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, 2011as 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.
remaining the surviving entity. As a result of the merger, we acquired the business of
CLS Labswas originally incorporated in the state of Nevadaon May 1, 2014under 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 Coloradogrowers 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 Labstook its first step toward commercializing its proprietary methods and processes by entering into agreements through its wholly owned subsidiary, CLS Labs Colorado, with certain Coloradoentities. 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
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 $250,000upon signing, which was followed by an additional payment of $1,800,000on 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: $5,995,543in cash, a $4.0 millionpromissory note due in December 2019, and $6,000,000in shares of our common stock. The cash payment of $5,995,543was less than the $6,200,000payment originally contemplated because we assumed an additional $204,457of 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 Massachusettscorporation and a wholly-owned subsidiary of the Company ("CLS Massachusetts"), and In Good Health, Inc., a Massachusettscorporation ("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, 2019and 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 millionin cash, $7.5 millionin the form of a five-year promissory note, and $5 millionin the form of restricted common stock of the Company, plus $2.5 millionas 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, 2018between 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 $2,500,000as 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, 2020and 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 $2,497,884in principal and $822in accrued interest. As of November 30, 2021, the principal balance of the IGH Note was $0and 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, $1,000,000of which was paid on or before July 12, 2021. The remaining $2,000,000and accrued interest was paid in 12 equal monthly installments, which began on August 12, 2021. During the year ended May 31, 2022, we received $2,740,820under the IGH Settlement Note, which included $2,666,670in principal and $74,150in accrued interest. During the three months ended August 31, 2022, we received $348,165was due under the IGH Settlement Note, which included $333,333in principal and $14,382in 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
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 Councilof 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 Riverat a cost of $3,500per 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 Vegasfacility, 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 milliontowards 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 $750,000per 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 Sessionsrescinded the memorandum issued by former Deputy Attorney General James Coleon 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 Barrserved as United StatesAttorney General from February 14, 2019to December 23, 2020. The DOJ under Mr. Barrdid not take a formal position on federal enforcement of laws relating to cannabis. On March 11, 2021, United States President Biden'snominee, Merrick Garlandwas sworn in as the U.S.Attorney General. During his campaign, President Bidenstated 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 Justicewill not change. We incurred a net loss of $1,148,478attributable to CLS Holdings, Inc.for the three months ended August 31, 2022, resulting in an accumulated deficit as of August 31, 2022of $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 Sisolakdeclared 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 Sisolakreleased the Nevada Health Response COVID-19 Risk Mitigation Initiative ("Initiative"). This Initiative provided guidance related to the March 12Declaration 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
In light of the Initiative,
Governor Sisolakissued Declaration of Emergency Directive 003 on March 20, 2020which mandated retail cannabis dispensaries to operate as delivery only. On April 29, 2020, Governor Sisolakissued 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, 2020so 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 LLCdeveloped the required procedures and submitted and received State approval on April 30, 2020to conduct curbside pickup sales effective May 1, 2020. Further, the City of Las Vegasrequired cannabis facilities to obtain a temporary 30-day curbside pickup permit. Serenity Wellness Center LLCwas issued its first temporary curbside pickup permit from the City of Las Vegason May 1, 2020. Serenity Wellness Center LLChas subsequently received a temporary curbside permit every thirty (30) days thereafter. Upon expiration every 30 days, the City of Las Vegasreviews the licensee and determines if a new temporary permit shall be issued. On May 7, 2020, Governor Sisolakissued Declaration of Emergency Directive 018. Directive 018 worked to reopen the State of Nevadaas a part of Phase One of the Nevada United: Roadmap to Recovery Plan introduced by Governor Sisolakon 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 LLCdeveloped the required procedures and submitted and received State approval on May 8, 2020to conduct limited in-store retail sales effective May 9, 2020. The City of Las Vegasdid not require a separate permit for limited in-store sales. On July 31, 2020, Governor Sisolakissued 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, 2020Declaration 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 PMon Friday, July 31, 2020shall remain in effect until terminated by a subsequent directive promulgated pursuant to the March 12, 2020Declaration 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 2021with 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.
Results of operations for the three months ended
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
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, 2022and 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
$6,044,927during the three months ended August 31, 2022, an increase of $544,217, or 10%, compared to revenue of $5,500,710during 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 $3,745,575during 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 $40,713during the first quarter of fiscal year 2022 to $42,267during 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 $401,235or 23%, compared to $1,755,135for 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, 2022was $3,002,730, an increase of $398,263, or 15%, compared to cost of goods sold of $2,604,467for the three months ended August 31, 2021. The increase in cost of goods sold for the three months ended August 31, 2022was 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, 2022resulting in a gross margin of 50%. Cost of goods sold was 47% for the three months ended August 31, 2021resulting 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 $2,636,259of product cost, $198,261of state and local fees and taxes, and $151,507of supplies and materials.
Selling, general and administrative expenses
Selling, general and administrative expenses, or SG&A, increased by
$306,508, or approximately 11%, to $3,202,302during the three months ended August 31, 2022, compared to $2,895,794for the three months ended August 31, 2021. The increase in SG&A expenses for the three months ended August 31, 2022was primarily due to increases in costs associated with operating the Oasis LLCs. SG&A expense during the three months ended August 31, 2022was primarily attributable to an aggregate of $2,686,829in costs associated with operating the Oasis LLCs, an increase of $327,633compared to $2,359,196during the first quarter of fiscal 2022. The major components of the $327,633increase in SG&A associated with the operation of the Oasis LLCs during the three months ended August 31, 2022compared to the three months ended August 31, 2021were as follows: payroll and related costs of $1,413,836compared to $1,001,651; lease, facilities and office costs of $700,454compared to $522,217; professional fees of $150,232compared to $88,370; depreciation and amortization of $161,556compared to $101,358; and travel of $106,074compared 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 Mexicoand Northern Nevada. These increases were partially offset by a decrease in sales and marketing costs of $231,769due toa concerted effort to reduce professional outsourced marketing programs. Finally, SG&A decreased by $21,125during the three months ended August 31, 2022as 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 $515,474from $536,599during 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 $28,467as 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 InvestmentDuring the three months ended August 31, 2022, we had a loss on equity investment in the amount of $234,430compared to $0during 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 $348,165compared to $1,174,082for 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 $3,000,000IGH Settlement Note. Pursuant to the IGH Settlement Note, IGH paid us $1,000,000on or before July 21, 2021. The remaining $2,000,000and 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 $766,670for the three months ended August 31, 2022, an increase of $348,078, or 83%, compared to $418,592for 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 $185,081which 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 $174,601in 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 2021Debenture 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 $519,085during the three months ended August 31, 2022compared to $328,340during 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
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
Our net loss attributable to
Cash and capital resources
The following table summarizes our total assets, liabilities and short-term working capital as of
August 31, May 31, 2022 2022 Current Assets
$ 5,965,967 $ 6,883,557
Working capital (deficit)
August 31, 2022, we had a working capital deficit of $22,822,630, an increase of $1,593,997from the working capital deficit of $21,228,633we 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 $805,234to 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 $798,707and a decrease of interest payable in the amount of $107,708, which was the result of the payment of accrued interest on the November 2021Debentures. 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 2023and December 2024. We are actively seeking to re-finance the remaining U.S.Convertible Debenture that matures on October 25, 2022but 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 $1,461,763during the three months ended August 31, 2022, an increase of $676,488, or approximately 86%, compared to $785,275during 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 $317,974and $(975,743)for the three months ended August 31, 2022and 2021, respectively. For the first quarter of fiscal year 2023, the most significant item deducted from the net loss was $348,165related to the gain on settlement of the IGH Settlement Note; compared to $1,174,082during the first quarter of fiscal 2022. 38
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
$447,612during the three months ended August 31, 2022, compared to a decrease in cash from operating activities of $237,401during 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 $454,468during the first quarter of the prior fiscal year because of increased inventory levels necessary to support increased sales;; tax liability increased by $519,085during the first quarter of fiscal 2023, compared to $328,340during 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 $120,942during the first quarter of fiscal 2023 compared to a decrease of $160,306during the first quarter of prior fiscal year due to an increase in revenue; and operating lease liability decreased by $79,974during the first quarter of fiscal 2023 compared to $61,068during the first quarter of prior fiscal year as certain leases were renegotiated resulting in lower monthly amortization. Cash flows used by investing activities were $545,302for the three months ended August 31, 2022, a decrease of $1,626,405, or 150%, compared to cash flow provided by investing activities of $1,081,103during 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 $348,165during the three months ended August 31, 2022, compared to our receipt of $1,174,082during the three months ended August 31, 2021. Cash flows provided by financing activities were $47,246for the three months ended August 31, 2022, an increase of $47,246, or 100%, compared to cash flow used in financing activities of $0during 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 $ 4,000,000Repaid 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
$ 2,252,229Outstanding December 31, 2024 Half due December 31, 2023 and half due 2018 Convertible Debentures $ 5,253,872Outstanding December 31, 2024 2021 Debentures* $ 2,500,000Outstanding 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
2018 U.S. Convertible Debenture Offering
October 22, 2018and November 2, 2018, we entered into six subscription agreements, pursuant to which we agreed to sell, $5,857,000in original principal amount of convertible debentures in minimum denominations of $1,000each 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 $3.20per unit. Each unit consists of (i) one share of our common stock, par value $0.001and (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 $2.20for 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 $3.20per unit to $1.20per unit and the form of warrant attached to the subscription agreement will be amended to reduce the exercise price from $4.40per share of common stock to 137.5% of the debenture conversion price (presently $1.65per share of common stock). On April 15, 2021and 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 $3.20per unit to $1.20per 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 $1.65per 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.
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 $3,378,342in principal amount plus $56,307in accrued interest into units at the reduced conversion price of $0.29per unit; (ii) to decrease the conversion price of the remaining amount due under these debentures (following the mandatory conversion) to $0.40per unit; (iii) to reduce the mandatory conversion VWAP provision in the debentures from $2.40to $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, 2023and the remaining amounts due mature on December 31, 2024; (vi) to provide for the payment of interest accruing between July 1, 2022and December 31, 2024so that one-third of the total scheduled interest is paid on December 31, 2023and 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
December 12, 2018, we entered into an agency agreement with two Canadian agents regarding a private offering of up to $40 millionof convertible debentures of the Company at an issue price of $1,000per 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 $3.20per 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 $4.40per 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 millionin 8% senior unsecured convertible debentures at the initial closing. At the closing, we paid the agents: (A)(i) a cash fee of $354,000for 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 $25,856was 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 $1,514,006was 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 Companyas 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 $1.20per 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, 2021to December 12, 2022; (ii) reduce the conversion price from $3.20per unit (as such term is defined in the indenture) to $1.20per unit; (iii) reduce the mandatory conversion VWAP threshold from $1.20to $0.60per 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 $1.60per 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
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 $7,931,490in principal amount of the Canaccord Debentures plus $132,192in accrued interest on the Canaccord Debentures into units at the reduced conversion price of US$0.29per unit; (ii) to decrease the conversion price of the remaining Canaccord Debentures (following the mandatory conversion) to $0.40per unit; (iii) to reduce the mandatory conversion VWAP provision in the Canaccord Debentures from $2.40to $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, 2023and the remaining Canaccord Debentures mature on December 31, 2024; (vi) to provide for the payment of interest accruing between July 1, 2022and December 31, 2024so that one-third of the total scheduled interest is paid on December 31, 2023and 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 $33,787in principal and $563in 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 millionin 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 SECto 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, we commenced an offering of a maximum of $5,500,000of 2021 Debentures and warrants to purchase shares of our common stock at an exercise price of $1.65per share in an aggregate amount equal to one-half of the aggregate purchase price for the 2021 Debentures The proceeds of the November 2021Debenture 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 2021Debenture Offering. Between December 1, 2021and January 4, 2022, we completed multiple closings of the November 2021Debenture Offering in which we sold an aggregate of $2,500,000of 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 $1.65per share of our common stock. 42
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
2022 Financing Agreement Effective
September 30, 2022, we entered into a Business Loan and Security Agreement with CBR Capital LLCto borrow $900,000. The loan is repayable in 48 weekly installments in the amount of $13,312.50for weeks 1-8 and $29,287.50for weeks 9-48. CBR Capital LLChas 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
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 Exchangeon January 7, 2019. During the year ended May 31, 2020, we also issued investors 760,542 Special Warrants with a fair value of $7,142,550as a penalty for failure to timely effect a Canadian prospectus with regard to the securities underlying the Special Warrants. The Navy Capital InvestorsEffective July 31, 2018, we entered into a subscription agreement with Navy Capital Green International, Ltd., a British Virgin Islandslimited 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 ( $1.60per 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 $2.40per share of common stock (the " Navy CapitalOffering"). We valued the warrants using the Black-Scholes valuation model, and allocated gross proceeds in the amount of $1,913,992to the common stock and $1,086,008to 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 SECregistering 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 Capitalan 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 SECwhich 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
August 8, 2018and 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 ( $1.60per 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 $2.40per share of common stock. We valued the warrants using the Black-Scholes valuation model, and allocated gross proceeds in the amount of $1,670,650to the common stock and $1,079,350to 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 Capitalsubscription 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 $250,000upon signing, which was followed by an additional payment of $1,800,000approximately 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: $5,995,543in cash, a $4.0 millionpromissory note due in December 2019, known as the Oasis Note, and $6,000,000in shares of our common stock. The cash payment of $5,995,543was less than the $6,200,000payment originally contemplated because the Company assumed an additional $204,457of liabilities. The number of shares to be issued was computed as follows: $6,000,000divided by the lower of $1.00or 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 $0.272per 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 $1,000,000payment from us because the Oasis LLCmaintained an average revenue of $20,000per day during the 2019 calendar year. We made a payment in the amount of $850,000to the sellers on May 27, 2020. We deposited the balance due to sellers of $150,000with an escrow agent to hold pending the outcome of a tax audit. During the year ended May 31, 2020, the State of Nevadanotified 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 $43,000of the escrowed amount to reimburse ourselves for the portion of the tax liability properly payable by the sellers, and returned approximately $107,000of 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 $11,600per 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 $23,200in stock payable on the accompanying balance sheets. The shares were valued based on the closing market price on the grant date. 44
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 $42,500included 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 Americaapplicable 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 $96,228,295as of August 31, 2022, compared to $95,079,817as of May 31, 2022. We had a working capital deficit of $22,822,630as of August 31, 2022, compared to a working capital deficit of $21,228,633as of May 31, 2022. The report of our independent auditors for the year ended May 31, 2022contained 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
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 $25,185,003pursuant 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.
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