses for the first quarter of
fiscal 2023 and the first quarter of fiscal 2022, certain non-cash items were
(deducted from) or added back to the net loss for each such period. These
amounts were $317,974 and $(975,743) for the three months ended August 31, 2022
and 2021, respectively. For the first quarter of fiscal year 2023, the most
significant item deducted from the net loss was $348,165 related to the gain on
settlement of the IGH Settlement Note; compared to $1,174,082 during the first
quarter of fiscal 2022.



                                       38

————————————————– ——————————

Contents




Finally, our cash used in operating activities was affected by changes in the
components of working capital. The amounts of the components of working capital
fluctuate for a variety of reasons, including management's expectation of
required inventory levels; the amount of accrued interest, both receivable and
payable; the amount of prepaid expenses; the amount of accrued compensation and
other accrued liabilities; our accounts payable and accounts receivable
balances; and the capitalization of right of use assets and liabilities
associated with operating leases. The overall net change in the components of
working capital resulted in a decrease in cash from operating activities in the
amount of $447,612 during the three months ended August 31, 2022, compared to a
decrease in cash from operating activities of $237,401 during the first quarter
of fiscal 2022. The more significant changes for the first quarter of fiscal
2023 were as follows: inventory increased during first quarter of fiscal 2023 by
$798,707, compared to an increase of $454,468 during the first quarter of the
prior fiscal year because of increased inventory levels necessary to support
increased sales;; tax liability increased by $519,085 during the first quarter
of fiscal 2023, compared to $328,340 during the first quarter of the prior year
as we accrued potential taxes in connection with Section 280E of the tax code;
accounts receivable increased by $120,942 during the first quarter of fiscal
2023 compared to a decrease of $160,306 during the first quarter of prior fiscal
year due to an increase in revenue; and operating lease liability decreased by
$79,974 during the first quarter of fiscal 2023 compared to $61,068 during the
first quarter of prior fiscal year as certain leases were renegotiated resulting
in lower monthly amortization.



Cash flows used by investing activities were $545,302 for the three months ended
August 31, 2022, a decrease of $1,626,405, or 150%, compared to cash flow
provided by investing activities of $1,081,103 during the three months ended
August 31, 2021. This decrease was primarily due to payments for our investment
in the Quinn River Joint Venture of $805,234, and payments to acquire property,
plant and equipment of $88,233, all of which occurred in the first quarter of
fiscal 2023. The decrease was partially offset by our receipt of principal
payments on the IGH Settlement Note in the amount of $348,165 during the three
months ended August 31, 2022, compared to our receipt of $1,174,082 during the
three months ended August 31, 2021.



Cash flows provided by financing activities were $47,246 for the three months
ended August 31, 2022, an increase of $47,246, or 100%, compared to cash flow
used in financing activities of $0 during the three months ended August 31,
2021. This increase was primarily due to proceeds from the Short Term Financing
Agreement in the aggregate amount of $650,115. This increase was partially
offset by principal payments we made on our equipment financing lease
obligations of $16,907, and payments on the Short Term Financing Agreement in
the aggregate amount of $585,962. There were no comparable transactions during
the first quarter of fiscal  2022.



Third Party Debt



The table below summarizes the status of our third party debt, excluding our
short term receivables-based debt facility and reflects whether such debt
remains outstanding, has been repaid, or has been converted into or exchanged
for our common stock:



                                       Original             Outstanding
Name of Note                           Principal Amount     or Repaid     Payment Details

Oasis Note                             $        4,000,000   Repaid        Repaid

2018 U.S. convertible debentures Outstanding amount of $365,991 repaid


                                                                          Half due on December 31,
Amended and Restated 2018 U.S.                                            2023 and half due on
Convertible Debentures                 $        2,252,229   Outstanding   December 31, 2024

                                                                          Half due December 31,
                                                                          2023 and half due
2018 Convertible Debentures            $        5,253,872   Outstanding   December 31, 2024

2021 Debentures*                       $        2,500,000   Outstanding   Due July 10, 2024.

2022 Financing Agreement               $          900,000   Outstanding   Due September 2023



* The terms of the 2021 debenture provide for additional payments in the aggregate amount of at least $375,000 per year for five years after the maturity of the 2021 Debentures.

                                       39

————————————————– ——————————

Contents

2018 U.S. Convertible Debenture Offering




Between October 22, 2018 and November 2, 2018, we entered into six subscription
agreements, pursuant to which we agreed to sell, $5,857,000 in original
principal amount of convertible debentures in minimum denominations of $1,000
each for an aggregate purchase price of $5,857,000.



Under the original terms, the debentures bear interest, payable quarterly, at a
rate of 8% per annum, with capitalization of accrued interest on a quarterly
basis for the first 18 months, by increasing the then-outstanding principal
amount of the debentures. The debentures originally matured on a date that was
three years following their issuance. The debentures were convertible into units
at a conversion price of $3.20 per unit. Each unit consists of (i) one share of
our common stock, par value $0.001 and (ii) one-half of one warrant, with each
warrant exercisable for three years to purchase a share of common stock at an
initial price of $1.10. The warrants also provided that we could force their
exercise at any time after the bid price of our common stock exceeds $2.20 for a
period of 20 consecutive business days. The debentures include a provision for
the capitalization of accrued interest on a quarterly basis for the first 18
months. After capitalizing accrued interest in the aggregate amount of $738,663,
the aggregate principal amount of the debentures increased to $6,595,663.



The debentures have other features, such as mandatory conversion in the event
our common stock trades at a particular price over a specified period of time
and required redemption in the event of a "Change in Control" of the Company.
The debentures are unsecured obligations of the Company and rank pari passu in
right of payment of principal and interest with all other unsecured obligations
of the Company. The warrants have anti-dilution provisions that provide for an
adjustment to the exercise price in the event of a future sale of our common
stock at a lower price, subject to certain exceptions as set forth in the
warrant.



On July 26, 2019, we entered into amendments to the debentures with four of the
purchasers, pursuant to which we agreed to reduce the conversion price of the
original debentures if, in general, we issue or sell common stock, or warrants
or options exercisable for common stock, or any other securities convertible
into common stock, in a capital raising transaction, at a consideration per
share, or exercise or conversion price per share, as applicable, less than the
conversion price of the original debentures in effect immediately prior to such
issuance. In such case, the conversion price of the original debentures will be
reduced to such issuance price. The amendments also provided that, if a dilutive
issuance occurs, the warrant to be issued upon conversion will be exercisable at
a price equal to 137.5% of the adjusted conversion price at the time of
conversion of the debenture. If a dilutive issuance occurs, the form of warrant
attached to the subscription agreement would be amended to change the Initial
Exercise Price, as defined therein, to be the revised warrant exercise price.



On March 31, 2021, we amended the Canaccord Debentures. This Debenture Amendment
(as hereafter defined) was a dilutive issuance. As a result, the conversion
price of the convertible debentures was automatically reduced from $3.20 per
unit to $1.20 per unit and the form of warrant attached to the subscription
agreement will be amended to reduce the exercise price from $4.40 per share of
common stock to 137.5% of the debenture conversion price (presently $1.65 per
share of common stock).



On April 15, 2021 and April 19, 2021, we amended three of the purchasers'
debentures and subscription agreements in order to (i) reduce the conversion
price of the debentures from $3.20 per unit to $1.20 per unit, and (ii) extend
the maturity date of the debentures by one year to four (4) years from the
execution date of the debentures. The subscription agreements, as amended, also
provide that we will file a registration statement to register for resale all of
the shares of common stock issuable to these three purchasers upon conversion of
the debentures and the exercise of the warrants issuable upon conversion of such
debentures. Each warrant issuable pursuant to the debentures is exercisable for
one share of common stock at a price equal to 137.5% of the conversion price
(presently $1.65 per share) for a period of three years from the earlier of the
date of issuance of the warrant or the effectiveness of a registration statement
registering the warrant shares.



On October 25, 2021we repaid three of the debentures at maturity, which included $365,991 of the principal and $2,065 of interest.

                                       40

————————————————– ——————————

Contents




Effective September 15, 2022, we entered into agreements with the holders of two
of the debentures to make the following changes to these debentures and the
related subscription agreements: (i) to permit the mandatory conversion, in our
discretion, of an aggregate of $3,378,342 in principal amount plus $56,307 in
accrued interest into units at the reduced conversion price of $0.29 per unit;
(ii) to decrease the conversion price of the remaining amount due under these
debentures (following the mandatory conversion) to $0.40 per unit; (iii) to
reduce the mandatory conversion VWAP provision in the debentures from $2.40 to
$0.80; (iv) to provide for a reduced conversion price to holders of these
debentures who elect to covert more than the mandatory conversion amount on or
prior to September 15, 2022; (v) to change the maturity date so that half of the
remaining amounts due mature on December 31, 2023 and the remaining amounts due
mature on December 31, 2024; (vi) to provide for the payment of interest
accruing between July 1, 2022 and December 31, 2024 so that one-third of the
total scheduled interest is paid on December 31, 2023 and the balance of the
accrued interest is paid on December 31, 2024; and (vii) subject to the receipt
of regulatory approvals, to grant a security interest in certain of our assets
(such as licenses, inventory (including work in process), equipment (excluding
equipment subject to purchase money financing) and contract rights (excluding
investments in entities other than wholly owned subsidiaries)) to the holders of
these debentures and to other holders of our debt, now or in the future, as we
may elect. Following execution of the amendments to these two debentures and the
related subscription documents, the Company elected to effect the mandatory
conversion provided for in the amended documents.



Offering of convertible debentures 2018




On December 12, 2018, we entered into an agency agreement with two Canadian
agents regarding a private offering of up to $40 million of convertible
debentures of the Company at an issue price of $1,000 per debenture (the
"Canaccord Debentures"). The agents sold the convertible debentures on a
commercially reasonable efforts private placement basis. Each debenture was
convertible into units of the Company at the option of the holder at a
conversion price of $3.20 per unit at any time prior to the close of business on
the last business day immediately preceding the maturity date of the debentures,
being the date that is three (3) years from the closing date of the offering
(the "2018 Convertible Debenture Offering"). Each unit will be comprised of one
share of common stock and a warrant to purchase one-half of a share of common
stock. Each warrant was initially exercisable for one share of common stock at a
price of $4.40 per warrant for a period of 36 months from the closing date.



We closed the 2018 Convertible Debenture Offering on December 12, 2018, issuing
$12,012,000 million in 8% senior unsecured convertible debentures at the initial
closing. At the closing, we paid the agents: (A)(i) a cash fee of $354,000 for
advisory services provided to us in connection with the offering; (ii) a cash
commission of $720,720, equivalent to 6.0% of the aggregate gross proceeds
received at the closing of the offering; (B)(i) an aggregate of 46,094 units for
advisory services; and (ii) a corporate finance fee equal to 93,844 units, which
is the number of units equal to 2.5% of the aggregate gross proceeds received at
the closing of the offering divided by the conversion price; and (C)(i) an
aggregate of 110,625 advisory warrants; and (ii) 225,225 broker warrants, which
was equal to 6.0% of the gross proceeds received at the closing of the offering
divided by the conversion price. During the year ended May 31, 2020, principal
in the amount of $25,856 was converted into 8,080 shares of common stock. The
debentures include a provision for the capitalization of accrued interest on a
quarterly basis for the first 18 months. Accrued interest in the amount of
$1,514,006 was capitalized, and the principal amount of the debentures is
$13,500,150.



The debentures are unsecured obligations of the Company, rank pari passu in
right of payment of principal and interest and were issued pursuant to the terms
of a debenture indenture, dated December 12, 2018, between the Company and
Odyssey Trust Company as the debenture trustee. The debentures bear interest at
a rate of 8% per annum from the closing date, payable on the last business day
of each calendar quarter.



Beginning on the date that is four (4) months plus one (1) day following the
closing date, we could force the conversion of all of the principal amount of
the then outstanding debentures at the conversion price on not less than 30
days' notice should the daily volume weighted average trading price, or VWAP, of
our common stock be greater than $1.20 per share for the preceding 10
consecutive trading days.



Upon a change of control of the Company, holders of the debentures have the
right to require us to repurchase their debentures at a price equal to 105% of
the principal amount of the debentures then outstanding plus accrued and unpaid
interest thereon. The debentures also contain standard anti-dilution provisions.



On March 31, 2021, the holders of the Canaccord Debentures approved the
amendment of the indenture related to the Canaccord Debentures (the "Debenture
Amendment") to: (i) extend the maturity date of the Canaccord Debentures from
December 12, 2021 to December 12, 2022; (ii) reduce the conversion price from
$3.20 per unit (as such term is defined in the indenture) to $1.20 per unit;
(iii) reduce the mandatory conversion VWAP threshold from $1.20 to $0.60 per
share; and (iv) amend the definitions of "Warrant" and "Warrant Indenture" (as
such terms are defined in the indenture), to reduce the exercise price of each
warrant to $1.60 per share of our common stock. Simultaneously, we amended the
warrant indenture to make conforming amendments and extend the expiration date
of the warrants to March 31, 2024.



                                       41

————————————————– ——————————

Contents




On August 18, 2022, we announced that we were holding a meeting of debenture
holders on September 15, 2022, to seek the affirmative vote of the holders of
the Canaccord Debentures to accomplish the following things: (i) to permit the
mandatory conversion, in our discretion, of $7,931,490 in principal amount of
the Canaccord Debentures plus $132,192 in accrued interest on the Canaccord
Debentures into units at the reduced conversion price of US$0.29 per unit; (ii)
to decrease the conversion price of the remaining Canaccord Debentures
(following the mandatory conversion) to $0.40 per unit; (iii) to reduce the
mandatory conversion VWAP provision in the Canaccord Debentures from $2.40 to
$0.80; (iv) to provide for a reduced conversion price to holders of Canaccord
Debentures who elect to covert more than the mandatory conversion amount of
Canaccord Debentures on or prior to the date of the meeting of debenture
holders; (v) to change the maturity date of the Canaccord Debentures so that
half of the remaining Canaccord Debentures mature on December 31, 2023 and the
remaining Canaccord Debentures mature on December 31, 2024; (vi) to provide for
the payment of interest accruing between July 1, 2022 and December 31, 2024 so
that one-third of the total scheduled interest is paid on December 31, 2023 and
the balance of the accrued interest is paid on December 31, 2024; and (vii) to
grant a security interest in certain of our assets (such as licenses, inventory
(including work in process), equipment (excluding equipment subject to purchase
money financing) and contract rights (excluding investments in entities other
than wholly owned subsidiaries)) to the holders of the Canaccord Debentures and
to other holders of debt of ours now or in the future, as we may elect, provided
that we are able to secure all regulatory approvals required to make such a
grant. Following the meeting, we elected to effect the mandatory conversion
provided for in the amendments to the Canaccord Debentures and received an
additional voluntary conversion of $33,787 in principal and $563 in accrued
interest of the Canaccord Debentures.



If, at the time of exercise of any warrant in accordance with the warrant
indenture, there is no effective registration statement under the Securities Act
covering the resale by the holder of a portion of the shares of common stock to
be issued upon exercise of the warrant, or the prospectus contained therein is
not available for the resale of the shares of common stock by the holder under
the Securities Act by reason of a blackout or suspension of use thereof, then
the warrants may be exercised, in part for that portion of the shares of common
stock not registered for resale by the holder under an effective registration
statement or in whole in the case of the prospectus not being available for the
resale of such shares of common stock, at such time by means of a "cashless
exercise" in which the holder shall be entitled to receive a number of shares of
common stock equal to the quotient obtained by dividing [(A-B) (X)] by (A),
where: A = the last volume weighted average price, or VWAP, for the trading day
immediately preceding the time of delivery of the exercise form giving rise to
the applicable "cashless exercise"; B = the exercise price of the warrant; and X
= the number of shares of common stock that would be issuable upon exercise of
the warrant in accordance with the terms of such warrant if such exercise were
by means of a cash exercise rather than a cashless exercise.



Pursuant to the agency agreement, we granted the agents an option to increase
the offering by an additional $6 million in principal amount of debentures,
which option was not exercised by the agents prior to the closing date of the
offering.



Pursuant to the agency agreement and the subscription agreements signed by
investors in the offering, we granted certain registration rights to the holders
of the debentures pursuant to which we agreed to prepare and file a registration
statement with the SEC to register the resale by the original purchasers of the
debentures of the shares of common stock issuable upon conversion of the
debentures or exercise of the warrants.



November 2021 Debenture Offering




During November 2021, we commenced an offering of a maximum of $5,500,000 of
2021 Debentures and warrants to purchase shares of our common stock at an
exercise price of $1.65 per share in an aggregate amount equal to one-half of
the aggregate purchase price for the 2021 Debentures The proceeds of the
November 2021 Debenture Offering were used to fund our investment in the Quinn
River Joint Venture.



On March 9, 2022, we conducted the final closing of the November 2021 Debenture
Offering. Between December 1, 2021 and January 4, 2022, we completed multiple
closings of the November 2021 Debenture Offering in which we sold an aggregate
of $2,500,000 of 2021 Debentures and issued an aggregate of 757,576 Debenture
Warrants to the investors. The 2021 Debentures bear interest at the rate of 15%
per annum calculated on the basis of a 360 day year and mature on July 10, 2024.
Commencing 36 months after issuance of the 2021 Debentures and for a period of 5
years thereafter, all note holders shall receive, on an annual basis, cash
payments equal to the greater of (i) 15% of the principal amount of the notes
they purchased, or (ii) such purchaser's pro rata portion of 5% of the
distributions we receive for the prior fiscal year pursuant to the terms of the
Quinn River Joint Venture Agreement. The Debenture Warrants have a term of 3
years and are exercisable, in whole or in part, at any time, or from time to
time, after the date of issuance for $1.65 per share of our common stock.



                                       42

————————————————– ——————————

Contents

Accounts Receivable Financing Agreement

We maintain an accounts receivable financing agreement (the “Short Term Financing Agreement”) with LeafLink Financial pursuant to which we may sell certain of our accounts receivable for a discount of 3%. In April 2022the discount rate has been reduced to 2.5% Loans granted under the facility cannot exceed a total of
$1,500,000 and are payable within 30 days.



2022 Financing Agreement



Effective September 30, 2022, we entered into a Business Loan and Security
Agreement with CBR Capital LLC to borrow $900,000.  The loan is repayable in 48
weekly installments in the amount of $13,312.50 for weeks 1-8 and $29,287.50 for
weeks 9-48. CBR Capital LLC has stated that it is aware of the Canaccord
Debentures and the U.S. Convertible Debentures and will agree to subordinate the
CBR security interest to these debenture holders. Certain terms of the loan
remain subject to regulatory approval.



Sales of Equity


Canaccord’s Special Warrant Offering




On June 20, 2018, we executed an agency agreement with Canaccord Genuity Corp.
and closed on a private offering of our Special Warrants for aggregate gross
proceeds of CD$13,037,859 (USD$9,785,978). In connection therewith, we also
entered into a Special Warrant Indenture and a Warrant Indenture with Odyssey
Trust Company, as special warrant agent and warrant agent.



Pursuant to the offering, we issued 7,243,014 special warrants at a price of
CD$1.80 (USD$1.36) per Special Warrant. Each Special Warrant was automatically
exercised, for no additional consideration, into Units on November 30, 2018.



Each Unit consisted of one Unit Share and one warrant to purchase one share of
common stock. Each warrant was to be exercisable at a price of CD$2.60 for three
years after our common stock was listed on a recognized Canadian stock exchange,
subject to adjustment in certain events. The warrants expired on January 7,
2022. Because we did not receive a receipt from the applicable Canadian
securities authorities for the qualifying prospectus by August 20, 2018, each
Special Warrant entitled the holder to receive 1.1 Units (instead of one (1)
Unit); provided, however, that any fractional entitlement to penalty units was
rounded down to the nearest whole penalty unit.



In connection with the Special Warrant Offering, we paid a cash commission and
other fees equal to CD$1,413,267 (USD$1,060,773), a corporate finance fee equal
to 362,163 Special Warrants with a fair value of USD$1,413,300, and 579,461
Broker Warrants. Each Broker Warrant entitles the holder thereof to acquire one
unit at a price of CD$1.80 per unit for a period of 36 months from the date that
our common stock is listed on a recognized Canadian stock exchange, subject to
adjustment in certain events. Our common stock commenced trading on the Canadian
Stock Exchange on January 7, 2019. During the year ended May 31, 2020, we also
issued investors 760,542 Special Warrants with a fair value of $7,142,550 as a
penalty for failure to timely effect a Canadian prospectus with regard to the
securities underlying the Special Warrants.



The Navy Capital Investors



Effective July 31, 2018, we entered into a subscription agreement with Navy
Capital Green International, Ltd., a British Virgin Islands limited company
("Navy Capital"), pursuant to which we agreed to sell to Navy Capital, for a
purchase price of $3,000,000, 1,875,000 units ($1.60 per unit), representing (i)
1,875,000 shares of our common stock, and (ii) three-year warrants to purchase
an aggregate of 1,875,000 shares of our common stock (the "Navy Warrant Shares")
at an exercise price of $2.40 per share of common stock (the "Navy Capital
Offering"). We valued the warrants using the Black-Scholes valuation model, and
allocated gross proceeds in the amount of $1,913,992 to the common stock and
$1,086,008 to the warrants. The closing occurred on August 6, 2018. In the
subscription agreement, we also agreed to file, on or before November 1, 2018, a
registration statement with the SEC registering the shares of common stock and
Navy Warrant Shares issued to Navy Capital. If we failed to file the
registration statement on or before that date, we were required to issue to Navy
Capital an additional number of units equal to ten percent (10%) of the units
originally subscribed for by Navy Capital (which would include additional
warrants at the original exercise price). On August 29, 2019, we filed a
registration statement with the SEC which included the shares of common stock
and Navy Warrant Shares issued to Navy Capital. The warrant was exercisable from
time to time, in whole or in part for three years. The warrant had anti-dilution
provisions that provided for an adjustment to the exercise price in the event of
a future issuance or sale of common stock at a lower price, subject to certain
exceptions as set forth in the warrant. The warrant also provided that it is
callable at any time after the bid price of our common stock exceeds 120% of the
exercise price of the warrant for a period of 20 consecutive business days. This
warrant expired on July 31, 2021.



                                       43

————————————————– ——————————

Contents




Between August 8, 2018 and August 10, 2018, we entered into five subscription
agreements, pursuant to which we sold, for an aggregate purchase price of
$2,750,000, 1,718,750 units ($1.60 per unit), representing (i) 1,718,750 shares
of our common stock, and (ii) three-year warrants to purchase an aggregate of
1,718,750 shares of our common stock at an exercise price of $2.40 per share of
common stock. We valued the warrants using the Black-Scholes valuation model,
and allocated gross proceeds in the amount of $1,670,650 to the common stock and
$1,079,350 to the warrants. These warrants expired on August 7, 2021. The
balance of the terms set forth in the subscription agreements are the same as
the terms in the Navy Capital subscription agreement summarized above.



Oasis Cannabis Transaction



On December 4, 2017, we entered into the Acquisition Agreement, with Alternative
Solutions for us to acquire all of the outstanding equity interests in
Alternative Solutions and the Oasis LLCs. Pursuant to the Acquisition Agreement,
we paid a non-refundable deposit of $250,000 upon signing, which was followed by
an additional payment of $1,800,000 approximately 45 days thereafter and were to
receive, upon receipt of applicable regulatory approvals, an initial 10% of each
of the Oasis LLCs. Regulatory approvals were received and the 10% membership
interests were transferred to us.



On June 27, 2018, we closed on the purchase of the remaining 90% of the
membership interests in Alternative Solutions and the Oasis LLCs from the owners
thereof (excluding Alternative Solutions). The closing consideration was as
follows: $5,995,543 in cash, a $4.0 million promissory note due in December
2019, known as the Oasis Note, and $6,000,000 in shares of our common stock. The
cash payment of $5,995,543 was less than the $6,200,000 payment originally
contemplated because the Company assumed an additional $204,457 of liabilities.



The number of shares to be issued was computed as follows: $6,000,000 divided by
the lower of $1.00 or the conversion price to receive one share of our common
stock in our first equity offering of a certain minimum size that commenced in
2018, multiplied by 80%. This price was determined to be $0.272 per share. The
Oasis Note was secured by a first priority security interest over our membership
interests in Alternative Solutions and the Oasis LLCs, and by the assets of each
of the Oasis LLCs and Alternative Solutions. We also delivered a confession of
judgment to a representative of the former owners of Alternative Solutions and
the Oasis LLCs (other than Alternative Solutions) that would generally become
effective upon an event of default under the Oasis Note or failure to pay
certain other amounts when due. We repaid the Oasis Note in full in December
2019.



At the time of closing of the Acquisition Agreement, Alternative Solutions owed
certain amounts to a consultant known as 4Front Advisors, which amount was in
dispute. In August 2019, we made a payment to this company to settle this
dispute and the Oasis Note was reduced accordingly.



The former owners of Alternative Solutions and the Oasis LLCs (other than
Alternative Solutions) became entitled to a $1,000,000 payment from us because
the Oasis LLC maintained an average revenue of $20,000 per day during the 2019
calendar year. We made a payment in the amount of $850,000 to the sellers on May
27, 2020. We deposited the balance due to sellers of $150,000 with an escrow
agent to hold pending the outcome of a tax audit. During the year ended May 31,
2020, the State of Nevada notified the Oasis LLCs that it would be conducting a
tax audit for periods both before and after the closing of the sale to CLS. In
February 2021, we finalized the tax audit, used approximately $43,000 of the
escrowed amount to reimburse ourselves for the portion of the tax liability
properly payable by the sellers, and returned approximately $107,000 of the
escrowed amount to the sellers.



We received final regulatory approval to own the membership interests in the
Oasis LLCs on December 12, 2018. We received final regulatory approval to own
our interest in the Oasis LLCs through Alternative Solutions under the revised
structure of the transaction on April 26, 2022.



Consulting Agreements



We periodically use the services of outside investor relations consultants.
During the year ended May 31, 2016, pursuant to a consulting agreement, we
agreed to issue 2,500 shares of common stock per month, valued at $11,600 per
month, to a consultant in exchange for investor relations consulting services.
The consulting agreement was terminated during the first month of its term. The
parties are in discussions regarding whether any shares of our common stock have
been earned and it is uncertain whether any shares will be issued. As of August
31, 2022, we included 5,000 shares of common stock, valued at $23,200 in stock
payable on the accompanying balance sheets. The shares were valued based on the
closing market price on the grant date.



                                       44

————————————————– ——————————

Contents




On December 29, 2015, pursuant to a consulting agreement, we agreed to issue
6,250 shares of common stock per month, valued at $21,250, to a consultant in
exchange for investor relations consulting services. The consulting agreement
was terminated during the first month of its term. The parties are in
discussions regarding whether any shares of our common stock have been earned
and it is uncertain whether any shares will be issued. As of August 31, 2022, we
had 12,500 shares of common stock, valued at $42,500 included in stock payable
on the accompanying balance sheet. The shares were valued based on the closing
market price on the grant date.



Going Concern



Our financial statements were prepared using accounting principles generally
accepted in the United States of America applicable to a going concern, which
contemplate the realization of assets and liquidation of liabilities in the
normal course of business. With the exception of the first quarter of fiscal
2022, we have incurred losses from operations since inception, and have an
accumulated deficit of $96,228,295 as of August 31, 2022, compared to
$95,079,817 as of May 31, 2022. We had a working capital deficit of $22,822,630
as of August 31, 2022, compared to a working capital deficit of $21,228,633 as
of May 31, 2022. The report of our independent auditors for the year ended May
31, 2022 contained a going concern qualification. Our ability to continue as a
going concern must be considered in light of the problems, expenses, and
complications frequently encountered by early stage companies.



Our ability to continue as a going concern is dependent on our ability to
generate sufficient cash from operations to meet our cash needs, and to borrow
capital and to sell equity to re-finance our debt and support our plans to
acquire operating businesses, execute on joint ventures, open processing
facilities and finance ongoing operations. There can be no assurance that we
will be successful in our efforts to raise additional debt or equity capital on
reasonable terms, or at all, and/or that cash generated by our future operations
will be adequate to meet our needs. These factors, among others, indicate that
we may be unable to continue as a going concern for a reasonable period of time.



Off-balance sheet arrangements




We do not have any off-balance sheet arrangements that have, or are reasonably
likely to have, a current or future effect on our financial condition, changes
in financial condition, revenues or expenses, results of operations, liquidity,
capital expenditures or capital resources that are material to investors.



Critical Accounting Estimates



Management uses various estimates and assumptions in preparing our financial
statements in accordance with generally accepted accounting principles. These
estimates and assumptions affect the reported amounts of assets and liabilities,
the disclosure of contingent assets and liabilities, and the reported revenues
and expenses. Accounting estimates that are the most important to the
presentation of our results of operations and financial condition, and which
require the greatest use of judgment by management, are designated as our
critical accounting estimates. We have the following critical accounting
estimates:



? Estimates and
  assumptions
  regarding the
  deductibility
  of expenses
  for purposes
  of Section
  280E of the
  Internal
  Revenue Code:
  Management
  evaluates the
  expenses of
  its
  manufacturing
  and retail
  operations and
  makes certain
  judgments
  regarding the
  deductibility
  of various
  expenses under
  Section 280E
  of the
  Internal
  Revenue Code
  based on its
  interpretation
  of this
  regulation and
  its subjective
  assumptions
  about the
  categorization
  of these
  expenses.

? Estimates and
  assumptions
  used in the
  valuation of
  derivative
  liabilities:
  Management
  utilizes a
  lattice model
  to estimate
  the fair value
  of derivative
  liabilities.
  The model
  includes
  subjective
  assumptions
  that can
  materially
  affect the
  fair value
  estimates.

? Estimates and
  assumptions
  used in the
  valuation of
  intangible
  assets. In
  order to value
  our intangible
  assets,
  management
  prepares
  multi-year
  projections of
  revenue, costs
  of goods sold,
  gross margin,
  operating
  expenses,
  taxes and
  after tax
  margins
  relating to
  the operations
  associated
  with the
  intangible
  assets being
  valued. These
  projections
  are based on
  the estimates
  of management
  at the time
  they are
  prepared and
  include
  subjective
  assumptions
  regarding
  industry
  growth and
  other matters.



Recently issued accounting standards




Accounting standards promulgated by the Financial Accounting Standards Board
(the "FASB") are subject to change. Changes in such standards may have an impact
on our future financial statements. The following are a summary of recent
accounting developments.



                                       45

————————————————– ——————————

Contents




In January 2017, the FASB issued ASU No. 2017-04, Simplifying the Test for
Goodwill Impairment, which simplifies the subsequent measurement of goodwill by
eliminating Step 2 from the goodwill impairment test. In computing the implied
fair value of goodwill under Step 2, current U.S. GAAP requires the performance
of procedures to determine the fair value at the impairment testing date of
assets and liabilities (including unrecognized assets and liabilities) following
the procedure that would be required in determining the fair value of assets
acquired and liabilities assumed in a business combination. Instead, the
amendments under this ASU require the goodwill impairment test to be performed
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 loss recognized
should not exceed the total amount of goodwill allocated to that reporting unit.
The ASU became effective for us on January 1, 2020. The amendments in this ASU
were applied on a prospective basis. During the year ended May 31, 2020, the
Company recorded an impairment of goodwill in the amount of $25,185,003 pursuant
to ASU No. 2017-04.



In May 2017, the FASB issued ASU No. 2017-09, Stock Compensation - Scope of
Modification Accounting, which provides guidance on which changes to the terms
or conditions of a share-based payment award require an entity to apply
modification accounting. The ASU requires that an entity account for the effects
of a modification unless the fair value (or calculated value or intrinsic value,
if used), vesting conditions and classification (as equity or liability) of the
modified award are all the same as for the original award immediately before the
modification. The ASU became effective for us on January 1, 2018, and is applied
to an award modified on or after the adoption date. Adoption of ASU 2017-09 did
not have a material effect on the Company's financial statements.



In July 2017, the FASB issued ASU No. 2017-11, Earnings Per Share (Topic 260),
Distinguishing Liabilities from Equity (Topic 480), Derivatives and Hedging
(Topic 815). The amendments in Part I of this update change the classification
analysis of certain equity-linked financial instruments (or embedded features)
with down round features. When determining whether certain financial instruments
should be classified as liabilities or equity instruments, a down round feature
no longer precludes equity classification when assessing whether the instrument
is indexed to an entity's own stock. The amendments also clarify existing
disclosure requirements for equity-classified instruments. As a result, a
freestanding equity-linked financial instrument (or embedded conversion option)
no longer would be accounted for as a derivative liability at fair value as a
result of the existence of a down round feature. For freestanding equity
classified financial instruments, the amendments require entities that present
earnings per share (EPS) in accordance with Topic 260 to recognize the effect of
the down round feature when it is triggered. That effect is treated as a
dividend and as a reduction of income available to common shareholders in basic
EPS. Convertible instruments with embedded conversion options that have down
round features are now subject to the specialized guidance for contingent
beneficial conversion features (in Subtopic 470-20, Debt-Debt with Conversion
and Other Options), including related EPS guidance (in Topic 260). The
amendments in Part II of this update recharacterize the indefinite deferral of
certain provisions of Topic 480 that now are presented as pending content in the
Codification, to a scope exception.



These amendments do not have an accounting effect. For public business entities,
the amendments in Part I of this update are effective for fiscal years, and
interim periods within those fiscal years, beginning after December 15, 2018.
Early adoption is permitted for all entities, including adoption in an interim
period. If an entity early adopts the amendments in an interim period, any
adjustments should be reflected as of the beginning of the fiscal year that
includes that interim period.



There are various other updates recently issued, most of which represented
technical corrections to the accounting literature or application to specific
industries and are not expected to a have a material impact on our consolidated
financial position, results of operations or cash flows.

© Edgar Online, source Previews

Comments are closed.